Larry Summer’s latest comment at the Financial Times, “What we can do in this dangerous moment.” is troubling both for its analysis of our economic mess and its remedies.
Start with his first paragraph:
It is quite possible that we are now at the most dangerous moment since the American financial crisis began last August. Staggering increases in the prices of oil and other commodities have brought American consumer confidence to new lows and raised serious concerns about inflation, thereby limiting the capacity of monetary policy to respond to a financial sector which – judging by equity values – is at its weakest point since the crisis began. With housing values still falling and growing evidence that problems are spreading to the construction and consumer credit sectors, there is a possibility that a faltering economy damages the financial system, which weakens the economy further.
There is not a shred of acknowledgment in this entire piece that the crisis we are now in is the product of many years of misguided policies. If you believe Thomas Palley, the genesis goes back to the 1980s, when we made a devil’s pact of eliminating labor’s bargaining power as a method of containing inflation and relying on growth increasingly fueled by debt and financial innovation rather than rising worker incomes. Palley has argued that that program is inherently self limiting and we have run its course.
Even if you don’t agree with Palley, the inattention as consumer savings went from low to zero was irresponsible, nay, reckless, as was cutting taxes in the face of a war, watching debt to GDP rise to a level never witnessed before, save prior to the Great Depression, and seeing the focus of investment be consumer housing, which does nothing for American competitiveness. And that’s before we get to the Fed sponsoring overly lax monetary policy by not factoring in the inflation-suppressing impact of cheap imports on inflation.
Thus as I read the article (and readers are welcome to differ), the subtext is that if we can find a way to steer through this juncture, we will, after a difficult period, be back to clear sailing.
Perhaps I am lacking in imagination, but I see lower living standards for Americans an an unavoidable outcome. We’re seeing it now, via rising food and energy costs with stagnant wages. If you were to describe what ails this economy in its most fundamental terms, we have gone on a borrowing binge to support an unsustainable level of consumption. Merely having consumption fall to a healthier level would precipitate a slowdown. And that’s before we get to the problem of “and what do we do with the debt hangover?”
The other noteworthy lapse in Summer’s analysis is that he depicts our situation and our remedies as strictly domestic. But the commodity inflation that Summers mentions in passing is due not to US or advanced economy demand, but emerging economies. Some of them, China in particular, are overheating due to the fact that they effectively have no independent monetary policy. Their dollar pegs and not-fully-successful efforts to sterilize their dollar purchases gives them an overly expansive monetary policy.
Instead of using the bully pulpit of an FT op-ed to address the real problem and possible (although admittedly unlikely) remedies, such as coordinated action, Summers falls back on leading edge conventional wisdom: pass the housing bill, engage in more aggressive fiscal stimulus (increased unemployment benefits, infrastructure spending), end ethanol subsidies, and make it easier for banks to raise new capital.
There are some good observations in the piece, but too often they come as asides. For instance, Summers notes that changes in bankruptcy laws would have been beneficial, and calls for legislative changes to make it easier for the powers that be to manage the failure of a major financial institution. Yet these points are juxtaposed with wishful thinking. For instance, Summers urges regulators to encourage banks to cut dividends, yet seems to believe that like making it easier for private equity funds to invest in them will have a meaningful impact.
From the Financial Times:
After a period of intense activity at the beginning of the year with the passage of fiscal stimulus legislation, strong action by the Federal Reserve to cut rates and provide liquidity and the introduction of anti-foreclosure legislation, policy has again fallen behind the curve. The only important policy actions of the past several months have been those forced on the Fed by the Bear Stearns crisis. It would be a mistake to overstate the extent to which policy can forestall the gathering storm. But the prospects for a more favourable outcome would be enhanced if four actions were taken promptly.
First, the much debated housing bill should be passed immediately by Congress and signed into law. It provides some support for mortgage debt reduction and strengthens the government’s hand in its troubled relationship with the government-sponsored enterprises – Fannie Mae and Freddie Mac. While it is an imperfect vehicle – too limited in the scope it provides for debt reduction, insufficiently aggressive in strengthening GSE regulation and failing to increase the leverage of homeowners in their negotiations with creditors through bankruptcy reform – it would contribute to the repair of the nation’s housing finance system. Failure to pass even this minimal measure would undermine confidence.
Second, Congress should move promptly to pass further fiscal measures to respond to our economic difficulties. The economy would be in a far worse state if fiscal stimulus had not come on line two months ago. The forecasting community is having increasing doubts about the fourth quarter of this year and beginning of the next as the impact of the current round of stimulus fades. With long-term unemployment at recession levels, there is a clear case for extending the duration of unemployment insurance benefits. There is now also a case for carefully designed support for infrastructure investment, as financial strains have distorted the municipal credit markets to the point where even the highest-quality municipal borrowers are, despite their tax advantage, paying more than the federal government to borrow. There are legitimate questions about how rapidly the impact of infrastructure spending will be felt. But with construction employment in free fall, there will be a need for stimulus tied to the needs of less educated male workers for quite some time. Fiscal stimulus measures must be coupled to budget process reform that provides reassurance that, once the crisis passes, the fiscal policy discipline of the 1990s will be re-established.
Third, policymakers need to make a clear commitment to addressing the non-monetary factors causing inflation concerns. Though this could change rapidly and vigilance is necessary, it does not now appear that there are embedded expectations of a continuing wage price spiral. Rather, the primary source of inflation concern is increases in the price of oil, food and other commodities. Even if structural measures to address these issues do not have an immediate impact on commodity prices, they may serve to address medium-term inflation expectations. Appropriate steps include reform of misguided ethanol subsidies that distort grain markets to minimal environmental benefit, allowing farm land now being conserved to be planted; measures to promote the use of natural gas; and reform of Strategic Petroleum Reserve Policy to encourage swaps at times when the market is indicating short supply. Major importance should be attached to encouraging the reduction or elimination of energy subsidies in the developing world.
Fourth, it needs to be recognised that in the months ahead there is the real possibility that significant financial institutions will encounter not just liquidity but solvency problems as the economy deteriorates and further writedowns prove necessary. Markets are anticipating further cuts in financial institution dividends; regulators should encourage this to happen sooner rather than later and more broadly to reduce stigma. They should also recognise that no one can afford to be too picky about the timing or source of capital infusions and rapidly complete the review of regulations that limit the ability of private equity capital to come into the banking system. Most important, regulators should do what is necessary, including possibly seeking new legislative authority, to assure that in the event of an institution becoming insolvent they can manage the resolution in a way that protects the system while also protecting taxpayers. It was fortunate that a natural merger partner was available when Bear Stearns failed – we may not be so lucky next time.
Unfortunately we are in an economic environment where we have more to fear than fear itself. But this is no excuse for fatalism. The policy choices made in the next few months will matter to the lives of millions of Americans, to America’s economic strength and to the global economy.
Larry Summers recommends more of the same lame economic policy, just more and faster, that got the US into its simultaneous inflation and recession condition. All Mr. Summers’ recommendations will do is give the same incompetent people more time to implement their flawed strategy, and continue the US economic slide. What is needed is a 180 degree change in the direction of economic policy, emphasizing the production of real things on Main Street rather than financial engineering on Wall Street, with all new people in charge.
Exactly, Eric. Instead of knocking the hot air out of the ballon, Summers wants to pump even more hot air into the ballon, making an even greater blast when the ballon bursts.
“Lower living standards for Americans” is not a popular rallying cry-even though it looks very likely. Does Summers know how much corn goes to feed livestock as opposed to making ethanol? Does he know how efficiently chickens and turkeys are at making protein versus steers and hogs? He could have pointed to Americans wasteful comsumption of beef instead of chicken. But he didn’t. Telling people they can’t afford to eat beef is too blunt. Let’s just write some swaps on the Petroleum Reserve.
I am no fan of the irresponsibilty that led to this crisis, but lets not jump to:
Liquidate labour, liquidate stocks, liquidate the farmers, and liquidate real estate. It will purge the rottenness out of the system
We may *have* to drink some more kool aid.
I don’t tend to think of it as a “lower” living standard. I think of it as a healthier, more emotionally connected, saner lifestyle that is in line with our environmental needs and concerns.
Red meat just gives you high cholesterol and heart attacks anyway, people. Lean meats, organic produce, walking — all WAY better for you.
what i’d like to see:
1) major overhaul at the SEC. heads must roll for aiding and abetting this mess.
2) restrain the extreme amount of leverage used at financial institutions, especially the GSEs
3) pull out of iraq, and use the savings to reduce the deficit, or to bailout wall street. possibly both.
4) let the housing problem correct itself; the only thing that will solve this thing is time.
5) adopt an energy policy focused on conservation, rather than blame (OPEC, “speculators,” greedy oil corporations, etc.)
6) licensing requirements for mortgage brokers
7) yves as treasury secretary
Thanks for taking on the Summers’ comments. At best they were half baked and I agree completely with your comments about his error in ignoring global implications and focusing on a domestic solution.
I do find it hard to buy into Palley’s arguments. Generally, I like him but I think the the defeat of labor argument contains just too much conspiracy theory. Regardless of whether or not it happened as he likes to depict, the net result is that globalization would have and has produced the same result. The time table might have been different but the outcome wouldn’t have varied.
Nevertheless, this is the best article I’ve seen on Summers’ article this evening.
Cut entitlements and Earmarks
I have just one OT (Crystal Ball) word to add: Bitimun!
IMHO, Oil costs will begin to impact physical infrastructure, as in roads and roofs!
Old story here, which was off the radar screen, but now ore and more interesting IMHO:
The roofing industry is experiencing a double burden due to the oil dilemma. The high cost of gasoline is affecting materials transportation and operating expenses for roofing contractors. In Atlanta, asphalt roofing is a common preference among home owners for its economic-friendly price and durability. Since 85% percent of homes in the Atlanta area are covered with asphalt shingles, an increase in raw materials can be significant.
The problem KTM and many other roofers in the Atlanta area face is that since asphalt is created from crude oil, as the oil prices rise, so must the price of asphalt shingles. It is expected that despite the increased cost to produce, roofers will continue using asphalt shingles because of its common use with today’s homeowners.
“From January 2008 to June 2008 our cost for asphalt shingles has gone from $30 to $46 for the same roof coverage area,” explains Tim McLoughlin, President of KTM Roofing. “A portion of this cost will need to be passed on by KTM and all roofing companies. Unlike the price of oil, once the cost of shingles goes up, it historically stays at that level. Asphalt shingle prices do not fluctuate like oil prices do.”
“I think the the defeat of labor argument contains just too much conspiracy theory.”
Maybe not a conspiracy, but it is hard to ignore the concerted efforts of many in power to weaken labor as much as possible.
As a prime example, by no means isolated, witness the first act of Bush when it came the time to create Homeland Security. What was the very first thing he insisted upon rather heavily? Sweeping concessions from the Civil Service unions because said contracts would “thwart the fight against terrorism.”
Excuse me but the existence of unions did not prevent us to defeat without an overt war, a power (USSR) that had 7,000+ nuclear warheads pointed at us, didn’t it?
How to explain this insistence, then? I suggest that it is contempt: behind his attitude, the president was implying that unions just can’t be trusted when it come to be strong on national security, thus, they just couldn’t be real patriots.
It goes without saying the in the 60’s and 70’s, unions really damaged themselves by sheer arrogance and lust for power without regard to the consequences of their actions. Today, the situation is completely reversed. Even common sense proposal just won’t be listened too, and workers are left out in the cold to fend for themselves.
It is hard to build a solid and motivated middle class this way.
Other than the fact that voters elected the Congress I don’t see a problem here. You get what you deserve. It’s all unfolding exactly as one would expect, knowing the players involved.
Members of Congress have a hard time doing anything unless they can make a buck off it.
Most people are going about their own business as the Ponzi scheme reaches its ultimate conclusion but they will pay for it.
I said before that the US Treasury needs to issue their own new currency (with no interest) because in the end they are going to have to do it anyway and it will hurt just as much if they do it now or later on.
The conversion rates, accepted debt tender, backing, foreign obligations, etc. are all minor details but the Fed Reserve needs to go bye-bye. With a dependable currency everything else will work its way out(in time). If not, it’s going to be a nightmare.
One would hope that one outcome of the present crisis is to get rid of the Summers’ and Brad De Long’s of the world whose recipe for every slump is to lower interest rates, spend lots of money and have everyone get into more debt.
Prosperity doesn’t come from consumption; at best, prosperity allows consumption.
As usual, Yves is right on. Treasury Secretary? Why not Fed Chairman?
Larry is looking for a job in the new adminstration or maybe a slot on the FED, either way old bull Democrats are getting higher speaking fee’s and more press.
Shameful shortsightedness…makes me feel better about his ousting from Harvard, actually.
But irresponsible for an economist to advocate the housing bill in its current form.
And throwing money at the i-banks? Laughable. Angling for a job at Citibank, more likely. Or too close to Rob’t Rubin. Is this what the party has come to?
joebhed said –
anon at 3AM says it all.
For the country and the economy, it’s our best and maybe only shot.
anon at 11:57 –
to answer your question, it’s their party.
Larry summers just like his shadow Larry Kudlow are not citizens of the United States. They are parasites who produce nothing but commentary. If they fail in their policies of domination through economic intimidation, they will simply leave the country and go abroad. They cannot solve the problems we have, because they suffer no consequences.
Asking either Larry for solutions is akin to asking a PETA member how
to improve efficiency in the cattle slaughter biz. The only way out of this mess is through economic collapse, followed by denunciation
of all the Larrys who contibuted to this catastrophe. We have laws which imprison those individuals who threaten the state. When Larry Kudlow is behind bars, you’ll know
we have matured as a nation.