Andrew Smithers - The Road to Recovery: How and Why Economic Policy Must Change

Andrew Smithers is a truly remarkable man. He brings to his analysis of the economy and financial markets a combination of abilities that is, in my experience, unique. Notable in this list are intelligence, eclecticism, pragmatism and independence. Andrew is devoted to the facts, is never impressed by status and possesses both deep knowledge of financial markets and a penetrating understanding of economics. Above all, he has an apparently uncanny indeed, downright infuriating tendency to be right.

Yet, in truth, his tendency to be right is not uncanny at all. Andrew is so often right not just because he has great intellectual abilities but because he cares about being right. His record is a triumph of character. He has the abilities of a first-rate academic. But he has never been one. He is, as a result, liberated from what he justly condemns as the scholasticism of academic economics.

When I look back on my many discussions with Andrew over the last quarter of a century, I find myself reminded of Bertrand Russell's remark that Every time I argued with Keynes, I felt that I took my life in my hands and I seldom emerged without feeling something of a fool. I feel the same way about debates with Andrew. But however foolish Andrew may frequently have made me feel, I know how much I have benefitted from his insights. Alas, I would have gained even more if I had paid his views even more attention than I did.

I first became aware of Andrew's exceptional qualities when I met him in Tokyo in the late 1980s, where he was then working for the late lamented S. G. Warburg. I learnt much from him at that time about what was happening in the Japanese corporate sector and particularly about the implications of the extensive cross-holdings of shares.

Yet Andrew's analysis first transformed the way I thought in the mid-1990s. It was then that I read his work for Smithers & Co., his recently founded research house, on the correct way to value stock markets and the emerging bubble in US stocks. I found this analysis both brilliant and persuasive. It influenced my writing on the stock market throughout the decade. The fruit of this work was subsequently published for a wider public in March 2000, perfectly timed for the market peak, as Valuing Wall Street: Protecting wealth in turbulent markets , co-authored with Stephen Wright of Cambridge University.

Andrew's introduction of Tobin's Q (the ratio of the market value of equity to the replacement value of corporate net assets) into the valuation of stock markets was a profoundly important idea. It was a theoretically better-grounded complement to Robert Shiller's cyclically adjusted price earnings ratio. To me, the idea was an eye-opener. It would have been an eye-opener to the rest of the world, too, if more people had been willing to pay attention. But it is hard to persuade people to change their minds if their salaries depend on remaining un-persuaded.

In making this point, too, Andrew introduced me to the idea of stockbroker economics. That is the art proving that assets are always cheap, however expensive they may actually be. But the purpose of stockbroker economics is, he noted, not wisdom, but sales. In the 1990s stockbroker economics needed to show extraordinary imagination, as stock prices soared, on occasion even suggesting that no equity risk premium was needed.

A particularly significant contribution of Valuing Wall Street was the book's demonstration that the efficient market hypothesis does not hold for the stock market as a whole, even though it does hold for the relative values of individual stocks. The stock market does not follow a random walk, but shows serial correlation, instead. In other words, markets show trends. Sometimes they become increasingly overvalued. At other times they become increasingly undervalued. Such bubbles can persist, partly because the cost of betting against long-term market overvaluation is prohibitively high. In the case of housing markets, it is effectively impossible to bet against overvaluation.

This argument demonstrated that, contrary to the conventional wisdom of economists, it was not only possible for markets to enter bubble territory but also possible to know when they were doing so. Andrew's conclusion was that central bankers were profoundly mistaken in refusing to identify and prick bubbles, relying on cleaning up the mess afterwards instead. In