One of the most basic distinctions in finance, with which any stockbroker or fund manager is intimately familiar, is that between equity (or shares), and debt. As the global economy teeters on the edge of a debt and banking crisis, with global debt more than 300 per cent of global GDP, the merits of equity is something that needs to be better understood.
With equity investment, the investor puts up the money without any guarantee they will get it back. That is, the risk is all on the person providing the capital. This is the opposite of debt investment, where the risk, as far as possible, is put on the person receiving the capital. They are asked to secure it against another asset — in Australia usually property — and are expected to make regular interest payments. In equity investment payments are only made, in the form of dividends, when the enterprise can afford it.
It might be expected that, because the risk is lower when lending than when investing in shares, that the returns from debt would be better. The opposite is the case. In the medium and long term, equities always outperform debt. Those fund managers and stockbrokers only buy debt securities to smooth out volatility in stock markets. It is generally thought that in the longer term they need to mostly buy shares to get good returns.
That much is well known. What is not as well known is why shares do so much better. Indeed, the question is almost never asked. Neither is the history of stock markets given much consideration. These things should be scrutinised, because they contain some important lessons.
For one thing, the development of equity capital is one of the main reasons that Karl Marx turned out to be wrong. His understanding of capital was principally as debt, and much of what he said about debt was not far off the mark. It is a form of enslavement, which is why it has been regularly banned for being usury, and it does lead to collapse. Debt payments routinely grow at a faster rate than the ability to pay, leading to more debt.
But that is not what happened in the north of England as it was industrialising. Possibly because access to the London banks was hard for the northerners to gain, there was the widespread creation of cooperatives, mutual funds, provident funds, that pooled capital, which was