Wednesday, October 28, 2009

EMH and intervention in bubbles

Martin Wolf in the FT looks at the latest book by equity strategist Andrew Smithers. This argues that the central bank should intervene in asset bubbles. Wolf says:

Yet, for those interested in economic policy, Mr Smithers’ arguments have wider significance. If markets can be valued, it is possible to tell whether they are entering bubble territory. Moreover, we also know that the bursting of a huge bubble can be economically devastating. This is particularly true if there was an associated surge in credit. This is also the conclusion of a significant chapter in the latest World Economic Outlook. In extreme circumstances, monetary policy loses its impact, as the financial system is decapitalised and borrowers become bankrupt. What we see then is what Keynes called “pushing on a string”.

It all makes great sense, but it omits the fact that contrarian action as practised by Buffett and Smithers is not so much a triumph of analysis but of nerve, obstinacy and an accumulation of political capital. The majority will argue that it is not a bubble, that the central bank is outmoded and 'does not get it'.

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