It's time for capitalism to grow up

Is free-market capitalism, as historically practiced in the United States, still alive, or is it now just a footnote in our economic history?

Americans have traditionally believed that the invisible hand of the market means that capitalism will benefit all of us without requiring any oversight. However, Adam Smith never said that there would be, nor did he believe in, a magically benevolent market that operated for the benefit of all without any checks and balances.

He railed against monopolies and the political influence that accompanies economic power, worrying about the encroachment of government on economic activity; but his concerns were directed at least as much toward smaller institutions as to the national government, since these institutions were part and parcel of eighteenth-century government.

Smith was sometimes tolerant of government intervention, especially when the object is to reduce poverty.

“When the regulation, therefore, is in support of the workman,” Smith passionately argued, “it is always just and equitable; but it is sometimes otherwise when in favor of the masters.” He saw a tacit conspiracy on the part of employers to keep wages as low as possible.

While Adam Smith may have been the father of free-market economics, he argued that bank regulation was as necessary as fire codes on urban buildings and called for a ban on high-risk, high-interest lending—the eighteenth century version of the subprime loan.

Rama Cont, one of the leaders of the new science of financial modeling, recently asserted his belief that Adam Smith was wrong about the “Invisible Hand.” Specifically, investors in financial markets rationally pursuing individual profit can produce outcomes that are bad for almost everyone.

Simple forecasts can also be mistaken, argues Cont, if they fail to account for the actions of market participants themselves. Investor strategies can influence prices, which in turn influence future strategies in a feedback loop that can cause considerable instability.

Cont recalls the severe stock market crash of October 1987, which seemed to strike out of the blue, since nothing significant was happening in the real economy.

Subsequent research, though, blamed the crash in part on a new investment strategy, “portfolio insurance,” which a large number of fund managers had simultaneously adopted. Based on the famous Black-Scholes options-pricing model, a quantitative mathematical formula that is used to price stock options, this strategy recommended that fund managers reduce their risks by automatically selling shares whenever their values fell. But the approach didn’t take into account what would happen if many investors followed it simultaneously; a massive sell-off that could send the market plummeting.

The 1987 crash was thus not provoked by events in the real economy but by a supposedly smart risk-management strategy— and the current downturn also derives at least partly from a global craze for a seemingly foolproof financial innovation.

Investors in financial markets rationally pursuing individual profit, can produce outcomes that are globally negative. Doesn’t that contradict classical economic theory? “Both theory and empirical facts do tend to show that,” says Cont. “On the financial markets, the ‘Invisible Hand’ does not always lead to welfare-improving general outcomes.”

Hence, free-market capitalism is not dead, but it is unclear whether there is any better alternative. In fact, I strongly believe that capitalism has to grow up and become less naïve, relying less on a blind faith in the invisible hand and more on an understanding of human nature, including insights from the field of behavioral economics. It must include sophisticated checks and balances to make sure that the system is not gamed, instead of childish ideas about the inherent stability of the market.

In 2009, President Obama compared American Exceptionalism to “British exceptionalism, and the Greeks in Greek exceptionalism.”

That is wrong.

The British built an empire that ruled the world based on the might of their navy. The Greeks built a civilization based on the power of their intellect. They were both unique, even great; but they were not exceptional.

Exceptional is a nation that can rise in less than 200 years to become the strongest, most dynamic economy in history; a nation born not of ancient tribes but of the brightest, the best, and the hardest working the rest of the world’s nations had to offer. That is what makes America “exceptional.” There is no other nation like this nation on Earth. There never has been and there probably never will be again.

It is not too late to restore the global standing of America and stop the systematic pilfering of the American people. We have the resources and the capital to restart the engines of our economy and put Americans back to work. We need resolve and courage.

The time has come for a regime change in America. If we are going to save ourselves, we must reclaim and overhaul our government.

We must have a second American Revolution. We must reclaim our economic liberty.

The best way to protect yourself and your family in this time of uncertainty is to create wealth for yourself. Don’t believe the media doomdayers or financial pundits who tell you that it cannot be done today.

It can.

America still provides many opportunities for an individual to create real, significant wealth. Despite the best efforts of the anti-capitalists who have taken over the national debate, you can still get rich in America. The question is for how much longer you will be able to do that and how much of your earnings you will be allowed to keep. It takes a lot of effort and some time, but you can create your own safety net. And yes, you can join the ranks of the rich.

Ziad Abdelnour is president and CEO of Blackhawk Partners, Inc, founder & chairman of the Financial Policy Council and the author of "Economic Warfare: Secrets of Wealth Creation In the Age of Welfare Politics" (Wiley, 2011).