The Road to RecoveryHow and Why Economic Policy Must Change
Renowned economist Andrew Smithers offers prescriptive advice and economic theory on avoiding the next financial crisis In The Road to Recovery, Andrew Smithers—one of a handful of respected economists to have accurately predicted the most recent global financial crisis—argues that the neoclassical consensus governing global economic decision-making must be revised in order to avoid the next financial collapse. He argues that the current low interest rates and budget deficits have prevented the recession becoming a depression but that those policies cannot be continuously repeated and a new consensus for action must be found. He offers practical guidance on reducing government, household, and business debt; changing the economic incentives for the management class that currently inhibit long-term growth; and rebalancing national economies both internally and externally. Further, he explains how central bankers must broaden the economic theories that guide their decisions to include the major factors of debt and asset prices. Offers practical, real-world economic policies for restructuring and rebalancing the global economic system Presents a modern economic theory for preventing the next collapse Ideal for economists, investors, fund managers, and central bankers Written by an economist described by the legendary Barton Biggs as "one of the five best, most dispassionate, erudite analysts in the world" As the global economy continues the long climb out of recession, it's imperative that central bankers and other economic decision-makers not repeat the mistakes of the past. The Road to Recovery offers prescriptive guidance on redesigning an economic system that is healthy, stable, and beneficial to all.
Foreword ix Chapter 1 Introduction 1 Chapter 2 Why the Recovery Has Been So Weak 3 Chapter 3 Alternative Explanations for Today’s Low Business Investment and High Profit Margins 47 Chapter 4 Forecasting Errors in the UK and the US 61 Chapter 5 Cyclical or Structural: The Key Issue for Policy 69 Chapter 6 The Particular Problem of Finance and Banking 81 Chapter 7 Japan Has a Similar Problem with a Different Cause 107 Chapter 8 The End of the Post-War Era 125 Chapter 9 Misinformation as a Barrier to Sound Policy Decisions 149 Chapter 10 Avoiding Future Financial Crises 169 Chapter 11 The Current High Level of Risk 179 Chapter 12 Inflation 195 Chapter 13 Prospects Not Forecasts 219 Chapter 14 Tackling the Bonus Culture 229 Chapter 15 The Need for Change in Economic Theory and the Resistance to It 237 Chapter 16 Summary and Conclusions 255 Appendix 1 Mean Reversion of US Profit Margins 259 Appendix 2 Goods’ Output Requires Much More Capital Than Service Output 261 Bibliography 263 Acknowledgements 269 Index 271
Andrew Smithers is Chairman of Smithers & Co. Ltd. and is a leading expert on financial economics and global asset allocation. His forty-five years’ experience in international investment includes twenty-five years at SG Warburg & Co where, amongst other roles, he ran the investment management division, and over twenty years as head of his own investment consultancy firm, Smithers & Co, based in London. He is the co-author of three books on international finance: Valuing Wall Street, co-written with Stephen Wright, published in 2000; and Japan’s Key Challenges for the 21st Century, co-written with David Asher, published in 1999. His book Wall Street Revalued - Imperfect Markets and Inept Central Bankers was published by John Wiley & Sons, Ltd. in July, 2009. He is also the author of Chapter 6, “Can We Identify Bubbles and Stabilize the System?” in The Future of Finance: The LSE Report, published by The London School of Economics and Political Science in September, 2010. Andrew is a Trustee of the Daiwa Anglo-Japanese Foundation, a Fellow of CFA (UK) and member of the Advisory Board for the Centre for International Macroeconomics and Finance (CIMF) at Cambridge University. As head of Smithers & Co., Andrew has helped pioneer the application of academic analysis of financial economics to investment management. He is well known for his work on valuing markets, including application of ‘q’, for his pioneering studies on the distorting impact of employee stock options on US profits, and for work on showing the understatement of Japanese published profits compared with US ones. www.smithers.co.uk
“This remarkable work deserves the widest possible audience. I cannot recall a text so full of astonishing evidence, sharp insights and unconventional arguments. Smithers quotes Cassandra as a kind of role model. She has ‘the three typical attributes of a sound analyst: Her forecasts were correct; she made no claim about their timing and her views were invariably ignored.’ The last condition must be avoided at all costs.” —Jonathan Steinberg, Walter H. Annenberg Professor of Modern European History, University of Pennsylvania, Philadelphia “With Western economies continuing, at best, to move sideways in the aftermath of the ‘Great Recession’, despite conventional fiscal and unconventional monetary policies, in his new book Andrew Smithers identifies the missing ingredients to economic recovery. To do so he draws impressively, in his scholarly yet entertaining style, on both economic theory and historical data, lambasting policymakers for their reliance on defunct theory. A must-read, offering an illuminating insight into current economic debates.” —James Mitchell, Professor of Economic Modelling and Forecasting, Warwick Business School, University of Warwick “Andrew Smithers’s latest book is tough, argumentative, entertaining and deep. It is all that you would expect from someone with his long track record of incisive thought, iconoclasticism, and – as Martin Wolf’s foreword reminds us – simply being right most of the time. The core of this book is the argument that the way we pay managers in the USA and UK is drastically distorting the economy, and that this will be a major impediment to sustainable recovery. Andrew’s arguments are not just abstract theorising. Everything he says is backed up with data (the book contains no less than 128 charts), many of which reveal features of the economy that most of us either never knew, or would prefer to forget. Those who take themselves too seriously, and do not like to see their own analysis drastically undermined, will not like this book at all. But those who want to take arguments back to first principles, and are prepared to address new ideas and new data, will find it a rich source of brain food.” —Stephen Wright, Professor of Economics, Birkbeck College, University of London “This book is a tour de force that combines original thought, a wealth of empirical material, and a lifetime’s experience of financial markets and public policy. Andrew Smithers has an extraordinary ability to address academics, finance ministers, central bankers and the corporate sector in a manner that challenges the core assumptions and institutional failings of each. Andrew Smithers predicted the current economic and financial crisis repeatedly, which gives his powerful thinking the force of prophecy. And while central banks might have been foolish to ignore his insights – for example that asset prices can indeed become overvalued or that the bonus culture is as destructive to the value of corporations as it is entrenched - they would be irresponsible to do so yet again.” —Simon May, Visiting Professor of Philosophy, King's College London “Andrew Smithers has never been afraid of challenging conventional thinking and offering his own solutions to issues central to our economic well-being. He does so from the relatively rare standpoint of a strong, analytical mind and a wealth of experience in the real financial world. In this latest book, he again develops his arguments cogently and with aplomb. Readers will find much to reflect upon and enjoy in this latest book. It is no surprise that Andrew’s output over the years is so widely quoted in the serious financial press.” —Dimitri Vayanos, Professor of Finance/Director of the Paul Woolley Centre for the Study of Capital Market Dysfunctionality, London School of Economics
The financial crisis caused widespread misery and the greatest loss of output and employment of the post-war era. The subsequent weak and faltering recovery has prolonged the pain. In The Road to Recovery: How and why economic policy must change, Andrew Smithers shows that both the crisis and the weakness of the recovery are the result of poor policies based on faulty economics. It is vital that governments and central banks can be persuaded to abandon the misconceptions on which their current policies are based. The Road to Recovery explains, in non-technical language, the major change in our thinking that will allow the world economy to recover and to prevent another financial crisis. There has been a dramatic change in the way managements are paid in the UK and the US. Incentives have changed and this has naturally led to a change in behaviour. This key problem is being ignored. The current management incentives are not only the reason for the massive gap between high and average pay but also for our economic stagnation. Attempts to generate growth, while ignoring the cause of this inaction, threaten to create another financial crisis. In his foreword Martin Wolf states that Andrew ‘has an apparently uncanny – indeed downright infuriating - tendency to be right’. Readers need to understand the errors that are currently being made in order to persuade policy makers to change tack and, in case that fails, to be warned and take action to reduce the costs of the financial and economic troubles that otherwise loom ahead.