Must-read: Larry Summers: “Heed the Fears of the Financial Markets”

Must-Read: Larry Summers: Heed the Fears of the Financial Markets: “They understood the gravity of the 2008 crisis well before the Federal Reserve…

…Markets are more volatile than the fundamentals they seek to assess. Economist Paul Samuelson quipped 50 years ago, ‘the stock market has predicted nine of the last five recessions’. Former Treasury secretary Robert Rubin was right when he would regularly reassure anxious politicos in the Clinton White House that ‘markets go up, markets go down’ on days when a market move created either joy or anxiety…. Still, since markets are constantly assessing the future and aggregate the views of a huge number of participants, they often give valuable warning when conditions change…. Policymakers who dismiss market moves as reflecting mere speculation often make a serious mistake. Markets understood the gravity of the 2008 crisis well before the Federal Reserve. They grasped the unsustainability of fixed exchange rates in Britain, the UK, Mexico and Brazil while the authorities were still in denial, and saw slowdown or recession well before forecasters in countless downturns….

Signals should be taken seriously when they are long lasting and coming from many markets, as with current market indications that inflation will not reach target levels within a decade in the US, Europe or Japan…. It is conceivable that Chinese developments reflect market psychology and clumsy policy responses, and that the response of world markets is an example of transient contagion. But I doubt it. Over the past year, about 20 per cent of China’s growth as reported in its official statistics has come from its financial services sector…. This is hardly a case of healthy or sustainable growth…. Traditionally, international developments have had only a limited effect on the US and European economies because they could be offset by monetary policy actions…. Because of China’s scale, its potential volatility and the limited room for conventional monetary manoeuvres, the global risk to domestic economic performance in the US, Europe and many emerging markets is as great as at any time I can remember. Policymakers should hope for the best and plan for the worst.