By Lawrence H. Summers
The views expressed are his own.
In his celebrated essay “The Stalemate Myth and the Quagmire Machine,” Daniel Ellsberg drew out the lesson regarding the Vietnam War that came out of the 8000 pages of the Pentagon Papers. It was simply this: Policymakers acted without illusion. At every juncture they made the minimum commitments necessary to avoid imminent disaster—offering optimistic rhetoric but never taking steps that even they believed offered the prospect of decisive victory. They were tragically caught in a kind of no man’s land—unable to reverse a course to which they had committed so much but also unable to generate the political will to take forward steps that gave any realistic prospect of success. Ultimately, after years of needless suffering, their policy collapsed around them.
Much the same process has played out in Europe over the last two years. At every stage from the first signs of trouble in Greece to the spread of problems to Portugal and Ireland, to the recognition of Greece’s inability to pay its debts in full, to the rise of debt spreads in Spain and Italy, the authorities have played out the quagmire machine. They have done just enough beyond euro-orthodoxy to avoid an imminent collapse, but never enough to establish a sound foundation for a resumption of confidence. Perhaps inevitably, the gaps between emergency summits grow shorter and shorter.
The process has taken its toll on policymakers’ credibility. As I warned European friends quite some time ago, authorities who assert in the face of all evidence that Greece can service on time 100 percent of its debts will have little credibility when they later assert that the fundamentals are sound in Spain and Italy, even if their view is a reasonable one. After the spectacle of stress tests that treat assets where credit default swaps exceed 500 basis points as riskless, how can markets do otherwise than to ignore regulators assertions about the solvency of certain key financial institutions.
A continuation of the grudging incrementalism of the last two years risks catastrophe, as what was a task of defining the parameters of too big to fail becomes a challenge of figuring out what to do when key insolvent debtors are too large to save. There are many differences between the environment today and the environment in the Fall of 2008 or any other historical moment. But any student of recent financial history should know that breakdowns that seemed inconceivable at one moment can seem inevitable at the next.
To her very great credit, new IMF managing director Christine Lagarde has already pointed up the three principles any approach to Europe’s financial problems must respect. First, Europe must work backwards from a vision of where its monetary system will be several years hence. The reality is that politicians have for the last decade dismissed the widespread view among experienced monetary economists that multiple sovereigns budgeting and bank regulating independently will over time place unsustainable strains on a common currency. The European Monetary Union has been a classic case of the late Rudiger Dornbusch’s dictum that “In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.” So it has been with the buildup of pressures on the Euro system.