[update 2017/03/18] I have since learned that John Kenneth Galbraith described all of this in The Affluent Society (abridged).
[update 2018/11/11] A weakness of this essay is that it doesn't consider the interests of those outside of the USA, who also cannot be ignored indefinitely.
It is September 2011 and the world needs a reminder about the invisible hand.
Capitalists such as Milton Friedman tell us that the point of money is not to separate the "haves" from the "have nots", but rather to provide an efficient means of information flow. Only a consumer is competent to assess his own needs, and only a producer is competent to assess the scarcity in supply. Together, millions of consumers and producers working together communicate about the relationship between supply and demand using money.
We call this communication "the invisible hand", because it defies complete analysis. Billions of people with their own agendas individually make their daily decisions, and the market conveys this information to various factories. If a factory makes a mistake when anticipating demand and builds too many widgets, it is the invisible hand that will tell them to cut back. The hand will operate through various techniques: the rent for a warehouse to hold the excess capacity; the decreasing price of an over-supplied commodity; a competitor opening a factory that builds the same widget; and so on. It is because it is so complicated and unpredictable that we call it "invisible". But the hand is always there, steering all of the rudders in our economy.
One can imagine a panel of bureaucratic experts examining the needs of the people and sending work orders to the various factories to satisfy those needs (as in a command economy). Minor errors in their estimates -- like a failure to anticipate a fad -- will cause such a system to be inefficient. The actual realities of supply and demand will assert themselves, and the system will either fail or grow to include a black market.
So the free market economy is like unto a massive distributed computer network that is constantly optimizing variables among millions of differential equations. And the best thing is that no one needs to know anything about the equations, we just need to agree to participate in the information flow by spending money. The rest sorts itself out.
The invisible hand works. Very well. And in fact, it is god's way: there is no alternative. The invisible hand is not dependent on money to operate. The information flows in the end either way, whether it is in a black market, religious charities, or a political revolution. Communist revolution is a RESULT of the invisible hand, not an action against it.
If you own a pencil factory, you use money to decide how many pencils to build. So ultimately, you care who has money. You can only service those with money. In today's America, the top 1% has 43% of the wealth, and the top 20% has 93% [cite]. So if you run a widget factory, 80% of the populace is totally irrelevant to you. Nothing they can think or want can possibly matter -- if you want money, you have to get it from the people that have it.
So instead of having millions of independent consumers and producers communicating through money, we are increasingly in a situation where a very small group of people controls all the communication. The information conveyed in our economy has become the mind-fruit of an elite group.
This is the core cause of an economic depression. In order for a deep supply chain to operate, the communication enabled by money is essential. But today we have people who want widgets, and we have people who want to work making widgets. Nothing tangible has changed. But the communication between the two is choked. The factory believes it only can make money if it makes enough widgets to service the richest 20% of the population and as a result it is laying off its employees. This exacerbates the problem, as now its own employees join the large group of people whose demand is not communicated through the markets.
If you have a billion dollars, what is your desire? You might want a Learjet, which would help communicate to the factory owners that it is better to own a factory building luxury aircraft than to own a factory building affordable food. But that's really a best case, and not what happens in reality.
What billionaires ACTUALLY want is two-fold: more money, and the guarantee of money in the future. A billionaire gets that way by having an insatiable competitive need to accumulate. They communicate this need through the market, as all needs are communicated.
So they invest in stock markets and growing companies, hoping to make more money in the process. The invisible hand communicates to them that this is the most valuable labor simply by virtue of the fact that our government taxes investment income at a much much lower rate than it taxes employment income. They receive the signal that there is no reason to stop at a million dollars profit, or even a billion dollars profit. Especially when there is a fraud-generated bubble (such as the recent multifaceted securities rating scandal), money makes more money so easily that they are told (forced by the hand, really) to invest in the most profitable corners of the market (the bubble) and ignore the rest.
But what happens if that changes? What happens if invested money stops giving phenomenal returns, and instead drops merely to good returns? If your career has been exploiting the gigantic growth of a bubble, and you find that that is no longer possible...if you wake up one day to discover that the billions you thought you made might not even reallity exist, how would you react?
You'd panic.
You'd take your money out of volatile stock markets, and you'd invest it in the most reliable positions you can imagine. Suddenly your expectation switches from making astronomical profits to simply trying to keep the money you imagine you have aleady earned. There are three obvious reliable investments: cash money, gold, and government bonds.
Cash money is actually an awful investment, because there is a huge potential for inflation. Gold tends to be pretty reliable, and you can tell that the rich people think so too because gold has shot up incredibly in recent years -- the invisible hand communicating this panic to us. But gold is nothing compared to government bonds. How does the invisible hand tell us that there is demand for government bonds? By lowering the rates. And bond rates are really really low right now. Fantastically low. The government is basically getting to borrow money at 0% interest.
At some points over the last couple years, there have been days when the stock market has swung 100s of points and simultaneously gold went up. This is not the wisdom of America -- most Americans aren't even involved. It is the result of a very small number of investors making the decision to remove billions of dollars from the market at once and stuff it under their pillows. These people don't represent the invisible hand -- their wisdom is no more than that of a small bureaucracy. The invisible hand is the result of all of the people working together, but this is just a small group of investment bankers and rich families ("oligarchs"), literally telling the factories to stop making widgets, even while the vast unrepresented crowd still desires widgets.
In order for a free market based on the flow of money to efficiently convey information, the money must not be concentrated in a tiny subset of the population. The money is so concentrated today, and today the free market is not operating efficiently.
We can resolve this by injecting new money into the system (perhaps deficit spending or printing money). If that new money winds up in the pockets of the wealthiest, then nothing changes and the communication is still broken. But if that new money winds up in the hands of people who have no current economic voice, it will make it more efficient for our markets to communicate the supply and demand represented by these individuals.
We can also resolve this situation by taking money from the rich people (perhaps taxation or inflation). You do not even have to give it to the poor, though that would help. Remember, capitalism is not about wealth distribution, it is about INFORMATION distribution. The signal is the needs and abilities of the multitudes. The noise is the whims (and panic) of billionaires. If you take away the noise, then the signal can be discerned again, even if it is very small.
Or we can resolve this situation by cutting taxes on the rich and cutting spending on the poor. Without any way to convey their needs (such as food) to the producers, they will simply disappear in a puff of logic and we will have rid ourselves of a lot of useless cruft, leaving only the wealthy. The economy of plenty that god has promised us will have arrived, and it is reserved just for us!!!
Sadly no.
The invisible hand is an expression of the wisdom of the crowd. It is not the result of the money, money is just a way to communicate its intentions. If you deprive money from the crowd, its wisdom will have to make itself heard through less efficient (and more brutal) methods. I'm talking about class warfare, revolution, petty theft and fraud, slums, vagrancy, counter-culture, mass incarceration.
You can't fight the invisible hand forever. Friedman was describing no less than god's will: the ever-changing network of extant feedback systems that regulate all life on our planet.
Remember when Apple's board decided to ditch Steve Jobs at his prime? Remember when your neighbor lost his house because he used it as collateral to start a restaurant? Ever see something like this?
"We know what's coming. Government continues to borrow-and-spend, then taxpayers get stuck with a bill. That kills investment and job creation."
--Don Hickman, founder of ProsLink, a government contractor.
Ever watch all the biggest banks in your country invest in loans that were certainly not going to be repaid because they were "tricked into it"? Were you paying attention when all of the nation's largest insurance companies decided to take out policies on eachother so that if one of them fails, they all fail?
Individual business owners are often stupid. They don't seem to know anything about why they are succeeding or what the future effects of their decisions will be. It's as if together they are trying everything all at once hoping that the invisible hand will lift some of them out of failure just by luck.
Which is exactly what they're doing, and exactly what capitalist theory suggests they should be doing.
Remember this when your tea party congressman says, "I asked a businessman how to make jobs and he said we have to stop spending so much money." The businessman is not the invisible hand, he is merely a visible fraction of it. He is one human making one set of wild guesses about what the future will bring.
The invisible hand is the result of the interactions of the multitudes. And it is just that -- invisible. You can see its side effects, but you can't ask it in for an interview. So when you want to understand the invisible hand, you have to look at things such as trends over time and historical crises. Indicators of the masses.
The invisible hand does not favor the nation that cuts spending at a time of recession. This is a well-known experience in our cultural heritage, but most of us individually only know about it from history books. C'est la vie.
The hand is, again, playing the role of god. The invisible hand is ultimately as unknowable to us as god is. No scientist can build a complete theory of it, no computer can predict it. It is an example of irreducible complexity. It is a series of small and simple interactions combining to have the strength to build a civilization from nothing. Or destroy it.