HAASS: When you say serious economic downturn, what is it—what would that look like?
SUMMERS: So I’m going to answer the question, but I don’t want anybody to confuse my answering the question what would serious economic downturn look like with my predicting that there will be such a serious economic downturn. I said one in three of a recession. By the way, if the Fed actually carries through with four increases this year, then I think it’s probably closer to one in two of a recession. But I don’t think they—but I don’t think they will, which is why I’m predicting one in three.
But what does it—what does it look like? The confidence in China starts to deteriorate. As in some—as in February, they have to spend $250 billion holding the currency, and people calculate that at that rate the reserves will all be gone in a year, so they can’t do it. And then they have to spend $350 billion in March or they can’t do it, so at some point they give—at some point they give up. The currency falls 15 percent, 20 percent, exporting huge pressure—deflationary pressure to the rest of the world and leading to a major switch in demand towards China. In that process, the price of oil falls to a point where the world is glutted with it and it has to be stored on tankers, which is enormously expensive, and so the price falls below $20. There’s a revision in sentiment about the global economy in the United States, and so stock market investors decide that the price-earnings ratio on the U.S. market, instead of being at the 85th percentile of history, should be at the 25th percentile of history, and at the same time corporate profits fall by 20 percent. And those two things are sufficient to take the Dow to 8,500. The—
HAASS: Can I withdraw the question now? (Laughter.)
SUMMERS: But I’m saying, I don’t expect any—I don’t expect any of that. But just think about the last—think about the last thing I said. Is it—it’s not—it’s not at all what I would predict, but it is not beyond the realm of possibility that multiples in U.S. markets would start to look like a significantly below-average level rather than a significantly above-average level. And it’s not beyond the realm of possibility that, in a troubled global economy, profits would fall 15 or 20 percent. And then the rest of it is arithmetic. And, you know, by the way, I think we’ve done a great deal to make financial institutions more robust, but if you take a scenario of the kind that I just described, there would at least be some questions about some major global financial institutions.
Again, that’s not my prediction, but it is why I think those who are worried about overheating the economy and generating inflation, rather than being worried about slowdown, low-flation, and difficulty of response, are sort of entirely missing the central issue of our time, from an economic point of view.