Larry Summers’ New Model

Larry Summers spoke on Friday afternoon at the InterAmerican Development Bank in Washington DC.  As he was addressing a group with  much experience living through and dealing professionally as economists with major crises, he spoke the “language of economics” (as he called it) and largely cut to the analytical chase.

Summers made five points that reveal a great deal about his personal thinking – and the structure of thought that lies behind most of what the Administration is doing vis-a-vis the crisis.  Some of this we knew or guessed at before, but it was still the clearest articulation I have seen.

  1. All crises must end.  The “self-equilibrating” nature of the economy will ultimately prevail, although that may take massive one-off government actions.  Such a crisis happens only “three or four times” per century, so taking on huge amounts of government debt is fine; implicitly, we will grow out of that debt burden.
  2. We will get out of the crisis by encouraging exactly the kind of behaviors that “previously we wanted to discourage” two years ago.  It is “this insight, this view” particularly with regard to leverage (overborrowing, to you and me) that “undergirds the policy program in the United States.”
  3. There is a critical need to support financial intermediation and to ensure it is adequately capitalized, with a view to the risks inherent in the current situation.  He then said, with a straight face, that the current bank stress tests are designed with this in mind.
  4. Growth in the 1990s and more recently was based too much on finance (this appears to be a relatively new thought for Summers).  The high and rising share of finance in corporate profits “should have been a warning”.  The next expansion should be based less on asset bubbles and more on investment in key public services.
  5. The financial regulatory system “in fundamental respects has been a failure”.  There have been too many serious crises in the past 20 years (yes, this statement was somewhat at odds with the low frequency of major crises statement in point 1).

Crises definitely end.  But do they end with rapid recovery or with stagnation?  There was nothing in Summers speech that addressed how we avoid – at the US or global level – becoming more like Japan in the 1990s, given the state of consumers’ and firms’ balance sheets around the world.  There is no issue with debt levels; apparently, we can turn everything around with fiscal expansion and support for banks.

The essence of the government’s short-term strategy is obviously to prop up the financial sector, in order to sustain something close to the current levels of debt in the economy.  But there was no hint in his remarks that this creates tension with point #4 – growth needs to be less finance-oriented in the future, i.e., talent has to be allocated elsewhere.  If the rents are now government-generated but still in the financial sector, why would people or capital move?

And if enormous effort goes into sustaining the prosperity (and apparently the bonuses, according to first quarter set-asides) of Big Finance, how will that help with serious regulatory reform – which presumably will be opposed by the banks that are now regaining their fortunes?  This thinking,  put next to the NYT article this morning on Tim Geithner’s work at the NY Fed, is not encouraging.

More generally, there was not even an indirect mention of political economy.  Summers’ public narrative for the crisis is essentially that there was an accident: stuff happens.  This narrative matters.  Irrespective of what he thinks privately, unless he and other senior Admininistration officials can start to use the language (even of economics) regarding regulatory capture, political connections, and the way in which economic booms can create disproportionate political influence for the finance sector, we are unlikely to change the structure of power and the risk of crisis in our economy.

You may not care too much about this – “let’s first turn the corner and then worry about other things”, is a standard refrain.  And for a recovery, obviously, much depends on actions that Summers and the White House can only indirectly influence – including the Federal Reserve’s push towards inflation and the actions of European governments.

But defering to big banks and prefering fiscal expansion is very much a decision in the hands of Treasury and the White House.  They may feel this is essential to restoring confidence, but that is not the general experience of countries facing major crises.  The usual advice – given by the IMF, often at the behest of the US Treasury – is: manage an insolvency process for failed banks, precisely to reduce fiscal costs now and in the future, and to help restore confidence in the economy.  Come to think of it, wasn’t this exact point made – forcefully and publicly – by Summers to the Japanese government during the 1990s?

Forbearance on banks may work, but at great cost to the taxpayer.  And how is that helpful to either to Summers’ stated strategy of growth led by further public investment, or – given the existing state of our public finances – to a more plausible strategy of (nonfinancial) technological innovation?

By Simon Johnson

92 thoughts on “Larry Summers’ New Model

  1. In my totally uninformed opinion, Japan may be a best case scenario for us. We didn’t have quite the leveraged bubble that they had in relative terms, but they had a high personal savings rate to fall back on, where we will have to get to and likely overshoot on a long term sustainable savings rate over the next decade (net, including a sustainable amount of govt. debt.) Further, Japan had an overheated global economy to export into. And look what’s happening to them now: with all that, they’ve only managed to delay their depression a decade and a half.

    The glimmer of hope that I see is that U.S. population growth means we have at least a shot at growing ourselves out of this. (If I were a betting man, and I’m not, I’d lay a small bit of money down on our population peaking earlier than expected, as it is with Japan. See the recent articles on a rise in both abortions and vasectomies.)

    Muddling along Japanese-style may be the best thing we can hope for.


  2. Point #4 is the most terrifying to me, since it represents Obama’s motivation. The banksters have essentially told Obama exactly what he wants/needs to hear to justify the bailout. Does he really think that digitizing healthcare records and a carbon cap will save the economy?

    Forget regulatory capture. This is kool-aid capture!

  3. Unfortunately, #1 sounds much too like the idea that markets will simply self-correct. This only makes sense if you understand the underlying nature of the problem, and you also know that those forces will not impede market recovery. However, points 2-5 suggest that may be it is not so simple. Alas, I am afraid that may represent the true case.

  4. Restoring the status quo ante would be a good thing, if the status quo ante had been a good thing. But was it? We need a new “philosophical idea” about what we want our society to be about. Absent a “new idea” it is hard to see what will drive this recovery. Like the Bush Administration before it, the Obama Administration is suffering from a “failure of the imagination.” But who expects “imagination” from people who are straining to retain power?

  5. Thanks for allowing us this access to his thinking.
    The first one could be the most dangerous – giving rise to a complacency along the lines of well we’ve had the big one so not to worry there won’t be another for 100/4 years.
    But these things might cluster like earthquakes and London buses.

  6. “let’s first turn the corner and then worry about other things”

    And then forget?

    No, I’m with you – we need to tackle this now while the populist anger still exists that is strong enough (one hopes) to offset the power of bankers.

  7. Reading the Geithner article in NYC, it leaves me with one question:

    How many lunches/dinners has he had (at the Four Seasons?) with you, Paul Krugman, and the multitude of other economists who don’t have a vested interest in maintaining the status quo?

    Maybe he is able to keep his objectivity, but if he lives in an echo chamber, it’s hard to believe that he can really see anything “outside the box”.

  8. At some point people will generally realize that the entire intellectual framework of this administration, despite it’s ‘progressive’ pretensions, is an attempt to turn the clock back.

    Giving back legal privileges to the unions, we’ve been there. Their response to the financial crisis is solely about trying to find a way to write a check big enough to return us to where we were. Environmental restrictions aim to take us back to some pre-industrial or early industrial age. Even in the area of health care, where they want to do something which would be new for the US, the goal is to take us back to where the UK was in 1947.

    No matter how many smart people work in the administration, they aren’t going to engage any of our real problems and opportunities without shedding this framework. Unfortunately, if one can discern a core element in Obama’s thinking, this appears to be it.

  9. Actually Carson, based on a statement by a friend I did a little demographic digging, and apparently between the baby boomers waiting and Gen-X not when it comes to child birth – the census bureau’s projections for 2010 have over 100 million people in the country under 25. This is by far the largest generation, bigger than the baby boomers by 20-25 million depending upon how you quantify the generations.

    This is very good news – lower birth rates after that group shouldn’t be as much of a concern any time soon, since it’s the “pig in the python” of the baby boomers that has always been the big financial issue.

    So there is a natural growth element inherent in our demographics that the Japanese did not have, the problem is it’s going to be 10 years before that group begin to enter the working, consuming phase of their lives. Can we muddle along until then?

  10. (Whatever happened to transcripts?)

    #1: I suppose the inherent contradiction in #1 (if it takes massive “one-off” govt. actions every 25 years, then how is the system “self-equillibriating”?) is obvious to everyone?

    This is aside from previous work Summers has written about situations where the system is specifically not “self-equillibriating” – such as when he argues that price flexibility can be destabilizing (1986) or that aggregate demand management might very well reduce long term unemployment (1988). Of course those were the DeLong papers… So maybe DeLong was the brains behind the duo.

    #2: Summers is expressing an utterly perverse version of Keynesian anti-cyclical demand management. Most Keynesians (even new Keynesians) argue that government should PRINT MONEY to support demand as leverage deflates (and allow it to deflate smoothly without causing systemic shock and deflation). Then destroy that money later on as the economy booms (and there are many ways to destroy money – most scholars focus on interest rates and Fed actions, but raising taxes to pay off our massive federal debt is another way to destroy money during boom-times to prevent bubbles – if only we had the political will to enforce it).

    Who in their right mind argues that the key to easing the economy out of debt is to create more debt?

    Or, does Summers believe that the debt ratios in the US economy really were sustainable long term? (Which seems inconsistent with his sudden realization – #4 and #5 – that finance really has gotten too big and isn’t producing much of real value?)

    #4 & #5) Hallelujah!

    Perhaps Summers should ask himself (or one of his previous co-authors) these fundamental questions:

    WHY is the government dependent on banks to maintain the size of the money supply?

    WHY is _credit_ the “lifeblood of the economy”? (Isn’t _money_ supposed to be the lifeblood of the economy?)

    What, exactly, are the tradeoffs to running a money supply on _privately created debt_ vs. _publicly created money_?

    I am certain that manipulation of the money supply & demand through interest rates seemed like such an elegant solution – compared to the “crude” method of taxation/spending/printing money. But perhaps there are some hidden costs that weren’t in those models? Like the size of the finance sector, the allocation of labor talent, moral hazard, the zero bound, and so forth…

    Until Larry Summers answers these questions for himself, or President Obama decides to make a staff change, we are unlikely to see real change. Bernanke, I think, is a few steps ahead of Summers.

  11. The underlying assumption of Summers and many economists, including those in the government, is that house prices were irrationally inflated due to an asset price bubble.

    Subsumed in this thinking is that the decline in home prices were not due to any rational response to changes in future expectations about the value of this asset class. Instead, the assumption is that the price decline is a return to normative valuations and a return to rationality. While there may be some negative overshooting of the correct price, the correct price is nowhere near previous valuation levels.

    However, homes are long-lived assets, in fact inter-generational. What if homes were correctly valued based on a rational expectation of the future economy and demand prior to their sharp price declines? If the new, lower home prices correctly reflect changes in investor and owner expectations about the future economy and house demand, then the self-equilibrating point of the economy will be substantially below that envisioned by Summers and others in the government.

    As an example, Earl Thompson, an economist at UCLA, studied the 1600s Dutch tulip bulb mania and found that the bursting of that “asset bubble” was a rational response to a change in demand and a change in the law. Germans who were a significant part of the demand for tulip bulbs lost a battle with the Swedes and the German peasants began a revolt. German demand for tulips declined. In addition, Dutch law changed and tulip bulb futures contracts became option contracts. Dutch futures required purchase of the bulbs, but options did not require purchases. The decline in tulip bulbs prices was a rational response to a changing demand environment for bulbs.

    If the bursting of the tulip bulb bubble was a rational response to a changing legal and demand environment, there is the possibility, (according to rational expectations and efficient markets a highly likely possibility) that the recent and continuing decline in home prices is a rational change to a changing future economic environment for housing. Since homes are an inter-generational long-lived asset class, a substantial decline in house prices can happen before the future events that caused the decline reveal themselves.

    We may not as of yet seen the economic, legal and societal causes for the rational decline in home asset values. If that is the case, the government may not have responded correctly as of yet to offset this future economic, legal or societal event, or its actions to date, or expected, may have unintended future consequences which are responsible for the decline in the stock market and home values.

    There may have been permanent shifts in consumer and housing demand for rational reasons yet unknown and unrevealed. While the economy may be self-equilibrating, it may not be at the place Summers envisions or wants.

  12. this is precisely why we have to keep housing away from the financial engineers. what we saw in the last decade is that if we allow housing to become a financial asset — something to be financed with huge leverage and borrowed against — then it will be rational for prices to rise in a competitive market.

    however, we are all better off if housing is cheap and safe. maintaining conservative financing and leverage practices will keep housing prices low.

  13. Here’s why “let’s turn the corner and worry about other things” is correct: 1) health care reform, and 2) climate/energy policy.

    On both, the administration and congress are moving ahead with very good choices. “Going long” on finance/banking right away would have been a mistake.

    Geithner and Summers can always be dumped later. Nothing is written in stone….except for the health insurance crisis, where people are going bankrupt NOW, and the global climate disaster, where the costs of inaction far outweigh the trumped up and relatively low costs of action.

    This is the window where we need policy change beyond just finance.

  14. Unfortunately the let’s turn the corner view is prevailing because we have not felt enough economic pain for the political will to attack the financial sector. Sadly this is reminiscent of the Bosnian/Serb conflict. They were not ready for peace until each had suffered enough pain to be willing to negotiate.

    Until we feel our second wave dip in this crisis we will happily talk about “green shoots”. The administration may as well work on health care and energy policy. They are not ready to take on finance.

  15. nice response.

    credit will dominate the money system as long as there are large groups of people which want to accumulate future claims on money. demographics will dictate this if nothing else. ultimately this will make it difficult to avoid bubbles.

  16. Simon, I really appreciate your expertise and writing on these important issues.

    Probably wishful thinking here, but I’m hopeful that the administration understands the political economy. I actually think the narrative is slowly changing and that this is in some part because those outside the White House like yourself are pushing for it.

    If it is true that our short-term needs and current microeconomic issues are competing with the regulatory and structural changes that will make us stronger long-term than I wonder if they can really do both at the same time as many argue.

    I’m thinking it’s possible they could be too effective in pushing a narrative that would prevent our government from taking the necessary actions to keep us afloat. The abuses of those in power and the resulting damage only become more clear. As public outrage grows, so does political will. Hopefully your efforts will help to reduce the amount of apathy and ignorance that allowed us to get into this situation.

  17. MK,

    I am not as sanguine as you are MK. The baseline census projection assumes constant reproduction rates. (For those of you following along at home, see here: The “low” estimate, like the “adverse” financial scenario, seems likely to become the new baseline.

    We are at replacement reproduction rates domestically, and are reliant on immigration for population growth. Domestic reproduction rates are probably going to continue to decline, perhaps precipitously going into this downturn. I can imagine plausible arguments being made that the downturn would either increase or decrease immigration rates, so I’ll have to pass over it without commenting. But I would note that Mexico and many other Latin American countries also have declining (I would say plummeting) population rates (Mexico is already nearly at replacement.) With all this uncertainty, it’s plausible that the U.S. population peaks in the next 30 years.

    I believe that this crisis, like Japan’s, will figure in decades, not years, and that therefore these demographic facts will very much play a part in the story.


    Note: I use my real name in these comments because it forces me to be polite (well, at least more polite than I would be otherwise) to stand by my statements and to reverse myself when I am shown to be wrong. I encourage other people to do the same.

  18. The rational response arguments begin with locally rational behavior under specific conditions, and project it to globally rational behavior.

    Even if individuals were rational in buying houses at inflated values, even if lenders were rational in making unsecured loans to people with undocumented incomes and questionable credit records and no/minimal down payments (with the only collateral being the house as an asset), and even if CDO buyers were rational in buying those loans…

    We are still left with the fact that a long term change in asset performance that is projected into the present can instantly wipeout asset values, and when those assets are purchased with leverage, that turns wealth negative. Given that home prices were so high (predicated on sustained very high economic growth, which was driven by the financial sector), and so many of those homes were purchased with massive leverage, then are you still implying that those decisions were rational?

    They only seem rational if you have _very high_ confidence that the bull market economy would continue uninterrupted for decades.

    And given history, that doesn’t seem very rational, does it?

  19. Thank you Simon for writing this piece without the obligatory “brilliant” reference to Summers that seems so prevalent in the media whenever he is spoken of. Even when media speaks of him in unflattering terms, folks still find it necessary to say how brilliant he is, i.e. “arrogant but brilliant”. A simple question needs to be asked, what makes this guy so special?

    Maybe we need someone with less “brilliance” and a little more common sense. Let’s stick to the real economy and not esoteric econobabble that Summers seems so fond of. The general public has to stop being intimidated by the way Wall Street talks and see through it. America, these people aren’t as smart as you think they are, they don’t know what you think they know.

  20. Paul Samuelson (Swedish Bank Prize) spawned: Larry Summers (Just A Prize) – Stantley Fischer (Bank of Israel) – Robert Merton (Swedish Bank Prize).

    Summers is Samuelson’s nephew. Is this significant in any way?

  21. The notion of financial “self-equilibration” without rules, in this case, about money, seems like a cart before horse problem. Those, like Mr. Summers, who are betting on “self-equilibration” need a history lesson. I wonder how many Romans expected something similar to occur…until Atilla showed up.

    This mess was created by the removal of rules. Perhaps the old rules were not the best, but the decision to drop rules altogether and justify this by mystification of finance was just silly.

    There is, it seems to me, a science of money- and all science aims to discern the governing rules. On that note, the current crisis is a wonderful data point on what happens when there are no rules in finance.

  22. Nice discussion. I’m not an economist, but I see a flawed assumption. Am I wrong?

    The Obama Administration Faulty Assumption: If the government gets the banks to supply loans, then the economy will expand, so the government must expand the capital of banks.

    By analogy that is like saying if you want to expand the sales of autos create more autos.

    Shouldn’t the assumption be: Expand aggregate demand and borrowers will appear.

    Am I missing something? Sure, we needed to stem the depositors panic, and Bernanke did, but shouldn’t the emphasis be now on massive stimulus (preferably investment that yields a return), not the little stimulus congress passed? The banks will heal if borrowers appear, won’t they?

    With the information now coming out on Wall Street relationships, I fear this treasury department effort will all come out badly. Geithner and Summers are part of the Wall Street power structure. Obama is not. Perhaps Obama will pull away from these people if things start to get worse, not better, and take a new path. I hope so, but time is running out.

  23. > What, exactly, are the tradeoffs to running a money supply on _privately created debt_ vs. _publicly created money_?

    it seems like you are asking a communism versus capitalism question, no?

    if money is publicly created, how would you distribute it, and how would you make decisions about how it gets allocated?

    clearly the financial system hasn’t done a good job in the past ten years — but what is the real alternative?

  24. i should clarify my response. imho the early boom years were in some way “rational” in that financial innovation actually made houses more valuable. the mere fact that i can easily borrow money against my house makes whereas previously i couldn’t makes it more valuable to me.

    however, doing this increases my risk.

    banks are supposed to keep the aggregate level of risk low (they are supposed to care about getting repaid when they make loans) but for a number of reasons they failed to do this. certainly by 2006, we were in a serious irrational bubble.

    milton, like anything, housing prices should be driven by supply and demand, and not by utility. it doesn’t cost that much to build housing and so it shouldn’t price that much above replacement cost. so i am not sure what your logic is.

  25. I still say Summers is the privileged white boy version of Sarah Palin. This whole argument is a complex mesh of rationalizations for taxing the poor and funding the rich. For instance, his complaint that “regulation in the past 20 years has failed”. Well, yes, because you and yours persuaded our leaders that it wasn’t necessary. There’s every reason to believe that Summers is a narcissistic con man. Why does anyone trust him?


  26. Finally, someone who see’s the light. NOTHING will change in America, until THE PEOPLE flat out demand it. All this blogging and complaining is NOT going to end the theft that is occuring now. You must let those who bet and lost, lose what they bet. I believe your government is planning on reimbursing Wall Street for it’s malfeasance, then allowing the whole thing to collapse AFTER the losses are passed on to the American taxpayers. The evidence is clear – 100% reimbursement for Goldman Sachs on CD’s that have not even yet defaulted? THATS THEFT. And, I might add, against the Federal Reserve act, which means it’s theft. “Just because” the thieves are dressed in suits, and occupying offices in Washington, doesn’t make stealing and breaking long established banking regulations legal. If a guy in a good suit robs a bank at gunpoint, is it OK? No. This is no different. YOU ARE BEING ROBBED. And they will continue to steal from you until you take action. All this nonsensicle “blogging” on web sites like this one is idiotic. TAKE ACTION. March into Washington, armed, and then you may get “change you can believe in”. Can someone tell me why Chris Dodd has not been indicted?

  27. I’ve always wonder what Obama was thinking when he chose Summers.

    Now, I’m totally kerflummoxed. “Crises always end” with total disregard as to how it will end and in what shape will the social fabric be left? Tone deafness at its worst; it so sounds like “I’m fully vested and I couldn’t care less what happen to the little people”.

    There is a big price to pay for an attitude like that and Obama should know that.

  28. Japan is actually ahead of the curve regarding the need to reconcile the cancer cell philosophy of endless growth that drives our economic system with the realities of a finite planet and resource base. If growth were the answer, how come we are not in nirvana by now with national productivity having steadily risen since 1980, approximately doubling every decade? We need to progress to an economic system not driven by demographic growth. “Growing ourselves out of this” is kind of like a drunk “drinking himself out of” getting a hangover; all it does is postpone the inevitable and makes it worse when it does occur.

  29. We are a nation of common laws…laws of precedent as opposed to statute or constitutional laws. By ignoring to enforce constitutional laws we establish a law of precedence which automatically invalidates it. All illegal future behavior under a common law precedent cannot be legally enforced so that any law passed to nullify a common law precedent cannot be enforced. It is incumbent upon us to look back so that we can look forward to preserving for our progeny the great law abiding America they deserve. I love my grand children…don’t you? alfie

  30. Phase 1: Prop up the banksters.

    Phase 2: ????

    Phase 3: New growth, but not finance oriented.

    Larry Summers is an Underpants Gnome!

    No matter how much blood you pump into a zombie, it’s still a zombie.

  31. There are many things I do not understand about the economy system we currently see in America. Simon’s summation of what Larry Summers had to say in his speech leaves my questions unanswered.

    Here are just three questions I’d like Larry to tackle:

    1) How can the “self-equilibrating” nature of the economy ultimately prevail, when the market forces are overruled by any number of interesting policy decisions – like forcing BofA to buy Merrill; spreading tax dollars by the billions to healthy AND diseased firms, etc.?

    2) PLEASE CORRECT ME IF I’M WRONG – but it is my understanding that the “toxic assets” on the books of the Wall Street firms nearly brought down the economy last fall. So where is the money coming from to fund the exorbitant salaries of the Wall Street execs?

    In this NY Times story (, their pay is on track with the golden moments of yesteryear.

    But with asset sheets clogged with toxic debt/assets, whatever they are, shouldn’t the profits from this quarter go to recapitalize?

    3) Are taxpayers the only ones responsible for the losses these firms experienced in 2007?

    I’m hoping any of the astute readers of this blog would feel free to jump in with their answers….

  32. “Such a crisis happens only ”three or four times” per century, so taking on huge amounts of government debt is fine; implicitly, we will grow out of that debt burden.”
    One of the many statements that are made trying to explain or justify the problem.Yet things are VERY simple.There is NOT/CANNOT be a healthy economy when is based on borrowing PERIOD.The math is not there to supported it.Is an impossibility.A healthy economy is based in spending of DISPOSABLE income.Until that happens (and it won’t) ten years from now we are going to have the same problem (look 80s and 90s).
    To correct the pattern first we have to OUTLAW LOBBYING (it won’t happen),second we have to reform the BANKING LAWS (it wont happen)third we have to get rid of the Wall Street (good luck),fourth we have to reform the Judicial system (not much hope there either) and fifth the most important part of the deal, we have to TOTALLY REFORM EDUCATION (we are a third world country right now on that subject.If you think we have problems now, wait five more years.The time for discussion, politics and views has long gone .This is the for action ONLY.Every new piece of legislation, every new way the government is finding to justify bail outs it get us in to a deeper hole.Look at the noise about saving GM -so many people will loose their jobs- they said.Yet GM today announced that is letting go of 20,0000 people.Why would you save GM the bustards haven’t made a good car the last thirty years, and singlehandedly give the industry to the Japanese.How many investors got any money from the wall street bailout?And the rest of us are keep forking out the money. I’m willing to bet any expert $100 to my $ than in ten years we will be having the same problem and we will be claiming then as do today, that this is new and we have not see it before.LOL

  33. The next expansion should be based less on asset bubbles and more on investment in key public services.

    This is a particularly ironic turnabout, since it was Summers and Rubin who most forcefully argued the contrary in the first year of the Clinton Administration — bureacratically eviscerating those, like Robert Reich, who thought more investment in key public services was what “putting people first” was all about.

    It took me some time — and repeated exposures — to Summers to understand that for all his intellectual fire power, his emotional and social retardation really does cripple his analytical abilities. Now it looks like everybody’s gonna get a chance to find out.

  34. Sommers is working off an agenda that Obama has bought into. The goal of taking care of the crisis now, and dealing with the reforms and controls later is something that the niave Obama may feel good about – as a politician, but to all the others that are involved, it is duplicitious. The big joke to me is that we will grow out way out of the crisis and pay back the debt — through growth? Just like Bush pass thge war off to is successors, Obama is passing the reconciliation off to…. his daughters. NMP.

  35. I agree with Ted. I am slightly bemused to hear everyone refer derogatorily to Japan’s lost decade. As a long time resident of the country, I can assure you things are not as bad as some may like to imply. For starters, the landing from the economic bubble was very soft indeed. I know the liberal economists were cheering for more blood and guts, like fans at a nascar event. But let us not forget we talking about real people, with friends and family, not just numbers or god forbid, workers! One must concede that compared to the phenomenal growth enjoyed by the US economy in the last decade, Japan’s growth was quite pedestrian. It limped along at about 1 or 2 percent. But when combined with the deflation of prices, the actual buying power of average people actually increased. In other words, people’s life styles somewhat improved. Can the same be said for Americans? I mean regular Americans, not just the CEO class. And what good is all that growth anyway if it is just erased overnight, leaving massive debt and dread? I could also talk about Japan’s national health insurance, impeccable public transportation system, superior energy efficiency, ridiculously low crime rate, etc. I think America would be lucky to meet the same fate Japan did after their bubble economy. But I know that for Americans this is just not sexy enough. We demand infinite growth, even if that means an endless series of booms and busts. Perhaps we are just trill seekers more enamoured with the bumpy ride and HOPE then with actually getting anywhere.

  36. Save jobs? What jobs? The only jobs Timothy Geithner is trying to save are tose of his fat cat banking executive friends. He only takes pride in trying to BS people – including Obama.

  37. Although we debate in terms of extremes, the real world surely lies somewhere in the middle.

    It’s not really whether we have public money or private money (e.g. bank debt), but what percentage of the money supply is public vs. private.

    Public money is secured with the promise of the govt. and the force of law. Private money is secured by private resources (capital, assets, reputation, credit rating). Too much of one or the other seems to cause problems. Each has advantages and disadvantages. But right now, we have a lot of private money, which was secured by private capital (that got vaporized by the asset bubble deflation). Creators of private money have benefited from a windfall as debt rose faster than base money, and now that assets are deflating the public taxpayer is confronted with a choice to accept worldwide depression, or backstop private money.

    If taxpayers are going to be on the hook, should they not benefit from a reduction from a slight reduction in taxes that should occur when government actually gets to spend the money that gets created, rather than banks?

  38. <>

    If this is true, then Summers is stunningly naive about risk.

    Big Finance went all-in on black. For a long time, it kept coming up black, and Big Finance kept doubling-down, congratulating itself on its brilliance.

    Then it came up red.

    I guess that’s what an “accident” looks like!

  39. This site seems to me to be one of the few places one can get reasonable reports on the state of the economy, and once in a while somebody mentions “political economy,” but what worries me is that no one, as far as I can see, has talked about the fact that it takes a couple of million dollars to win a seat in Congress. Not only the economy, but our electoral system is broken. Obama could get rid of the current set of oligarch supporters and hire people like Stiglitz, Krugman, and our host, and still be unable to get anything significant through a Congress controlled by the moneybags. How are we going to change that?

  40. StatsGuy —

    I assume you know the “standard” answer to your question, which is that if Congress had the power to print money, the temptation to simply do so in lieu of taxation would be irresistible. Hence the desire for an “independent” central bank.

    Theoretically, private money (i.e., credit) only gets created when there is an investment worth putting it into as determined by the free market. Obviously, in practice something has gone a tad wrong. :-)

    The question is, is the idea itself completely wrong? Would we really be better off with publicly created money? Or did something just go wrong with the implementation, and we just need to “fix” it?

  41. “NOTHING will change in America, until THE PEOPLE flat out demand it. All this blogging and complaining is NOT going to end the theft that is occuring now.

    I’m a longview big picture type myself and the way I see it, you’re not gonna get the PEOPLE to flat out demand anything until unemployment is a bit higher than it is now, say 20 percent, at least.

    I’m just wondering how long before we get there. A year? Two?

  42. Start by arming yourselves, then get a map that leads to the corruption capitol of earth – Washington, DC. The place where the fox guards the hen-house.

  43. “There was nothing in Summers speech that addressed how we avoid – at the US or global level – becoming more like Japan in the 1990s” – Simon Johnson

    Comparing US today to Japan’s lost decade is fear mongering. To revive our economy requires strong action in following:

    1. monetary policy
    2. fiscal policy
    3. international collaboration to prevent protectionism

    On both 1 & 2, what the US has done so far is miles ahead of what Japan did in the 90s. This is especially impressive considering Obama and his team has only been in office for ~100 days! Considering the vast differences in initial conditions between US today and Japan in the 90s, anyone seriously prophesizing that we’ll follow Japan’s lead is an intellectual lightweight fear mongering an ill informed audiences. Anyone interested in more information can listen to old episodes on Japan’s lost decade from NPR’s planet money or Russ Robert’s Econtalk pod cast.

    Notice, the cleaning up of our banking system IS NOT a requirement to turning around the economy. “Fixing the financial system is often not necessary (or actually sufficient) for a rapid economic recovery”[Simon Johnson]. This is collaborated by Krugman and Simon’s peers at the Petersen Institute. Simon, how much more historical evidence is sufficient to suggest IMF’s prescription is wrong in this crisis?

    Lastly, I’ll also put the comparison of today’s crisis with great depression to bed too. During the great depression the unemployment was 25% of *household* because women at the time often stay home. Not to mention FDIC, unemployment insurance, and etc. didn’t exist. Back then a family’s entire household saving could get wipe out when the community bank fails in addition to the husband loosing his job. That is not happening today.

    We cannot say for certain that we won’t have a Japan style lost decade or a repeat of great depression. However, no one can make a high probability case that we will.

    Simon, fear mongering is great if you want to fool the populists. To be honest, I don’t mind that too much since I tend to find getting the populists bent out shape very entertaining! Great sport, old chap! However, do keep in mind we are still in the worse recession in recent memory. Perhaps it is a better use of your time to help the recovery process instead of toying with populists and creating unnecessary distraction for those busting their ass trying to turn things around!

  44. Does this speech by Summers mean that the US is likely to risk their #1 position in the world economy?

    What position will have the US in the world if Finance is highly regulated and deleverage? He admits that finance grow out of proportion and can not sustain that grow anymore.

    Thanks to finance most US companies offshore and outsource thusands of jobs to other countries so companies can low their cost. With such low cost and highly sucess in the financial markets this companies enjoy huge, and huge amounts of wealth. Does this mean that the US government is willing to bring that jobs backs. If so, what is the time for that to happen. Or are there too much green jobs to support the #1 position in the world.

  45. We have been spending our resources on the wrong emergencies – 9/11? Iraq? Banks? Oil export-import market!

    Look at Mexico. Their oil output is tumbling. Down 7% Q1 08 to Q1 09. Not good. Why? Largest field (Cantarell) is in 34% Y-O-Y decline.

    there is more…
    Mexican oil exports are down 14+ % for the same period.

    2 edges to that sword:
    #1 – Mexican Federal Gov’t gets 40+ % of revenue from oil – because they own it. Lower exports & lower prices means very bad days ahead.
    #2 – Their main customer is the USA. We import 60+ % of the oil we use. We need to be spending our resources to prepare for what is coming. If a couple more countries have production declines like this the USA will be in a heck of a scramble.

  46. James Kwak, you’ll notice “Feeding the shark” is spam! Hmmm, the relative value of comments…

  47. Point #1 sounds positively idiotic. What a beautiful approach to problem-solving

    1. Do something
    2. (waves hands)
    3. Everything is wonderful again!

    Somehow, I doubt this will happen. The people who invented NINA loans are just not capable of fixing things.

  48. Just fix it? There is such a long and consistent a history of highly destructive failures resulting from the “exorbitant privilege” (creating money from nothing,) whether public or private, and yet the illusion that there is a fix persists.

    When a system is inherently flawed, only a complete redesign will do. Until said privilege is eliminated, many will be “shocked, shocked” anew every time we go through a crisis.

    The cultural conditioning James writes about along with much public propaganda may explain why even brilliant people seem unable to observe such an obvious and consistent pattern of failure – they don’t want to because it challenges a fundamental view of the world that they’ve bought into. Similar to the firestorm that Galileo and others faced when challenging the cosmology that prevailed for millennia.

  49. The fact that oil hit $147 a barrel a year ago is almost totally ignored by analysts. It’s passed off as covariation or a dependent variable, etc. even though its price affects virtually everything we do and consume -even Greenspan said so in Dec 2007. The empirical case is that crude oil production hit a plateau in May 2005, with 2006 and 2007 production less than 2005; and in 2008 it barely increased. We appear to be at the peak with demand destruction in progress.

    There is virtually no prospect of growing out of this crisis; any recovery will sputter and fail as oil prices will once again rise. We’ve reached the limits to growth -something Larry Summers is on record as saying is impossible. This is the policy context of the future.

  50. silly things
    Your ideas are worthy of consideration but you diminish their serious consideration with your attitude of condescension. In addition to distracting from your points, you reveal a personal insecurity in your efforts to mask it. Something to think about…

  51. I am aware of the standard aruments – the notion that “independent” central banks can serve as a commitment device to achieve monetary stability, because elected governments just can’t be trusted with the power to print money.

    Or, to be brief:

    “Bankers are better stewards of the money supply than democratically elected leaders.”

    In making that argument, neoclassical economists have propagated so much fear of the democratically elected government that we have fled helter-skelter into the waiting arms of the banking oligarchy.

    But the world has changed:

    1) World capital markets are vastly larger than individual national bank reserves; this creates strong pressures on govts. _not_ to print excessive amounts of money, and international capital markets are brutal and immediate in their response. This provides a new disciplinary function that is not considered in the commitment arguments for a central bank.

    2) The notion behind privately created money is that rational banks will not create too much money, lest they be wiped out. However, this is a one-sided risk for two reasons: a) low capital asset ratios mean that banks have limited downside risk (e.g. if they win a big bet, they keep it; if they lose, they lose only their capital, which could be 4% or less of total assets). b) banks – either really big ones or many small ones acting as a herd – can take down the financial system if they fail, forcing govt. to back them up and thus creating even more asymmetric reward structures.

    Also, banks may not be as rational as we thought (they are, after all, run by people…)

    c) We have been told – repeatedly by our leaders, as if repetition creates truth – that “modern economies run on debt”.

    They run on debt because that’s how the system was built. They don’t need to run (so completely) on debt.

    We have not grasped the full downsides of running a money supply through debt, rather than cash. Or, to be more accurate, as the proportion of debt in the total money supply increases (relative to cash), we don’t know what the impact is – in terms of stability, resistance to asset value shocks, moral hazard, efficiency, political pressures, govt. capture of federal institutions (instead of Congress), etc.

    What we DO KNOW is that allowing banks to create an increasing proportion of the money in the system has effected a massive transfer of wealth from the sovereign government to banks – which is made worse if the system is so unstable that systemic risk compels the national govt. to backstop the banks.

    Which goes back to the core proposal:

    Lower capital-asset ratios globally (in a phased step-wise manner), print more cash (to hold money supply stable until capital-asset ratios reach their new target levels), spend the cash on useful things (including paying down national debt).

    This is a separate, but synergistic, proposal to the proposals to restore some degree of regulation to the system.

    But let’s take a step back – if you tell a main street American that we are massively indebted, and the key to restoring economic growth is to get people to go deeper into debt… What in tarnation do you think they will think?

    Is it any wonder why Americans fundamentally do not believe that “recapitalizing banks” is the most critical thing we can do to restore growth?

    No reasonable people are arguing for getting rid of all privately-created money (debt), or printing a mountain of money… just restoring the balance of Public Money (cash) to Private Money (debt) to a more sane level.

  52. i think we are stuck with a ‘debt’ economy and not a ‘cash’ economy. the reasons is that people and institutions (including international central banks) want large amounts of interest bearing guaranteed instruments.

    think of a billion people saving for retirement. that’s a lot of promises, so it is a lot of debt. (as the population ages and development equalizes, you might need a quadrillion dollars to do this.) if you print anywhere near that much cash, so that it can all be liquid at once, you will have extreme inflation at times.

    ie if you have all these ‘promises’ made in the economy — and people want them — you will end up with a lot of debt, because promises are debt.

  53. Only a total collapse of the financial system will produce the structural changes you’re looking for. The rest of us just want a floor under the economy, thank you very much, I don’t care if a few bankers get rich in the process

    Restoring confidence in our financial system (which like it or not is necessary for the rest of the economy) and punishing financial institutions that are teetering on the brink are mutually exclusive goals.

  54. I’m not arguing for a return to pure cash – and certainly not gold. I’m arguing for a graduated increase in capital-asset ratios of 1/3 to 1/2, phased in over several years (perhaps 5 years) on a fixed schedule. This would take leverage ratios down from around 25 to somewhere between 15 and 18. In order to prevent deflation, replace the destroyed-debt with cash. Inject the cash into the economy through federal spending. (We don’t even need to increase federal spending, really – just to stop selling t-bills to finance deficit spending for a few years, and refrain from excessive increases in taxation.)

    The only rational reason for not printing money (other than a poisonous hatred for all government in any form, or a fear that once we print a little we won’t be able to stop) is fear of a future inflationary rebound. That rebound is largely contained by the increase in capital-asset ratios.

    As to fear of “getting the genie back in the bottle”, note that the Fed has always had the ability to print money. And, even in a crisis, they still barely managed to agree on it even after months of debate. Why do we expect them to agree on printing money when we have healthy/moderate inflation levels?

  55. i certainly agree with you that cap ratios were too low and i more or less agree with you on the amount by which they are too low.

    i think that a lot of the problems in the financial sector now are fundamental. they come about because people predominantly use financial instruments (as opposed to rents or productive assets) to create long term economic insurance, a high level of debt on rent generating or productivity generating assets will be the consequence.

    i’ll try to hash this out more in comments to your postings going forward.

  56. Banks are very leveraged. They have a ton of assets (which produce huge income), a ton of debts, including depositors (which is costly to service, but is rolled over unless there’s a liquidity event), and a thin sliver of equity capital.
    Banksters can pay themselves huge bonuses while making losses. This just means they are eating into the equity or the assets… leaving less recovery for bondholders, or bigger losses for the FDIC, or a bigger mess/bailout for the Treasury if the bank is TBTF.

  57. StatsGuy, q, nonim, Nemo…you guys are on the right track. This is a _monetary_ problem more than an “economic” problem. The market works fine, it’s the scoring system that’s screwed up.

    Maybe the hosts here could have a post dedicated to thoughts on monetary systems, or how we keep score in this game.

  58. summers is a brilliant and nerdy mind. i’ve been standing behind him for many years. he is opinionated and doesn’t like to hear anything else but his thinking. that’s good…..we need that!!!he’s numero uno in this thang. as i said months ago,,,,,we will be fine. did anybody go long on banks a month ago?should have.

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