How did the world economy fall into such a deep hole? It is recovering, but painfully, and after a deep recession, despite unprecedented monetary and fiscal easing. Moreover, how likely is it that a balanced world economy will emerge from this force-feeding? The very fact that such drastic action has been necessary is terrifying. The fact that there is little room for a policy encore is yet more terrifying. Most terrifying of all is that this is not the first time in recent decades the world economy has had to be guided through a post-bubble collapse.
In his latest book – a successor to Valuing Wall Street, which appeared in time to help alert readers avoid the 2000 meltdown – Andrew Smithers of London-based Smithers & Co, provides an invaluable guide to past errors of analysis and policy.* He is a rare guide – a man with a deep understanding of economics and a lifetime's experience of financial markets. His work helps to explain the stock-market bubble of the 1990s, the fiscal errors of Gordon Brown and the recent credit excess.
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.