by Chicago economists — people who have their heads fuddled with nonsense “Fisher Says Prices of Stocks Are Low,” said a headline in the New York Times on October 22, 1929, referring to economist Irving Fisher. Two days later, the stock market crashed, and by the end of November the New York Stock Exchange was down 30 percent from its peak. Fisher had based his statement on strong earnings reports, few industrial disputes, and evidence of high investment in research and development (R&D) and in other intangible capital. But since market prices fell dramatically so soon after Fisher’s statement, most analysts and economic historians concluded that Fisher was wrong: in October 1929 stocks were overvalued. In this paper, we use modern growth theory to evaluate
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Chicago economists — people who have their heads fuddled with nonsense
“Fisher Says Prices of Stocks Are Low,” said a headline in the New York Times on October 22, 1929, referring to economist Irving Fisher. Two days later, the stock market crashed, and by the end of November the New York Stock Exchange was down 30 percent from its peak. Fisher had based his statement on strong earnings reports, few industrial disputes, and evidence of high investment in research and development (R&D) and in other intangible capital. But since market prices fell dramatically so soon after Fisher’s statement, most analysts and economic historians concluded that Fisher was wrong: in October 1929 stocks were overvalued.
In this paper, we use modern growth theory to evaluate this conclusion. When stocks of corporations are correctly priced, this theory says, their market value should equal the value of corporations’ productive assets, what we will call the fundamental value of corporations.2 Productive assets include both tangible and intangible assets. We have direct measures of corporate tangible capital and land and of the tax rates that affect the prices of these assets. We also have measures of profits and the growth rate of the economy which, together with the tangible capital measures, allow us to infer the size of the stock of intangible capital in the corporate sector. We thus can compare the total value of corporate productive assets to the actual market value of corporate stocks at the time of the crash.
Our results support Fisher’s view. A conservative estimate of the fundamental value of U.S. corporations in 1929—which assumes as low a value for intangible capital as observations allow—is at least 21 times the value of after-tax corporate earnings (or 1.9 times gross national product or GNP). The highest estimate of the actual 1929 market value of corporate stocks (based on samples of publicly traded stocks) is 19 times the value of after-tax corporate earnings at their peak in 1929 (or 1.67 times GNP). This is strong evidence that Fisher was right: stock prices in the fall of 1929 were a little low relative to fundamental values.
I think we better leave the commenting on this “research” to Robert Solow:
Suppose someone sits down where you are sitting right now and announces to me that he is Napoleon Bonaparte. The last thing I want to do with him is to get involved in a technical discussion of cavalry tactics at the battle of Austerlitz. If I do that, I’m getting tacitly drawn into the game that he is Napoleon. Now, Bob Lucas and Tom Sargent like nothing better than to get drawn into technical discussions, because then you have tacitly gone along with their fundamental assumptions; your attention is attracted away from the basic weakness of the whole story. Since I find that fundamental framework ludicrous, I respond by treating it as ludicrous – that is, by laughing at it – so as not to fall into the trap of taking it seriously and passing on to matters of technique.