Howdy, gang! I hope that everyone now has a better understanding of (and the difference between) fiscal and monetary policy, because we’re going forge ahead and take a peek behind the curtain this week. The peek is completely innocent, I assure you. The curtain is more of a veil that’s used against us by individuals in high (and low) places of power and influence, as well as by ourselves through historical and economic obliviousness (it’s kind of normal not to have a thriving knowledge base about economics, so don’t beat yourself up if you start feeling like you should already know most of this information).

The stuff behind the curtain has always been there, but it changes and alters form every now and then in order to remain relevant and maintain political and economic “sex appeal.” I’m talking about economic theory! More specifically, the significant economic models of Adam Smith (1723 – 1790) and John Maynard Keynes (1883 – 1946) as it relates to shaping modern American economic policy. It’s important to know what we were, what we are, and what we might end up becoming. So, let’s sneak up to the curtain and take a gander!

History is sprinkled with the names of individuals who have made dramatic impacts and developments in general economic theory. Milton Friedman, F.A. Hayek, John F. Nash (the film “A Beautiful Mind” was based on Nash), Thomas Sowell and even Karl Marx are names that I would never intentionally omit from a serious debate on economics, but they essentially added to (or subtracted from) the ideas of Adam Smith. The impact of Keynes’ philosophy has had a lot of staying power but it was Smith’s ideas that sparked the flame. So, let’s start with the person who came first and shook the world with his wisdom: Adam Smith.

Adam Smith is the father of what we call: Classical Economics, which is still taught in textbooks (history books) across the nation…and the world (if you’re lucky enough to live in a country that doesn’t sensor certain things). It’s the economic theory that provided insight for our Founding Fathers when determining the blueprints for the amount of central planning allowed in our nation’s emerging economy and government. As simply as I can explain, Classical Economics is based on the premise that a rapidly adjusting market ensures equilibrium (where supply meets demand and price), stability and prosperity on its own.

Smith placed great emphasis on the ability of markets to adjust to economic shocks and placed a lot of significance on the idea known as laissez faire, which was an economic theory originating from France (meaning, “let it be”) during the mid to late 18 century. The dogma of laissez faire advocates for absolute minimal government intervention with a belief that the market will eventually achieve the most efficient outcome and that government regulations distort the reality of the market, thus leading to inefficiency. Today, we define those inefficiencies as economic bubbles. We’re all painfully aware of economic bubbles because of what happened to our economy in 2008 – 2009. We also know that economic bubbles have a tendency to BURST!

Smith often mentioned the “invisible hand” of the market/economy, which he referenced as the tool by which markets would balance out if it experienced periods of tumult. The “invisible hand” he’s referring to is us! People! Human beings! Our actions and transactions yields a certain reasonable response during unexpected maneuverings of the economy and given enough time will either allow the market to adjust or allow us to readjust to norms. Smith argued against government intervention in the economy because he saw fiscal (we can now add monetary) stimulus policies as something that would only restrict the market’s ability to form a new equilibrium. These policies artificially boost incomes, for example, at times of crisis, thus temporarily supporting an increasingly unstable economic situation. By the way, these types of fiscal policies come at a great cost to the taxpayer and usually only store up even more problems for a future date! I personally believe that “policy” can’t fool individuals (indefinitely) into a response primarily because even a loose expectation of rational behavior is still based on the idea that human beings will always act rationally. We know better than to expect rational behavior all the time, every time.

I like the idea…the premise…of classical economics as outlined by Adam Smith. It makes sense to me and I’m usually a fan of any set of ideals that keeps the government as far away from things as possible. I may be polemical by nature, but I try to keep an open mind about things to allow myself the opportunity to learn and absorb additional information. While the theory of laissez faire makes complete economic sense to me, it’s not the ideal set of standards for everything. Imagine, for a moment, that you adopted a parenting method based on laissez faire principles. You and your spouse simply decided to “let it be” when it came to raising your children because you felt strongly that your kids would naturally find their way back to “equilibrium” after adjusting for periods of hullabaloo. Have you gasped at the thought, yet? Well, I certainly did! There are obvious situations where intervention is required, but when is enough? How far should those interventions go…and for how long? Welcome to the economic school of thought brought to us by John Maynard Keynes….which we will tackle next week!

Be good. Do good. Know good.

~Kleiny

@KnowGoodThings