Amsterdam, March 20, 2008 – Adam Smith was the author of the theory of the invisible hand that guides unregulated markets to produce the optimum result, but he took for granted that the hand was clean. Today's securities markets cannot be described as expressing the unsullied result of a mass of rational individual decisions on the best interests of corporate and public society. Smith's model has broken down.
The Nobel Prize in Economics has been won by analyses of how flawed or idiosyncratic the "rationality" of consumers, sales organizations, entrepreneurs, CEOs, and corporate boards really is.
Even so theoretically reliable sources of business rationality as avarice and personal self-advancement can assume counterproductive forms. The private rationality of a business executive, or government official, may dictate a quick trip to Washington to rendezvous with a call-girl in whom he already has an $80,000 investment, rather than attend a meeting on the uses of a new investment instrument he finds impossible to understand. The lack of optimum economic rationality in market decisions is well known, the insiders' joke.
The head of the Deutsche Bank AG, Josef Ackermann, well known as a true believer in the autonomy and efficiency of markets, came back from a trip to New York last week to tell a gathering at the Swiss consulate in Frankfurt, "I no longer believe in the self-correcting nature of markets. It pains me to say something like this."
He said that governments must join central banks and the market's participants "to stop this meltdown." He thus reinforced the demands of some union officials as well as avowed Keynesian economists that the state "have the courage to demand more transparence" in the financial market, "even if the banks don't want it."
Most don't want the transparence, but would take the government's money. The IKB bank in Germany, Northern Rock in Britain, and Bear Stearns in the U.S. have already done so. Axel Weber, president of the German Bundesbank, says banks are responsible for looking after themselves and should solve their own problems; to call on the state means that the taxpayer will pay. The Wall Street Journal would applaud.
But a senior American-educated French economist, Daniel Cohen, professor at the French Ecole Normale Superior and the University of Paris, says that the Federal Reserve in Washington has shown that it lacks the tools to deal with the sub-prime mortgage crisis. A climate of fear now exists, blocking the offer of credit by banks, and creating a vicious circle of illiquidity which requires international solution. He sees action necessary at the level of the G7 nations, in order to recapitalize the banks.
There has been a "frenzied" rush of available speculative money into commodities (quoting Bloomberg). As of the end of February there were 361 commodity funds with $98 billion in assets. This is why oil and gold are at their present heights, together with minerals and agricultural products, the last fueling consumer price inflation and an international rise in the cost of living.
As with the sub-prime mortgages, this is sheer waste of money, in terms of the public interest. Gambling in commodities is now the game, even if credit no longer is available to push prices to the delirious heights reached by the "securitized" but valueless "new investment instruments" before they collapsed.
Regulation as well as government reflation of the economy now are being demanded to replace the now palsied guiding hand in the deregulated and globalized international market which the Reagan, Clinton, and two Bush administrations have bestowed upon a credulous world during the last three decades.
Adam Smith was not only an economic theorist but a moral philosopher. A recent book on that dimension of his work, "The Impartial Spectator" by D.D. Raphael (published by Oxford) emphasizes, as a reviewer writes, that his work in economics "never led him to revise his view that benevolence, along with justice and self-command, is more important and admirable a [public] virtue than mere prudence," essential as the last quality may be to validate his belief in the ultimately benevolent workings of the free market.
He also believed that value arises from the labor expended in the process of production, not from the level of remuneration paid chief executives and stockholders, or the manipulation of speculative investment debt instruments, of which he fortunately knew nothing. Had he known, he might never have made his famous claim that in a laissez-faire economy self-interest would assure the public interest.
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