Economist and uber-pundit Andrew Smithers is on a roll, having drawn attention in the financial media this week with his latest report contending that the US stock market is 40 per cent overvalued.
Smithers – who regularly opines on everything from Japan to the US stock markets and UK monetary policy – also has central bankers firmly in his sights with his new book, “Wall Street Revalued: Imperfect Markets and Inept Central Bankers”.
He argues that central banks, particularly the Fed, helped create the current recession and financial crisis with errors of policy and analysis – namely by ignoring asset prices and claiming they could not be realistically valued.
The FT’s Martin Wolf, describing Smithers in a column this week as “a man with a deep understanding of economics and a lifetime’s experience of financial markets”, sums up Wall Street Revalued thus:
The big points of the book are four: first, asset markets are only “imperfectly efficient”; second, it is possible to value markets; third, huge positive deviations from fair value — bubbles — are economically devastating, particularly if associated with credit surges and underpricing of liquidity; and, finally, central banks should try to prick such bubbles. “We must be prepared to consider the possibility that periodic mild recessions are a necessary price for avoiding major ones.” I have been unwilling to accept this view. That is no longer true.
Anybody interested in investing would understand from reading this book why, for example, the “buy and hold” strategy advocated by many pension advisers, even at the peak of the stock market bubble, was such a catastrophe, says Wolf, noting that “value matters, as Warren Buffett has said so often”.
But Smithers’ arguments have wider significance for those interested in economic policy, he adds:
If markets can be valued, it is possible to tell whether they are entering bubble territory. Moreover, we also know that the bursting of a huge bubble can be economically devastating. This is particularly true if there was an associated surge in credit.
So that is why, when Smithers – currently on a long visit to Japan – made a rare speaking appearance in at the Foreign Correspondents’ Club in Tokyo, he drew a full-house.
The first time he spoke at the club, he recalled, was about 10 years ago, on the subject of the stock market bubble. “I am here now to talk about its sad consequences”, he said.
Reiterating his line about the role of errors by central bankers, particularly the Fed under Alan Greenspan and Ben Bernanke, in bringing about the financial crisis, he reminded listeners of the “ephemeral” effect of interest rate cuts:
“This tends to push up asset prices and this stimulates the economy by discouraging savings and encouraging investment. But … [we must look at] the long term relationship between interest rates and asset prices. As we have recently seen, if asset prices get driven up too far, they fall even though interest rates are cut, so central banks lose control of the economy.”
Now, however, after their “egregious mistakes”, central banks and governments have initially at least taken the right steps, he noted. “They have thrown money at the problem”. That, however, was the easy part; the hard bit will be to “take the money out again with disrupting the economy”. He concluded:
By their past errors, central banks have increased the risks of both inflation and deflation. It will require luck as well as skill to achieve a recovery from this recession which is neither prematurely halted and thus falls back into a double dip, nor leads quickly to rising inflationary expectations. If expectations are allowed to pick up we will face the unpleasant combination of rising inflation and weak demand known as stagflation.
Ending on a mildly bullish tone, however, Smithers says he is “nonetheless hopeful that we will manage to muddle through”:
A weak recovery which should not set off a rise in inflationary expectations seems already underway.
Related links:
QE according to Smithers – FT Alphaville