Michael Berube Is Shrill
Department of "Huh?"

Larry Summers on the International Financial Situation

John Berry reports on Larry Summers's views of the international financial situation:

Former Treasury Secretary Lawrence H. Summers said last week that the $800 billion U.S. current account deficit represents a risk to the global economy and that if its decline isn't carefully managed, it could lead to a world recession.... In contrast, several of the other conference speakers, including Harvard economist Richard N. Cooper and economist Peter Garber of Deutsche Bank, portrayed the deficits as relatively benign....

Summers was skeptical about both the smoothness of the adjustment and its timing. In recent years, numerous economists have predicted the foreign investors and central banks whose purchases of U.S. stocks and bonds, direct investments in companies and bank loans have financed the current account deficits would become reluctant to continue doing so. That could have forced up interest rates and caused the deficits to decline. That hasn't occurred, of course, and now some of those economists are wondering if it ever will....

"Since the conventional view hasn't been right, that's evidence that view is wrong," or so that argument goes, Summers said. To the contrary, there's "more risk now" than previously that a crisis could erupt, he said.

On June 15, the Boston Federal Reserve Bank's president, Cathy E. Minehan, asked how many of the participants expected a smooth correction of the deficits at some point. So many hands went up that she didn't ask who disagreed. The next day, the bank's research director, Jeffrey C. Fuhrer asked how many thought there was at least a 10 percent to 20 percent probability that a financial crisis would force the adjustment to occur. A similarly large majority held up their hands to that as well.

I put the probability of something going wrong much higher than 20 percent because so many things have to happen to avoid a crisis.

Either way, smooth or rough, American households are going to feel a lot of pain when the adjustment does occur. It isn't going to be much comfort either that the pain elsewhere, particularly in Europe, is likely to be worse...

You have to look at the whole distribution. We are probably going to be OK--although other countries may not be. There is a chance--I would put it at 25%--that we are going to have a serious financial crisis.