The term ‘ profit ‘ and ‘ loss ‘ are common parts of the business vernacular, but many people do not fully understand their role in a market economy. This became even more pronounced after the recent financial crisis, as the Government has tried to perpetuate a system of profits without losses. The inherent problem in trying to build a market economy without both profits and losses is that will inevitably lead to one of two extremely undesirable results.
A feeling that was popular in the mid 20th century was the notion that private profits are basically immoral and that all production should be socialized. This is the basic tenant of socialism and communism and eventually results in a suffocating because risk premiums for entrepreneurship become nonexistent. In this environment, resources available for redistribution and don’t grow Government control costs place a huge burden on domestic production as access to wealth becomes a function of political connections rather than skill or productivity.
Another feeling that was opened over the second half of the 20th and early 21st century is the notion of socializing losses from private practice through bail-outs of the creditor. The term book by sector that enjoys a Government-sponsored monopoly power and implicit (or explicit) solvency guarantees is the “corporate State”. In this model, the profits are privatized enterprises connected politically and losses are socialized on the backs of taxpayers.
The fundamental characteristic that both these flawed Share models is that distribute wealth based on political influence rather than ideas and productivity. In both cases, the Government can exercise enormous power and entrepreneurship is suppressed by the absence of profits from top or from entrenched competitors with the support of the Government and crush the competition.
In a capitalist economy ‘ true ‘, the profits are generated by success in market failure results in losses for equity investors and debt. The current logo of “CRONY capitalism” has engineered the bailout after bailout of the lenders who financed overly risky operations. The importance of this stems from the fact that lenders have historically been the primary guardian of prudence in commercial activities.
Consider that a lender does not receive any prize, if a company is successful as a shareholder … all you get is their regular interest payments. For this reason, the creditors in a ‘ normal ‘ environment will demand a higher interest rate to risky businesses. These higher interest rates will temper risk from entrepreneurs since increased financial obligations reduces the chances of success.
However, if the Government guarantees lenders a particular company, then they have no reason to encourage caution … they are going to get their money back from the Government if things go upside down. This creates perverse incentives, where the risk becomes more intense and the cost of borrowing remains low because of a Government guarantee. When roll big profits, management gets major props. If there is a collapse, government bails out lenders and taxpayers get stuck with the Bill.
Even in cases where the Government guarantees were «success» for companies that do not require an explicit bailout, contributors to risk taking crowds finally culminated in the financial crisis of 2008. In addition, these bailouts ‘ success ‘ are fomenting an even bigger collapse, since the fundamental incentives have not changed.
In the end, both profits and losses are necessary for true capitalism. Unfortunately, true capitalism does not exist in the developed world for almost 100 years. In a context of growing government control and manipulation, strategy for success is to gain control of the activities of producing income that can be financed with fixed rate debt. This will allow you to realize financial gains when it arrives the day of financial reckoning and the Government of the United States falls back on creating inflation by printing money to finance its bailouts and promises.