Summers’ New Model: Details, Contradictions, and Odd Assumptions

By Simon Johnson

Larry Summers had “lunch with the FT” (p.3 in the Life and Arts section Saturday) – although unfortunately the paper does not report when this happened; a week or two makes quite a difference these days.

Putting this next to his April speech to the IDB, Summers’ view of the way forward has a few problems.

Summers says

The American problem this time has more in common, at least qualitatively, with the Japanese post-bubble problem, where the issue was not reassuring foreigners but maintaining sufficient domestic demand to push the economy forward.

But Japan had a chronic current account surplus, which became bigger as firms saved more in order to pay down their debts during the 1990s. The Japanese government could finance its deficit domestically – and the country exported capital consistently. In contrast, with our well-established and large current account deficit and our eye-popping budget deficit, we rely much more on the confidence of foreigners – unless Summers is assuming that the increase in our private sector savings will be truly enormous.

As Summers says, quite accurately, the Asian and other crises of the late 1990s,

… took the form of a foreign lack of confidence in a country that led to a mass withdrawal of funds and made reassuring foreigners the central priority. That’s why interest rates often had to be increased.

Surely, we face some sort of hybrid Japan/emerging market crisis. Or perhaps we are heading towards blending Japan in the 1990s and the US in the 1970s, i.e., there has been a permanent shock (oil then v. financial sector now) to which we should adjust, and if we attempt to postpone that adjustment excessively through overexpansionary macro policies, we’ll experience a great deal of inflation.

On Japan in the 1990s, Summers is famous for first arguing it was an aggregate demand problem and later coming to the view that the banks were undercapitalized and – without this – the economy could not sustain a recovery. His ideas on the US are likely to go through the same evolution.

It is also striking that he makes no mention of balance sheets problems, either for consumers or businesses – in Japan then or the US now. It sounds like he is getting ready to push for a second fiscal stimulus – actually, for him this would be the third stimulus, as he argued hard for the tax cut stimulus of early 2008.

Summers is almost certainly wrong when he says,

The very great enthusiasm for accumulating reserves that one saw globally is likely to be a smaller factor over the next decade than it has been in recent years.

On the contrary, most emerging markets are glad they had more reserves than in the past and are now wondering about how to build up those reserves further. This may, of course, help the US sell some of its forthcoming government debt – but it doesn’t reduce “global imbalances” or address the fact that we are on an unsustainable public debt and foreign debt path. Most of all, it lets us dig a deeper hole for ourselves and for the world economy.

More broadly, Summers continues to argue, at least implicitly, that we face a temporary shock or one-off aberration of some kind. He distinguishes sharply ”fixing” the banking system and “getting the economy out of the rut” from long-run issues, “like fixing health-care, like having real energy policy, like reforming education.” He apparently does not see much by way of connections between these two sets of issues.

But doesn’t the economic and political power of our troubled banking system threaten our longer run opportunities? Aren’t our nonfinancial reform options (e.g., on universal healthcare coverage) already limited by the doubling of government debt (towards 80% of GDP) we are undertaking as a direct consequence of financial sector misfeasance? And won’t Medicare – and much else – be undermined by the behavior of “too big to fail” banks down the road?

Summers has commendably switched some of his rhetoric, so now he emphasizes nonfinancial technology development – presumably in the private sector – as the road to sustainable growth. And he rightly contrasts this with the financial engineering that brought us to this point. But does his model really offer the most plausible or appealing path from here to there?

Comments

[dcb:]

Yesterday Mr. Obama asked for more time patience from the public from regarding the economy. Personally, I do not believe Mr. Obama's policies deserve more time, they are misguided, driven by special interests, not directed towards the root of the problem , will actually make the economy worse, and rip off taxpayers for wall streets benefit.

He has abandoned the policies he stated he stood for while running for election at every chance when faced with industry pressure. He has allowed wall street to manipulate the markets increasing borrowing costs, driving up the price of oil , delaying recovery.

He has knowingly talked about green shoots when there were none, creating false expectations. If we wanted a president we knew would lie to use we would have kept bush.

He has spent trillions bailing out wall street to keep credit flowing while American's need help to reduce debts.

He has staffed the White house with wall street insiders.

If you believe, like I do, that Mr. Obama needs to change course and has had enough time I urge you to write the white house explaining why he has had enough time, and why he doesn't deserve more. Below is the link:

whitehouse.gov/con.../

Jul 12 01:37 PM

[PastTense:]

"unless Summers is assuming that the increase in our private sector savings will be truly enormous."'

The FED and Treasury are very hostile toward increasing private savings, as shown by circa 0% interest rates. Why should people save when if they do they get they are losing money (after true inflation, not phony government figures) when doing so?

Jul 12 03:06 PM

[derryl:]

Simon wrote,
"Summers has commendably switched some of his rhetoric, so now he emphasizes nonfinancial technology development – presumably in the private sector – as the road to sustainable growth. And he rightly contrasts this with the financial engineering that brought us to this point. But does his model really offer the most plausible or appealing path from here to there?"

Technologies can improve efficiency and productivity in the physical economy, but our problems at root are not physical. They are monetary. All of the workers, productive facilities and raw resources are still there ready to go to work producing goods and services. But nobody can do anything because everybody has too much monetary debt.

Money and the economy are 2 separate systems. The best way to see this is to look at a bank balance sheet compared to a non-bank balance sheet. On a bank balance sheet your account balance--your money--is their liability. On a bank balance sheet your loan--your debt--is their asset. Bank assets and liabilities are the opposite of non-bank assets and liabilities.

Banks alone have the right to create money. If the economy creates money it is called 'counterfeit'. You can produce all the goods and services you like but unless somebody has money to pay you for them you can never repay your money debt to the bank. You cannot solve a monetary problem with economic solutions. The solution must be monetary.

Jul 12 03:29 PM

[user344210:]

Agreed. However, debt reduction (and with it the reduction in debt balances subject to interest rates above zero) is a form of savings. It's the Suze Orman theory that if you pay off a credit card balance that's costing you 15%/year, you're earning 15% on that money. Granted that form of savings primarily goes to the bank/credit card company's balance sheet, but it does make money available for lending as well. Problem is, as you probably know, hardly anyone wants to borrow.


On Jul 12 03:06 PM PastTense wrote:

> "unless Summers is assuming that the increase in our private sector
> savings will be truly enormous."'
>
> The FED and Treasury are very hostile toward increasing private savings,
> as shown by circa 0% interest rates. Why should people save when
> if they do they get they are losing money (after true inflation,
> not phony government figures) when doing so?

Jul 12 03:37 PM

[conceptwizard:]

Obama is shacked up with Larry Summers, that says it all. Had it not been for Summers, Greenspan & Clinton 1999 with the repeal of Glass-Steagal, we could not have been where we are today.

This man and his lobby for the Financials have left us with what is remaining of the wealth of Amerca. I believe that history will record this as his legacy.

The fact that Obama would hold him in high regards is very disturbing. He would have to know Mr Summers's role in the crippling of America. Mr Summers interests have never been one of patriotic design, they are not directed at the betterment of Individuals, only that of an elite few as his record clearly shows.

The fact that Obama does not reprimand or incarcerate those responsible for this national security breech of wealth deprevation and aligns himself with those critically responsible trumpets loudly as to what the future will hold, and who he has loyalties to.

Jul 12 04:49 PM

[Tom Armistead:]

Summers has been a source of concern due to his involvement during the Clinton administration in the repeal of Glass-Steagall and the passage of CFMA, which gave us Enron and unregulated derivatives such as CDS. He was something of a power driver during this interlude.

It is reassuring to read in the interview that he has moved on from the views he espoused at the time. A biographical sketch I read on him portrays a man who is deeply interested in ideas, at Harvard he created teams of undergraduates devoted to the production of ideas. As such he might be useful in making sure that Obama has access to a broad range of economic opinions, in contrast to the situation with Bush where he was basically getting all his info from Paulson. So there is room to hope that he will not go into the power driver mode.

He promotes a vision of an economy that is less consumerist (and consequently less debt-ridden), less devoted to energy production and consumption (and less subservient to BIg Oil), less reliant on financial engineering (and hopefully the head honchos at former investment banks), and based on a stronger middle class as opposed to the prevailing steady enrichment of a very small part of the population.

Getting there from here doesn't sound that easy. But if Summers proves willing to limit himself to a role of promoting the exchange of ideas on the economy, as opposed to setting himself up as a power broker based on his access to the President, he might possibly redeem himself for his past errors on Glass-Steagall and CFMA.

Jul 12 05:15 PM

[rosey99:]

Each day that I see Summers, Geithner, et al, still have jobs I am shocked all over again. Despite changes at the margins of Summers' rhetoric, it's abundantly clear that he represents the status quo, and is simply waiting for the storm to blow over so he and his ilk can get back to business as usual. If the sense of crisis passes quickly enough, they may yet pull it off.

The systemic problems remain massive, and the risks of a double dip seem to be increasing with current policy, so I think that success will amount to deferring the consequences, not fixing the problems, i.e., trade deficit, over-leveraged balance sheets, and the public debt/dollar situation. If they can kick the can down the road one more time, they will be heroes to their real constituencies, the FIRE establishment and their investors.

Jul 12 08:51 PM

[Dave Wrixon:]

Summer cannot admit that Government Debt is a key part of the problem, otherwise, he is simply proposing that the US increases the size of its problem. Even to a dumb-assed electorate, that is not going to sound very appealing.

Jul 13 12:41 AM

[Moon Kil Woong:]

Larry Summers is merely doing what all Fed chiefs in the past 2 decades have done to secure their appointment, promise the powers that be that they will support full throttle government spending coupled with easing interest rates. Since Bernake has already floored interest rates all Summers can proffer to the Obama administration is that he will embrace QE and continue to make the US an economic loose cannon whith little or no regard to long term fiscal health.

Rather than take him as the head of the Federal Reserve we should be taking a person who supports everything Summer's doesn't want. Fiscal prudence, a re-adoption of Glass Stegal (repeal of the Graham Leech Bliley Act), and a tamed federal deficit. We need to stop being lured by the sugar coated bribes from people like Summers. Don't they think they already did enough already? We can't afford another decade of their reckless economics.

His paper, asides from acknowleging that financial engineering isn't real or lasting economic prosperity (rather different from 4 years ago), is the same panhandling rhetoric he has always been peddling with 0% content or new ideas. Thus, he has assured the fact that no one will ever bother reading it in full. So much for the hope we may ever find an economic genius to run the Fed.

Jul 13 01:16 AM

[ron_paulite:]

You are right.
Summers cannot be that stupid not to see the difference between cash-rich Japan in 1989 and debt-ridden USA now.

I am quite sure Summers and gang are all very smart people and they are all aware of the real problems facing the country. They probably agree with many of the things spoken by Peter Schiff, Nouriel Roubini, etc.

But they cannot speak the truth. They have their own agenda ...


On Jul 13 12:41 AM Dave Wrixon wrote:

> Summer cannot admit that Government Debt is a key part of the problem,
> otherwise, he is simply proposing that the US increases the size
> of its problem. Even to a dumb-assed electorate, that is not going
> to sound very appealing.

Jul 13 03:14 AM

[Old Rick:]

Your note seems to argue for Paul Volker to head the Fed again. I think the problem is that he has become out of step with Obama and his merry band of spend-ocrats. Interesting how he and Buffet were introduced with such fanfare as "part of the Obama team" and both have since faded into the background of administration policies.


On Jul 13 01:16 AM Moon Kil Woong wrote:

> Larry Summers is merely doing what all Fed chiefs in the past 2 decades
> have done to secure their appointment, promise the powers that be
> that they will support full throttle government spending coupled
> with easing interest rates. Since Bernake has already floored interest
> rates all Summers can proffer to the Obama administration is that
> he will embrace QE and continue to make the US an economic loose
> cannon whith little or no regard to long term fiscal health.
>
> Rather than take him as the head of the Federal Reserve we should
> be taking a person who supports everything Summer's doesn't want.
> Fiscal prudence, a re-adoption of Glass Stegal (repeal of the Graham
> Leech Bliley Act), and a tamed federal deficit. We need to stop being
> lured by the sugar coated bribes from people like Summers. Don't
> they think they already did enough already? We can't afford another
> decade of their reckless economics.
>
> His paper, asides from acknowleging that financial engineering isn't
> real or lasting economic prosperity (rather different from 4 years
> ago), is the same panhandling rhetoric he has always been peddling
> with 0% content or new ideas. Thus, he has assured the fact that
> no one will ever bother reading it in full. So much for the hope
> we may ever find an economic genius to run the Fed.

Jul 13 09:28 AM

[Gem Hudson:]

What hyper-inflated with all of their breathed hot air went pop. The fast and easy credit money all on a low, low down next to nothing interest rate payments is to inflate away. Stimulating by hyper-inflating only crash the dollar and you just can't win. Now where and when ever there is no nothing to spread around. There is no wealth building.

That is because going from your rags to your riches is to know how your business works and once known how, what you are selling. You have produced their money worth but spending 26 more billion of dollars than what the world's largest economic could made for them is deficit spending dying the deficit death. California just bankrupted.

Jul 13 09:43 AM

[sunnsea:]

In the way that Reagan was a front man for Orange County CA Republicans, Obama is turning out to be the front man for the Chicago Richard Daley, Warren Christopher "impeachment is off the table, we won't prosecute you and Cheney if you just go quietly into the night" faction of the Democrats. I'm beginning to think it would have been better for Palin to be elected because then the true business of forming a totally different approach to governing the country could begin. By this I mean under a Phil Gramm Treasury the level of disgust, economic calamity and corruption would be so great that only then can fundamental "change" come about. We almost got there in last year but it was only just beginning. In November 2008 things were getting bad and the subsequent stimulus will ameliorate the downturn somewhat but the real change will not take place. Now Obama will get hund with the blame, most people will stay home in the next election and the Republican corporations remain supreme.

Here's my reform platform for a new America:

1) Reform of the Democratic Party is the main problem. Republicans will always be Republicans serving corporate greed and interests. There's no reforming them. But the corporatized corruption of the Democrats began with Carter and the dealing with 401ks and IRAs and the end of defined benefits for workers back in the late 70s, deals made with Reagan through the 80s, the Republican "lite" Clinton years with NAFTA, Glass-Steagall repeal, Telecommunications Act of 1996, and the Summers and Geithner careers. As the 1982 Billy Joel song "Allentown" puts it: while the factories were shutting down, the union people just crawled away, not uttering a word and abetting the process of deindustrialization of America. And you want to know why Rush Limbaugh has such a large audience.

2) A Constitutional amendment is required to nullify the corporatized (Supreme Court justices with prior corporate experience are never influenced by their personal experiences, right?) Supreme Court decisions such as First National Bank of Boston vs. Bellotti and Buckey vs. Viejo which basically enshrined corporate personhood as having the same rights as individuals including partititioning the government under the 1st Amendment, otherwise known as lobbying, and that "money" is "free speech." These turned reality on its head. Corporations are not "persons" and should not enjoy the same right as we do .
The Amendment should also define "money" and its synonyms as not being free speech. Without such an amendment covering both lobbying and money, all attempts at "reform" are doomed. But without a natonal economic calamity being experienced by a large enough portion of the population, then such true reform as this amendment cannot hope to pass, unfortunately.

3) Development of a national industrial strategy to have American companies successfully compete with Made in USA products globally. The point here is to develop profitable businesses that can actually make things here and employing persons in this country.

Jul 13 09:57 AM

[American in...:]

Actually, Obama's policies are less driven by special interests than those of his detractors, most of whom care more about their wallet than the nation (usually the same people who argue for a strong national defense but never served in the military ...).


On Jul 12 01:37 PM dcb wrote:

> Yesterday Mr. Obama asked for more time patience from the public
> from regarding the economy. Personally, I do not believe Mr. Obama's
> policies deserve more time, they are misguided, driven by special
> interests, not directed towards the root of the problem , will actually
> make the economy worse, and rip off taxpayers for wall streets benefit.
>
>
> He has abandoned the policies he stated he stood for while running
> for election at every chance when faced with industry pressure. He
> has allowed wall street to manipulate the markets increasing borrowing
> costs, driving up the price of oil , delaying recovery.
>
> He has knowingly talked about green shoots when there were none,
> creating false expectations. If we wanted a president we knew would
> lie to use we would have kept bush.
>
> He has spent trillions bailing out wall street to keep credit flowing
> while American's need help to reduce debts.
>
> He has staffed the White house with wall street insiders.
>
> If you believe, like I do, that Mr. Obama needs to change course
> and has had enough time I urge you to write the white house explaining
> why he has had enough time, and why he doesn't deserve more. Below
> is the link:
>
> whitehouse.gov/con.../

Jul 13 02:30 PM

[James Quinn:]

I think Larry Summers will be the perfect fool to lead us into the next financial crisis as head of Fed Reserve.

theburningplatform.com...

Jul 13 04:40 PM

[Fighting Yoda:]

Larry Summers was the architect behind repeal of Glass-Stiegel and non-regulation of derivatives, and now he is a proponent of stimulus, son of stimulus,...

Likes of Summers etc fit in well in any administration – they promote bubbles, bailouts and spending. I think everyone is putting all their thoughts behind how to create the next bubble – hey it is only the $, it the Chinese/Japanese who would lose the most.

Jul 13 06:46 PM

[M.R. Henderson:]

money and the economy are separate? economies are a phenomenon of circulation, and they are finally, on a macro scale, only this. so when you ask us to compare bank and non-financial balance sheet you mean to say that banks are, in a way, opposite their bricks and mortar counter part. money and the economy are not separate; one is the blood in the beast, but separate?

as for Summers... for investors, the most important thing he has said is that the economu will likely get worse.


On Jul 12 03:29 PM derryl wrote:

> Simon wrote,
> "Summers has commendably switched some of his rhetoric, so now he
> emphasizes nonfinancial technology development – presumably in the
> private sector – as the road to sustainable growth. And he rightly
> contrasts this with the financial engineering that brought us to
> this point. But does his model really offer the most plausible or
> appealing path from here to there?"
>
> Technologies can improve efficiency and productivity in the physical
> economy, but our problems at root are not physical. They are monetary.
> All of the workers, productive facilities and raw resources are still
> there ready to go to work producing goods and services. But nobody
> can do anything because everybody has too much monetary debt.
>
> Money and the economy are 2 separate systems. The best way to see
> this is to look at a bank balance sheet compared to a non-bank balance
> sheet. On a bank balance sheet your account balance--your money--is
> their liability. On a bank balance sheet your loan--your debt--is
> their asset. Bank assets and liabilities are the opposite of non-bank
> assets and liabilities.
>
> Banks alone have the right to create money. If the economy creates
> money it is called 'counterfeit'. You can produce all the goods
> and services you like but unless somebody has money to pay you for
> them you can never repay your money debt to the bank. You cannot
> solve a monetary problem with economic solutions. The solution must
> be monetary.

Jul 13 07:19 PM

[MSimon:]

I have an industrial policy that is guaranteed to work:

Buy low, sell high.

Which of course means free trade. The weak will perish, the strong will survive.

===

The only way out of our current situation that I see is to lower energy costs. That will put money in the hands of the consumers and industry.

I really like Polywell Fusion being researched by EMC2 Corporation for the US Navy. The project is relatively starved for funds (it gets a few million a year). But despite the low investment we will know in two years or less if it can be a viable energy generator.

The only major politician to take a direct interest in the project was John McCain. Fortunately he is still in Congress and I would assume he is keeping an eye on the project.

Our Energy Secretary, Chu, also knows of the project.

===

Compare the paltry millions spent on Polywell with the money being lavished by the US (in the hundreds of millions per year) on ITER and other tokamaks.

As notable Plasma Physicist Dr. Nicholas Krall said, "We spent $15 billion dollars studying tokamaks and what we learned about them is that they are no damn good."

Small fusion project of all types have been strangled by the ITER Mafia.

Jul 13 08:48 PM

[geewow:]

The fact remains that what we have with Larry "the Bagman" Summers is one of many, dozens, financial crime syndicate worker bees sent out to grab all the nectar laden dollars for the crime syndicate banks and their bosses. Summers was on the inside of the crime syndicate bankers, and then went off with Rubin to enforce deregulation and allow for more nectar to flow into the bankster's hives. This plan to steal the middle class's cash had been in the making for decades.

It won't go away until the American people protest out in front of the Gates of the White House by the tens of thousands. And, that won't happen. Nothing will change unless the protests are huge like in Iran, or the top 1% begin to go down.

The people are prime for a massive protest but it must be organized and publicized. Then the people will rally.

Jul 16 12:51 AM

[drpaul1139:]

"Money and the economy are 2 separate systems"
Very astute observation! Let me add to this two system observation...

The Corporate - Banking Model Confusion

To date economic confusion starts with not being able to separate the corporate model from the banking model…because all banks are corporations but not all corporations are banks in the classical sense of the word banking.

To be sure a corporation is a bank in that its shares are freely converted to cash by the multiple value creation formula of x=(a*b)/c where X is stock price, A is revenue, B is earnings as a percentage of revenue, and C is a rate of return. Simple plug in $1 revenue and .63 earnings and .03 rate of return with 1 share and see X as $21 created.

And see that many corporations with lots of cash do lend money in order to protect its share value.

But the cash of the generic corporation obtained is from the customers buying things by the corporation.

The cash that the bank corporation obtains is from the customers depositing their money with a corporation specifically called a bank with a special charter to take in government insured deposits and then sell credit in the form of fiat currency creating debt with interest attached to the debt.

For those that are not students of banking, the fractional reserve aspect of banking further confuses the laypersons (well actually how can one be confused if one does not know?) and I suspect confuses all of the so-called experts especially since M3 has been taken our the 7 ways to measure how $1 in reserves can in fact turn into $300?

Interest is the revenue for the Bank Corporation and then earnings for the bank increasing the stock price for this special type of corporation.

The cash received from the generic, or the general corporation’s customers from the products and services are the revenue for the corporation and then earnings producing a stock price.

Both the generic corporation and the banking corporation have stock or shares.

To understand the ‘positive’ generic corporate model means understanding the three base components of the corporation:

1. Capital
2. Equity
3. Cash

To understand the ‘negative’ banking model (a special type of corporation) means understanding the three base components of banking:

1. Credit
2. Debt
3. Interest

Until we can understand the base meaning of a corporation and separate the functions of a special type of corporation called a bank by law then we can begin to solve this economic problem.

Look closely a see that the generic corporation model has three base components, but the bank corporate model has six.

What this says is that we need a new ‘extended’ consumption function in economics where the current consumption function states that ‘consumption is a function of income’ where now income from jobs are clearly shrinking, the new consumption function clearly must be tied to either the generic corporate model or the banking model for balance?

Consumption is currently tied to the ‘negative’ banking model of ‘credit’ in that in the US demand is credit driven which is unsustainable; somehow we must tie the new or extended consumption function to ‘capital’ in the generic corporate model.

This means that we need for the first time a precise definition of positive capital so that the capitalist system can work. To this day economic literature has not pinpointed how and why the concept of ‘positive capital’ is commingle with ‘negative credit’, and the running wild of its consequent debt and interest.


On Jul 12 03:29 PM derryl wrote:

> Simon wrote,
> "Summers has commendably switched some of his rhetoric, so now he
> emphasizes nonfinancial technology development – presumably in the
> private sector – as the road to sustainable growth. And he rightly
> contrasts this with the financial engineering that brought us to
> this point. But does his model really offer the most plausible or
> appealing path from here to there?"
>
> Technologies can improve efficiency and productivity in the physical
> economy, but our problems at root are not physical. They are monetary.
> All of the workers, productive facilities and raw resources are still
> there ready to go to work producing goods and services. But nobody
> can do anything because everybody has too much monetary debt.
>
> Money and the economy are 2 separate systems. The best way to see
> this is to look at a bank balance sheet compared to a non-bank balance
> sheet. On a bank balance sheet your account balance--your money--is
> their liability. On a bank balance sheet your loan--your debt--is
> their asset. Bank assets and liabilities are the opposite of non-bank
> assets and liabilities.
>
> Banks alone have the right to create money. If the economy creates
> money it is called 'counterfeit'. You can produce all the goods
> and services you like but unless somebody has money to pay you for
> them you can never repay your money debt to the bank. You cannot
> solve a monetary problem with economic solutions. The solution must
> be monetary.

Jul 21 02:18 PM