If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content
Current time:0:00Total duration:8:30

Inverse relationship between capital price and returns

Video transcript

so much of pic ADIZ book is about this idea of more more and more returns to capital that that the return to capital is going to grow faster than the growth of the economy and we see charts like this where we have the value of private capital as a percentage of income and we see this dynamic and we see this dynamic played out in multiple charts where as we go through the Gilda's age we hit kind of a a peak right over here at least a local peak and then as we get into the beginning of the 20th century it drops down and then it starts to pick back up until the present time and this is the present time right over here this data point and then everything we see after that this is piketty's projections really based on this idea of returns to capital be growing faster that are is growing faster than gee but one thing to think about is why this dynamic might be happening and then that might inform what how we think about what the projections might be so let's think about why the value of private capital could go down and why the value of private capital could go up so one reason so let's just say we have some asset some capital asset right over here and let's say its current value I went down some to some market and I bought it and its current value is $100 so this let me just write this this is today today it has $100 and let's say it gives an income an annual income of $10 of $10 so for this asset my return on asset right over here is 10% I get $10 on a 10 percent on $100 investment now there are several reasons why the value of this could go up one reason is that this asset starts producing more income so this would be in line with the idea of more maybe income because of more of capital becoming more and more valuable it's able to capture more and more income or maybe it's utilized in a better way and so let's write this as the future so in the future you could have a situation where it's generating an income it's generating an income of let's say $20 and let's say that the return is the same so the expected turn is the same so people are still willing to say you know I'm willing to pay as much for things so I still get a 10% return so people are saying okay I'll pay as much so I still get a 10% return so that means that they're going to pay in the market they'll pay $200 for it so this is one reason why you could have an increase in the value of something and you could go the other way maybe the value is $200 but because the income goes in half and the return stays constant the value goes in half so this is one scenario this is one reason why the price of an asset could go up but it's not the only reason why the price of an asset could go up another reason why a price of an asset could go up is maybe there's more and more capital and maybe there's fewer and fewer projects to put it to especially if the growth of the economy isn't growing so more capital capital chasing chasing fewer fewer projects or fewer of things for it to produce and in this world what is going to happen well this will just assume that this continues to produce ten dollars of income so the income continues to be ten dollars here but people let's say you know I were able to buy this for $100 let's say the next person who has a hundred dollars - of capital or you know to invest in capital says well I can't find something with ten dollars of income I can't get ten dollars so hey I'm willing to take nine percent so I'm going to bid this up I'm willing to buy this from you from 101 dollars 102 dollars and maybe it goes all the way where they can't get anything they can't get better than a 10 percent return anything better than a 5 percent return on their incremental hundred dollars and so they're willing to do a 5 percent return for this asset so they would bid this thing up the more and more capital you have chasing or a more more money you have chasing this this project I guess you could say this this asset could just bid the value of this up so the value could go to $200 it's still producing the same income and now the return is 5% and so the reason to point this out is a increasing value of capital doesn't necessarily mean increasing returns in fact normally in the market they move inversely with each other when bonds have higher returns then you have lower than their prices are lower when their prices are higher for bond prices that means that they have a lower lower return so when we look at something like this when we look at something like this this could be speaking to more and more capital accumulation chasing fewer and fewer potential projects or whatever it might be especially because you have slowing economic growth but this would be a story of capital accumulation but with our slowing down with the actual potential return slowing down and probably starting to converge to g2 the rate of growth another similar idea this is more capital chasing fewer projects but you also have might have a reality is that the reason why this is getting a 10% return is people find a scary they've been burned on investments before there have been Wars they don't want to put their money into some kind of factory they want to stuff it into their into their mattress but then over time maybe people become a little bit less risk-averse and they're willing to invest in the market they're willing to invest in a project or start a business or whatever it might be and so people become more risk tolerant so maybe this is a world that is very risk-averse risk-averse so if you want me to invest in capital you have to give me a high return but maybe the future is going to be more risk tolerant risk tolerant risk tolerant and then in a more risk tolerant world you could also go to something like this so this is risk in a more risk tolerant world you might say hey okay well okay I don't have to stuff in my mattress I'm getting 0% or in my bank account I'm not getting a lot but hey and I'm going to take my money to invest it more in capital and so once again they will bid up capital and they will have a lower expected return here they need a high respected return because there was a lot of risk they were scared of things hey you better give me a lot of return on my capital if you want my capital because it's a scary world out there hey okay maybe now I'm less worried about wars and my wealth disappearing and whatever else so I'm more willing to invest and so that also is in line with more capital and so there is a lower expected return and so you have the value going up and actually this is consistent with what we see happening right over here is that this this period right over here was a period this is a period of major unrest you have the two largest wars in global history right over here you could imagine people becoming very very very risk-averse you could imagine people starting this stuff money in there but putting putting they're trying to sell their assets worried what might happen and so you're going to have less and less capital more and more risk aversion driving driving that reality but then as we go into the post-war period the memories of those wars go away people become more risk tolerant more capital gums into the system because of the de practive 'ti you have more and more capital accumulation if we go back into you know even pre Industrial Revolution times if we go to medieval times and all the rest you had a limited amount of capital it was mainly land as you go into the Industrial Revolution especially in the 28th 21st centuries land represents a smaller and smaller percentage of the value of total capital now you have created capital you have technology you have intellectual property and so this could be a trend once again I'm not sure it's up for you to make the judgement this trend isn't necessarily a return to a Gilded Age it could be more and more capital chasing fewer and fewer projects which actually could be a sign of lower returns or it could be just people's risk premium is going down they're becoming more and more risk tolerant and so they're willing to accept lower and lower returns so it's not clear what the what the trajectory is but I just want to make it very clear that this isn't necessarily saying that hey because this graph looks the same as here that we're necessarily going into a second Gilded Age but it's up for you to decide