The state of the economy and where it is headed; My beef with Larry Summers

Everyone is talking about a recession. Most everyone seems to think that we will be in one soon if we are not in one already. The big debate is over whether it will be mild like the dotcom bubble bursting or closer to the financial crisis. Most seem to think the former.

As for me, I have absolutely no idea. Plenty of evidence can be found to argue that we are headed for a recession. The biggest piece of evidence is the Fed raising interest rates to bring down inflation. Historically, most notably in the 1980s, bringing down inflation has ended in a recession. That said, the sample size of those examples is very small. Those previous examples were also not dealing with messed up supply chains and a pandemic.

Plenty of people are making educated guesses about where the economy is headed and lining up the evidence accordingly. The problem with trying to predict recessions is that they are notoriously very difficult to predict. Economists in particular are very bad at making such predictions. A joke I have heard before is that economists have successfully predicted 10 of the last 5 recessions.

The world economy today is more complicated than ever. With globalization, governments, including central banks, have much less influence and control over their economies than in previous decades. Central banks can raise or lower borrowing costs, which have all kinds of ripple effects, but they cannot do anything about Russia invading Ukraine or the pandemic. Central banks cannot do anything about supply chain issues either, at least not directly.

I have plenty of issues with economists, but some sympathy, too. The models they use seem to consistently fail to predict major events, whether it is a financial crisis or inflation. Even when they work, they can quickly become obsolete. Often times, their ideas work for one set of conditions, but fall apart the next time they are used. At the same time, we need models of some sort because we have to have some sense of direction. As much as it is accurate to point out the failings of models, I readily admit I do not have any alternative. My rule is to expel the word impossible from your vocabulary, but beyond that I do not have anything specific to say with respect to the economy and where it is headed.

What is going on now is, of course, a mismatch of supply and demand, hence higher prices. That sounds like stating the obvious, but there is much more to it. It is important to know why they are mismatched so we can figure out how to proceed. To figure that out, we have to remember that much of the world is still going through a pandemic and the ripple effects of it are still very much being felt. China, for example, which is a major supplier of all kinds of goods, seems to be in a perpetual state of lockdowns. When they will abandon their insane zero cases approach is anyone’s guess. For all anyone knows they may never abandon it.

Businesses cut back on production when the pandemic first hit in anticipation that demand for their products would plummet. That was not an unreasonable belief at the time. Here is where things get, shall we say, interesting. Demand did not collapse. Why? Because governments took major actions to prevent that. In the US, Congress and the Fed provided massive relief, which prevented demand from falling apart. While unemployment initially surged, it has come down quickly and the US has gained back almost all of the jobs lost in 2020. That is an amazingly fast recovery and much faster than after the financial crisis, which took nearly 8 years to recover from.

That is the good news. The bad news is because demand was taken care of while supply plummeted, we have inflation. While demand probably does need to be brought down from where it is now, lower supply is undoubtedly a contributing factor, if not a bigger factor. How much each are responsible for the rise in inflation is not agreed on and I am not remotely qualified to make any determination.

In a way, the inflation we are seeing now is a side effect of successful policy. Successful how? Because demand was taken care of we are not in a depression. If demand had been allowed to fall to match the fall in supply, inflation would not be an issue. The problem is a collapse in demand means a collapse in employment, which is what the Great Depression was in a nutshell. The inflation we have now needs to be brought down, but I find it ludicrous that people would be happier with very low inflation and 25% unemployment. If you do not believe me, read any book on how life was during the 1930s. I can assure you it was not happy.

Another offshoot of the inflation debate is how much the American Rescue Plan (ARP) in 2021 contributed to it. Some have argued it contributed as much as 3 percentage points to it while others have argued it contributed very little and its effects are now over or close to it. Like the debate over what is causing inflation, I am not remotely qualified to make a determination.

The ARP though does beg one question. Absent it passing, what would things have been like? Inflation may have been lower, but growth may have been weaker and unemployment higher. Maybe it could have spent less or spent the money more gradually. I tend to think that even if the ARP had been designed perfectly, there still would be many problems. Inflation would still be higher than normal, especially given that it is a global phenomenon. Supply chain issues would still have been a problem. The housing market still would have been a mess. Pandemic disruptions, particularly Delta and to a lesser extent Omicron, would have happened. Labor shortages would also have still been an issue.

What I am getting at is the economy was disrupted like never before when the pandemic hit. Life was disrupted in ways that were unprecedented. Remote work, once a rarity, is now much more common and odds are will remain that way. Because people can work remotely, they can now live potentially anywhere. This has contributed to the massive surge in home prices. People are still making as much money as before and they remained employed the whole time, but now can live in a much cheaper place. Home prices and prices in general in the cheaper areas are guaranteed to surge. That is just one example of a disruption caused by the pandemic creating all kinds of ripple effects that were not anticipated by anyone pre-2020. An economy disrupted on such a large scale is not just going to bounce back overnight.

Where things go from here, I have no idea. I hope the Fed can achieve a “soft landing,” where inflation is brought down without causing a recession. That has not been done before with inflation this high, but the historical sample size is very small and so I do not know how helpful looking at that history is. Most seem to think we will not have a “soft landing,” but who knows? Nobody has any idea and anyone who is confident of what will happen should probably be ignored. This is probably the most uncertain economy anyone has ever lived through.

Larry Summers

I normally would not write about an individual unless they are a candidate for office, a public official or the richest man in the world. I am going to have to break that rule here. I really did not want to write this, but I really need to get some stuff off my chest.

One of the central figures in the inflation debate is Larry Summers. For those not familiar, he was Deputy Treasury Secretary and later Treasury Secretary under Clinton, president of Harvard and an economic adviser to Obama. According to lore, he warned about the threat of inflation and that the ARP would contribute to it when few others did. Since inflation has been worse than many predicted, he has been treated as a sage.

Before I go any further, let me be clear from the outset that I am not a fan of his and never have been. I think his record as a public figure is largely atrocious, especially as an adviser to Obama. I also do not like him as a person. He is annoying, bombastic and loves attention. He also still has sour grapes because he wanted to be Fed Chair after Bernanke and did not get it. Thank god he did not get it because if he was in charge now he would be sending us towards a recession full speed ahead.

Going back to March 2021, he is said to have been one of the few economists to warn about the threat of inflation. Today, he is everywhere on TV and a paid contributor to Bloomberg, where, I kid you not, they write about his every move. He also writes op-eds in The Washington Post and still teaches at Harvard. Most former cabinet officials go away and quietly make money. Larry Summers has charted a different path to say the least. Ask yourself when was the last time you heard the name of any cabinet officials from any administration besides Trump, if you can even name any.

Despite his terrible record, he is still widely listened to and widely sought out for advice. It is truly amazing how someone with such a bad record can still have an iron grip on everyone’s attention. I really am starting to believe he has some kind of magic power. I would love to have some of it.

What did he actually say in March 2021? True, he said there were risks from the ARP of spending too much. On that broad point, he can be said to have been accurate. But the story of what exactly he predicted is a bit more messy. At the time, he decried the ARP as bad and here is what he predicted would happen: 1/3 chance of stagflation, 1/3 chance of recession and 1/3 chance of rapid growth with no inflation. He apparently has a love of the 1/3 fraction as he has given those odds of a recession before.

There are many problems with that. For starters, those three events are very different outcomes. There is no way, no how that they all have an equal chance of happening. That is just not possible. I have no idea what the odds of any of those things are now or were in March 2021, but I guarantee you they are not and were not equal.

The second problem has to do with what specifically he predicted. Between those 3 events, they are almost every possibility. He essentially predicted that every possible outcome could happen. That is like someone predicting that each of the teams in the Final Four could win the championship. It is really disingenuous because no matter what event transpires, he will say he was right.

The third problem is no date was given for when those things might happen. Pro-tip, if you see someone make a prediction about any kind of economic event and there is no date on it, pay no attention to it. Recessions, for example, are not uncommon. If someone predicts every single day that a recession will happen, they are all but guaranteed to be right at some point, but that has nothing to do with their aptitude at predicting outcomes. A broken clock is right twice a day as they say.

Here is what you can take to the bank about Larry Summers: 1/3 chance his desire for attention is normal, 1/3 chance higher than normal and 1/3 chance much higher than normal. Right now, we are in much higher than normal. I’d guess there is a 1/3 chance it lasts for at least two more years, 1/3 chance at least five more years and 1/3 chance it lasts for the rest of his life.

What prodded me into writing this section though is none of that. I have been thinking about writing about my thoughts on him for some time because of the outsized role he has played in the inflation debate, but have held off because I just found him mostly annoying and full of himself. More irritating has been the fawning over him in the press and treating him like he was Paul Revere screaming “inflation is coming.”

What prodded me into writing about him were his remarks earlier this week. What he said was that to get inflation down to 2%, we will have to have either 6% unemployment for five years, 7.5% unemployment for two years or 10% unemployment for one year. Where he came up with those numbers, I do not know and nobody else seems to either. I am sure he thinks there is a 1/3 chance of each happening.

His remarks were not annoying. They were infuriating. Leaving aside the dubious merit of it, think about what that would mean. Millions of people would be out of work for years. Two years of 7.5% unemployment is almost as bad as the financial crisis and one year of 10% unemployment would be about the same. The recovery from the financial crisis was lousy by all measures. Millions were out of work and fell far behind. He is saying we have to go through something like that again. That is defeatism if there was ever such a thing.

I have no idea what the unemployment rate will be one year from now, let alone in five years or more. What I can be confident of is that what he is saying will have to happen is wrong. There is no reason for unemployment to be that high for that long. If it happens it will be because we chose that. The strength or weakness of an economic recovery is a choice, not an inevitability. The lousy recovery from the financial crisis was a policy decision. No deity came down from the heavens and decreed it to be the only path forward.

In Summers’ defense, he has a great record of pushing to keep unemployment high. As an economic adviser to Obama, he opposed spending any more than the bare minimum on stimulus measures on the grounds that it was not "politically acceptable." Obama’s main economic advisor, Christina Romer, wanted a stimulus package twice the size of the one that passed. Because of Summers’ opposition, Obama was never even told of it. Had he been told, he may still have gone with what passed, but maybe not and maybe we would have gotten a bigger package and stronger recovery. Instead, the lost jobs were not fully recovered until around 2016.

When I talk about his atrocious record as a public official, that episode crystallizes it more than anything else. But that is not all. As Treasury Secretary, he presided over across-the-board deregulation of the financial sector. To be fair, he was hardly the only one doing it. Virtually everyone from Bill Clinton to Alan Greenspan was on board that gravy train. Some of the deregulation was just making official what had been the case for a while and many regulations were out of date. But the mindset behind it, that financial markets are rational and always produce optimal outcomes, is a big part of what led almost everyone to let their guard down. That illusion came crashing down in 2008.

To be clear, I agree with Summers on a whole host of issues. In fact, on the ideological spectrum I would say we are in the same camp. I would much rather have him in charge than Elizabeth Warren, let alone AOC. Still, his track record leaves so much to be desired, he is obnoxious and addicted to attention and is now all but rooting for a recession. Maybe the institutions that pay him should take his advice and lay him off. I am sure he would be fine with that. While we’re at it, he lives in Cambridge, Massachusetts and I bet home prices there are sky high. You can’t have a recession without some foreclosures so maybe his house should be foreclosed on. I am sure he would be willing to take one for the team.