Following up on my blog Why we need the rich. at http://blackhawkpartners.com/Blog.aspx?id=42 the big question nowadays becomes:
Is free market capitalism actually practiced in the United States today still alive or is it now just a product of our imagination?
Lets analyze the facts and see for ourselves.
Americans have traditionally believed that the “invisible hand of the market” means that capitalism will benefit us all without requiring any oversight. However, the man (i.e. Adam Smith) who came up with the idea of the invisible hand did not believe in a magically benevolent market which operates for the benefit of all without any checks and balances:
Smith railed against monopolies and the political influence that accompanies economic power…
Smith worried about the encroachment of government on economic activity, but his concerns were directed at least as much toward parish councils, church wardens, big corporations, guilds and religious institutions as to the national government; these institutions were part and parcel of 18th-century government…
Smith was sometimes tolerant of government intervention, ‘especially when the object is to reduce poverty. Smith passionately argued, ”When the regulation, therefore, is in support of the workman, it is always just and equitable; but it is sometimes otherwise when in favor of the masters.” He saw a tacit conspiracy on the part of employers ”always and everywhere” to keep wages as low as possible.
Yes.Adam Smith may have been the father of free-market economics, but he argued that bank regulation was as necessary as fire codes on urban buildings, and called for a ban on high-risk, high-interest lending, the 18th-century version of subprime.
Now comes out one of the leaders of the new science of financial modeling – Rama Cont who points out that Adam Smith was wrong about the “Invisible Hand”. Specifically, investors in financial markets rationally pursuing individual profit can produce outcomes that are bad for almost everyone.
Simple forecasts can also be mistaken if they fail to account for the actions of market participants themselves: investor strategies can influence prices, which in turn influence future strategies in a feedback loop that can cause considerable instability.
Cont recalls the severe stock-market crash of October 1987, which seemed to strike out of the blue, since nothing significant was happening in the real economy. Subsequent research, though, blamed the crash in part on a new investment strategy, portfolio insurance, which a large number of fund managers had simultaneously adopted.
Based on the famous Black-Scholes options-pricing model, this strategy recommended that fund managers reduce their risks by automatically selling shares whenever their values fell. But the approach didnt take into account what would happen if many investors followed it simultaneously: a massive sell-off that could send the market plummeting.
The 1987 crash was thus not provoked by events in the real economy but by a supposedly smart risk-management strategyand the current downturn, of course, also derives at least partly from a global craze for a seemingly foolproof financial innovation…
Find more information : http://www.financialpolicycouncil.org/BlogDetails.aspx?id=5
http://www.financialpolicycouncil.org