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What Capital Actually Is | Canadian Investing · How Canadian Markets Work

0:00
Okay, let's unpack this. I want you to picture
0:02
something for a second. There is money right
0:05
now, just sitting in your bank account. Right.
0:08
And let's just say it is exactly $4 ,000. Okay,
0:12
four grand. Yeah. You are not really doing anything
0:15
with it at the moment. It's just kind of sitting
0:16
there, you know, acting as a buffer for whatever
0:19
life throws your way, waiting to pay next month's
0:22
rent or maybe just sitting around until you need
0:25
to buy groceries. It's just idle cash. Exactly.
0:29
Now, I want you to hold that thought and picture
0:32
something entirely different. Imagine a location
0:35
about, I don't know, 2 ,000 kilometers away from
0:38
where you are sitting right now. OK. Out there,
0:42
there's this massive energy company staring at
0:44
an empty field, and they're trying to build a
0:46
state -of -the -art wind farm. Oh, wow. Yeah.
0:49
OK. And they have done all the geographic surveys.
0:52
They own the land. They have spent years, I mean,
0:55
literally years, clearing regulatory hurdles
0:57
and securing every single environmental permit.
1:00
The only thing missing is the $200 million required
1:03
to actually pour the concrete and, you know,
1:06
erect the turbines. Right. So they essentially
1:09
have the blueprint and the space, but they are
1:11
completely lacking the fuel to bring it into
1:14
the physical world. Exactly. Which brings us
1:16
to the mission of our deep dive today. We are
1:19
taking this stack of sources we've gathered to
1:21
really explore what capital actually is. And
1:25
like, more importantly, to map out the hidden
1:28
plumbing of our financial markets. Yeah, the
1:31
invisible stuff. Because here is the hook, right?
1:34
How does your idle four thousand dollars end
1:36
up inside that wind farm? Which it does, by the
1:39
way. Yes. And I promise you, it actually does.
1:42
That is not a metaphor. We are going to uncover
1:44
the actual traceable path straight from your
1:47
everyday checking account to that spinning wind
1:50
turban. I love this because understanding that
1:52
invisible journey is well it's essentially the
1:55
skeleton key to understanding how the physical
1:57
world around us gets built. Right. It happens
2:00
completely out of sight just you know millions
2:02
of times a day. So to trace that four thousand
2:05
dollars we first need to correct a fundamental
2:07
misunderstanding like a trap most of us fall
2:10
into when we use the word capital. Oh, definitely.
2:13
Because we hear it all the time on the news or
2:15
in articles and people generally use it as a
2:17
fancy synonym for money. But based on our research
2:20
today, that is just completely wrong. Yeah, using
2:23
capital to just mean money obscures what is actually
2:26
happening under the hood. A much more accurate
2:29
working definition, and this is key, is that
2:31
capital is accumulated wealth that has been put
2:35
to productive use. Accumulated wealth. put to
2:38
productive use. Right. That is the core idea
2:41
to hold onto throughout this whole discussion.
2:43
And to break it down even further, this capital
2:46
really comes in two distinct forms. OK, what's
2:48
the first one? The first form is what economists
2:50
call real capital. These are the physical, tangible
2:54
things that produce value in the real world.
2:57
Like actual objects. Exactly. A massive automotive
2:59
manufacturing factory. A fleet of long haul delivery
3:02
trucks. a hospital treating patients and, you
3:05
know, obviously the wind turbine we opened with.
3:08
Right. The stuff you can touch. Yeah. Items that
3:10
actually exist in the material world and create
3:12
more value than they cost to operate. OK. So
3:15
the physical stuff doing the heavy lifting. But
3:17
I mean, you can't build a factory out of dollar
3:19
bills, which I guess brings us to the second
3:22
form. Right. And that would be financial capital.
3:25
OK. This includes the money in your checking
3:27
account. Yes. But also things like stocks. bonds,
3:30
and various bank deposits. The crucial thing
3:33
to understand here is that financial capital
3:35
is not productive in and of itself. Like, you
3:38
cannot heat a home during a blizzard with a bond
3:41
certificate, right? No, definitely not. And you
3:43
can't transport a ton of steel using a bank deposit.
3:46
What financial capital actually does is act as
3:50
a claim on that real capital. A claim, OK. Yeah.
3:54
It is a highly efficient mechanism for moving
3:56
purchasing power from one person to another across
3:59
space and time. Okay, so financial capital is
4:03
basically a VIP ticket. Ooh, I like that. It
4:05
isn't the concert itself, right? It doesn't make
4:07
the music. But it's the claim that gets you in
4:10
the door. And it's something you can seamlessly
4:12
trade with someone else who wants your spot.
4:14
That is exactly it. The VIP ticket isn't the
4:18
value. The experience of the live concert is.
4:21
financial capital just facilitates your access
4:24
to the value. Right, right. And that facilitation,
4:27
you know, moving the purchasing power around
4:29
is exactly what we are focusing on today. Because
4:32
at any given moment in any economy, there are
4:35
two distinct economic camps that people or companies
4:38
or even governments fall into. OK, let me see
4:40
if I can synthesize this from the reading, because
4:42
I thought this was super interesting. Go for
4:44
it. The first camp would be the savers. So these
4:48
are people or entities who currently have capital
4:50
but they have no immediate use for it exactly
4:53
like you the listener with that $4 ,000 buffer
4:56
we talked about or I don't know a massive pension
4:59
fund collecting automated contributions from
5:01
thousands of workers Yeah, or even an insurance
5:03
company holding on to premiums, you know waiting
5:06
for a claim on a hurricane that hasn't happened
5:07
yet Right. They all have surplus purchasing power
5:11
just sitting idle. You nailed it Which means
5:13
the other side of that coin is the users. The
5:15
ones who need it. Exactly. These are the entities
5:17
who desperately need capital right now, but they
5:19
don't have it. This is the energy company that
5:22
wants to build the new wind farm. It is a local
5:25
municipality that needs to upgrade a failing
5:27
water treatment facility before the summer. Or,
5:30
you know, on a much more relatable scale, it
5:32
is a family trying to buy their first house.
5:35
So savers have capital, but no immediate use.
5:37
Users have an immediate use, but no capital.
5:40
That's it, in a nutshell. So if I'm a saver with
5:42
a buffer, and I want to return on my money so
5:45
inflation doesn't just eat it alive, and users
5:47
are clearly willing to pay for that money to
5:49
build their projects, I guess my question is,
5:52
why do we need this massive, complicated financial
5:54
industry? Right. Why not just cut out the middleman?
5:57
Yeah. Why can't I just Venmo the wind farm directly?
6:00
Well, I mean, the transaction costs alone would
6:03
completely sink the project. Really? Just from
6:05
trying to coordinate it? Oh, absolutely. Think
6:07
about it. If a wind farm needs $200 million,
6:11
Your $4 ,000 is a literal drop in the bucket.
6:14
Fair point. To fund their project directly through
6:17
people like you, that energy company would have
6:19
to find 50 ,000 individuals, negotiate 50 ,000
6:24
separate legal contracts, and then manage all
6:26
of those individual relationships over decades.
6:29
Oh, wow. Yeah, that sounds impossible. The administrative
6:32
nightmare would bankrupt them before a single
6:34
shovel even hit the dirt. OK, so the scale is
6:37
just entirely off. I have pebbles and they need
6:40
boulders. Exactly. That is the first mismatch.
6:43
Size. But, you know, even if I miraculously had
6:46
$200 million sitting in my account, I still wouldn't
6:49
just hand it to them. Right. Why not? Because
6:52
I might need to buy a house or pay for emergency
6:54
surgery next year. And they need that money locked
6:58
in for decades to slowly pay me back from the
7:01
electricity they generate. Right? Exactly. You've
7:04
just hit on the second major hurdle standing
7:06
between savers and users, which is time. Time.
7:10
OK. The time horizons are just completely incompatible.
7:14
They cannot function if lenders decide to pull
7:16
their money out in month three because of a surprise
7:19
dental bill. Wait. I have to challenge you on
7:22
this one, though. OK, shoot. Because everyday
7:23
people lock their money up for 25 or 30 years
7:26
all the time. That is exactly what a mortgage
7:29
is. We sign on the dotted line and commit for
7:32
decades. Why wouldn't a wealthy saver do exactly
7:35
the same thing to fund a wind farm? So what's
7:38
fascinating here is the distinction between who
7:40
is actually doing the locking up. What do you
7:42
mean? You are absolutely right that households
7:45
borrow money for 25 years when they get a mortgage.
7:48
But everyday people almost never lend their own
7:51
personal liquid emergency cash for that long
7:53
without the ability to pull it back. Oh. Oh,
7:57
I see. Yeah. When you get a mortgage, you are
8:00
the user. The saver on the other side of that
8:03
transaction is the one taking on the long -term
8:06
commitment. That makes total sense. As a saver,
8:08
you would never hand over your safety net to
8:10
a wind farm and say, sure, keep this until 2050.
8:13
I definitely won't need it. Ah, OK. Borrowing
8:17
long -term is totally normal for households,
8:19
but lending long -term with our everyday cash
8:22
is unthinkable. We need to be able to pull it
8:24
back. Exactly. Which, speaking of risk, brings
8:28
up another terrifying thought. If that wind farm
8:31
goes belly up because the technology fails or
8:34
regional power prices collapse, my $4 ,000 is
8:37
gone forever. And there it is. You've organically
8:41
arrived at the third hurdle, which is risk. Risk.
8:43
You cannot afford to lose your safety net. But
8:46
the reality of building a $200 million infrastructure
8:49
project is that it carries the very real risk
8:52
of total failure. Someone has to take the hit
8:54
if it fails. Right. Someone has to be willing
8:56
to carry the burden of total loss and it simply
8:59
cannot be someone who would be financially devastated
9:01
by it. OK. So that's size, time and risk. And
9:06
honestly, even if I had the size and the time
9:09
and a massive tolerance for risk, I still wouldn't
9:11
know if it was a good idea in the first place.
9:14
Why is that? I mean, I don't know the first thing
9:16
about wind shear or turbine supply chains or
9:19
reading geological surveys. Which perfectly illustrates
9:22
the fourth and final mismatch. Information. Information.
9:27
OK. You have absolutely no way to judge whether
9:29
this specific project is a sound investment or
9:32
a complete disaster waiting to happen. Right.
9:34
So these four mismatches, size, time, risk, and
9:37
information, they are the entire reason the financial
9:40
system exists. The banks, the brokers, the markets,
9:43
their entire job description is to bridge those
9:46
four gaps. OK. So if the whole point of a bank
9:48
or a stock market is to bridge those massive
9:50
gaps, let's look at how that actually works for
9:53
our wind farm. Let's do it. The sources use a
9:55
fictional company called Bayridge Wind. They
9:58
are planning this $200 million project. It has
10:02
an expected operational life of 25 years. And
10:05
once it is up and running, it is expected to
10:07
generate about an 8 % return per year. OK, solid
10:09
project. So how does Bayridge actually get that
10:13
money from the savers? Well, they don't just
10:15
go out and ask for $200 million in one big chunk.
10:18
They solve the risk mismatch right out of the
10:20
gate by splitting the funding into two completely
10:23
different financial products aimed at two completely
10:25
different types of sabers. Oh, interesting. First,
10:28
they raise 60 million dollars in equity. These
10:31
are shares of ownership in the company. So if
10:33
the wind farm is a pie, equity is like buying
10:36
a slice of that pie and hoping the whole thing
10:39
gets massive. Yes. If it's a huge success, your
10:42
slice is incredibly valuable. But if the pie
10:44
burns in the oven, you get absolutely nothing.
10:47
High risk. high potential reward. That is a perfect
10:50
analogy. The equity holders carry the heavy risk
10:53
of total loss, but they capture the unlimited
10:56
upside. Right. Then you have the remaining 140
10:59
million dollars, which comes from debt. So Bay
11:03
Ridge issues bonds. Bonds. OK, explain bonds.
11:06
Think of a bond as a very formal, legally binding
11:09
IOU. Bay Ridge promises to pay the bondholders
11:12
a flat five percent interest every year for 20
11:14
years. And at the end of that 20 years, they
11:17
will return the original loan amount. Okay, continuing
11:20
with the pie analogy, the debt holders are just
11:23
demanding a guaranteed $5 slice, regardless of
11:26
how big or small the pie ends up being. They
11:29
don't get rich if the farm's wildly successful.
11:32
Exactly. But the risk is substantially lower.
11:35
They get paid their 5 % before the shareholders
11:37
see a single dime. Oh, they get paid first. Yes.
11:40
And if Bay Ridge goes bankrupt, the bondholders
11:42
have the first legal claim on whatever assets
11:45
are left to sell off, like the land or the uninstalled
11:48
turbines. Got it. So by creating these two distinct
11:50
products, Bay Ridge has successfully carved up
11:53
and managed the risk mismatch. OK. So they have
11:56
these lower risk bonds paying 5%. But who is
12:00
actually buying them? Because we already established
12:02
I'm not locking my emergency fund away for 20
12:04
years. Right. So a massive pension fund comes
12:07
in and buys 40 million dollars worth of these
12:09
bonds. Why would they do that? Because a pension
12:12
fund's entire existence is based on obligations
12:14
that stretch decades into the future. They know
12:17
for a fact they have to pay a specific predictable
12:20
amount to retirees in the year 2050. Oh, right.
12:24
So buying a long -dated bond that pays a steady
12:27
interest rate for 20 years perfectly matches
12:29
their timeline. They actively seek out the lock
12:32
-in that a household saver would run away from.
12:34
So the time mismatch is solved for them. Exactly.
12:38
Okay, here's where it gets really interesting
12:39
because this is where you, the listener, finally
12:42
enter the picture. Yep. The pension fund took
12:44
40 million. An insurance company maybe takes
12:47
another 30 million. But what about the rest?
12:50
Right. The rest gets bought up by mutual funds
12:53
and exchange traded funds or ETFs. You would
12:57
probably never hear about a company called Bayridge
12:58
Wind. You certainly wouldn't log on and buy their
13:01
individual bonds. But you might have a standard
13:04
Canadian bond ETF sitting inside your retirement
13:07
account or your tax free savings account. And
13:10
that ETF pulls together money from, say, 200
13:12
,000 everyday people. OK. If the average person
13:15
has $15 ,000 in there, that ETF manager is suddenly
13:19
sitting on a colossal pool of $3 billion. Wow.
13:23
Yeah. For a $3 billion fund, buying a $20 million
13:27
slice of Bay Ridge wins debt is incredibly easy.
13:31
Your $4 ,000 gets mixed into that massive pool.
13:35
The size mismatch is completely eliminated. So
13:38
Bayridge didn't have to negotiate with 50 ,000
13:40
people. Exactly. They just negotiated with one
13:43
single ETF manager. That covers size, time, and
13:46
risk. But what about information? Because I still
13:50
didn't read Bayridge's environmental surveys.
13:52
You didn't, but you paid someone else to do it.
13:54
I did. Yeah, the investment dealer who underwrote
13:56
the bond issue analyzed the projections, a credit
14:00
rating agency assigned a risk rating to the debt,
14:02
and that ETF manager we just talked about. They
14:06
employ floors of analysts whose entire job is
14:09
to model wind energy economics. They do the homework
14:12
on your behalf. Right, but they don't do it for
14:14
free, obviously. They take a small fee out of
14:16
my overall return. Exactly. But that is a brilliant
14:20
trade -off. I sacrifice a tiny fraction of my
14:23
profit to ensure the information mismatch is
14:26
handled by full -time experts, protecting my
14:29
capital from disastrous choices. Exactly. It's
14:32
a system of delegation. Hold on though. Let me
14:35
make sure I'm wrapping my head around this next
14:37
part because I'm stuck on the time mismatch again.
14:40
Okay, where are you stuck? The pension fund is
14:43
happy to wait 20 years, but my $4 ,000 is in
14:47
that ETF. If I wake up next month... My transmission
14:51
explodes, and I urgently need that $4 ,000 to
14:54
fix my car. What happens? Good question. Like,
14:58
does Bayridge have to dismantle a wind turbine
15:00
to give me my money back? How does the math on
15:03
that actually work? No, not at all. The wind
15:06
farm never even notices you left. Really? And
15:08
this brings us to what is arguably the most crucial
15:11
piece of the entire financial puzzle, the resale
15:14
market, also known as the secondary market. OK.
15:16
If you need your $4 ,000 next month, you simply
15:19
log into your brokerage app and sell your ETF
15:22
units to another investor on the exchange. The
15:24
money you receive comes directly from that new
15:26
investor's bank account, not from the wind farm.
15:29
Oh, okay. So using our earlier analogy, I'm just
15:33
selling my VIP ticket to someone else standing
15:35
in line outside the venue, while the concert
15:37
keeps playing under Derrupted Inside. That is
15:39
beautifully put. The actual capital remains permanently
15:42
committed to the long -term project, building
15:45
the physical infrastructure, while the individual
15:47
savers can freely move in and out of their positions
15:49
whenever their unpredictable lives demand it.
15:52
That is wild. It really is. It is a kind of financial
15:55
magic trick that allows a society full of people
15:57
with short -term, chaotic financial needs to
16:01
successfully fund massive, decades -long infrastructure
16:04
projects. That really is incredible when you
16:06
step back and look at the scale of it. It's massive.
16:08
But, you know, reading through our sources, it's
16:11
not all sunshine and smooth sailing. There are
16:13
a few harsh realities that complicate this picture.
16:16
Let's get into the first complication, which
16:18
is the fact that capital is actually scarce.
16:21
And because it is scarce, it has a price. Right.
16:24
There is not an infinite pool of accumulated
16:26
savings in the world. Unfortunately. Yeah. At
16:29
any given moment, there are far more brilliant
16:31
ideas, ambitious projects, and eager users out
16:34
there than there is capital available to fund
16:36
them. Right, so they have to compete for it.
16:39
Exactly. Because it is scarce, it has to be rationed.
16:42
And the mechanism we use to ration it out is
16:44
price. In the financial world, the price of capital
16:47
is what we call the interest rate. Okay. So interest
16:51
rates aren't just arbitrary numbers set by central
16:54
banks to punish people trying to buy a house.
16:56
Far from it. They act as an economic gravity,
16:59
really. A sorting mechanism. Okay, how so? Let's
17:03
look back at Bayridge. They expect an 8 % return
17:05
on their wind farm. If the going market rate
17:08
to borrow money is five percent, the math works
17:10
out beautifully. The project gets funded, the
17:12
turbines get built. OK, because they make more
17:14
than it costs. Right. But if capital becomes
17:17
scarcer and the borrowing cost, the interest
17:19
rate rises to nine percent. Suddenly, borrowing
17:23
at nine to earn eight is a guaranteed path to
17:26
bankruptcy. Oh, wow. Yeah, the project dies.
17:29
So what does this all mean? Like when a central
17:31
bank raises rates, are they actively trying to
17:34
kill good ideas or? Is it just the necessary
17:37
mechanism to weed out the weak ones so the strongest
17:39
survive? Mechanically speaking, higher rates
17:42
raise the bar for success. They ensure that only
17:45
the most productive, most vital projects get
17:48
access to the limited pool of savings. It is
17:50
a harsh sorting process, definitely, but without
17:53
it, capital would be wasted on inefficient projects
17:55
that don't actually grow the economy. Which leads
17:58
us to the second complication. A lot of people
18:01
think that savings automatically equal investment.
18:04
Like, if I save my money, the economy grows.
18:07
But our sources make it clear that's not automatically
18:09
true. No. It is a very common misconception.
18:13
Yeah. Because if you take your $4 ,000 and stuff
18:16
it under your mattress, yes, you have savings.
18:18
But it is completely useless to the broader economy.
18:22
Right. It's just cotton and linen sitting there.
18:24
Exactly. It is not building anything. Savings
18:27
only transform into productive capital when they
18:29
successfully travel through that transfer machinery
18:32
we've been discussing and reach a user who will
18:35
physically build something with it. And if that
18:38
transfer machinery breaks down? The real economy
18:41
stops dead in its tracks. The financial system
18:43
isn't just a layer of convenience sitting on
18:45
top of the real economy of factories and farms.
18:48
It is the load -bearing structure of the real
18:51
economy. Wow. And the sources point to the 2008
18:54
financial crisis as the ultimate example of this.
18:57
The actual savings didn't just vanish into thin
19:00
air. The households still had deposits in their
19:03
accounts. The physical projects the companies
19:05
needing to make payroll, they were all still
19:07
there. Yes. What completely evaporated was the
19:11
trust connecting them. The trust. Because banks
19:13
suddenly couldn't accurately value the risk of
19:16
the assets they were holding, specifically those
19:18
toxic subprime mortgages, they panicked. Right.
19:21
They hoarded their capital to protect themselves.
19:24
They completely stopped acting as the bridge
19:26
between the savers and users. Banks stopped trusting
19:29
other banks, lenders stopped trusting borrowers,
19:31
and the entire credit market just froze solid.
19:34
The mechanism of transfer just shattered. Exactly.
19:38
And perfectly healthy businesses suddenly couldn't
19:39
get the routine daily cash flow they needed just
19:41
to pay their employees. The bridge collapsed.
19:44
And it nearly brought the global economy down
19:47
with it. terrifying how fragile that invisible
19:50
plumbing really is. Very fragile. Now, there
19:52
is one final complication mentioned in our sources,
19:55
and it's a structural one. This entire system
19:58
doesn't just efficiently allocate capital to
20:00
build things, it also fundamentally distributes
20:03
wealth. Right. The simple act of owning capital
20:06
entitles you to a return on it. Yes. If you own
20:09
equity or debt, you are receiving an income stream
20:11
without having to physically work for it on a
20:14
daily basis. Right. Conversely, people who do
20:17
not own capital rely entirely on their daily
20:19
labor for their income. And our sources point
20:21
out that over time, that return on capital compounds.
20:25
It acts as a massive force shaping who ends up
20:28
with what in a given society. Now, I want to
20:31
be perfectly clear to you, listening, we are
20:33
not taking a side on this. Right. It's just what
20:36
the sources present. Exactly. They present this
20:38
as a highly debated ongoing argument among serious
20:41
economists. Some argue this compounding reward
20:44
is the absolute necessary incentive that drives
20:47
innovation. It encourages people to delay gratification
20:51
and save in the first place. Others argue it
20:54
inevitably leads to structural inequality that
20:56
needs to be heavily managed. We are simply imparting
20:59
the fact that this mechanism of wealth distribution
21:02
is a baked in reality of how the financial system
21:05
operates. It is an inescapable feature of the
21:08
plumbing. You cannot look at how capital moves
21:10
without acknowledging that the destination of
21:12
the returns shapes the structure of society just
21:15
as much as the physical infrastructure projects
21:17
do. Realizing that the transfer of capital isn't
21:20
just a financial convenience, but the load -bearing
21:23
structure of society itself, brings us to our
21:26
final takeaways for this deep dive. Let's hear
21:28
them. Let's distill all of this down into three
21:31
core nuggets. Point number one, capital is not
21:34
just money. It is accumulated wealth put to productive
21:37
use. It exists as real capital, the physical
21:41
factories and turbines, and financial capital,
21:44
which acts as a claim and a VIP ticket to move
21:47
purchasing power. Point number two. The entire
21:51
massive complex financial system exists for one
21:55
primary reason, to solve the four mismatches
21:58
of size, time, risk, and information that stand
22:02
between savers who have surplus wealth and users
22:05
who have the vision to build. And point number
22:08
three, this transfer machinery is absolutely
22:11
load -bearing. It is not an optional add -on.
22:14
When it works, idle savings are magically transformed
22:17
into hospitals, railways, and clean energy. But
22:20
when trust evaporates and the bridge breaks,
22:23
the real economy grinds to a halt. If we connect
22:26
this all back to the bigger picture, it really
22:29
changes how you should view your own financial
22:31
footprint. Oh, absolutely. Those digits on your
22:34
banking app? that idle deposit you haven't thought
22:37
twice about, it isn't actually idle at all. It
22:41
is an active puzzle piece currently deployed
22:43
out in the real world, carrying risk, earning
22:46
a return, and physically building the infrastructure
22:49
around us. Which leaves us with a final thought
22:51
for you to mull over. Think about your own bank
22:53
account, your retirement fund, the various pools
22:56
of capital you are already a part of. If financial
22:59
markets exist to efficiently route our pooled
23:01
savings to the highest bidder, wait. No, let
23:04
me rephrase that. Go ahead. If financial markets
23:07
exist to efficiently route our pooled savings
23:09
to the highest bidder, what kinds of massive
23:12
world altering projects is your idle cash silently
23:16
voting into existence right now, without you
23:18
even knowing? It's a crazy thought. It really
23:20
is. Thank you for joining us on this deep dive.
23:23
Be sure to follow the show to continue exploring
23:25
the unseen mechanics of your world. Catch you
23:28
next time.