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.

The remainder of this article can be read here. Please post comments below.

About a month ago, I visited the aero engine factory of Rolls-Royce, in Derby. I was hugely impressed. Making jet engines able to work at extreme temperatures is an extraordinary achievement. Why does the financial industry not work this way? How might we bring the performance of finance close to that of other sophisticated businesses?

Continue reading "Why curbing finance is hard to do"

From the FT:
King calls for the breakup of banks Chris Giles
Darling responds to King’s bank speech Chris Giles FT video

Elsewhere:
Mervyn King’s speech in full Bank of England
Volcker fails to sell a bank strategy NY Times
The consensus on big banks begins to move The Baseline Scenario
Mervyn King calls for banks to split as public finances take record hit The Times

A year ago, at the height of the financial panic, the world yearned for a profitable and confident financial sector. It now has what it wants, but hates it. As joblessness soars and the hopes of hundreds of millions of people are blighted, the financial sector’s survivors are thriving. Even bonuses are back. Policymakers have made a Faustian bargain. Success feels like failure. Continue reading "How to manage the gigantic financial cuckoo in our nest"

From the FT:

Goodbye, Macroeconomics - Eli Noam

The travesty of the commons - Christopher Caldwell on the field of Nobel winner Elinor Ostrom

The free market is not up to the job of creating work - Mort Zuckerman on US unemployment

Countdown to the next crisis is already under way - Wolfgang Münchau

Down but not out - Krishna Guha on the dollar

Elsewhere:

Cognitive Dissonance and Global Macroeconomics - James Kwak on rhetoric and reality in the global imbalances debate, at Baseline Scenario

Escaping the state should cost Lloyds - Peter Thal Larsen, Reuters

Herbert Hoover and the start of the Great Depression - Lee E. Ohanian on history VOXEU

No L - James Hamilton on having avoided an ‘L-shaped’ recovery, at Econbrowser

Goldman Turns Into a Financial Frankenstein While the Fed Snoozes Away - Huffington Post

A reflection on the G20 (The question never asked to Mr Zoellick) - Biagio Bossone on the legitimacy of the G20 for small nations, at VOXEU

By Michael Pomerleano

I was in Chicago last week to participate in the 12th Annual International Banking Conference sponsored by the Federal Reserve Bank of Chicago and the World Bank. The answer to the question posed — have the rules of the global financial game really changed? — is a resounding no.

This was my first week back in the US after being away for three years, and the conference gave me an opportunity to gauge the state of the debate there. Compared to my two years at the Bank of International Settlements in Basel and my year at the Bank of Israel, the openness of the debate and the quality of the discussions in Chicago were refreshing. However, in the US — the epicentre of the crisis and the country that is supposed to lead the world toward reform and out of the crisis — I expected a far more forceful articulation of remedial measures. Continue reading "Another crash is all too possible"

The FT has a new series on the future of investment. But what, I wonder, is the future of finance itself? Who is confident that the financial system now emerging from the crisis is safer, or better at servicing the public’s needs, than the one that went into it? The answer has to be: few people. The question is how to remedy this dire situation.

Continue reading "Why narrow banking alone is not the finance solution"

By Richard Robb

For anyone who was engaged in the financial markets during the week of September 15, 2008, Lehman changed everything. It was obvious. So what could be more tempting to finance professors than to overturn this conventional wisdom? Descartes described the man of letters who takes more pride in his speculations “the more they are removed from common sense,” and so showing that the Lehman collapse was inconsequential has spawned a minor literature. Continue reading "Why the Lehman failure did change everything"