Podcast: Inflation nation: How Larry Summers predicted skyrocketing prices in the US

TRANSCRIPT: Inflation nation: How Larry Summers predicted skyrocketing prices in the US

Larry Summers:

A society where inflation is accelerating is a society that feels out of control.

Ian Bremmer:

Hello and welcome to the GZERO World Podcast. This is where you'll find extended versions of my interviews on public television. I'm Ian Bremmer, and this week, just days before the annual American retail riot, also known as Black Friday, we dive deep into the global supply chain crisis. How did this network of manufacturing, trade and logistics hit such an enormous speed bump in how long will our global shortages last? I'm joined by economist and former treasury secretary, Larry Summers. Try to find the light at the end of this backed up tunnel.

Announcer:

The GZERO World Podcast is brought to you by our founding sponsor, First Republic. First Republic, a private bank and wealth management company understands the value of service, safety and stability in today's uncertain world. Visit firstrepublic.com to learn more. This podcast is also brought to you by Walmart. Walmart is committed to supporting jobs in the communities we serve. That's why we're investing an additional $350 billion in products made, grown or assembled in the United States supporting 750,000 new jobs. Learn more at walmart.com/america.

Ian Bremmer:

- Summers, good to see you man.

Larry Summers:

Good to see you, my friend.

Ian Bremmer:

So let me start off with this big inflation thing. I remember when you came out at the beginning of the Biden administration and you said, "My God, inflation is going to be a very serious worry." And I mean, not only did the journalist pile on on you, but the White House piled on on you and now here we are and we have the highest levels of inflation in 30 years. So what did you see that they did not? Why did they all get it so wrong?

Larry Summers:

I don't really know. I applied what I thought was basic economic analysis. I looked at what the prospective GDP gap was. It was about 2%. I looked at what the fiscal stimulus was about 15% of GDP. I compared them assuming even a modest multiplier. And that told me there was going to be a substantial overheat. Then I added to that the recognition that monetary policy was incredibly loose. I added to that, that there was a real possibility that potential GDP, the economy's capacity would be reduced by COVID, and I added to that that there was a big overhang of savings from all the money that people couldn't spend during the first year of the pandemic. And it seemed obvious to me that we were going to have massive demand and we weren't going to have such large supply. And I don't usually make really strong off-consensus economic forecasts because I think there's a lot of wisdom in the consensus, but this one seemed pretty clear to me.

I think there were a number of, if I might, cognitive biases that got a lot of people to go wrong. One was what I call motivated belief. People really wanted to engage in a lot of support for families, and so they convinced themselves that what was politically imperative was economically prudent. That's one part of it. Another part of it was believing recent history and their then-current model. And after 35 years without inflation, people basically had assumed that inflation wasn't something that was coming back and it was something that was gone for good.

And I think that was another part of the error as well. And I think it may have just been some difficulty in engaging in risks. If you look at the magnitude of the initial stimulus Ian, and there was no one who did an economic analysis that said that it was the right size, that came out of after the Georgia election with the political imperative of the tax cuts and so forth. It was a politically-derived number and it was the mathematics of the vote count rather than the mathematics of the economy that drove the choices that were made. And that has turned out to have led to something that I think was, in retrospect, a pretty clear economic error, one that was compounded by the actions of the Fed.

Ian Bremmer:

The 1.9 trillion you're talking about at the beginning of the Biden administration.

Larry Summers:

On top of the 900 billion people forget that, there was 900 billion passed in December and then there was another 1.9 trillion. So I didn't do anything really very hard. I looked and I said, "Relative to trend, how low were payrolls?" And the answer was 20 to 30 billion dollars a month. And then I looked at 2.8 trillion, and I calculated that was about $240 billion a month. And so I said, if you put $240 billion a month in to close a 20 or 30 billion dollar gap, even if there's a lot of leakage and there's a lot of delay and there's a lot of other stuff in the 240 billion, you are going to get yourself something that's got a good chance of being a problem.

Ian Bremmer:

Now, I mean, I understand that an extra $2 trillion is a hell of a lot of money. I also understand that at the time that it was passed, there was still an enormous amount of uncertainty in terms of where we were in the pandemic, the effectiveness, the rollout of the vaccines, the fact that you were still at that point looking at very high unemployment numbers. If you could have made that decision when Biden first came in, how would you have done it differently?

Larry Summers:

I would have, in fact, I did recommend at the time doing something like $1.5 trillion rather than $2.8 trillion. And then I think you would've had demand reasonably well-matched to supply and with demand reasonably well-matched to supply, you would've had a much better economic outcome.

Ian Bremmer:

Now, is inflation somewhat less of a problem in the United States now in the sense that we have written a lot of checks, absolute poverty levels are down, savings are up, social security benefits will be indexed to that inflationary jump? Is the scarring that's going to happen in the United States through this inflationary cycle going to be reduced as a consequence of all of that?

Larry Summers:

Maybe some. And there'll be people who will be happy when they get their social security index checks this January, that'll be up 5.1% from where they were before. On the other hand, they'll see that and they'll expect that we now have a kind of inflationary economy and that will feed through to produce more inflation. Look, I think a lot of what's damaging about inflation is not its direct economic consequences if you do some kind of economic calculation. You're right that when prices start going up faster, wages start going up faster and it balances out for many people. Interest rates adjust, other things adjust. I think the problem is a society where inflation is accelerating is a society that feels out of control. And people feel like things were supposed to be brought under control, not taken out of control. And when they see prices at the gas pump, when they see what they're paying for meat at the supermarket going up very rapidly, they wonder whether things are under control, particularly if it looks like the authorities aren't seeing those things as a problem.

And then I think there's a psychology thing that maybe is a failure of economics education, Ian, but is nonetheless a reality. And that is when people get a 5% raise and there's 5% inflation, they think they deserved every penny of the 5% raise and it's due to their good work and that the 5% inflation is stealing their hard-earned gains. Now, the truth that we would teach in an economics class is that if there wasn't inflation, they'd be getting a 2% raise. But we all tend to internalize the good and externalize the bad, and that's what happens with respect to inflation. And so people see it as robbing them of the gains they would otherwise have gotten.

I think the other thing is that you have to be careful about the idea that we're going to make everything accommodate to inflation because the more you accommodate to inflation, the more likely you actually are to have inflation. One of the things that I've seen in the last week that bothered me was there was a union agreement with John Deere. The agreement ultimately didn't hold, and the union's still on strike. But even so, the cost of living allowances that had been removed from the contract a dozen years ago because we no longer needed cost of living allowances, those cost of living allowances were being put back into the contract.

Well, the more you start having wage escalators to past inflation, the more you're going to start having an adverse psychology where you get a spiral. So what I see in all the business surveys is two things. People are reporting that all their input costs are going way up. There are all kinds of bottlenecks. They can't find workers. And they're reporting that they've got a lot of pricing power. And so they're not encountering resistance in passing on prices. In fact, lots of businesses are reporting something they've never seen before, which is that people are offering to pay higher prices in return for promises of reliable supply. So you've got customers going and saying, "Yeah, just promise me you'll keep delivering this stuff. But yeah, I'm okay if you raise the price." And that kind of psychology is one where you don't want to be confident that you're headed into an inflation deceleration.

Ian Bremmer:

Now, Biden's response to this, I mean there's been a little bit on the energy side, "Hey, OPEC needs to produce more. Maybe we should release some oil from the strategic petroleum reserve." I mean, it doesn't feel like there's anything structural at this point that the president can do to respond to this challenge as we head into Christmas, Thanksgiving, difficulties with buying presents for your kids, can't get a Turkey that's right size for my family. I mean, okay, these are quality problems to have, but nonetheless, it's going to cheese people off. What are you going to tell Biden he should be doing right now, since he didn't listen to you last time around?

Larry Summers:

Well, the president's got his advisors. Look, I think the most important thing is that the Fed needs to acknowledge much more explicitly than it has that it had misjudged the situation, that overheating is the principle problem facing the American economy, that it will do what is necessary starting as soon as is necessary to assure the maintenance of stable prices defined as an inflation rate that is running around 2%. That the president needs to be very clear as he refashions the Fed, that he's going to be appointing people who are focused on the objective of making sure that we don't go back to the inflation of the 1960s and 1970s, that the Fed is a place for people committed to financial stability, not a place for people committed to being social justice warriors.

I think he needs to signal that in the approach that he takes to the Federal Reserve system. I think they need to be careful that their Build Back Better, which I continue to strongly support, be fashioned in a way that isn't even in the short run, substantially increasing the level of demand in the economy. And I think the president, in addition to focusing on clearing up the ports and doing that for supply chains, which is the right thing to do, absolutely the right thing to do, but is not a hugely important thing to do, needs to look at the full range of his policies.

Should we buy America when buying America is much more expensive? Should we maintain every tariff when every one of those tariffs is holding up price levels and raising input costs for American producers? If OPEC should produce more oil, maybe we should too. And we need to keep that in mind as we look at fracking, as we look at natural gas. When we think about regulatory policies, don't we also need to pay attention to the costs of those policies where they will feed into higher prices? Industrial policies are fine, but if the industrial policies are translating into higher prices, that's something we now need to be paying attention to.

Ian Bremmer:

A couple questions there, but one immediately that comes up when you said we have to ask about buy American. I see that structurally in the sense that you're making a pro-free trade, pro efficiency, get the cheapest things you can get because that's going to help you with inflation. In the near term, in the immediate term, with supply chains being challenging, is it not a more right thing to do to try to simply buy more local?

Larry Summers:

No, I think the right thing to do is to buy cheap and buy inexpensive. And I think when we buy solar panels that are made in America, that are more expensive than solar panels that are made in China, we're contributing to a higher price level and an inflationary psychology. When we procure components for infrastructure in ways that are designed to support suppliers in America rather than to get that infrastructure as inexpensively as possible, we are contributing to a higher price level. I'm all for an agenda of resilience, but we need to think very hard about domestic costs and whether the policies we're pursuing are going to be constructive for the price level. Look, Washington made a mistake 10 months ago in privileging its various structural objectives over the inflation issue when it designed a macroeconomic stimulus bill. We need to not make the same mistake micro economically and privilege our particular objectives, whether it's the environment or strengthening labor or what have you, over the inflation issue going forward, or at least we want to do that if we want to avoid significant increases in inflation.

Ian Bremmer:

Now, I mean, you're an economist, obvious political pushback on a lot of the things you're saying, you know where they are, I know where they are. I mean, one interesting one, you mentioned tariffs, and I mean tariffs between the US and Europe are coming down. Tariffs between the United States and China of course are not. Are you suggesting right now a really smart thing to do would be for the Americans and Chinese to sit down and say, "Okay, lets reciprocally actually remove a bunch of those because we're just right now staring at the teeth of inflation."

Larry Summers:

For that reason and because the tariffs are costing Americans jobs. Look, it's a negotiation. It's a negotiation with the Chinese and whatever our sins are, their sins are substantially greater. And when you're in a negotiation, you don't unilaterally make concessions without getting things. But I think the approach of maintaining truculence and resisting dialogue that was pursued at the beginning of the administration on the theory that the American economy would look substantially stronger and that America would be in a more confident position 10 months later, that was a strategy that some of us said was a mistake at the time. And it's a strategy that is now not looking very strong in terms of what's happened to economic sentiment in the United States because of inflation. So I think it's time that we move to address the removal of these tariff barriers and that we internalize that just because some of the tariffs are burdensome for the Chinese doesn't mean they're good for the Americans. And when we make the price of steel more expensive, we probably hurt more automobile workers than we help steel workers.

Ian Bremmer:

Well, I went there just because you said, I mean you're arguing buying cheap. It's hard to buy cheap when one of your principal tools of economic diplomacy is to raise tariffs. So I mean, it's the other side. Now you've said that you're very supportive of the Build Back Better Bill. One of the reasons you've said you support it is because well over 10 years, the impact and the size is so much smaller than the $3 trillion that we saw over the first few months of the administration. So I mean wonder on the one hand, good to see that you support it, on the other hand, is it going to matter very much? What is about this bill that you think will end up moving the needle, assuming we actually get it done?

Larry Summers:

I don't think this is going to move the needle on inflation. I don't think the argument that it's going to increase supply and therefore reduce inflation holds water. I think they're going to be small overall increasing demand effects from the spending and they're going to be very small, increase the supply effects from the investments over time. And I think the first is going to come before the second. The reason I support the bill is the reason the president ran for president around issues contained in the bill. I think we need to do much more to support energy technology because we face a severe climate challenge. I think that kids need stronger starts before they start public school and that government can help.

Ian Bremmer:

Last question, Larry. I mean with all of these challenges that we're seeing, not just in the United States, inflation and supply chain challenges are global. Are you starting to worry a lot more about the potential for real economic implosion among the countries that don't have anywhere close to the governance and resilience and stability that the world's largest economy does?

Larry Summers:

Ian, I'm very concerned that a slowing of growth in the United States and in particular, a big hike in US interest rates, which I think may well be necessary given inflation, is going to have all sorts of consequences for heavily-indebted, poor countries and particularly poor countries that have a desperate need to borrow to meet the expenses of dealing with COVID, to meet the expenses of a world where there's a lot more protectionist pressure. So I think there's a prospect that this could lead to a very difficult period and the difficulty will not be confined to the United States. It even will be more severe abroad.

Ian Bremmer:

Larry Summers, thanks so much for joining us on GZERO World.

Larry Summers:

Thank you. Bye-bye.

Ian Bremmer:

That's it for today's edition of the GZERO World Podcast, like what you've heard, come check us out at gzeromedia.com and sign up for our newsletter Signal.

Announcer:

The GZERO World Podcast is brought to you by our founding sponsor, First Republic. First Republic, a private bank and wealth management company understands the value of service, safety and stability in today's uncertain world. Visit firstrepublic.com to learn more. This podcast is also brought to you by Walmart. Walmart is committed to supporting jobs in the communities we serve. That's why we're investing an additional $350 billion in products made, grown or assembled in the United States supporting 750,000 new jobs. Learn more at walmart.com/america.

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