Obama State of The Union Address; Geitner and Summers should go

In his great, second State of The Union Address (SOTU), President Barack Obama kept his focus on creating new jobs, and called for a new sprit of bipartisanship, but without caving in on Heath Care Reform. But left out of the SOTU was what would have been his boldest stroke of all: firing Treasury Secretary Tim Geitner and Chief Economic Advisor (title: Director of the National Economic Council) Larry Summers.

Larry Summers

This blog post is more directed at Larry Summers than Tim Geitner, because according to The New Yorker's January 28th edition, Larry Summers failed to present the $1.2 trillion Economic Stimulus Plan Option to President Obama, even though his colleague, Berkeley Professor Christine Roemer said that all of the models she ran pointed to that size of stimulus as the best plan:

The most important question facing Obama that day was how large the stimulus should be. Since the election, as the economy continued to worsen, the consensus among economists kept rising. A hundred-billion-dollar stimulus had seemed prudent earlier in the year. Congress now appeared receptive to something on the order of five hundred billion. Joseph Stiglitz, the Nobel laureate, was calling for a trillion. Romer had run simulations of the effects of stimulus packages of varying sizes: six hundred billion dollars, eight hundred billion dollars, and $1.2 trillion. The best estimate for the output gap was some two trillion dollars over 2009 and 2010. Because of the multiplier effect, filling that gap didn’t require two trillion dollars of government spending, but Romer’s analysis, deeply informed by her work on the Depression, suggested that the package should probably be more than $1.2 trillion. The memo to Obama, however, detailed only two packages: a five-hundred-and-fifty-billion-dollar stimulus and an eight-hundred-and-ninety-billion-dollar stimulus. Summers did not include Romer’s $1.2-trillion projection. The memo argued that the stimulus should not be used to fill the entire output gap; rather, it was “an insurance package against catastrophic failure.” At the meeting, according to one participant, “there was no serious discussion to going above a trillion dollars.”

“There was no serious discussion to going above a trillion dollars," even as economists were talking about a stimulus package that had to be over $1 trillion. Dean Baker of the Center for Economic and Policy Research was quoted as saying "You're talking about a gap on the order of twelve-hundred-fifty billion dollars, and we're trying to plug that with four-hundred-something, so we've got a long way to go."

Paul Krugman said "I'd like to see it bigger." Krugman said. "I understand that there's difficulty in actually spending that much money, and I--they're also afraid of the--of the T word."

The "T" word is "Trillion" but with the economic stimulus package already close to that number, and the country in deep trouble, worrying about what Congress would think - rather than letting Congress deal with the truth - was a big mistake.

China's Economic Stimulus Package was 20 percent of GDP, and many eonomic observers used that as the benchmark for what the size of a U.S. Economic Stimulus Plan would be. Instead, it came in at just about 5 percent of U.S. GDP. The problem feared the most: of doing too little, too late is now facing America, just as it did Japan in the 90s.

Fears of the "T" word and the total U.S. Debt have backed us into this corner. The misunderstanding is that GDP growth guarantees a smaller percentage of GDP that is debt. The Economic Stimulus Package is supposed to jump-start growth. The fact that even the $800 billion version did is proof that the theory is sound, but it didn't boost American Economic Growth to levels that would reduce the record high unemployment rates around the country.

Larry Summers is to blame for this problem:

Summers brought a third argument to the debate, one that echoed his advice to Bill Clinton sixteen years earlier, when his Administration was facing persistent budget deficits that Summers believed were suppressing economic growth. He, like Romer, was guided by an understanding that in financial crises the risk of doing too little is greater than doing too much. He believed that filling the output gap through deficit spending was important, but that a package that was too large could potentially shift fears from the current crisis to the long-term budget deficit, which would have an unwelcome effect on the bond market. In the end, Summers made the case for the eight-hundred-and-ninety-billion-dollar option.

If Larry Summers had done the opposite: that is make an argument for the trillion-dollar option, there's clear evidence America's economic recovery would have been larger and more robust, as the extra $400 billion could have gone to a temporary injection of, say, $5,000 for every American taxpayer under $100,000, thus buying time for the other parts of the stimulus plan to take effect, and boosting consumption at the same time.

But that did not happen, and now America still has its employment problem and a Congress shy to spend more money, even though its badly needed. America has lost $976 billion in wealth due to jobs moving overseas over the last 30 years; over $400 billion just in the last eight years. Turning that problem around is going to take a lot of money.

Stay tuned.