TED recently discussed “the pool of capital available to the economy” as if this were a concept with a clear meaning. Capital is sometimes used to refer to the equity in a business, to the working capital used to operate a business or simply to the investable funds that investors have and fund-managers or IPO-issuers want to get.
Equity capital is something that we think we understand – until we think about it a little longer. It often incorporates the value of many intangible assets that may be alienable only as part and parcel of the whole business and/or fragile in the sense that they may be easily destroyed by bad managerial decisions (e.g. goodwill). Furthermore it is axiomatic that equity capital is inflated when asset prices are too high and it evaporates when they fall. (Steve Waldman has expounded on these issues much more thoroughly and penetratingly than I do here.) In order to have a meaningful “pool of [equity] capital,” it’s necessary to have some kind of stability in asset prices – but this is precisely what we don’t have in our current system.
Thus, it’s a mistake in my view to think of equity capital as part of the “pool of capital available to the economy,” as if there were a simple fixed quantity of “capital” in the world and it’s only the price that varies. What precisely the aggregate value of the stock market represents is far from clear – and that’s why it is in some sense not particularly surprising when this value drops by 40% over the course of a year. What comes to my mind when I hear “pool of capital” is the “K” of economist’s models working to constrain our ability to think about what capital is.
In addition, the focus on equity capital obfuscates the important role played by the finance of working capital in the economy. Many real goods come into existence only because of the availability of working capital. While only a fraction of the output financed by working capital is converted via retained earnings into equity capital, the ubiquitous finance of working capital may mean that it plays a more important role in the economy and production process than equity capital itself. I get the impression that most people don’t consider working capital to be an important component of the “pool of capital available to the economy,” but it’s far from clear to me why this is the case and whether it could possibility be justified.
As I have argued elsewhere, the finance of working capital plays an important role in the transformation of human capital from an inalienable asset into tangible, alienable assets. The realization of human capital is, possibly, the most important role played by financial institutions in the economy — and this requires unsecured lending and well developed underwriting processes that distinguish borrowers who are likely to repay from those who will not. Capital is created along with “good” debt and destroyed when the enforcement mechanisms for debt weaken.
In short, capital should be understood as a social construct, not in fixed supply or growing due to investment, but a product of institutional infrastructure.
Related posts:
What banks do
The problem with collateral
Comparing bankers past and present
Synthetic Assets 
Don’t understand what exactly you mean.
happens when, and only when, a client / customer pays you.
Another way to see this is instead of looking at the aggregate weighted index price, look at time-varying component prices. If I gave $100k to Abbott Labs and $100k to Bank of America, and then their prices go up and down relative to what I paid in, what the heck is happening to their “equity capital”?