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prose, having gone from Uighur to German to English, is not graceful but neither does it distract from the power of Ms Kadeer’s story—from child refugee, poor housewife, wealthy tycoon and high official to political prisoner and exiled campaigner. In its response to last month’s violence, China has shown little desire to change its approach to Xinjiang and the restless Uighurs. Ms Kadeer is visiting Australia so Chinese diplomats have mounted a ham-fisted campaign to pressure Australia’s National Press Club and Melbourne’s city council into cancelling her speeches and the screening of her film, “The 10 Conditions of Love”, at the Melbourne International Film Festival. Rather than address the root causes of Uighur discontent, China continues to attack the messenger. Copyright © 2009 The Economist Newspaper and The Economist Group. All rights reserved. -129-
Valuing stockmarkets When the signals flash red Aug 13th 2009 From The Economist print edition Wall Street Revalued: Imperfect Markets and Inept Central Bankers. By Andrew Smithers. John Wiley; 256 pages; $27.95 and £16.99. Buy from Amazon.com, Amazon.co.uk IN EARLY 2000, just as the dotcom bubble was at its height, two books appeared that argued the stockmarket was overvalued. One, “Irrational Exuberance”, turned its author, Robert Shiller of Yale University, into something of a guru. The second, “Valuing Wall Street” received less attention but its insights were no less perceptive. One of its two authors, Andrew Smithers, a British economist, has now returned to the theme of stockmarket valuation. This time he expands his remit to argue that it is not only possible to ascertain a fair value for stockmarkets but that central banks should try to do so and adjust their policies accordingly. That would once have been a very controversial assertion. It requires central bankers to second guess the markets, to assume that they know more about share price values than investors do. Markets were believed to be efficient, that is to reflect all publicly available information. But the bursting of the dotcom bubble followed by the credit crunch have dented the notion of perfect markets governed by rational investors. Mr Smithers prefers the idea that markets are “imperfectly efficient”, in other words, that they fluctuate around their fair value. Having argued this, Mr Smithers has to demonstrate two things. The first is a reliable method for valuation, of which he says there are two. One is the replacement cost of a company’s assets, the socalled “q” ratio. The other (which was also an important point in Mr Shiller’s book) is the cyclically adjusted price-earnings ratio, which compares shares with the profits earned over the previous ten years. When bull markets have reached their heights (as in 1929 and 2000), these ratios have clearly indicated overvaluation. Mr Smithers makes his case convincingly, dismissing alternative indicators of valuation, such as the dividend yield, along the way. But that still leaves Mr Smithers to deal with a tricky second point: if there is a reliable way of knowing when markets are overvalued, why haven’t investors used it to make their fortunes? Moreover, investors armed with such information would presumably sell their shares before they reached their peaks, thereby preventing the extremes from being reached in the first place. The answer to this conundrum, which is at the heart of efficient market theory, is that valuation is not a useful guide to stockmarket direction over the short term. On Wall Street there were five valuation peaks in the 20th century, or one every 20 years or so. Most investors simply do not have that kind of time horizon. Get market timing wrong and they may lose a fortune (or, if they are a professional fund manager, their clients will). The market can be irrational for longer than you can remain solvent, as the saying goes. A job for the banks Even so, Mr Smithers argues that central banks should use the valuation data to decide whether stockmarkets are over- extended. And they should look at house prices and the price of liquidity (defined as the interest spread on corporate bonds that is not attributable to the risk of default) as well. None of this is easy. But central banks already try to estimate the “output gap”, the extent to which economic growth is above or below trend, when setting interest rates—and that’s fiendishly difficult. In the past central bankers have claimed that, rather than try to pop bubbles, they should clean up the mess after they have burst. But the cost of the recent financial crisis makes that policy hard to justify. If all the signals (including house prices and liquidity) are flashing red, then central banks should act. Their best tool might not be increases in interest rates but changes in the capital ratios of banks. By requiring -130-
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Politics this week Aug 13th 2009 Fr
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KAL's cartoon Aug 13th 2009 From Th
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democratic region. But Brazil’s l
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World trade and commercial aircraft
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Galileo, four centuries on As impor
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Correction: America's sex laws Aug
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SIR - You mentioned the slaughter d
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Professor of the history of art Sch
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Their arrival coincides with, and i
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and integrated well.) Peru has beco
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Clean energy in the Midwest Greenin
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The economics of natural gas Drowni
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meetings on health reform planned f
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Drought in Texas Not a cloud Aug 13
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Rich animals The dog will have his
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twice the national average. But it
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international institutions and the
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Energy v environment in Canada Bomb
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further sanctions. Yet it is doubtf
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egistered voters are frauds. Yet Mr
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Australia's opposition His own wors
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Taiwan's typhoon Taiwan's disastrou
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Banyan The Burmese road to ruin Aug
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Fatah and the Palestinians Fresh fa
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Iran and human rights The crackdown
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Security in Iraq A return to the ba
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Ethiopia's resilient prime minister
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America and Africa Hillary (not Bil
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Southern Italy's ills The messy mez
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Copyright © 2009 The Economist New
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Italy's vigilantes On the beat Aug
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crisis-driven entanglement in banks
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colluded with the Russian patriarch
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Prospects for recovery Mervyn's rea
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Conservatives will be fighting over
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advanced to scale down much. If the
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Scotland's capital and recession Pa
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