February 10, 2009

Adam Smith Article

My comments on the following article will be in red. I was going over my nightly reading and thought this was great. Enjoy

Adam Smith gets the last laugh

By P.J. O’Rourke

Published: February 10 2009 19:22 | Last updated: February 10 2009 19:22

The free market is dead. It was killed by the Bolshevik Revolution, fascist dirigisme, Keynesianism, the Great Depression, the second world war economic controls, the Labour party victory of 1945, Keynesianism again, the Arab oil embargo, Anthony Giddens’s “third way” and the current financial crisis. The free market has died at least 10 times in the past century. And whenever the market expires people want to know what Adam Smith would say. It is a moment of, “Hello, God, how’s my atheism going?” I love this quote how appropriate.

Adam Smith would be laughing too hard to say anything. Smith spotted the precise cause of our economic calamity not just before it happened but 232 years before – probably a record for going short.

“A dwelling-house, as such, contributes nothing to the revenue of its inhabitant,” Smith said in The Wealth of Nations. “If it is lett [sic] to a tenant for rent, as the house itself can produce nothing, the tenant must always pay the rent out of some other revenue.” Therefore Smith concluded that, although a house can make money for its owner if it is rented, “the revenue of the whole body of the people can never be in the smallest degree increased by it”. [281]*

Smith was familiar with rampant speculation, or “overtrading” as he politely called it.

The Mississippi Scheme and the South Sea Bubble had both collapsed in 1720, three years before his birth. In 1772, while Smith was writing The Wealth of Nations, a bank run occurred in Scotland. Only three of Edinburgh’s 30 private banks survived. The reaction to the ensuing credit freeze from the Scottish overtraders sounds familiar, “The banks, they seem to have thought,” Smith said, “were in honour bound to supply the deficiency, and to provide them with all the capital which they wanted to trade with.” [308]

The phenomenon of speculative excess has less to do with free markets than with high profits. “When the profits of trade happen to be greater than ordinary,” Smith said, “overtrading becomes a general error.” [438] And rate of profit, Smith claimed, “is always highest in the countries that are going fastest to ruin”. [266] Quite a scary comment considering our time.

The South Sea Bubble was the result of ruinous machinations by Britain’s lord treasurer, Robert Harley, Earl of Oxford, who was looking to fund the national debt. The Mississippi Scheme was started by the French regent Philippe duc d’OrlĂ©ans when he gave control of the royal bank to the Scottish financier John Law, the Bernard Madoff of his day.

Law’s fellow Scots – who were more inclined to market freedoms than the English, let alone the French – had already heard Law’s plan for “establishing a bank ... which he seems to have imagined might issue paper to the amount of the whole value of all the lands in the country”. The parliament of Scotland, Smith noted, “did not think proper to adopt it”. [317]

One simple idea allows an over-trading folly to turn into a speculative disaster – whether it involves ocean commerce, land in Louisiana, stocks, bonds, tulip bulbs or home mortgages. The idea is that unlimited prosperity can be created by the unlimited expansion of credit. Violates the eternal principle of we reap what we sow.

Such wild flights of borrowing can be effected only with what Smith called “the Daedalian wings of paper money”. [321] To produce enough of this paper requires either a government or something the size of a government, which modern merchant banks have become. As Smith pointed out: “The government of an exclusive company of merchants, is, perhaps, the worst of all governments.” [570] I wish Washington would read more I agree with this statement.

The idea that The Wealth of Nations puts forth for creating prosperity is more complex. It involves all the baffling intricacies of human liberty. Smith proposed that everyone be free – free of bondage and of political, economic and regulatory oppression (Smith’s principle of “self-interest”), free in choice of employment (Smith’s principle of “division of labour”), and free to own and exchange the products of that labour (Smith’s principle of “free trade”). “Little else is requisite to carry a state to the highest degree of opulence,” Smith told a learned society in Edinburgh (with what degree of sarcasm we can imagine), “but peace, easy taxes and a tolerable administration of justice.” Sounds like a modern day platform for both the Democrat and Republican parties.

How then would Adam Smith fix the present mess? Sorry, but it is fixed already. The answer to a decline in the value of speculative assets is to pay less for them. Job done.

We could pump the banks full of our national treasure. But Smith said: “To attempt to increase the wealth of any country, either by introducing or by detaining in it an unnecessary quantity of gold and silver, is as absurd as it would be to attempt to increase the good cheer of private families, by obliging them to keep an unnecessary number of kitchen utensils.” [440] Awesome quote.

We could send in the experts to manage our bail-out. But Smith said: “I have never known much good done by those who affect to trade for the public good.” [456]

And we could nationalise our economies. But Smith said: “The state cannot be very great of which the sovereign has leisure to carry on the trade of a wine merchant or apothecary”. [818] Or chairman of General Motors.

* Bracketed numbers in the text refer to pages in ‘The Wealth of Nations’, Glasgow Edition of the Works of Adam Smith, Oxford University Press, 1976

The writer is a contributing editor at The Weekly Standard and is the author, most recently, of On The Wealth of Nations, Books That Changed the World, published by Atlantic Books, 2007

Great Article, fun to read and gives me hope that the invisible hand is not dead just slowly working out its issues.

February 01, 2009

Stalled Economy

I'm digressing from my infrastructure project idea to talk about the overall economy for the moment.

I am and was a supporter of Barack Obama, not becasue I agree with many of his social positions but because he seemed intelligent, and principled. I really hope that plays itself out, but I'm a little annoyed at some of his cabinet picks. What is with the tax problems? How can we expect Geitner and Daschle to fix our economic and health care problems when 6 months ago they were in violation of tax laws and had under reported their earnings. That is like having the fox watch the hen house. Probably a bad idea. I don't know who else you could tap for those positions but it is very disappointing that many of our new leaders have such bone headed problems. It does not give me a great degree of confidence that they can fix our problems, just that they are politicians, which like many, I simply don't trust in general.

As far as the problem I was shown an interesting power point presentation this week which was disconcerting. Here are a few images:

This slide is simply horrifying. We are seeing banks have to draw down against the Federal Reserve for a historically ridiculous amount of money. I'm not sure how this is even possible on a long term potential, but even in the short term this is a huge sum of money. Why do we think that the banks will stabilize if we give them more money? It does not seem likely. Not sure what the answer is, other than to let banks fail and the Fed to step in as a depositor insurer and basically start over.

In this slide we see the enormous debt we have gotten ourselves into. Debt is an interesting thing in America. There are some who believe that because we are America and because we have a stable government, the rule of law etc. we are a better bet, from an investment standpoint, than England, France, Brazil, etc. And as evidenced people buy our Treasury certificates loaning us money. The 10.5 trillion dollar question (amount of our current outstanding debt) is how long will foreigners continue to loan us money and how long will we be able to make our interest payments before those interest payments completely eclipse an enormous portion of our national spending?

I watched I.O.U.S.A. this week, it is more cerebral than entertaining, but a good film to highlight this problem. Check it out if you get a second.

Indefinite debt is a disaster, it is imperative that as we decide to take on this debt (stimulus package) we do so with the long term payoff in mind. We need to figure out how we are going to pay off this debt and reduce our spending. It doesn't seem prudent to simply except that we will need to borrow for daily operations forever.

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