Simon Johnson on Larry Summer's Economic Astraology
Indeed, our banks are again raking in the billions, courtesy of taxpayer's largess and some fancy sleight of hand. Yet of late the cafe has been dominated with thoroughly engaging torture discussions, leaving a relatively sparse collection of economic posts (causing some of us econ worrywarts to start jonesing for a fix). So I wanted to share this post from the always must-read former IMF chief economist and MIT professor Simon Johnson.
Last friday, Mr. Johnson attended a conference at the InterAmerican Development Bank that featuring our supreme economic Czar Larry Summers addressing a house of development experts. He posted an excellent blog exploring the implications of Summer's current thinking. Larry is the man who gives Obama his daily economic briefing, and seems to have the ear of the president. I would really like to know how Volker, Rohmer, Goolsbee and the rest of the economic brain trust fit into the picture (and if anyone has some insights please comment). However, it appears that despite his ethical conflicts, Larry's is the most influential voice in forming our economic policy.
Simon Johnson shares his insight into Mr. Summers thinking. It is not very encouraging. During his speech Mr. Summers made five main points that Mr. Johnson summarizes as:
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).
Proceeding from these premises Simon gives his analysis of the potential flaws and some of the implications that arise from our current policies.
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....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?
To Simon this is the crucial flaw in Larry's logic. Our bailouts through TARP, TALF PPIP, etc. are essentially subsidies to maintaining the current financial industry (and the powerful elite behind them). Even the most optimistic proponets acknowledge that Geithner's toxic asset strategy continues this by placing the risk to taxpayers and giving the banks and hedgefunds most of the upside. This simply encourages more resource allotment into the overgrown and unproductive FIRE sector. (There is more to Johnson's analysis and since I am really just cribing his thoughts I really recommend you send him some traffic.)
I would like to know more about Larry's reference to more investment in key public services. Is this contained in the budget? Or is there more to come? A second stimulus perhaps? Frankly, I am left wondering if the teabaggers might not be on to something that the Obama plan is simply for government spending to slowly rise and take up the slack that will be left from a dramatic reform of the financial industry.
I certainly would welcome a move towards a more European style system with a strong safety net and an infrastructure that works. However, I don't currently see that mandate so what is going to sustain us economically until that comes about? Are we just going to limp along until things get so bad that we all clamor to become Belgium? Is that the master plan? Starve'em to socialism?
Mr. Summer's clear annunciation of his first idea I find a little unnerving. I read it as a "stuff happens then eventually it stops". Johnson points to Japan as a potential worst case, but I would mimic Krugman and point to the 30's, or even more foreboding the depression of the 1870s. Does such a clear emphasis of this idea indicate a 'wait and see' strategy? Larry also made numerous statements this weekend that the Economy is going to keep declining . Great.
Of course as always of late I am left wondering how exactly is this going to be different from Japan? Or even if Japan is perhaps a best case scenario. Our position in the world's economy as consumer of last resort means that we can't export our way towards solvency. If we are not going to take the red pill and quickly write down our debts to manageable levels, are we going to limp along writing them off slowly (japan) or simply inflate them away? Do our leaders really think that there is a middle path that we can take? Can they give us some historical precedents?
Part of me wonders if perhaps the O team has been seduced by an idea that we can inflate without inflation. That because of the worldwide economic downturn and the resultant 'flight to safety' to dollar denominated T-bills that we can run the presses without worry of raising interest rates rise to attract buyers. I mean in these circumstances who is more credit worty than Uncle Sam? Is this even possible? Anybody care to venture another idea?
As an aside, I also can't help but note that in the last week we have seen a spate of negative pieces on Treasury Secretary Geithner. From yesterday's exhaustingly researched New York times piece on Geithner's 5 years as the head of the NY Fed, to Portfolio's recent portrayal of the Secretary as little more than the ever loyal burecratic apprentice, The reeducation of Tim Geithner. This has led to some speculation that the knives are coming out. (I too believe that Timmy has been groomed to be the designated fall guy but my money's on next September, anyone want to start a betting pool?).
And for those who read this far, here's a distressing bonus link. Via Krugman a thought provoking Financial times post Banking Credit Catch 22. Our haphazard bailout strategy combined with our fun financial products are creating some very intresting winners and losers. I find this amusing but I fear the implications. What good is a capitalist system that consistently rewards losers?
Oh well, its spring time, :)
