As PJ O’Rourke points out in Don’t Vote It Just Encourages the Bastards, a high rate of profits not always a harbinger of economic good news:
[Adam] Smith spotted the exact cause of the 2008 financial meltdown not just before it happened but 232 years before, probably a record for advice to sell short. In Book II, chapter 1 of The Wealth of Nations, Smith wrote, “A dwelling-house, as such, contributes nothing to the revenue of its inhabitant… If it is to be let to a tenant for rent, as the house itself can produce nothing, the tenant must always pay the rent out of some other revenue.” Smith therefore concluded that, although a house can make money for its owner if it’s rented, “the revenue of the whole body of the people can never be in the smallest degree increased by it.” Bingo. Subprime mortgage collapse.
Smith was familiar with rampant speculation, or “overtrading,” as he politely called it. The Mississippi Scheme and the South Sea Bubble had both collapsed in 1720, three years before his birth. In 1772, while Smith was writing The Wealth of Nations, a bank run occurred in Scotland. Only three of Edinburgh’s thirty private banks survived. The reaction of the Scottish overtraders to the ensuing credit freeze sounds familiar. “The banks, they seem to have thought,” Smith said, “were in honor bound to supply the deficiency, and to supply them with all the capital which they wanted to trade with.”
According to Smith, the phenomenon of speculative excess has less to do with free markets than with high profits. “When the profits of trade happen to be greater than ordinary,” he said, “overtrading becomes a general error.” And rate of profit, Smith claimed, “is always highest in the countries that are going fastest to ruin.”
Judging by how America invested in 2007 and voted in 2008 that would be us.
In this vein, it may be pertinent to note that both corporate profits and their stock prices reached record highs in 2013. Both are actually higher than the previous peak in 2007.
