Monday, May 3, 2010
Adam Smith, the Scottish professor of philosophy who published his magnum opus the same year that the American Colonies formally declared their independence from the British monarchy (1776), is generally known as “the father of modern economics.” The Wealth of Nations remains a classic to this day.
A fierce believer in free markets, Adam Smith postulated that a truly free and open market would be by definition a self-regulating enterprise. The rules of the game ought to be developed and enforced, but no government can possibly police every transaction in a booming economy. He believed that the market itself would keep self-interest in check. An “invisible hand,” he said, would both push the economy towards steady growth and keep it from overheating.
Justin Smith, in TIME (March 25, 2010), asked the question – “What would Adam Smith say?” In light of the congressional hearings when Congress went toe to toe with Wall Street’s financial giants, what might be his commentary if Adam Smith were a talking head on the business channel?
Ever since I heard Ronald Reagan’s advisor, Dr. Arthur Laffer (often credited for “supply-side economics” unleashed during the Reagan years) explain the independent power of the marketplace, I have pondered this dynamic: a self-regulating market. On many levels, it appears to hold true – to this day. Dr. Laffer (known for his “Laffer Curve”) made the case: all artificial attempts to control the economy will always fall short of the mark. Things like tax incentives, tariffs, credits, currency manipulation, price controls, regulation and de-regulation and all manner of government intervention will never truly change the course of the mighty economic river. Economies have a life of their own. For example, people complain about outsourcing. But producers of goods and services will always be on the hunt for cost-cutting opportunities – there is no stopping it. The economy will ebb and flow, as it will; in spite of our tireless, creative efforts.
From Adam Smith’s analysis, the concept of “fair market value” (FMV) is a guiding light. When a willing seller and a willing buyer agree on a price, we have fair market value. Throw in the “Golden Rule” (“do unto others what you would have done to you”) and the market takes care of itself. For the Scotsman, integrity and character are essential. Fairness and mutual respect remain at the core of an efficient market.
Of course, it is human nature to tamper with these fundamental principles. But when a buyer or seller manipulates FMV with even what appears to be an imperceptible premium, much less an outrageous one (e.g. price gouging), the “invisible hand” will eventually make its move. Oh, it may go undetected for a season, but the violator will ultimately pay. The Bernie Maddoffs will ultimately be exposed.
When integrity and fairness and character disintegrate, one might expect that the entire economy could well collapse. Well it may. When major investment banks sell investments at anything other than FMV, they have violated a basic principal of free markets. To represent that worthless investments have substantial value and are worthy recommendations, the entire system has been cheated, not just the individual investor.
Eventually, the “invisible hand” moves in.
To call this collapse a “correction” is a vast understatement. And yet, it is a correction. A necessary one. The white-hot growth of housing values and economic expansion was clearly unsustainable. The greatest travesty of all is that the financial wizards and overgrown institutions who gave lip service to fiduciary duty seem the least likely to suffer the consequences of the loss.
But in the end, that invisible hand, identified by Adam Smith more than two hundred years ago, is leveling the playing field again. For the courageous and the pro-active, opportunity is limitless. Integrity, character, fairness will still be mandatory. The Golden Rule remains golden.
Think about it. What is that invisible hand, anyway?
Copyright Kenneth E Kemp 2010