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November 2008

Financial vs Real investment

James Kroeger makes this ridiculous claim in the post "The New Deal Didn’t Always Work, Either":

Here you are guilty of conflating the two definitions of 'investment.' Rich people, generally, do not spend money on economic investments, but only on financial investments. While it is true that some financial investments (made by firms) are also economic investments, most financial 'investments' by rich people are not.

The purchase of a piece of land, for example, is a financial investment if it appreciates in value over time, but it is not an economic investment if it just sits there, undeveloped. Purchases of stocks in secondary markets (e.g., NYSE, NASDAQ) are clearly financial investments if the stocks appreciate in value, but they are not economic investments because they involve nothing more than exchanges of titles of ownership of already existing assets. They do not typically put any money into the hands of firm managers that could be used for economic investments. That normally happens only when stocks are first sold to underwriters, prior to an initial public offering.

So what happens to the money paid to buy financial assets (say, stocks on NYSE)? The person who sold the stocks must either spend the money (increase consumption) or fund new real investment(s). The seller can indeed use to money to buy other financial assets but the chain has to end in real consumption or real investment ultimately!