Friday, December 12, 2008

The Invisible Hand

I recently stumbled upon a very interesting website from a company in the Great Northeast that designs and builds high-end, high efficiency homes and commercial structures. This is a field that has interested me since my old advertising/public relations days with a great metropolitan electrical plug and connector manufacturer.

But enough about me.

On his blog page Tedd Benson (founder of Bensonwood, Inc.) takes his own industry to task for their complicity in the current housing collapse.

According to Tedd, the National Association of Homebuilders (NAHB) ignored the public good and continued to lobby for loose or non-existant credit standards in order to keep the housing bubble inflated. But for how long? The current bust, which may have broader implications far beyond our wildest nightmares, was both inevitable and predictable.

Tedd ends his blog entry with the following statement:

"Economist Adam Smith didn’t contemplate conscious, rationalized idiocy on such a large scale; his “invisible hand” was no match for such a massive, wanton snow job."

I enjoy Tedd's blog and often agree with his observations and conclusions. However, in this case I respectfully disagree.

Actually, Adam Smith anticipated exactly what has happened in this particular boom/bust cycle.

He made it very clear that considerable structure was needed before the invisible hand of the market could work efficiently.

For example, property rights must be strong, and there must be widespread adherence to moral norms, such as prohibitions against theft and misrepresentation.

In his time, property rights were only recognized among the aristocracy.

Adam Smith developed his theories in a centralized, heavily planned and dictatorial society where some individuals were above the law and others were effectively without any rights.

He saw the system of his time as corrupt and inefficient--a massive and wanton snowjob that enriched the few at the expense of the many.

He even anticipated the influence of special interests, writing that:

"People of the same trade seldom meet together even for merriment and diversion, but the conversation ends in a conspiracy against the public or some contrivance to raise prices."

The two greatest misrepresentations (uhh... outright lies) of the modern liberal/progressive movement are:

- Those who favor an Adam Smith approach to economics seek a law of the jungle society where the strong devour the weak without constraint, and…

- Adherence to Keynesian macroeconomic theory can eliminate the normal ups and downs of the business cycle.

Rather than leveling the cycles the present economic crisis is the result of the massive doses of Keynesianism our government has given us for decades. John Maynard Keynes did not trust the market economy therefore he called for central management of the economy by governments and central banks.

According to Keynes, since spending and consumption drive an economy the more that is spent the better. Smith, on the other hand, recognized the distinction between productive and nonproductive consumption.

It seems axiomatic that productive consumption is an agent of economic growth while nonproductive consumption--paid for with money fabricated out of thin air--leads to economic impoverishment, but this fact is lost on today’s generation of economic experts, including Nobel laureates.

In my opinion the strongest reason for leaving the allocation of effort and reward to the invisible hand is that when it misappropriates goods it is usually on a small scale. Centralized methods of allocating goods are more prone to corruption and waste. More importantly, when centralized planning succeeds it succeeds modestly and when it fails, it fails on a massive scale.

Smith wrote about the spending of other people's money this way:

"It is the highest impertinence and presumption, therefore, in kings and ministers to pretend to watch over the economy of private people, and to restrain their expense...They are themselves always, and without exception, the greatest spendthrifts in the society."

In place of kings and ministers substitute presidents, committee chairs, university professors and columnists… most especially columnists who are also university professors.

I don't blame the NAHB. They were advocating for their constituents. Where were our elected officials? Where was the adversarial press? Yes, there were some in 2004/2005 who wrote of the 18-year housing cycle and warned that the next bust could be deeper and longer than any in recent memory, but you really had to dig deep to find them.


Tedd Benson said...

It would be absurd to get into a tit-for-tat about what Adam Smith meant for his time or contemplated for the the future. Still, I will stick to my presumption that he couldn't imagine the effects of the perfect storm of greed we are witnessing.

You nearly make my point again when you say this about Adam Smith's philosophy:

He made it very clear that considerable structure was needed before the invisible hand of the market could work efficiently.

For example, property rights must be strong, and there must be widespread adherence to moral norms, such as prohibitions against theft and misrepresentation.

He understood that "considerable structure was needed," but "widespread adherence to moral norms" is not structure, it's an assumption about how people will behave in their social and economic relationships. He suggests that there will be a natural amelioration of greed and self-interest as one learns that the common good is a critical aspect of one's own self-interest. If this no longer happens in a natural way, it is fair to assume that "structure is needed."

We also have to remember that Adam Smith's influences and references involved much, much more physical labor and human contact than trade relationships do these days. In their barter-oriented economy, people learned that their personal gains were greatly dependent on their trade and interactions with others. Too much taking would be inherently self-defeating.

I don't think Smith had any conception of the, something-for-nothing mentality that is all too common now. It's a malaise that has infected all social strata and all economic sectors, from the hedge fund managers to minimum wage service employees. Free wealth is alluring, but it's becoming obvious that it's a nasty trap: a pot of gold on a sinkhole.

I also don't think this is anything like a normal "boom/bust cycle." I've built my business on an understanding of seasons and cycles. I know that winters come with regularity as do economic downturns. We therefore studiously avoid growth in response to what we see in the summer months or boom times. These ebbs and flows are natural and healthy and it is foolish to fight against them in an attempt to make things always good for our particular industry. Thus, my analogy of the ski industry possibly wanting "snow in July."

This is one of the reasons I blame the NAHB. If they were advocating for their constituents, they failed quite badly. They know about ebbs and flows in the housing industry. They study it and have the, numbers, graphs and charts going back decades to reflect on as a reminder. They also knew that the sub-prime type loans were a big problem. Yet they did nothing. Their knowledge and expertise also comes with responsibility, much like medical doctors. It's as if they looked at the effects of a growth hormone, saw a cancer starting to grow, but simply ignored it, perhaps hoping the growth would outpace the disease. Or...something.

This massive economic tragedy isn't a part of any cycle we should accept. To the dismay of many, it turns out we can't trust ourselves. Left to our unfettered inclinations, our penchant for free wealth leads us over even the cliffs we can see. We apparently need a hand to stop this insanity, and to be effective, it most certainly won't be invisible.

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