The Summer(s) of Our Discontent

Crossposted from New Deal 2.0

Another volley from Marshall Auerback, Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

Larry Summers’s misguided approach to deficits and surpluses could strangle our long-term vitality.

Virtually every profile on Larry Summers tells us that he is one of the most brilliant economists of his generation, celebrated for having allegedly helped to create the boom of the 1990s.  Statistical maven at age 10, the youngest tenured professor at Harvard, chief economist of the World Bank, this is a man whom the French would surely call “un homme serieux”.

But after reading his latest defense of President Obama’s fiscal policy in Monday’s Financial Times – “America’s Sensible Stance on Recovery” – one wonders.   Only Robert Rubin and Alan Greenspan played a more important role than Summers in promoting the deregulation and lax oversight that laid the foundations for the current crisis. Certainly the plethora of innocent frauds that the Director of the National Economic Council peddles in Monday’s Financial Times calls his economic perspective into question.  In addition to the usual apologia of the Clinton Administration’s budget policies, the latest FT defense reflects Summers’s fundamental lack of understanding of modern money. Contrary to his view, the late 90s surpluses was not the reason for that period’s prosperity. The surpluses are what ended the prosperity. And until the public understands this, we should expect no fundamental improvement in economic policymaking from the Obama Administration.

Let’s go to the article concerned itself.  To begin with, Summers first takes issues with critics, who “have complained that the continued commitment by the administration of President Barack Obama to support recovery in the short term and also to reduce deficits in the medium and long term constitutes a ‘mixed message’”. In fact, he goes on to argue:  “The only sensible course in an economy facing the twin challenges of an immediate shortage of demand and a fiscal path in need of correction to become sustainable.”

In this instance, Summers reflects the usual deficit dove position that budget deficits are fine as long as you wind them back over the cycle (and offset them with surpluses to average out to zero) and keep the debt ratio in line with the ratio of the real interest rate to output growth. In so doing, he violates one of Abba Lerner’s key laws of functional finance:  a government’s spending and borrowing should be conducted “with an eye only to the results of these actions on the economy, and not to any established traditional doctrine about what is sound and what is unsound.” In other words, Lerner believed that the very idea of what good fiscal policy means boils down to what results you can get  — not some arbitrary notion of “fiscal sustainability”.

Deficit cutting, whether now or in the future, is not a legitimate goal of public policy for a sovereign nation. Deficits are (mostly) endogenously determined by the performance of the economy. They add to private sector income and to net financial wealth and, in any case, decisions by the non-government sector to increase its saving will reduce aggregate demand and the multiplier effects will reduce GDP. If nothing else happens to offset that development, then the automatic stabilizers will increase the budget deficit (or reduce the budget surplus).  This is the kind of insight that Summers should be sharing with the readers of the FT if he were to demonstrate the economic leadership we need.

Then we get this misguided statement:

“A range of other considerations – including the crowding out of investment; reliance on foreign creditors; misallocation of resources into inefficient public projects; and reduced confidence in long-run profitability of investments – all make a case in normal times for fiscal prudence and reduced budget deficits.

And there are numerous examples, notably the US in the 1990s, where reducing budget deficits contributed to enhanced economic performance.”

Where to begin?  The “crowding out” thesis was discredited by Keynes over 70 years ago!  The basis of the “crowding out” claim is that such government spending causes interest rates to rise, and investment to fall.  In other words, too much government borrowing “crowds out” private investment. Because investment is important for long-run economic growth, government budget deficits reduce the economy’s growth rate.

Summers’s argument reflects a complete misunderstanding of government spending. Increases in the federal deficit tend to decrease, rather than increase, interest rates. In reality, fiscal policy actions are those which alter the non-government sector’s holdings of net financial assets. This is because deficit spending leads to a net injection of reserves into the banking system. (And big deficits imply big injections of reserves.) When the banking system is flush with reserves, the price of those reserves — in the U.S. the federal funds rate — is driven to zero in the absence of countervailing measures (such as bond sales). Unless a zero-bid is consistent with Fed policy, the central bank will begin selling bonds in order to drain excess reserves. The bond sales continue until the fed funds rate falls within the Fed’s target band.

It is also questionable whether budget deficits do, as Summers suggests, reduce confidence in long run profitability in all investments.   In fact, the historical record suggests that given spare capacity, public expenditures are not only productive but also foster additional activity in the private sector.  In a study of a century of UK macroeconomic statistics, Professor Vicky Chick and Ann Pettifor provide very compelling evidence illustrating that active fiscal policy promoted economic growth and helped to REDUCE the UK’s public debt to GDP ratio.  By contrast, periods during which the single-minded focus on debt and deficit reduction became the main focus on policy, economic growth slowed and the UK’s debt to GDP ratio rose.

This study validates one of Keynes’s central conclusions: “For the proposition that supply creates its own demand, I shall substitute the proposition that expenditure creates its own income” (Collected Writings, Volume XXIX, p. 81). Summers ought to read the study before he perpetuates myths to the contrary which continue to be used by unscrupulous people, to support cuts in Social Security and Medicare that can neither be justified by economic logic, nor empirical evidence.

Nor do we rely on foreign creditors, notably China, to “fund” our spending, another horrible, but eminently predictable canard trotted out by Summers.  The folklore he is trying to etch firmly into the public debate is that when China finally sells of its US bond holdings, those yields will sky-rocket, no-one else will want the debt and it will be the end America as we know it.  But Summers has the causation all wrong: government spending comes first and debt (in the form of bond sales) only comes afterward.  Bonds are issued as an interest-maintenance strategy by the central bank.  Their issuance has no correspondence with any need to fund government spending.  The denomination of the debt, NOT the denomination of the debt holder, is the key consideration. China can only do what the Americans and everyone else it trades with allow them to do. They cannot sell a penny’s worth of output in USD and therefore accumulate the USD which they then use to buy US treasury bonds if the US citizens didn’t buy their stuff.

As Bill Mitchell has argued repeatedly, Americans buy imported goods made in China instead of locally-made goods because they perceive it is their best interests to do so. By the same token, America’s current account deficit “finances” the desire of China to accumulate net financial claims denominated in US dollars. The standard conception is exactly the opposite – that the foreigners finance the local economy’s profligate spending patterns. Unfortunately, people like Summers apparently believe the latter, and they allow Beijing to play us for fools.

Good for China. They are playing a weak hand very skillfully. We, by contrast, are being played for patsies. The Federal Reserve sets the key interest rate in the U.S., and it can always hit any nominal interest rate it chooses, regardless of the size of the budget deficit (or debt). And this isn’t just true of the Fed, but of any central bank which issues its own free floating, non-convertible currency.

Of course, an article from Larry Summers wouldn’t be complete if he didn’t repeat the usual claims of virtually all the Clintonistas – namely, that reducing budget deficits and running 4 consecutive years of budget surpluses contributed to enhanced economic performance.

No, it didn’t. The government budget surplus meant by identity that the private sector was running a deficit. Households and firms were going ever farther into debt, and they were losing their net wealth of government bonds. Growth was a product of a private debt bubble, which in turn fuelled a stock market and real estate bubble, the collapse of which has created the foundations for today’s troubles. This destructive fiscal policy eventually caused a recession because the private sector became too indebted and thus cut back spending. In fact, the economy went into recession within half a year after Clinton left office.

No criticism of the government deficit is ever complete without the usual invocation of concerns for our grandchildren and the omnipresent threat of “intergenerational theft”, and here again, Summers does not disappoint:  “Fiscal responsibility is not only about our children and grandchildren. Excessive budget deficits, left unattended, risk weakening our markets and sapping our economic vitality.” As we have argued before, forget about future public debt service becoming a yoke around the neck of future generations.  A person plunged into long-term unemployment in the US faces a high chance of becoming poor (relatively in this sense) and losing a significant proportion of the assets they had built up while working (housing etc), largely as a consequence of the types of myths championed here by Summers. Their children also inherit the disadvantage that they grew up with and face major difficulties in later life  because the retired and retiring baby boomers want their high nominal fixed incomes plus purchasing power preservation (if not deflation) now and until the day they die.  But the youth want jobs and the prospects of a life worth living, which they won’t get if we cut expenditures today on things like education and proper job training.

Fiscal hawks and deficit doves alike are strangling the baby in the crib today by denying a sensible fiscal response for the current generation’s plight, while hyperventilating that fiscal deficits will do the strangulation of the next generation tomorrow. That, in a nutshell, is what is truly sapping our long term economic vitality. The only way to avoid this ongoing plight is to champion a return to full employment policies, and stop being enslaved by the economic shibboleths which people like Larry Summers and his ilk continue to champion recklessly.

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  1. attempter

    It’s always the same ideological fraud, no matter which criminal ideology.

    If we suffer today (of course always so the gangsters of today like Summers and his corporate masters can gorge themselves) there’ll be universal prosperity in some utopian future. (Needless to say that future never comes in practice, and “tomorrow” always remains tomorrow.)

    Never mind that this means the permanently unemployed of today have to be sacrificed. And as for how their children are to escape the cycle of poverty, you’re not supposed to ask that. The answer is simply: ideological magic.

    Austerity is nothing but the next stage of robbery. “Normal” corporatism went as far as it could go before the returns started declining. Now the Bailout is the standard. But they’re reaching the limits of how much they can steal via the Bailout. So the next step is to loot public programs which have already been paid for by the people. That’s the “austerity” plan. (A further stage would be returning to theft by taxation, but the kleptocracy wants to avoid that as long as possible, since it’s the most politically hazardous type of robbery. There seems to be no end to how much less direct robbery the people will tolerate.)

    This is a conscious criminal plan on the part of Summers and every other deficit terrorist among the elites. All their phony arguments are just pretexts. (And Krugman’s absurd psychoanalysis of their motivations is also meant to obscure the class war truth.)

    They want to steal, destroy, and enslave, plain and simple.

    Fiscal hawks and deficit doves alike are strangling the baby in the crib today by denying a sensible fiscal response for the current generation’s plight, while hyperventilating that fiscal deficits will do the strangulation of the next generation tomorrow.

    This is correct in substance, though I confess I don’t understand the terminology, especially “deficit dove”. How is that different from a “fiscal hawk”? And why not call them all deficit terrorists, which is what they are? Or just thieves, robbers, criminals, which is what they are?

  2. Andrew not the Saint

    Russ, I agree with you completely on this – all the austerity vs. deficits arguments are a mere diversion, just like the elections. There are ways for the elite to redistribute wealth in either scenario.

    First and foremost, you need to restructure the foundations of the economic system, the way debt is created, the taxation… the whole lot. And this clearly won’t happen without restructuring the political system.

    With so many clever people wasting so much energy on fairly useless discussions, it’s hard not to feel resigned on the fate of our society.

    1. Toby

      The discussions don’t change much, at least not quickly anyway (pretty much everything humans have ever done started out as an idea), and I agree discussions won’t prevent collapse, but I do believe they sow good seeds for the post-collapse world, when the real rebuilding can begin in earnest. Also, discussion is part of encouragement to others to withdraw their support, moral or otherwise, from the current system. This then feeds into collapse, which is a necessary, though painful precondition for true change.

      1. Raging Debate

        Well stated Toby. Gen X, Y and Z are going to have to solve the problems and preparing ourselves to “lead” rather than simply “read”. Both education and acting to create fiscal plans for resumed growth are important.

        China was the focus of symbiotic growth as the supposed new engine of world growth. That is going to flop but to the world leadership, they already extracted their wealth in fees so what is the motivating factor for them to launch citizen income growth strategy as Auerback suggests?

        He is correct about raising incomes to pay down the debt. The U.S. government solved the Great Depression not through world war but the sustainable energy creation programs launched in the 1930’s. War accelerated the development of such technologies such as jet power, atomic power and the computer. The world had the advantage of abundant oil afterward which made product affordable. The solution (on top of sound money evolution) is in abundant energy to fuel growth for the next 70 years.

        Rubin, Greenspan and Summers are tired and lack vision so they attempted to take the easy way out which certainly did support the Boomer WWII generation for a time but that party is over.

        Successors are needed and not just for these individuals. Corporate America needs successors also. The management took a big a bite when fully trusted so some trust was broken.

        As for the U.S.A., it has to produce as much as it consumes. The idea of Chimerica is going to have to go away for now or the leadership accepts revolution and almost complete devastation of the American economic engine. Letting it simply “play out” means world war is probable leveling everything.

        Since I don’t see any serious fiscal planning, I believe we have passed the point of moderate pain and probably why Summers is resigned to let it all play out. It doesn’t excuse this leadership because if enough energy was created the country would eat the rest of the harsh pain and still have the method to rebuild, albeit in a disorderly fashion.

        1. Toby

          I agree with much of that Jason, but for for my ultra-radical tastes it seems to me too couched in the current paradigm. ;-)

          We can do better than 70 years of energy with current technologies; done properly and while simultaneously getting a grip on healthy growth, renewable energies would be enough for far longer I’m sure. Renewables present their own problems to the current PTB, but that’s for another debate.

          (As ever I’m talking globally. Nation states are creaking anachronisms. If we limit our thinking to saving this country or that one we’re selling humanity short, and fail to recognize how international the world really is. In the end we are one species dependent on the health of one planet, it’s really that simple. Of course culture, language, myth etc. are deep and important differences, but they are ultimately secondary to the simple facts of the situation.)

          I also want to pick you up on your emphasis on growth. In my opinion, before we have wised up and learned how to weave growth of wisdom, literacy, social health, mental health, safety from crime etc., into a new and more sensible economics, growth in terms of consumption alone should not be the socioeconomic fuel for getting us out of this stagnant and poisonous impasse. Sorry, really long sentence. More simply: we are unnecessarily, though mathematically, addicted to perpetual growth because of our money system; all new money is born as interest bearing debt. It’s a ponzi scheme which needs constant new debt, i.e. growth, to stay functioning. This is an addiction, and like all addictions to unnecessary things, it is unhealthy.

          So yes to growth, but of the right type, perhaps a growth which takes the global situation into account, and which can systemically ‘slow down’ should circumstances demand this.

          Here’s another way of looking at where we are. I see it crudely like this: the slow, egalitarian hunter gatherer train took us to farming, and we had to change trains. On the farming train we’ve learned about scarcity, ‘controlling’ nature, growth of populations with good food production, economic growth, rigid hierarchies leading to elitism, the symbol of wealth we call money, capitalism, and so on. That track has taken us as far as it can and we have covered a great distance, but it’s time for a new train.

          I think the next phase of our journey will prove to be a non-hierarchical, non-elitist, abundance-based world which will transcend things like ownership (capital and even nations) and perhaps money (certainly the money we know today). We will not be addicted to perpetual economic growth for its own sake. And while I realize fully that this is quite difficult for most to imagine, we nevertheless need a vision here and now which is relevant for the longer term (centuries and more), if we are to put our feet on a truly sustainable path. Pretty much every core assumption which underpins and justifies how we do business today is part of our problem. Only a full disembarking of the old over to the new—to be overly corny for a second—will work.

          My 2c.

      2. LeeAnne

        Very wise. Thank you for a nuanced perspective.

        Your words interrupted another of my ‘why the f*^k don’t they just fire this guy?’ comments.

        Comment canceled!

        I had almost forgotten why I write on this blog other than for my own satisfaction and writing practice until you reminded me.

      3. Andrew not the Saint

        Toby, I don’t mean that no discussions should take place, but there are way too many ‘austerity vs. deficits’ discussions which are all pretty much trying to fix a completely broken engine instead of talking how to build a new one. Why is virtually nobody discussing on how to completely eliminate debt (e.g. conversion of debt to equity)? There are paths other than austerity or deficits, just like there are more options than the big parties…

        We will probably end up having a no engine at all, so we may as well discuss on how to live a pedestrian life for a while… That would definitely be something productive.

        1. Toby

          Oh, I see. And of course you’re right.

          However, it’s only depressing if we insist on expecting signs of hope and wisdom to emerge from inside the totally defunct system that led us directly into this mess. Hence my hope that the sorts of discussion ‘We the People’ have amongst ourselves on blogs like this can slowly serve to encourage sufficient numbers away from the broken and exhausted paradigm, and start taking genuinely radical ideas seriously, if, initially at least, in their thinking only.

  3. Sgetz99


    Question and belief I have is that summer’s trumpeted ideology for balanced budgets was based upon fealty to the bond market more than some actual belief that balanced budgets spur gdp growth. He may believe both but Summer’s ideology supports stability of the very rich as they have the majority of their wealth in bonds who’s return is eroded by inflation and hence controlling gov debt levels ensures a competitive bond return. Any thoughts?

    1. Richard Smith Post author

      Global class war, huh? It often looks like that, but particularly now.

      1. Sgetz99


        No, not class war but the traditional “crowding out” private investment theory against gov spending has been shown not to hold water. Then why does this theory keep getting trumpeted?

        My hypothesis is that “crowding out”, like many other neo liberal econ theories, whether baseless or not always seem to have the “unintended” effect of being accretive to the interests of the wealthy. Why such baseless theories get so much traction with the intelligensia and the powerful is precisely because of their “unintended ” effects.

      2. NOTaREALmerican

        The class war can’t happen until a large percentage of the peasants realize that the enemy isn’t other peasants. We’re a long long way from that now.

        The nobility is still worshipped by the peasants. Sure, Lord Blankenfiend might be a bad guy, but most of the peasants know (in their patriotic hearts) that the nobility deserves their riches because (queue: slow motion flag) America was built on the hard work of successful people (queue: slow motion eagle) successful people who work hard for a living and the government shouldn’t redistribute their wealth to “those people”. You figure it out.

        (Queue: Peasants gazing skyward, looking at slow motion eagle and flag, tears nearly flowing. Everybody can someday be the nobility in America, because we love freedom and democracy – and eagles and flags).

  4. Gil Mendozza Zuntzes

    ….. An Open letter to my good friend Barack is on the Works… COMIMG SOON… all stupid… gullible American’s

    1. NOTaREALmerican

      Hey, that’s stupid gullible PATRIOTIC Americans who love eagles, flags, freedom and democracy, and freedom.

  5. Eleanor

    I figured Summers was an idiot, because he couldn’t hold onto a job as president of Harvard, which is usually a pretty safe line of work. I notice that articles about Bernanke also talk about how brilliant he is. I’m not sure what brilliant means in this context. A good student of the status quo?

    A nice essay, in any case.

  6. Tom Crowl

    Summers, Bernanke, Rubin, Geithner, Paulson, etc…


    And as we all know ‘STARS’ are BIG BALL of FLAMING GAS.

    Actually these guys are ‘SUPERSTARS’!!!!

    Extra big stars go nova and blow up…

    So, cheer up… there’s always a bright side.

    1. gil mendozza zuntzes

      hum… hum…. this go to you TOM CROWL! you must be one of those gullible and stupid American’s… what do you know about any of this CHRONIC S … ? as well my good friend and jackal President Barack!

  7. LeeAnne

    They want to steal, destroy, and enslave, plain and simple.

    A local example:

    Our hundred-million-dollar Mayor of the City of New York, Bloomberg just won a fight with New York City artists over their right to use the commons for selling their art on the sidewalks in and around parks, including the Met and Union Square.

    The number of spaces to the left and right of the Met Museum along Fifth Avenue have been reduced as of this past Monday, the locations and dimensions of each space clearly demarcated with little green squares glued to the sidewalk for vendors to follow.

    The reduced number of spaces are to be fought over by the artists themselves who, common knowledge, are not the organizing kind.

    Of course, establishing control of those spaces traditionally used by independent artists is for ‘monetizing’ them eventually, renting them off. Should it happen, independent artists will no doubt be replaced with such commercially viable stuff as the tourist junk added in recent years in front of the Met’s 5th Avenue entrance.

    Look at the important work of this Mayor who bought the job for $100,000,000 of his own money after he defied New Yorkers who voted for term limits not just once, but twice.

    The independent artist willing to settle for modest digs for a rich personal life in the public square cannot be tolerated by the likes of a Bloomberg who can only look upon their creativity, freedom and independence with envy, masked and projected by his contempt for the people not of his ilk.

  8. ChrisPacific

    “In fact, the historical record suggests that given spare capacity, public expenditures are not only productive but also foster additional activity in the private sector.”

    What’s your opinion of the public expenditures in the US over the last few years (TARP and the various bailouts) against this metric?

  9. gepay

    I think Summer’s ideas are wrong and along with Geithner are terrible choices for formualing economic policy. On the other hand it matters on what the money is spent for. The trillions spent for the wars in Iraq and Afghanistan is money, time, and effort that are more than a waste, they are a negative. The same can be said of the trillions for TARP etc.
    I don’t have a problem with unemployment insurance and money spent on infrastructure and education etc. However I wonder if most of the stimulus money is like this one instance that I know of. The man who lives with my daughter quit his job and moved with her to Knoxville as she is attending vet school there at the Univ of Tenn.
    She will come out of vet school in a form of debt slavery but being a vetinarian will pay for the debt incurred. (Now if she was borrowing 30 thousand a year to get a graduate degree in Art HIstory I would be worried.) It took Raymond a year to get a job after the move. It was a stimulus inspired job. Driving to Knoxville to visit Jenny, I noticed when the interstate got to Tennessee these new cable structures at various places along median strip. Sort of like guard rails. I was told by Raymond that is what he was hired for. They are to stop out of control vehicles from entering traffic from the other direction. Now they might. one imagines rarely, do some good and possibly save a life but are these the best way to spend our money? Can you think of better projects? I can.
    In another aspect of the accounting way of looking at deficits, it is stated that the only way the government deficits can be lowered if private savings are rising is by the trade balance. On a wood working project, I noticed the little tags on the piece of wood I was using. The piece of wood came from Chile. Another 1×4 came form New Zealand. How can it be economical to ship these small pieces of wood from Chile and New Zealand and have them end up where I live in rural Virginia. There are piles of trees and forests with similar wood where I live and in nearby states. This seems wrong to me.

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