Magazine article The International Economy

The Core Problem: An Exclusive Interview with Larry Summers

Magazine article The International Economy

The Core Problem: An Exclusive Interview with Larry Summers

Article excerpt

TIE founder and editor David Smick recently sat down with the former Treasury Secretary and Obama economic adviser to discuss the state of the world economy.

Smick: For months, financial markets were fixated on the Federal Reserve's December decision to raise short-term interest rates and the potential effects of such monetary tightening on dollar appreciation. After all, the risks are significant. The world's dollar-denominated debt, a lot of it held by emerging market economies, is said to exceed $19 trillion. But has there already been a regulatory "tightening"? The global carry trade appears to be in reverse. Japanese and European bankers suggest their American counterparts, under pressure from regulators, have been pulling back from lending to entities associated with emerging markets. There appears to be an emerging global dollar shortage. Does this trend trouble you? You've talked about the coming weakness in the global economy.

Summers: In general, the risks of slowdown and low inflation--if not deflation--significantly exceed the risks of overheating. The world is probably ready, rightly or wrongly, for a Fed tightening. But monetary policy is nonetheless a fragile exercise, and market expectations could easily become a matter of concern. I think the core thing to be worried about is that you have an industrial world that is very short on demand. Expected inflation from the industrial world over the next decade is running barely above 1 percent, and the real interest rate on average for the industrial world as inferred from swaps or indexed bonds is zero.

On top of that, the emerging markets are much more likely to be sources of capital outflows than capital inflows, in part because of their various problems. I'm thinking about Brazil, and about rising risks in China. Financial institutions in industrial countries are under pressure to build up capital to concentrate lending at home. So a demand-short industrial world is likely to confront an emerging market sector that is shifting toward much more capital outflow, much less ability to receive investment, and much more depreciated exchange rates. That raises the risk of a cycle where emerging markets pull the industrial world down and, in turn, the industrial world pulls emerging markets down.

So there are quite significant risks going forward. We're in a new era of problems relative to the problems and challenges that defined the previous generation. In previous times, problem solving involved more adequate monetary and fiscal discipline to avoid inflation. The problem was to stabilize short-run fluctuations. We're now in a period of potential secular stagnation that's more reminiscent of some of the challenges that the world faced during the 1930s and that people worried about in the aftermath of World War H. There's no certainty that those problems are going to materialize, but that's where I see the greater risks.

Smick: Ironically, capital inflows into the United States since the 2008 financial crisis have occurred at twice the rate as before the crisis. And it's not just Russian oligarchs and rich Chinese families. Germans are buying mid-sized U.S. companies. Yet the Anglo-Saxon-style system of liberalized markets and the so-called Washington consensus were supposed to have been discredited as a result of the crisis. Why this love since the crisis of all things American?

Summers: The United States is a safe haven. We are the only part of the industrialized world where there is significant labor force growth and significant dynamism around technology. As for alternative currencies to the dollar, the euro is a substantially more problematic construct than appeared to be the case a decade ago. Indeed, the euro's experience is another good example of the late economist Rudi Dombusch's dictum: "Things take longer to happen than you think they will, and then they happen faster than you thought they could. …

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