Your Free Market Is Rigged

Your Free Market Is Rigged

Most free-market advocates assert that the unregulated pursuit of individual self-interest promotes everyone’s well-being. If each of us focuses on maximizing our economic returns as producers and consumers, the “invisible hand” will ensure that everyone is as well-off as they can possibly be.

That idea is attributed to 18th-century Scottish economist Adam Smith’s The Wealth of Nations. But it’s only part of what Smith actually said.

Most people who speak confidently of Smith’s ideas haven’t read his works. They latch on to things they’ve heard attributed to Smith that appeal to their self-interest, and ignore the rest — usually because whoever they heard quote Smith didn’t mention those bits in the first place.

For example, Smith once said 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 in some contrivance to raise prices.” Ouch.

I was reminded of this by a little-noticed report from late last year by Bank of America (BofA) investment strategists. It illustrates nicely the critical difference between free markets and rigged markets … something Adam Smith understood very well.

Revisiting Adam Smith

I read The Wealth of Nations as a graduate student. Smith’s “individual self-interest” refers to economic “agents” — not necessarily individual people. A company is an economic agent; that company’s CEO isn’t. The former operates in a competitive marketplace, whilst the latter operates within the closed system of the company, accountable only to its internal rules and general laws.


That makes sense. My “individual self-interest” might be best served by becoming a thief or fraudster, but that would hardly contribute to overall social welfare. Likewise, a company as a whole always wants to maximize growth and profit, but the CEO might not — depending on the company’s internal rules. Even in a free market, there’s a difference between what’s good for the individual and what’s good for everyone.

That’s why Smith supported government intervention when individuals act in ways that “endanger the security of the whole society.” For example, Smith advocated laws to stop banks of his day from using risky financial instruments that maximized individual return but caused systemic instability. He also called for regulation of joint-stock companies, partnerships and so on, because he understood the difference between the interests of companies as economic agents and the interests of the individuals within them.

Quantitative Easing: Cui Bono?

There have been 606 global interest-rate cuts and $12.4 trillion in central bank asset purchases since the fourth quarter of 2008. This made borrowing money extraordinarily cheap — for those who can actually get loans. These are government acts of market intervention … for some reason, Smith’s “invisible hand” couldn’t be trusted to fix things in this case. Here are some of the results, cited by the BofA report:

  • For every job created in the U.S. this decade, traded companies spent $296,000 buying back their own stock to push up their share price and maximize stock options held by senior executives. This came at the expense of investment in plant and equipment to produce goods and services and grow market share. There’s no better illustration of the results of the pursuit of personal self-interest over the common good.
  • Partly because of this orgy of speculative financial engineering, an investment of $100 in a portfolio of stocks and bonds since Q4 2008 would now be worth $205. Over the same time, a wage of $100 has risen to just $114. Cheap money has pumped up asset prices, not wages. Look no further for an explanation of soaring inequality.
  • Quantitative Easing (QE) has produced the sort of liquidity that loves Wall Street, but hates Main Street. For every $100 U.S. venture capital and private equity funds raised at the start of 2010, they are now raising $275. But for every $100 of U.S. mortgage credit extended then, just $61 was extended in June 2015. Over the same period, U.S. prime commercial real-estate values have gained 168%, compared to 16% for residential property.

The lesson: Thanks to QE, there’s plenty of money available to speculate on assets … but for jobs and housing, not so much. As BofA put it:

Zero rates and asset purchases of central banks have, thus far, proved much more favorable to Wall Street, capitalists, shadow banks, ‘unicorns,’ and so on than it has for Main Street, workers, savers, retail banks and the jobs market.


It’s important to understand the context within which Adam Smith wrote. At the time, the landowning aristocracy dominated the British government. They made their money from agriculture, and looked on manufacturing and finance as dirty upstart professions. Smith assumed that such a government could be trusted to regulate the emerging market economy because it was detached from it. It wasn’t the sort of “bourgeois” democracy we have today, where bankers and corporations have lawmakers’ ears — and a few other bits of them as well.

Smith would be appalled at the central banks of our day, where private bankers regulate the same financial markets where they make their fortunes. He would immediately recognize that the “public policy” pursued by such central banks — QE — would be designed to benefit the banking elite, not the rest of us. He would know that even before he saw the statistics I just quoted, because it flows directly from the logic of his economic model, where individual self-interest doesn’t always produce optimal results for all.

I also know what Adam Smith would do with his investments in 2016. He’d look for stocks that don’t depend on artificial financial tricks for their value. He’d want to invest in genuine competitive enterprises producing goods and services for growing markets.

So do I. That’s why, starting soon, I’m going to be offering an investment service that reflects Adam Smith’s view of the world. It’s already performed better than the markets for the entire period since 2008. It can do the same for you.

Kind regards,

Ted Bauman
Offshore and Asset Protection Editor