6. The Supply of Capital

Earlier we pointed out that new capital can only emerge in the form of free capital. The means of subsistence which an economic subject receives as income will not be consumed, but instead will be supplied for a roundabout method of production. The sole source of any new capital in a market economy³⁰ is a change in the use of income, such that one who earns income and could otherwise consume it makes the means of subsistence available in order to initiate a roundabout production process. We can picture these provisions for a roundabout method of production such that this subsistence fund is given to an entrepreneur who with its help begins a roundabout method of production and only later pays back his debts out of the returns from production. The entrepreneur purchases factors of production with the free capital—let us assume first he pays laborers. The free capital will now be consumed by the laborers, and the entrepreneur possesses those capital goods—transformed raw materials or durable investments—that the laborers have produced. Once the production process is completed, the originally expended free capital is reproduced (plus interest; but that is not important here), and it can be returned to the owner of capital. This reproduction occurs more or less quickly, depending on how the free capital is used. Insofar as free capital is employed in a consumption related stage of production for the payment of laborers, it becomes freely available at the completion of production, and free capital in the form of new consumer goods is regenerated. If capital is used in earlier stages of production, then its release takes longer because the consumer goods in whose production the capital played a role only become available at the completion of the entire production process. If, however, the capital is invested in the production of fixed capital, then the waiting time until it can be regenerated is significantly lengthened: it will only be successively released when consumer goods with this investment are completed to the extent that a renewal fund is created during continuous production. Thus, the length of time free capital is tied up in the production process will vary greatly. Yet each portion of the free capital that is employed in the production process, even that which is used in the “heaviest” investments, must in the end be transformed into the originary form of capital, into free capital. The owner of the capital can again put this free capital to the same use: It remains available to the entrepreneur who repeats the same production process. In this case, the once-formed capital is maintained; it changes again more or less slowly from the form of capital goods into the form of consumer goods which are then reinvested. A loss will only occur where production was unsuccessful. This can mean that production failed in a technical sense; in economic fluctuations, however, it can also happen that a technically successful production process fails because it is not integrated into the framework of the economy and does not find a corresponding demand willing to pay. There will be more to say on this later. There is, however, something more to be said on the question of the liquidity of capital investments.

The principle that free capital once integrated into the production process only becomes available again when its products are completed—and under certain circumstances this can mean a long time—is perfectly compatible with the fact that in a market economy much higher private liquidity exists. This follows from each vertical differentiation of production. When an entrepreneur produces a capital good and sells this to an entrepreneur who needs it—perhaps as a renewal for his investment while he receives free capital in return—the free capital invested in this capital good becomes available again to the entrepreneur who produced it; in particular he can pay the borrowed capital back to the owner. It should be clear that the capital actually invested here will not become free in this exchange, but that two capital owners here merely switch their positions: the buyer who had free capital transfers it to an entrepreneur in exchange for capital tied up in capital goods. The proportion of free capital to capital goods (tied up capital) in an economy cannot be altered by such an exchange.

We have already dealt with the question of the price of capital goods under the assumption of an effectively operating law of costs. Each capital good represents a specific stage in the process of employing factors of production for the production of consumer goods. And just as according to the law of costs the price of the expenditures must be equal to the price of the product, so must at each stage of the production process the price of a capital good be equal to the sum of the expenditures necessary for its production, or the discounted price of the product minus the expenditures still necessary for its completion. Supply and demand will respond to every deviation in the price of a capital good from this height; movements will then be set in motion with the tendency towards adjusting to the cost price. It is obvious that here the reactions of the supply will often only become effective relatively late because the creation of many products requires a lengthy production time. During fluctuations in the economy, the fact that capital is tied up in lengthy roundabout methods of production can result in significant gains and losses in capital goods. In the first case, incomes will be produced which could bring about an expansion in the formation of capital through savings, and in the second case it can happen that the necessary renewal fund is not formed and thus capital is consumed. Regarding the formation of the price of capital goods, however, the principle applying to all products will in any case hold: it is not the size of the expenditures that determines the price, but the demanding entrepreneur’s willingness and ability to pay. If a large revenue can be expected for a product, the price of the capital good will reflect this; if a smaller revenue is expected, the price will fall without regard to the costs incurred. Only changes in the supply of a capital good will bring about an adjustment of these prices toward actual costs.

The available supply of capital in an economy, the available free capital and the existing capital goods are in constant motion during continuous production. Free capital becomes tied up and new free capital grows continually out of capital goods. Clearly the owner of capital is subject to more fluctuations in the course of the economy than the owner of other factors of production—of laborers as well as land. Losses which occur if production does not lead to success will only too quickly reduce the extent to which free capital is formed; large profits will make the further formation of new capital possible. Movements which occur in the various lines of production for different firms determine, in the sum of their effects, the amount of free capital available, and hence the possibility of adopting roundabout methods of production; and they thereby determine the size of the success of production in an economy in which production occurs exclusively in roundabout ways.

One more thing should be said here. Much energy has been spent attempting to present the formation of new capital in the form of a supply curve. Since what the saver receives as compensation for refraining from consumption and providing the capital—as a wage³¹ for the “act of saving”—is capital interest, a question must be raised regarding the relationship between the amount of savings and the height of capital interest. One must note that the argument to be applied in this case will hardly lead to a clear-cut result. It is probably justified to say that a higher interest rate will stimulate savings, and that consequently the supply of newly formed capital grows at a higher interest rate and that there will also be an increased incentive to maintain and avoid capital consumption, while on the other hand a lower interest rate will lead to a reduction in savings and—what is perhaps still more important—reduces the inhibitions which keep some individuals from consuming capital. One could then come to the conclusion that a drop in the interest rate below a certain minimum will not be possible because the lack of new formation of capital and the increased consumption of capital would so drastically reduce the supply of capital that the interest rate would in turn have to rise. Without disputing that these connections generally exist, we must point out here, however, that the opposite relationship can also exist: Whoever saves in order to achieve a certain income from interest will achieve this income earlier with higher interest and hence will cease to save sooner. Since one must undoubtedly consider this relationship as possible, it follows that a general proposition regarding a necessary relationship between savings and capital interest is not at all possible.