Financial news

Irving Fisher was a celebrated American economist who was at the origin of numerous concepts in finance. Nonetheless he was vilified at the time of the Great Crash, because he maintained that stock prices had reached a plateau. In autumn 1929, the market value of all shares listed on the New York Stock Exchange plummeted by 30 percent. Many analysts then and now have taken the view that stocks were overvalued and that the market stood in need of a correction. Irving Fisher argued at the time that in fact the fundamentals were sound and the market was undervalued. In a paper published in December 2001, Ellen R. McGrattan and Edward C. Prescott, both of the Federal Reserve Bank of Minneapolis, estimated the fundamental value of corporate equity in 1929 and compared it with actual stock valuations. They came to the conclusion that the Great Crash was not attributable to overvaluation. The evidence strongly suggests that on the contrary, even at their 1929 zenith when the Dow Jones reached 379.61, stocks tended to be quoted low. However, the Dow fell to 41 in June 1932. In another article the same authors demonstrate that in the first half of 2000, the overall value of US corporate equity was close to 1.8 times that of GNP and that because it was equal to the value of all productive assets in the US corporate sector, at that price it was correctly valued. In 2000 the Dow Jones was at around 12000, only to fall to 7500 two years later. Two tales of a bubble that wasn’t! As Adam Smith observed in the Wealth of Nations, the word value has two meanings: the value in use measures the utility of an asset,the value in exchange its purchasing power. In one of his afterthoughts on the history of capitalism, Fernand Braudel explains that everything that stays outside of the market has only a value in use, all that pass the footstep of the market acquires a value in exchange. The value in use can be defined as the value of an asset calculated by discounting the future cash flows obtainable from its continued use. Many market economists in America explain that the market price reflects long-term cash flow prospects, a value in use. On the contrary, there are a number of economists in Europe who consider that the stock price is only a value in exchange. They are very critical of the so-called investor’s rationality in determining market prices. They have adopted Keynes’ view that investors are concerned, not with what an investment is really worth to a man who buys it for keeps, but with what the market will value it at, under the influence of mass psychology, three months or a year hence. For most European economists everything depends on waves of irrational psychology. The relationship between price and value is a puzzle that has baffled economists since times immemorial.