Tuesday, January 18, 2011

"The world according to Smithers." (Smithers&Co,)

From Money observer via Smithers:
Would a shift towards exports and investment cure the chronic indebtedness of Western economies? Iain Murray asks economist Andrew Smithers for answers.

It was George Bernard Shaw who said if all economists were laid end-to-end they would not reach a conclusion. On that basis, it is perhaps wise to seek the opinion of just one and we have chosen Smithers.

He founded economics consultancy Smithers & Co in 1989 and his book, Valuing Wall Street, with co-writer Stephen Wright, predicted the bursting of the tech bubble. So, can he foretell what lies in store for markets and economies in 2011? Sadly, the answer is no.

Forecasting, he says, is not a very successful activity and the reason for this is that it shouldn’t be. ‘If you assume financial markets have a very important impact on the real economy, you can’t forecast the real economy unless you can forecast financial markets, and if you could do that they would always be correct, otherwise you could make money out of the mistakes.’

It’s tempting at this point to conclude the interview, but Smithers has more to say, about how we got into the current mess and why we may be digging a still bigger hole. ‘In the 1990s, the US Federal Reserve had a policy which was to pretend to ignore asset prices. The then chairman of the Fed, Alan Greenspan, and his successor Ben Bernanke, both said that you couldn’t value markets and it didn’t matter if they fell anyway because you could solve the problems afterwards with a little adjustment to monetary policy.

‘There are two things wrong with this. One is that the policy is not consistent with the claims because the Fed did actually interfere with markets, but asymmetrically. It interfered by lowering interest rates whenever the market showed signs of tumbling but it didn’t respond the other way.’

The result of prolonged and abnormally low rates was an asset bubble and the crash of 2008. After that shock, says Smithers, it seemed for a while that Bernanke had seen the light and decided that booming asset prices were dangerous.

‘It would now seem that that contrition was temporary and the current policy is quite clearly designed to create a bubble. The Fed has said it thinks the inflation rate in the US is too low and the proposal is to push it up by buying bonds. If you push inflation up you lower the value of bonds and a division between price and value is by definition a bubble....MORE