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Adam Smith was right about that invisible hand, you know

But just not in the way you think

Talk to the invisible hand

It's entirely the opposite of stating that a pure free market benefits everyone best. He's actually making a behavioural economics point (along the lines of “nowt so strange as folk”) that an imperfection in the idea of homo economicus as a rational calculating machine benefits that domestic economy.

Of course, that all foreigners are also prey to the same “fault” means that it evens out to some extent, but still. The actual point being made is the exact opposite of what the phrase is generally thought to mean today.

He's not at all describing the glories of the free market, how she'll be right when left alone; he's describing a quirk of human beings which is, rationally, an imperfection of such free markets.

Now, if Smith were wrong in this then we would expect everyone's investment portfolios to be perfectly balanced (risk adjusted that is) across the global markets.

It's no more difficult to buy a fund investing overseas than it is one investing at home after all. It's true that we wouldn't expect a perfect equality because that rational investor would have an eye on currency mismatches.

If I expect my future consumption is going to be denominated in sterling then I'm going to have a preference for sterling returns to any investments I make from my savings. Same for Canadian dollars, US dollars and so on. But we'd expect a great deal more of Canadian and UK investments to be in the US stock market for example. A great deal more than we do see.

And if Smith were right then we'd see something like what we do see. We'd see people investing by preference in their domestic markets. Over and above the fact that risk adjusted returns are higher abroad, or even if those have been arbitraged away in our modern world, we would see exactly what we do see.

People preferentially invest at home in their domestic markets. And by doing so, as if guided by an invisible hand, they promote an end which was no part of his intention.

Thus, Smith is in fact right about the invisible hand, in all three of his mentions. It's just that at no time at all what he using it as is a metaphor (or simile? Should I look this up?) for the perfection of markets nor the joys of laissez faire.

Quite the contrary in the economics book of his, he was making the point that we are not all the rational calculating machines that laissez faire tries to assume that we are.

As so often Smith is therefore correct. It's just that Smith isn't quite making the point that a couple of centuries of interpreters and promoters have him to be making. ®

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