Monday, August 11, 2008

Caveat Hedge Fund Advisors

Waving a false prospectus is no defence against falling flat on your face. I spot one such ‘unintended consequence’ about to happen if investors plunge into the ideas of “ a New York Hedge Fund Roundtable”, the goal of which “is to self-enforce otherwise voluntary and "weak" hedge fund practices”.

It comes via an article by Susan Mangiero, “ A Seal of Approval for Hedge Funds”. HERE:

"Goldstein's support of the free market to act as the ultimate enforcer is laudable, especially at a time when global regulators are far from silent about the need for more stringent rules. Will Adam Smith's "invisible hand" really work? Let's hope so. As this blogger has written many times before, regulations no doubt change the way market participants behave, often leading to the "Law of Unintended Consequences."

Goldstein strongly believes in the power of collective self-policing.”

For a start there is no ‘invisible hand’ to ‘work’ or ‘fail to work’. It was a metaphor, not a “theory” and was used to lighten up an otherwise strong discussion on the effects of risk aversion in the behaviour of 18th century merchants contemplating the higher risks (and higher profits) of engaging in trade with the British colonies in North America by crossing and re-crossing the north Atlantic versus investing in local trade with people they knew and a legal system they were surer of.

You wouldn’t guess this by following the editor’s note whose partial quotation from Wealth Of Nations (Book IV) is generalised as if he was talking about all trade among all merchants:

According to economist Adam Smith in his Wealth of Nations, "Every individual...generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention." Click for more quotes by Adam Smith". [Note that last invitation as if 'more quotes from Adam Smith' was a substitute for actually reading him.

This gives a wholly different slant to the only occasion in which Smith mentions the invisible hand metaphor in Wealth Of Nations – in his Books I and II, which are about markets, and invisible entities are not mentioned at all.

The editor adds another quotation from Book I that has nothing at all to do with his sole use of the metaphor over 400 pages later, crowned by the nonsence that the metaphor was Adam Smith’s ‘theory’:

According to the Library of Economics and Liberty, the "Law of Unintended Consequences" states that "actions of people - and especially of government - always have effects that are unanticipated or 'unintended.'" The concept is related to Adam Smith's invisible hand theory, wherein the famous economist wrote, "It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own self interest."

Oh dear. And these guys and gals invest millions of other people’s money in Hedge Funds! No wonder the world money system is in a mess. If they are waiting for a metaphor to guide them and secure their money they should be warned about ‘caveat emptor and caveat vendor’.

Susan Mangiero has an impressive resume (HERE), so she isn’t naïve; her formidable talents are misinformed by her acceptance of the standard modern economics model of Adam Smith’s political economy. Given with so much at stake in money markets investment advice she should invest a little time in reading what Adam Smith said and not what others say about him.


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