Friday, October 9, 2015

Lawrence Summers on the Global Economy

Like it or not, Lawrence Summers deserves a fair hearing. You might not want to read an old-line Democrat, but his views deserve some respect… before you explain why he is wrong. Anyway, it's better than being a new-line Democrat.

Writing in the Washington Post recently, Summers sounded an alarm about the condition of the world economy.

As the world’s financial policymakers convene for their annual meeting Friday in Peru, the dangers facing the global economy are more severe than at any time since the Lehman Brothers bankruptcy in 2008. The problem of secular stagnation — the inability of the industrial world to grow at satisfactory rates even with very loose monetary policies — is growing worse in the wake of problems in most big emerging markets, starting with China.

This raises the specter of a global vicious cycle in which slow growth in industrial countries hurts emerging markets, thereby slowing Western growth further. Industrialized economies that are barely running above stall speed can ill afford a negative global shock.

If the traditional monetary policy solution to this problem is lower interest rates and cheaper money, that solution is no longer available.

Summers continues:

Policymakers badly underestimate the risks of both a return to recession in the West and of a period where global growth is unacceptably slow, a global growth recession. If a recession were to occur, monetary policymakers would lack the tools to respond. There is essentially no room left for easing in the industrial world. Interest rates are expected to remain very low almost permanently in Japan and Europe and to rise only very slowly in the United States. Today’s challenges call for a clear global commitment to the acceleration of growth as the main goal of macroeconomic policy. Action cannot be confined to monetary policy.

As for the much-touted economic recovery, it is, Summers says, a mirage:

There is an old proverb: “You do not want to know the things you can get used to.” It is all too applicable to the global economy in recent years.While the talk has been of recovery and putting the economic crisis behind us, gross domestic product forecasts have been revised sharply downward almost everywhere. Relative to its 2012 forecasts, the International Monetary Fund has reduced its forecasts for U.S. GDP in 2020 by 6 percent, for Europe by 3 percent, for China by 14 percent, for emerging markets by 10 percent and for the world as a whole by 6 percent. These dismal figures assume there will be no recessions in the industrial world and an absence of systemic crises in the developing world. Neither can be taken for granted.

Summers does not believe that the markets can bail us out this time. It might be because the Federal Reserve and the administration have been manipulating the markets for so long, that once the markets have a chance to exact revenge they will make everyone pay a very high price.

For his part, Summers belongs to the anti-austerity group. He wants to see more government spending, and more deficits.

Just as homeowners can afford larger mortgages when rates are low, government can also sustain higher deficits. If a debt-to-GDP ratio of 60 percent was appropriate when governments faced real borrowing costs of 5 percent, then a far higher figure is surely appropriate today when real borrowing costs are negative.

If the bond market is strong, Summers explains, we are not having any trouble borrowing money. Thus, we should borrow more. We have not yet run out of other people’s money. So we should take more of it. Of course, the bond market does not merely show confidence in the American economy. It says that it has more confidence in America than it does in many other places to park money.

Summers adds that there is no real inflation risk at the moment. And he does not want to see the Fed increase interest rates in this environment:

After last Friday’s dismal U.S. jobs report, the Fed must recognize what should already have been clear: that the risks to the U.S. economy are two-sided. Rates will be increased only if there are clear and direct signs of inflation or of financial euphoria breaking out. The Fed must also state its readiness to help prevent global financial fragility from leading to a global recession.

What else can central banks do?

The central banks of Europe and Japan need to be clear that their biggest risk is a further slowdown. They must indicate a willingness to be creative in the use of the tools at their disposal. With bond yields well below 1 percent, it is doubtful that traditional quantitative easing will have much stimulative effect. They must be prepared to consider support for assets such as corporate securities that carry risk premiums that can be meaningfully reduced and even to recognize that by absorbing bonds used to finance fiscal expansion they can achieve more.

As I understand it, the Fed has been buying up treasury bonds and even mortgages. If it did not do so, interest rates would rise and economic activity would be choked off. Now, apparently, Summers wants to ensure that corporations have the same access to very easy money, so he proposes having the Fed buy up corporate debt.

Again, if you are recommending that people manipulate the corporate debt market you are not in a very good position to criticize the markets.

Few people on the planet understand economics as well as Lawrence Summers does. That does not make him right, but it certainly suggests that we should respect his opinions. He seems positively Krugmanian here, but still his tone is far more constructive than Krugman’s—not a great challenge, but still….

One suspects that the Summers analysis of a pending economic collapse is largely correct. And yet, one also suspects that his proposals are forestalling the inevitable. Summers believes in government and people who believe in government believe that the government can fix all problems.

One needs to mention that other great economic minds, from Jim Grant to Jim Rogers lean toward accepting the inevitable right now, even to accept a default, because a quick cleanse now will be better than a grand cleanse later.

They would certainly accept, with Summers, that the Fed is largely out of bullets. And that that is what scares everyone the most.

As for why there is no corporate investment and business growth, one suspects that it cannot easily be solved by offering companies more cheap money. As I understand it, most new jobs are created by small businesses. Small businesses do not have access to the corporate bond market. They tend to use local community banks. But, how many of those banks have either gone out of business or have seen their lending curtailed by the onerous compliance costs imposed by Dodd-Frank?

And one cannot fail to note that the Obama administration already tried to solve the problem with increased government spending, especially in 2009. If that failed, why should we expect that more government borrowing and more wasteful spending will work this time.

I will leave it to those wiser than I to answer the question of what Dodd-Frank has contributed to banks' willingness to hoard money than make productive investment. And how much wealth is being sucked out of the economy by the Obama administration’s mountain of new government regulations? How much does Obamacare provide a disincentive to hire and to invest?

As I said, I do not know anywhere nearly as much as Lawrence Summers about these matters. But, shouldn’t they be part of the discussion?


Anonymous said...

Excellent analysis. A significant problem is the Obama Administration's attitude. Entrepreneurial people have no idea what he's going to do or demagogue next. It heightens uncertainty. Markets need clarity to make big positive moves. If Obama wants to put us away, he should just make executive orders to enact his phony global warming agenda, which is economic control by regulatory means. Otherwise, let people out here make their own economic decisions. The tall cool one is out of his depth, and it shows more and more day after day. He's a jerk playing Oz. -$$$

KCFleming said...

Summers provides a decent analysis, but his diagnosis falls short, and the treatment is just more application of leeches.

Anonymous said...

I wonder what the Olympian God thinks.. No doubt it's sure to come... -$$$

Ares Olympus said...

I first heard of Lawrence Summers nearly 2 years with his speech on "secular stagnation", 15 minutes if you want to listen, and there was lots of media discussion after that speech.
Including Paul Krugman's envy, but as Stuart points out, both Summers and Krugman want to increase government spending to keep pushing the economic string with new debt.
And more recent:
Summers has proposed “secular stagnation” as the explanation for economic weakness since the 2008 recession: Private investment is falling because firms see slow population growth and innovation as a sign that future returns aren’t likely, creating a self-fulfilling prophecy of slow growth. His answer is more government investment—to jump-start demand, and the economy.
If Summers is right, slow growth and low interest rates will dominate the future unless major spending efforts come to bear, but Bernanke remains hopeful that trade and investment will return to balance internationally, allowing interest rates to rise.

What's important to me on Summer's message is that he's standing on ground zero of those who have lead us to where we are and have a responsibility to leading us forward. In fact he was basically first in line to replace Bernanke, but he withdrew, and wisely positioned himself as truth-teller over sweet-dreams that direct responsibility requires.

The key thing I've learned (since my oldest perspective against all debt) is that "sovereign debt" is the ONLY good debt, and so the Federal Reserve, which prints dollars as a world standard for exchange has a huge advantage. And for the moment, we can't seem to "print" dollars fast enough for the demand. So the US has an advantage we gained since winning World War II, and this advantage is necessarily temporary, but obviously can last a long time, and when this system fails, the whole global trade system will break down into chaos.

So I'm leaning towards the perspective that "liberalized trade" is a temporary and illusionary state and globalization as we know it will end, and Summers' fears show one way this ends, and every economic theory we have developed for the last century is based on continual growth that will halt and reverse for an extended period of time.

So I can support Summers' fighting the good fight, whatever he thinks it is, but the real value of the central banks might be nothing more than slowing down the chaos to a rate that people can react to. So "global growth" is nearly over, and now we'll have a free-for-all study on what to do next.

And the fundamental problem might be that globalization makes a few people very wealthy, while a shrinking pie won't allow "money as the only virtue" to continue. So it looks to me that accumulating individual wealth is a fools errand, but if you find yourself with such fortune, we're approaching a time of consequences, where your next investment may be your last, so choose well.