tv Davos Debate Ending the Experiment Bloomberg January 31, 2015 1:00pm-2:01pm EST
investor. larry summers, former u.s. treasury secretary. thank you for joining us in this panel debate. the world needs more of you. how difficult is it going to be for the fed to raise rates? >> they will probably raise rates this year. the expectation is to have any midyear, contrary to what is expected. the fact that the fed is going to do that is good news in and of itself. it shows that two things are moving in the right direction. employment is up, unemployment down. and inflation is hopefully getting little signs of moving up in the right direction. we have these two indicators which have been extremely well communicated and identified by
janet yellen, who has done a terrific job in communicating and getting the right anticipations to market operators. i think that is good news in and of itself. the consequences will be a different story. there will be side effects spillover effects, and volatility. this is unavoidable. in terms of the sheer raising interest, it is clearly a good sign. it is clearly an indication that the u.s. is growing, that it is reducing unemployment, and that prices are on the upside. >> gary, you disagree. [laughter] given what we just heard, you think the fed will not raise rates. does that mean we should be worried? >> no, i think the u.s. is growing. that is a non-debatable fact. what i am concerned about is the actual ability of the u.s. to
raise rates with what is going on with the rest of the world. when you look at the policy measures going on in europe and what is going to go on, and what you look at what is going on in japan, the interest rate differential already exists. there is enormous spread between u.s. positive rates in the negative rate environment in the rest of the world. you look at the strength of the dollar today, it will only get stronger if we raise rates in the united states. that will have a chilling effect on the u.s. economy. the good news is that we are getting back some of that payment in lower oil prices. madame lagarde talked about the unemployment picture. whatever news you want is in the unemployment picture. if you look at the headline unemployment rate, yes we have very good news. if you start peeling back the unemployment rate, you can find some less good news.
last month, we had negative wages. we are not pulling people into the u.s. job market. yes, we can have headline unemployment rates go down, that no one is looking for jobs because they think the jobs out there are very low-paying. on the inflation point, there is no inflation in the united states. you're not close to the fed's 2% target. we are nowhere close to 2% on wages and commodity prices. i think we are a long way from that. >> larry, what do you think the fed should be looking at in setting interest rates -- activity or inflation? >> inflation. the phillips curve is a constantly changing, ephemeral relationship that does not provide a consummate basis for tightening. the risks are enormously asymmetrical.
they settle a spiral towards deflation. the fed should not be fighting against inflation until they see the whites of its eyes. that is a long way off. in the u.s., europe, and japan markets are not just saying that inflation is below target, but that it will be low below the 2% target over the next 10 years. there are further questions about in a slow growth environment, where that target should be, and what kind of aspect there should be. the fed is right to be data dependent. but the data needs to be looking at inflation. as long as the that pressure is towards deflation, they should not be looking to move. i think they need to manage their communications quite carefully.
there has not been a moment when the gap between market expectations of monetary policy has measured in the marketplace and fed statement about future monetary policy as reflected has been greater. that suggests that there needs to be careful attention to communication policy going forward. >> ray, what is your take? you think of the more downward risks. >> i think we are in a new era where centralbanks largely lost their powers. originally, monetary policy worked by lowering interest rates, which would lower debt service payments, causing the present assets. to develop
when interest rates reach zero and there were large credit spreads in the market, denny purchases of those financial assets narrowed those spreads. the spreads are a transition mechanism for monetary policy. if you put liquidity in and there are spreads, people who want higher returns will buy those assets. the buying of those assets caused those future returns to go down. the yields of bonds, future expected returns, to go down producing low asset price appreciations, which have the wealth effect that we have. we have low spreads. as a result, the transition mechanism will be less effective. this is a big thing. throughout all history, monetary policy with the main tool. i believe we are entering an
era, the end of the super cycle. the end of the cycle in which the process of lowering interest rates causing higher levels of debt is coming to an end. since 1980, every cyclical peak and cyclical trough was lower than the one before it. we have a deflationary set of circumstances. with zero interest rates or negative interest rates, how far will negative interest rates carry? it calls into question the value holding money. what is money? with negative interest rates under the mattress looks good. i worry on the downside, because the downside will come. >> and why aren't banks functioning better? >> let me say it is a bad idea
to have your money under the mattress. [laughter] you should definitely have it in the bank. but having said this -- [laughter] >> what would you offer me? >> how much do you want to pay? no, i think the issue about monetary policy is critical. but i think we should look at this as a four-legged chair. of course you have monetary policy. monetary policy, fiscal policies, the demand side is important and it is encouraging that europe is doing some of this. we need banks to be lending again. everything has to work together. i think as we think about growth in jobs, we need to think about what people and communities are asking of us as politicians, regulators, and business
leaders. these kind of reforms are incredibly important. micro policies, governments, and banks working together to foster employment. we had a very interesting session yesterday on this because of technology. at the end there are deflationary pressures. i think having these forelegs of the chairs work together is an incredibly important. i can elaborate on the lending transmission, of the role of banks as a transmission of monetary policy. madame lagarde knows much more than i do, i encourage you to read it. it shows that an example of 300 banks, a lot of these things are ready to lend. i would say they are ready to support quantitative easing.
certain banks in certain countries are not in that situation. i think it is very important that before legs need to work together, but the transmission that banks have is critical. it is even more important than europe in any other place. >> gary, how concerned are you about that transmission? it qe would work better, what needs to change? >> you need to take both of their comments and bring together. ray was talking about the new paradigm, and anna is talking about the transmission mechanism. they go together. i don't know what came first. i would say the transmission mechanism being broken came first, which created a new normal. what i mean is historically, if you look at pre-2008, the way
the system works is that errol banks decided what monetary policy would be. -- federal banks decided what monetary policy would be. they would flow that to customers over the world. that worked. the central banks were able to control growth and control the flow of currencies. they were able to withdraw or generate spending. what happened after 2008 is with the new regulation -- and i am not complaining about regulation -- what they have done is that every time banks find new capital, they are told to hoard it. you need to make sure you are bulletproof for the 10,000 year
flood. that is what anna is talking about. whenever you get capital transmitted through our banking system, we used to turn around and get that out to clients to help stimulate and grow the economy. now she is in a position where she is not research leading capital, she is holding on to it. in many respects, in europe, as we discussed in a meeting earlier in zurich, it seems like that process is starting to get worse and not better. >> anna? >> the global financial report we have done analysis on a smaller sample of the european banks. if you take the 40 against lists of european banks and look at where they were in 2007 versus today, they are at the same level and capital is more than doubled.
the returns on these banks equity is around 6%. that is why i think banks are ready to lend again. this is incredibly important. i think two things are important. we want to use it to grow our lending. we are not going to buy anything. we are growing our balance sheet. it has actually grown our lending by 4%. nine out of 10 countries in europe in the americas have done this. we need more banks growing lending, not at huge rates, but at these rates so we can help monetary policy work. >> to follow up on that, it is really a case in point. the reason you have been able to raise as much capital as you have is caused by the chair with four legs.
it is also due to the fact that spain has managed to inspire confidence in the market because of various things. one is a fiscal discipline applied over time, most sensibly and with determination. the second, and most important one, is the structural reforms that spain has done in terms of policy. not only to legislate, but also implement. it was an important step the decision by the spanish authorities with the banking system to actually go through an inventory of all the spanish banks to see what was under the skin of the balance sheet and to do some cleaning up. that is not to say that all the nonperforming loans have evaporated. there are still quite a lot of those nonperforming loans.
certainly in a much better identified way than many other corners, particularly of the eurozone. this is why i look back to structural reforms. in the right structural reforms are inflated, at a level of bankruptcy, re-organization, then there is positive feedback loop that helps from a bank balance sheet point of view, which will then help the transmission that we were talking about. everything is linked together. >> overall, does the central bank divergence make it much more to the cult, or does it reduce the effectiveness? -- much more difficult. >> one thing for sure is that we are in uncharted territories. you have the entry route that is taken and the continuation route by various others including the bank of japan.
whether that will be counterproductive, whether it is anachronistic, it will only produce negative effects, i am not sure. if there is an of coordination it might prove helpful to have entry when there's potential exit by the fed. final point and then i will be quiet. i am instructed that there are middle downside risks and it the u.s. is in a bad place. the u.s. is in it that place, we are short of any options at the moment. i hope some of you saying that the u.s. is under threat are wrong. i think they are. [laughter] >> just to be clear, i think the u.s. is in a good place. i didn't mean that. i think there is the u.s., and there is the world. i think they are in different places generally speaking. it is just mechanistic.
when there is no ability to change interest rates, particularly when there is no ability to low interest rates and have a transmission that is in monetary policy to ease is a bad place. we do not have a ability to ease if we want to ease. the reason the united states is in a good place is partly because of the qe it did. 25% of gdp was in quantitative easing. $3.8 trillion. 26% was in the u.k. in japan it is been 36% of gdp. in europe it has been 3% of gdp. when you're in a situation in which credit is not going to work the same way as it did before, we cannot have debt the way it was before. the interest rates to bring down debt service payments cannot decline.
you can spend with debt or you can spend with money. we need to have more money into the system. money can produce more purchases. it also means that when the two levelers are interest rates and currency, when the interest rate lever doesn't work, currency becomes more effective. we must see more volatility in currencies. the average cost of structural reforms, structural reforms are important. the average cost of eight southern european, after adjusting for the amount of time that they work, vacation time, the workweek, retirement age, is about twice what it is of an
american worker. so it is expensive. either that will lead to structural reforms in the form of changing to make that more efficient. there is a lot of potential in europe to make things more efficient and more economic. the currency depreciation is going to have to be a part of it. it is the conversation that is not polite to have. in other words, we could talk about changing interest rates, but policy makers cannot talk about changing the exchange rate. >> why? >> it will be a bigger influence in the years ahead. this will produce a dynamic, because there are a lot of dollars in debt.
there's a lot of promises to deliver dollars that are more expensive to various entities. there is a short squeeze emerging in the dollar. very similar to 1980-85. it is similar in that there are falling oil prices, the relatively strong economy with falling inflation. back then, we could lower interest rates. we cannot lower interest rates now. it is a similar dynamic in terms of deflationary pressures. i agree with larry in that you have to wait until you see the whites of the eyes of inflation. in 1980, if we didn't lower interest rates, even though growth was strong but we would have had a disaster situation. it is somewhat analogous to that i think. ♪
>> the quantitative easing experiment in the united states --is qe in europe going to work? >> i am all for quantitative easing. the risk of doing too little far exceeds the risk of doing too much. stagnation is the macroeconomic threat of our time. that said, i think it is a mistake to suppose that quantitative easing is a panacea in europe, or that it will be sufficient.
there are several differences worth noting with the u.s. experience. the u.s. wanted easing was most effective at the getting, when markets were functioning less well than in europe today. qe functioned well in the u.s. starting with interest rates in the 3% range, not with long-term interest rates starting in the 40 basis point range. qe worked best in the united states when it was unexpected rather than when it had been widely predicted. qe worked best in the u.s. because it worked to a capital market channel and a large part of lending in europe takes place the rate banking channel that is not explained, clogged by regulatory processes. there is every reason to expect that to qe will be less impactful in the present than it
was in the u.s.. the story in the u.s. is a more complex one that is sometimes told. everyone at davos a year ago was not in doubt that the keeper coming in the u.s. expansion accelerating that the 10 year treasury was going to rise sharply from its level of 3%. a small minority, which included ray, that thought that the deeper issues went to the emergence of deflation. they have proved to be correct. i want to remind everyone in the u.s., why i think policy has a bias of expansion, if you look
at the postwar period, here are some facts --nobody has predicted the recessions a year in advance. never. and yet recessions do sometimes come. fact two. when it happens, the fed has to cut interest rates by 3-4% by more to combat that recession. are we anywhere near getting ourselves to a place where there is going to be 3-4% of the room to cut when the next probe happens? -- next problem happens? i don't think so, and i don't think the market think so either. we have to move to a broader
range of strategies, some of it goes to banking policy, some of it goes to structural reform. although, a lot of structural reform is on the supply side. much of the problem is on the demand side. we need to be strategic. >> anna? >> i think the central point we are trying to address is growth. broad based growth. and of course, creating jobs. macro policies are critical. the four legs of my chair that i was discussing. one of those, going to this point, is that we need to
generate confidence. if anyone asks the biggest risk in the coming year, evil with 80 more political uncertainties not on the economic side. i think how we achieve confidence is critical. a combination of all these macro reforms is very important. i think one of the reasons in the secular lower growth time, is because of disruptions in technology, less people needed to do the same things. i think we need not just macro policies, but also micro policies in the public sector and private sector working together to address this in different ways. again, in the discussion yesterday many of the leading countries and mental institutions are doing huge amount of programs in education. they invested 100 million in education and skills.
the public and private partnership is something we need to invest in. the macro policies on their own, we need qe, the school policies, we need banks to lend again, but we need to go a step further because otherwise we will not create the jobs we are looking for. >> if qe in europe will work, to a point you could say it has already worked. there are expectations that qe will be announced and significant. >> i want to point out on the question of u.s. doing well as
it ties into structural reform. you can do a natural vision of the two countries and it's a why is one doing better in one of the other? i think the vitality existing in the u.s., entrepreneurship, big data, the flexibility goes to structural reforms. there is twice the rate of entrepreneurship in u.s. that there is elsewhere. if you go through the statistics of how it takes to set up a business, or many of those issues, i won't go into them that does not stand in the way of the vitality that is existing. the world should be very optimistic about the incredible developments happening in technology. it is a productivity, a terrific force going on.
the two words that would characterize that would be good for europe are structural reforms and money. if you have more money rather than debt-based economy, meaning monetary policy, together with important structural reforms that would be an effective force. i agree with anna about the political issue. i think it is important. if the moderates of europe do not get together and change things in a meaningful way, i believe that there is a risk that the political extremists will be the biggest threat to the euro. youth unemployment in italy and spain is 50%. it will be a lost generation.
>> are we looking at currency wars, or have they never left? >> we are in it. i don't know if we have always been in it. >> five years? >> i don't know if it is five years. recently, when shinzo abe got invovled in japan and -- the europeans were looking at their export ability versus the japanese export ability. it put enormous pressure on the euro. now you're seeing the euro devalued again. interesting how the japanese will follow-up.
lo and behold, we have the u.s. sitting there watching and being the one currency that is rallying because everyone else is trying to devalue. they decided to join the currencies that would rally. we are happy to have them on that side of the ledger. [laughter] it does feel that we are in a global economy. i don't disagree with that the prevailing view is one of the easier ways to stimulate economic growth, to have a low currency. to hopefully create tourism and imports. it makes sense. >> currency wars -- i am sure someone on the panel can help me. the purchasing power is about 116. the problem is where we have been over the last couple of years because of qe in the u.s.
and the effective tightening in europe. it is because of the lending being constrained, and rightly so because we needed to deleveraging. usually currencies do not stay at their theoretical level, so we could go further. right now we are probably at the right place. i think that is an important fact to bear in mind as we set policy. >> would you agree that is the number? >> i would agree that taking japan aside, because there was a determined policy move on various fronts two years ago which had a clear influence on currencies. i'm not sure the currency itself was the this of the three hours economic policy. taking japan aside, yes i would agree with anna that there is in alignment between key characteristics of some of those
economies. if you look at the growth potential, it is not out of line. >> larry, who is worried about communication in central banks? anybody? >> i think it is for larry. [laughter] >> i am going to stay away from the swiss and just observe. how much deflationary risks are the main risk we had to deal with. we need to emphasize what everyone here is clear on, which is that a strategy of austerity and grudging acceptance of limited monetary accommodation in the hope that that will be a driver of structural reform has
proven itself to be substantially counterproductive. and it is instead bringing radicals to the fore in most of the places where it is being applied. the situation in europe is not yet in hand, i agree completely with you that the movements taking place in the euro have been desirable. i don't think, and i agree with christine, that qe has art had a significant impact. but that is why i'm worried. we have already had positive developments, and the forecast looks dismal from here. i don't think we should make the mistake of supposing that the situation in europe is in hand.
i am for structural reform too. i want everyone to think about what i find one of the most surprising global economic facts. it is quite different from the conventional wisdom. take men between the ages of 25-54. i choose that range because there is a strong expectation in most societies that they will all be working. ask yourself about the non-employment rate of men 25-54. in the dynamic, flexible united states, it is several percentage points higher than it is in france. that tells us something about the magnitude of the human
capital issues that the u.s. faces and it tells us something about the consequences because technology is more advanced in u.s. we can't be serene. we can't think that all will be well with reform. that is why i come back to the central importance of demand. i suggest there is a very basic idea that james had that has largely eluded europe's largest economic power. that is what we called the fallacy of composition. which i would explain it this way -- if anybody in this audience stands up, they will see better.
if everyone in this audience stands up, no one will see better, and everyone will be less comfortable. [laughter] if any one country saves more, or any one bank hoards capital it will strengthen its position. but if all countries save more there will be less spending, which will mean less income, which will mean less spending and the situation will not get better. if all banks simultaneously cut back on their lending, the result will be across the board reduction in asset prices, and ironically they will all end up with less capital. it is the failure to recognize that a one-off model that works
to produce export growth in germany in the early part of the decade, when applied collectively, is like everybody standing up. it leads to an outcome that is worse for everybody. it's the failure of generalization. the error of assuming a strategy that worked for one once when applied universally will work, that is the central error driving much of european economic thought. as long as it continues to drive european economic thought, the prospects of success will be limited. ♪
>> are there lessons to be learned from what we saw last week? if you are a central bank and you look at what happened last week -- >> i think it was very difficult for the swiss central bank to actually do any advanced communication. it was actually impossible to do that. equally, i am assuming that there was some indication between bankers -- communication
between bankers so that it was tempered by other authorities in the eurozone. assuming everything larry has said about standing and sitting, some reference to germany at some stage during the course of this conflict. [laughter] what i would like to do, larry if what i'm assuming from him is correct, and giving we are in a low inflation and low growth high unemployment and high debt
in the euro area. and given the fact that structural reforms are fine, but they take a long time and deal with the supply-side wearer we need most is demand. i would insist that structural demands are in order and must be conducted. if they are not, we will live with those issues for a long time. the fact that you can stimulate demand by either monetary policy, which we just agreed has run the end of its course, or by fiscal expansion, not many have fiscal space to actually do that. there are one or two countries in the eurozone. that can do it a big one, a special small one. do you think that can pull the eurozone out of this? >> i believe that europe collectively has quite substantial fiscal space. i believe that a decision to have a common currency taken without a decision to be prepared to use common fiscal
space is an irresponsible decision. [laughter] i believe that having taken a decision to have a common currency, if that currency is not to be a brittle failure, there is no alternative to finding mechanisms to support fiscal expansion on a common basis. i think there is a failure to think in a fully realistic way about liabilities. when you defer maintenance, when you underfund a pension, you are placing a liability on the future. when you sell a building and you
commit to rent a building for the next 30 years, you have not really changed your financial position. you may have reduced your measured debt, but they then have an obligation to pay rent for 30 years. a great deal of what is happening in europe is what i would call repressed budget deficit. in analogy to repressed inflation. this is where, by taking these steps to fetishize measured debt, in fact placing burdens on the future, and upsetting the long run fiscal arithmetic. i think that kinds of barring that are unaffordable, vastly
more affordable are negative in real terms. i do not accept the judgment that there is limited capacity for europe to engage in enhanced borrowing. there is limited imagination at present about the possible mechanisms through which that could take place. there is very substantial room. i believe without finding ways to mobilize lending and borrowing, that means through the public sector and finding ways to enable financial institutions to lend more, the money will pile up, but you will not see the desired results to the extent that is necessary.
is there anyone who believes that even if quantitative easing takes place today at a reasonabley robust way, that the situation is satisfactorily in hand at europe, and that europe will have a basis for growth if the growth strategy consists of qe and asking the south to do more structural reform? >> is the question that we cannot afford qe in europe? it is necessary, but is not sufficient. >> are you saying that we are not as imaginative as the u.s.? i am joking. i think it is an emerging market in terms of growth. i'm very positive of the u.s. i'm a lot less negative on europe than most americans.
allow me to use this example. we raised $9 billion, a lot of that came from america and may i say very smart money. we see a lot of investment in europe. i think the biggest challenge is unemployment and getting the recovery to be broad-based. when we do structural reforms, and i was happy that i was not want to bring it up, spain has created 3000 jobs. growth is up 2.5%. we need complementary economies. we cannot all do the same. talking to my customers, i make loans to companies that create jobs. spain has a very robust motor market.
about 11% of gdp. the most productive factories are in spain. we have more productive factories of the same company in spain and in germany. i don't think all is lost. we need to do more. i am confident though that europe will make it. let's look at the positives, where were we in the last crisis compared to today? how long did it take for the u.s. dollar to get back to normal? give us a chance. we are making progress. we have mechanisms in europe that we did not have. we are going to do qe, which a few years ago was difficult. we have a lot of work, but hopefully we will move a bit faster.
we are doing what it takes to get to a real currency union. >> do you agree that there is a difference between the way that the europeans see themselves and the americans? or is it groups of people, bankers and regulatory agencies? >> i think we all make the same mistake to compare the u.s. economy and the euro area economy. it is just not the reality. yes, there is the euro, which is the common currency. there is much more euro supervision of institutions. but is it to say that there is a euro fiscal policy? no. i don't think it is that the europeans are short of imagination. they have plenty of it. they are not at the place where they can have a unifying fiscal
stage. it is not tradable yet. there is no fiscal policy that is common to all. they are not yet determined to use that balance sheet to go into binge borrowing at low interest rates. i think is a question of process. massive progress has been made in the last five years next to -- thanks to the crisis. i hope it will not take another crisis to make more progress but more progress has to be made in terms of the union pursuing the banking unit. there is huge potential in this part of the world. to think of it as one single economy unit, it is not the case. >> just to larry's point.
while fiscal policy will be more important in the years to come i think you can't look at fiscal policy without thinking about the income that the debt -- you have to borrow money to have more fiscal stimulus. they can't let the debt right relative to the income levels. that must produce productive income to service the debt. there are limitations on that. fiscal policy is not a panacea. it must be used with monetary policy, if monetary policy hopes to fund deficits, that can allow progress. monitoring policy hoping to fund the deficits is monetization as a path to consider. in terms of structural reforms i am more optimistic than larry.
i think spain has done a wonderful job on structural reforms. it is almost the model of the countries. if you look at the countries growing the fastest in history they are not the most efficient countries. they are the countries that had big barriers. china is a great example. how did it grow its economy? by eliminating barriers. if those barriers are removed there is a lot of potential. a lot of southern europeans are having to deal with cultural questions. quality of life as they define it. efficiency is a key element here. >> i am sorry i want to cut you off.
i want 40 seconds from each of you on who needs to pull their weight. gary, i will kickoff with you. >> it is hard to separate it. i think business needs to pull their weight. if europe is going to grow -- if you look at what the u.s. got going, we had a cheap energy, we had low interest rates, and a very competitive currency. we used that to create jobs. the question is if europe can create jobs. you need the structural reform to create jobs. look at what we did in silicon valley in the tech world. millions of jobs created in the u.s. over the last 5-10 years. >> all. i think they all need to pull their weight.
there are big trade deals on the table. there is a big climate deal that would certainly feel anxiety. also a lot of opportunities. in the world of central bankers, all of them have to really rally around those jobs and growth objectives. all of them, and hopefully cooperatively as well. i think it is absolutely necessary. we have not talked about geopolitical issues. they need collective support to be eradicated. >> larry, is it politicians? >> all of the above. the central bank is doing its part and is doing as much as politics will allow. business leaders like on a are -- like anna are primed and ready to go.
the question is whether the political leadership will be there to put a dynamic framework that has both demand and supply elements in place for adequate growth. >> if you only had to choose one. >> i agree with what was said. [laughter] >> but you have to choose one, it makes it more exciting. >> i won't. [laughter] >> i'm going to be brief. i will say banks are prepared and ready to lend. we are the transmitters of monetary policy to the real economy. businesses and people want to buy a home, get a mortgage. we need a balanced approach to regulation that takes an broader public policy issues that we have discussed today. >> this is one of the things that will fuel much of the debate for this year -- the role of regulators with banks. thank you so much for joining us. it was a great pleasure. time really flew by.
>> it is the best of bloomberg television at davos 2015. i am tom keene. for the next hour, we will be giving you the highlights of some of the inside conversations that we had with our special guests over the three-day meetings at the world economic forum. let's go inside. >> here we are with larry summers again. there is so much to talk about. let's begin with this. particularly here in this country, the memory of last week's swiss franc fiasco, let's call it, is still pretty fresh. what happens if mario draghi