15 February 2012

Adam Smith, proponent of financial regulation

I just saw this passage from John Cassidy's book How Markets Fail: The Logic of Economic Calamaties, and was struck by the quote of Adam Smith.

To prevent a recurrence of credit busts, Smith advocated preventing banks from issuing notes to speculative lenders. “Such regulations may, no doubt, be considered as in some respects a violation of natural liberty,” he wrote. “But these exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments, of the most free, as well as the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed.”

Alan Greenspan and other self-proclaimed descendants of Smith rarely mention his skeptical views on the banking system, which were shared by many nineteenth-century economists who otherwise maintained a favorable view of the free market. J.S. Mill traced most economic downturns to disturbances that emerged from the financial system, as did Alfred Marshall, the late-Victorian economist whose Principles of Economics replaced Mill's textbook as the standard work. Marshall said, “reckless inflations of credit” were “the chief cause of all economic malaise,” and he called for vigorous action on the part of the monetary authorities to prevent them.

The notion of financial markets as rational self-correcting mechanisms is an invention of the last forty years. Before that, most economists sympathized with Charles Mackay, the journalist and sometime colleague of Charles Dickens whose 1841 book, Extraordinary Popular Delusions and the Madness of Crowds, compared speculative manias, such as the “tulipomania” that gripped Holland in the 1630s and the South Sea bubble of 1720s London, to witch trials, millenialism, and other examples of collective insanity. The transition from Mackay's jaundiced opinion of finance to Greenspan's sunny view took a long time, and it was based, at least partially, on a misreading of the theory of the invisible hand, which Smith had never intended to be applied to finance.

Emphasis mine.

That's a nice match to my quote of Locke sounding like a Marxist ....

No comments: