Modeling Adam Smith's Analysis of the Very Severe, Negative Impacts of 'Projectors, Imprudent Risk Takers and Prodigals' on the Macro Economy in the Wealth of Nations Using a Modified Lotka-Volterra Non Linear Coupled Model of Differential Equations

Abstract

Adam Smith, based on his knowledge of issues originally discussed by Plato (Socrates) and Aristotle, which were related to his own knowledge of how the Tulip Bubble, Mississippi Bubble and South Seas Bubble were created, recognized that problems of economic downturns, inflation and deflation could be directly traced to the economic behavior of three categories of economic decision maker, all of whom were members of the upper income class in an economic state. Adam Smith categorized these three types of economic decision makers as “projectors, imprudent risk takers and prodigals.” Essentially, all three types of economic decision makers in these categories attempted to make profits (money) without the production of any physical good or service. Such individuals attempted to use other people’s money, by leveraging their debt position to obtain bank loans, in order to manipulate the financial titles to physical assets so as to increase the value of the financial asset, irrespective of any increase in the actual underlying value physical asset. Bankers are particularly attracted to such economic decision makers plans because of the possibility of making very quick, short term profits. Any potential long term losses are simply ignored. Following Aristotle’s very advanced understanding of how money use or misuse can positively or negatively impact the macro economy, the goal of projectors, imprudent risk takers and prodigals is not C-M-C’, but M-C-M’ or M-M’. The latter two types of money use are purely speculative in nature. Smith concluded that these categories of individuals should not receive any access to bank loans since the long run results usually led to bank failure with resulting highly negative outcomes and impacts on the macro economy. Smith then contrasts these types of economic agents with individuals he terms the “sober” people. The “sober” people are middle class, small business owners who desire to obtain bank loans in order to expand their existing business and increase their access to needed resources to make and sell more products. These types of individual are using money in the manner, again pointed out by Aristotle, as being C-M-C’, to increase the amount of physical producer and consumer goods they could make in the future. Smith concluded that the great majority of bank credit and loans should be skewed toward these individuals, since this would lead to real economic growth, as opposed to the speculative, purely financial booms and busts engineered by, for instance, projectors such as John Law, Richard Cantillon or Andrew Dexter, Jr. early in the 18th and 19th Centuries. Smith conceived of the central bank as being independent of the private banking industry and the government. It could then enforce a policy of refusing to let private banks make loans to “projectors, imprudent risk takers and prodigals”, while simultaneously encouraging the granting of bank loans to the “sober” people. The contrast between a Mitt Romney type of economy ,where the “projectors, imprudent risk takers and prodigals” are able to get bank financing, which they employ for use as speculative finance (M-M’), is contrasted with a George Romney type of economy dominated by the “sober” people, where they employ the C-M-C’ approach to the creation or real, physical wealth. A nonlinear, coupled, Volterra model will illustrate mathematically precisely where the problems lie and what needs to be done to prevent future speculative collapse in the financial markets based on Adam Smith’s path breaking analysis in the Wealth of Nations in 1776. This will require that the central bank monitor private banks so as to prevent them from issuing credit/bank loans to the Mitt Romney type of speculative, stock market financier - promoter, while requiring them to issue loans/credit to the George Romney type of sober business man or women. A mathematical model is used to illustrate Smith’s view of how banking policy can create economic growth while avoiding the problems of speculative finance that leads to bubbles and crashes, which are the primary cause of the problems of inflation and deflation as banker financed, speculative bubbles are created and then collapse over time.