The Holding

The volume has laid its foundation and built its accounts. Boulding insisted that beneath every flow lies a stock, and that economics had studied the income statement while neglecting the balance sheet. Kuznets built the flow account — national income — and warned that it measures neither wealth nor welfare. Goldsmith built the stock account — the national balance sheet — and showed what a nation holds behind what it earns. Modigliani watched a single person build a stock of wealth out of a stream of income and spend it down across a life. What remains is to value the stock, and to answer the question with which the volume began: when does a fortune stop rewarding work and start being a position? For both tasks the guide is James Tobin, who more than any economist of his century saw the whole economy as a structure of balance sheets — of asset stocks, held and valued and claimed — and who gave us the ratio by which the market's valuation of a stock of capital governs the flow of its accumulation. With Tobin the volume completes itself: the stock is revealed as the master quantity, and the holding as the thing the whole subject has been circling.

Tobin's largest contribution was a way of seeing. The textbook macroeconomics he inherited ran on flows — income, output, spending — with money and bonds appended almost as an afterthought. Tobin turned the picture inside out. The economy, he insisted, is a web of BALANCE SHEETS: every household, every firm, every bank and government holds a portfolio of assets and owes a set of liabilities, and the economic system is the vast interlocking structure of these holdings and claims. Every asset is at once a thing held by someone and, if it is financial, a thing owed by someone else; the whole is a network of mutual positions. And the engine of the economy, on this view, is not the flow of spending alone but the VALUATION of the asset stocks — the prices the market sets upon the standing wealth. Monetary policy in particular works, for Tobin, not by some direct lever upon spending but by altering the yields and prices of assets, which shifts how people wish to hold their wealth, which moves asset prices, which only then drives the flows of investment and consumption. Tobin restored the stock — the balance sheet, the standing structure of wealth — to the center of macroeconomics, where Boulding had said all along that it belonged.¹

At the heart of this balance-sheet vision lies a principle about what a stock of wealth is WORTH, and it is the principle that binds stock to flow. An asset — a share, a bond, a building, a machine, a whole firm — is valued by the market at the price someone will pay to hold it, and what someone will pay to hold it is governed by the FLOW the asset is expected to yield: the dividends, the interest, the rents, the profits, the stream of income it will throw off over its life. A bond is worth the discounted value of its coupons; a share, the discounted value of its dividends; a building, the discounted value of its rents; a firm, the discounted value of its profits. The stock of wealth and the flow it generates are thus two faces of a single thing, joined by the act of valuation: the stock is the capitalized flow, and the flow is the yield on the stock. To hold an asset is to hold a claim on a future stream; to value the asset is to price the stream. This is the deepest expression of the stock-flow relation in the whole volume — not merely that a stock changes by its flows, as the bathtub showed at the outset, but that a stock IS, in its very value, the present worth of the flows it will yield.²

Tobin made this principle operational with a single ratio, which the profession now calls Tobin's q. Take the stock of capital a firm has installed — its factories, its machines, its equipment — and ask two questions about its value. First: what would it cost to replace this capital, to build it all anew at today's prices? That is its REPLACEMENT cost. Second: what does the market say the capital is worth, as reflected in the value the stock market places upon the firm that owns it? That is its MARKET value. The ratio of the second to the first — market value divided by replacement cost — is q. When q equals one, the market values the firm's capital at exactly what it would cost to rebuild; the two valuations agree. When q exceeds one, the market values the installed capital ABOVE its replacement cost — the standing stock is worth more than the price of building it. When q falls below one, the market values the capital BELOW the cost of replacing it — the stock is worth less than it would cost to build. q is, in a phrase, the market's standing verdict upon a stock of capital, expressed relative to the cost of reproducing it.³

From this ratio Tobin drew the law that links the valuation of the capital stock to the flow of investment that adds to it. If q exceeds one — if installed capital is worth more than the cost of building it — then a firm can profit by building more: it spends, say, a dollar to add capital that the market will then value at more than a dollar, and the difference is pure gain. So when q is high, investment — the flow that adds to the capital stock — runs fast. If q falls below one, the opposite holds: capital is worth less than the cost of building it, so no one builds; it is cheaper to acquire capital by buying up existing firms at their depressed market value than by constructing anything new, and the flow of investment dries up. Investment, in Tobin's account, is governed by the market's valuation of the existing stock. This is the bridge the volume has been building toward: the stock of wealth — the installed capital — valued by the market as a claim on its future flows, governs through q the flow of new investment that enlarges or starves it. The asset market and the standing capital stock are joined to the flow of real accumulation by a single ratio. The stock tells the flow what to do.⁴

The volume can now return, equipped at last, to the question with which it began: when does a fortune stop rewarding work and start being a position? Recall the two pictures of wealth the earlier plates supplied. Modigliani's life-cycle wealth is a BUFFER — built out of the stored income of a working life, held against the lean years of retirement, and meant to be spent down to nothing; it is the accumulated wage of labor, and it rewards work in the plainest sense, for it is labor's stored fruit, consumed in the end by the very one who earned it. But the seam in Modigliani's model — the fact that the wealthy old do not in truth spend their stocks down, that great fortunes are not exhausted but perpetuated and passed on — pointed to a second kind of wealth entirely, one the life-cycle picture could not contain. To mark the boundary between the two kinds is the volume's final task, and it is Tobin's framework, with its insistence that a stock yields a flow and a flow capitalizes into a stock, that supplies the exact terms.⁵

The boundary is a matter of stock and flow, and it can be stated exactly. Every stock of wealth, held as assets, throws off a return — a flow of income, the dividends and interest and rents the holding yields, which is simply the flow of which the stock is the capitalized value. Set that return-flow beside the holder's consumption, the flow he spends to live. So long as a person must add to his stock out of his labor — so long as his wage, and not his wealth, is what sustains his consumption — his fortune is the Modigliani buffer: the stored record of past work, drawn upon and depleted. But there is a threshold, and it is crossed at the moment the return-FLOW on the wealth-STOCK comes to equal, and then to exceed, the holder's consumption. At that point the holding sustains itself: the income it yields covers the spending it funds, the principal need never be touched, and labor becomes unnecessary. Beyond the threshold the stock does not merely sustain but GROWS, for the return exceeds what is consumed and the surplus is added back, so that the fortune compounds upon itself without any further work at all. This is the moment a fortune ceases to be the wage of labor and becomes a POSITION — a standing stock of wealth that maintains and enlarges itself out of its own yield, a permanent claim upon the economy's output that rewards no work because it requires none. The buffer is spent down; the position perpetuates.⁶

With the distinction made sharp, the confusions that cloud nearly every public argument about wealth come into focus, for they are, almost without exception, confusions of stock with flow. Consider who is called "rich." Public debate fixes upon INCOME — the high earner, the large salary, the top of the flow distribution — and taxes it, argues over it, ranks people by it. But the truly wealthy may earn little income in the ordinary sense; they HOLD — a great stock of assets that need not throw off any large taxable flow to constitute an enormous position. A person with a vast fortune and a modest income is, by the income measure, not "rich" at all, though he may hold more than a thousand high earners put together; the stock and the flow give opposite answers, and the public argument, conducted in the language of flow, misses the wealth entirely. The same confusion runs everywhere. A tax on income is a tax on a flow; a tax on wealth is a tax on a stock; they fall upon different things and upon different people, and to debate the one as though it were the other is to argue in the dark. A nation's DEBT is a stock — the accumulated total it owes; its DEFICIT is a flow — the amount it adds to that stock each year; and the tireless public confusion of the two corrupts every argument about public finance. The MONEY supply is a stock; spending is a flow. A windfall is a change in a stock; income is a flow. In each case the balance-sheet view, which forces every flow to be located as the yield upon, or the change in, some stock, keeps straight what the loose language of flows runs hopelessly together.⁷

This is the volume's deepest claim, and Tobin's vision makes it plain: the stock is the master quantity, the thing standing behind the things. Behind every flow stands a stock — income is the yield on wealth, output the product of a capital stock, spending the drawing-down of a balance, investment the addition to a standing structure. The flows that economics has chiefly measured are the surface motion of a deeper accumulation, and they cannot be rightly understood apart from it. Boulding said as much at the very outset: economics, built on the income statement, is only half a science until it is rebuilt on the balance sheet. The plates have made the case in full — that the flow account and the stock account are two halves of one reckoning; that a person's wealth is a stock built up from, and converted back into, flows; that the value of any stock is the capitalized worth of the flows it will yield; and that the gravest questions a society can ask about itself — who has what, who holds and who owes, who works for his living and who lives upon a position — are questions about STOCKS, about holdings, which the flow account cannot answer and the language of flows cannot so much as properly pose. To put the stock at the center, as Tobin did, is to see the economy at last as it really is.⁸

James Tobin completed the volume by seeing the whole economy as a web of balance sheets — of asset stocks, held and valued and claimed — and by giving us, in his ratio q, the law by which the market's valuation of a stock of capital governs the flow of investment that builds it. The value of any stock of wealth, he showed, is the capitalized worth of the flows it will yield, so that stock and flow are two faces of one thing joined by the act of valuation; and when the market values a stock of capital above the cost of building it, wealth accumulates, the stock telling the flow what to do. In these terms the volume's question finds its answer. A fortune rewards work so long as it remains the stored and dwindling wage of labor, the Modigliani buffer; it becomes a position the moment its return-flow comes to cover and then exceed the holder's consumption, so that the holding sustains and grows itself without any further work, a permanent claim that rewards no labor because it requires none. And in these terms the confusions that fog the public reckoning of wealth dissolve, for each is a confusion of stock with flow — the rich measured by income who are wealthy only in holdings, the debt taken for the deficit, the money supply for the spending, the windfall for the income. The stock is the master quantity, the standing structure behind the moving surface; the balance sheet completes the income statement; and the question of who has what is, in the end, a question of what is held. So the quantities close, upon the held thing — the stock — that all the flowing was ever for.