Adam Smith on the Main Cause of Recessions and Depressions: Bubbles Resulting From Bank Loans and Credit Made Available to Projectors, Imprudent Risk Takers and Prodigals

Abstract

Adam Smith recognized that there was a severe problem in all free market economies that no “Invisible Hand of the Market” could ever deal with effectively. Based on his readings of Plato (Socrates) and Aristotle, Smith explicitly identified a certain segment of upper income class individuals in The Wealth of Nations whose behavior greatly endangered the rest of society as a whole. Smith identified them specifically as Prodigals, Imprudent risk takers, and Projectors. These types of individual were described by Keynes as Wall Street speculators and rentiers in the General Theory. Marx used the term bourgeoisie to categorize them. Veblen called them Captains of Finance. Smith was very clear in The Wealth of Nations that the only solution was the proactive one that required the Government or Central Bank to prevent Prodigals, Imprudent risk takers, and Projectors from obtaining access to bank loans and credit in the first place. Smith’s solution was a version of the proverb that an ounce of prevention (credit restriction) is worth a pound of cure (bank bailouts). Without bank loans and credit, the Prodigals, Imprudent risk takers, and Projectors would be forced to rely on their own wealth to try to manipulate markets, such as land, real estate, stocks and other financial markets. This is precisely what they do not wish to do. They seek to use other people’s money to make money by financial manipulation only. Jeremy Bentham, who is the real founder of the Chicago school of economics, directly opposed Smith. Bentham believed that there was no role for government to play in the economy except the laissez faire one of “be(ing) quiet” and to “stay out of my sunlight”. Bentham desperately sought to discredit Smith’s position by redefining the term projector to mean innovator. This should not be surprising since Bentham’s fortune can be traced indirectly to the behavior of one of the greatest projector firms of all time, the British East India Company, in which he served. Bentham was thus opposed to any attempt by government at preventing the private behavior of the Prodigals, Imprudent risk takers, and Projectors from endangering the public. The problems that have surfaced since the late 1970’s in the American and world economies can be traced precisely to the same category of individual identified by Smith in 1776 in The Wealth of Nations as Prodigals, Imprudent risk takers, and Projectors.