Larry Summers and Financial Crises: Is He Being Graded on Attendance?

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Thursday, 01 August 2013 08:01

According to Ezra Klein, a major plus in the case for Larry Summers as Fed chair is his experience dealing with financial crises. While it is true that he took a leadership role in dealing with far more crises than Janet Yellen, the other leading contender for the job, it is hard to believe that his record in this area would be a plus if he was being graded by the outcomes.

Starting with the Mexican peso crisis in 1994, Summers helped to negotiate a deal that protected big investors in Mexico's debt, like Goldman Sachs. Mexico suffered a severe downturn in the immediate aftermath of the crisis and has had the slowest per capita GDP growth of any country in Latin America in the two decades since the crisis. That one doesn't look like much of a success story.

Then we can go to the East Asian financial crisis in 1997. As even the IMF now admits, Summers and the rest of the Committee to Save the World (CSW) largely misdiagnosed the crisis. They saw it as a problem of economies that were badly misbalanced as opposed to being largely an issue of liquidity and confidence. Malaysia broke with the IMF and applied capital controls, which were roundly rejected by Larry Summers, and managed to escape some of the worst effects of the adjustment.

The deal for the East Asian countries was that they had to repay their debts in full. In order to do so, the currencies of the countries in the region plummeted against the dollar and their exports to the U.S. soared.

It was not only East Asian countries that hugely increased their exports to the United States. Because of the harsh terms imposed by the Summers-IMF gang, developing countries throughout the world began to accumulate foreign exchange (i.e. dollars) like crazy as insurance, so that they would not be put in the same situation as the East Asian countries in dealing with the IMF.

This led to a huge run-up in the dollar. That in turn caused the trade deficit to explode, reaching a peak of almost 6.0 percent of GDP (@$960 billion in today's economy) in 2006. The trade deficit has been the fundamental imbalance in the U.S. economy. It means that a huge amount of the income generated in the United States is being spent overseas rather than creating demand domestically.

In the 1990s this hole in demand was filled by the demand generated by the stock bubble. In the last decade it was filled by the demand generated by the housing bubble. Currently the demand gap is being partially filled by the budget deficit and partially going unfilled, leaving millions unemployed. This outcome hardly seems like an item to put on Summers' boast sheet.

Finally we have Summers' role in the 2008-2009 financial crisis. Summers was one of the people who pushed the Democrats in Congress to accept the no (real) conditions TARP bailout given to them by Henry Paulson. Once in the White House he was the staunch defender of the bankrupt banks belligerently challenging anyone who proposed letting the market work its magic and put these behemoths out of our misery. As a result of Summers' work the too big to fail banks are bigger and more profitable than ever.

In fact, if we want a serious assessment of Larry Summers performance as a crisis manager we might ask what happens when countries don't take his advice. Probably the best example in this category would be Russia in 1998. The CSW had been struggling with the Yeltsin government for years to keep them paying their bills and maintain the ruble's link to the dollar. In the summer of 1998, Yeltsin gave up the effort. He abandoned the link to the dollar and temporarily defaulted on Russia's debt.

The word from the Summer's crew, which was dutifully repeated in the business press, was that Russia's economy would go down the tubes. While it did fall sharply in 1998, it made up all the lost ground in 1999 and then grew by more than 10 percent in 2000. In fact, Russia enjoyed a decade of exceptionally strong growth before the economic crisis in 2009 finally sent it into recession. The Russians probably do not miss the wisdom of Larry Summers.

In short, if we look at Larry Summers track record in dealing with crises it is pretty abysmal. But on attendance, he gets an "A."