The Health of Nations

If the 18th century Scottish economist Adam Smith were around today, I have no doubt he would have much to say regarding the state of the world economy. The degree to which governments worldwide are influencing markets has surpassed what even modern economists thought was wise just three years ago. Setting CEO pay, influencing hiring and firing of corporate leaders, and issuing debt to fund government investment in public companies is just the tip of the iceberg. I suspect editors of Merriam-Webster's Dictionary will be struggling to define 'free market' in the next revision.

Many governments, ours included, are trying to design a way out of the latest recession. They are crafting complex policies and interjecting in the markets to 'correct' problems that have plagued our economy for years: too much spending, too much leverage, and not enough savings.

But these are challenges that many countries have as well. Witness the debt issues in Greece, Portugal and Spain that are driving stocks down today, just days after the Obama Administration released a budget projecting a $1.6 trillion deficit for 2010. That figure will come to 10.6% of GDP, the worst in modern time. So the question must be asked: have government policies become the Invisible Hand that now guides society?

The theory behind the Invisible Hand that Adam Smith spoke of (and the one I prefer) is that if consumers and merchants buy and sell whatever they want and at whatever price they can get, then markets will efficiently divide resources and everyone will benefit. Smith felt government intervention just messed things up. Basically, by acting through their own self-interest, people allocate capital to those areas with the greatest returns.

So what does this have to do with small cap investing you ask? Everything.

Thankfully, we still have some semblance of a free market when it comes to investing in stocks. So investors can freely invest in both U.S. and foreign stocks. And while there are many profit opportunities in U.S. based small-cap stocks, I see tremendous potential in emerging market stocks for 2010.

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