Lawrence Summers

Europe’s hair-trigger economy

Lawrence Summers
Mar 18, 2013 10:56 UTC

Europe’s economic situation is viewed with far less concern than was the case six, 12 or 18 months ago. Policymakers in Europe far prefer engaging the United States on a possible trade and investment agreement to more discussion on financial stability and growth. However, misplaced confidence can be dangerous if it reduces pressure for necessary policy adjustments.

There is a striking difference between financial crises in memory and as they actually play out. In memory, they are a concatenation of disasters. As they play out, the norm is moments of panic separated by lengthy stretches of apparent calm. It was eight months from the Korean crisis to the Russian default in 1998; six months from Bear Stearns’s demise to Lehman Brothers’ fall in 2008.

Is Europe out of the woods? Certainly a number of key credit spreads, particularly in Spain and Italy, have narrowed substantially. But the interpretation of improved market conditions is far from clear. Restrictions limit pessimistic investors’ ability to short European debt. Regulations enable local banks to treat government debt as risk-free, and they can fund it at the European Central Bank (ECB) on better-than-market terms. The suspicion exists that, if necessary, the ECB would come in strongly and bail out bondholders. Remissions sometimes are followed by cures and sometimes by relapses.

A worrisome recent indicator in much of Europe is the substantial tendency of stock and bond prices to move together. When sentiment improves in healthy countries, stock prices rise and bond prices fall as risk premiums decline and interest rates rise. In unhealthy economies, however, as in much of Europe today, bonds are seen as risk assets, so they are moving, like stocks, in response to changes in sentiment.

Perhaps it should not be surprising that Europe still looks to be in serious trouble. Growth has been dismal; the euro-zone gross domestic product has been below its 2007 level for six years, and little growth is forecast this year. For every Ireland, where there is a sense that a corner is being turned, there is a France, where questions increasingly arise about the political and economic sustainability of policy.

Europe must be persuaded to make a permanent fix

Lawrence Summers
Jun 18, 2012 19:37 UTC

As the G20 leaders prepare to conclude their meeting today, once again good news has had a half-life in the markets of less than 24 hours. Just as news of European plans to stand behind Spanish banks rallied markets and sentiment for only a few hours, a Greek election outcome that was as good as could have been hoped did not even buoy markets for a day. There could be no clearer evidence that the current strategy of vowing that the European system will hold together, addressing each crisis as it comes in the minimally sufficient way and vowing at every juncture to build a system that is sound in the long term has run its course.

Nor is the G20 likely to change anything, at least not immediately. The troubled European economies and their sympathizers will demand more emphasis on growth, lower interest rates on their official debts and more transfers. The Germans will show sympathy with the objective of reform but will insist that financial integration must coincide with political integration, noting that no one gives away a credit card without maintaining control over its use. And the rest of the world will express exasperation with Europe’s failure to get its act together and demand that more be done. Officials blessed with more diplomatic ability than economic insight or courage will produce a communiqué that politely expresses a measure of satisfaction with steps under way, recognizes the need to do more, and looks forward to continued coordination and dialogue. The only good thing is that expectations are so low that this is not likely to disappoint the markets very much.

The unfortunate truth is that European debtors and creditors are both right in their main lines of argument. The borrowers are right that austerity and internal devaluation have never been a successful growth strategy, certainly not in an environment where major trading partners are stagnating. The suggested counterexamples, where fiscal consolidations have preceded growth, involve either stagnation relative to previously attained levels of income (Ireland and the Baltics) or buoyant demand associated with surging export demand, increasing competitiveness and low borrowing costs (many euro members in the early years). They are also right in their claim that even a previously healthy economy will quickly become very sick if forced to operate for several years with interest rates far above growth rates, as is the case across Southern Europe. And experience is clear in suggesting that structural reform is always difficult and slow-acting but much more difficult when an economy is contracting and there is no sector to absorb those displaced by reform.

Those chary of institutionalizing financial integration without major political integration are right as well. A sound system must involve those with deep pockets who are on the hook for liabilities, either as borrowers or guarantors, having control over borrowing decisions. A system where I borrow and you repay is a prescription for unsustainable profligacy. This is why there is now so much discussion of eurobonds and Europe-wide deposit insurance being linked with much deeper political integration. But there are two problems that lie behind the soft references to greater integration. The first is the question of who really has control. If decisions are to be made on a genuinely euro-area basis, it is far from clear, especially after the French election, that there is any kind of majority or even plurality support for responsible policies. If the idea is that the euro area’s future will be on the ECB model – a European façade behind which Teutonic policies are pursued – it is far from clear that this will or should be acceptable across the continent.

Austerity has brought Europe to the brink again

Lawrence Summers
Apr 30, 2012 02:13 UTC

Once again European efforts to contain crisis have fallen short. It was perhaps reasonable to hope that the European Central Bank’s commitment to provide nearly a trillion dollars in cheap three-year funding to banks would, if not resolve the crisis, contain it for a significant interval. Unfortunately, this has proved little more than a palliative. Weak banks, especially in Spain, have bought more of the debt of their weak sovereigns, while foreigners have sold down their holdings. Markets, seeing banks holding the dubious debt of the sovereigns that stand behind them, grow ever nervous. Again, Europe and the global economy approach the brink.

The architects of current policy and their allies argue that there is insufficient determination to carry on with the existing strategy. Others argue that failure suggests the need for a change in course. The latter view seems to be taking hold among the European electorate.

This is appropriate. Much of what is being urged on and in Europe is likely to be not just ineffective but counterproductive to maintaining the monetary union, restoring normal financial conditions and government access to markets, and re-establishing economic growth.

The perils of European incrementalism

Lawrence Summers
Sep 19, 2011 11:01 UTC

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.

Europe’s dangerous new phase

Lawrence Summers
Jul 18, 2011 11:00 UTC

By Lawrence H. Summers
The opinions expressed are his own.

With last week’s tumult in Italian markets, the European financial crisis has entered a new and far more dangerous phase. Where the crisis had been existential for small economies on the periphery of Europe but not systemically threatening to either the idea of European monetary union or to the functioning of the global financial system, it now threatens both European integration and the global recovery. Last week’s drama surrounding bond auctions in Europe’s third leading economy should convince even the most hardened bureaucrat that the world can no longer let policy responses be shaped by dogma, bureaucratic agenda and expediency. It is to be hoped that European officials can engineer a decisive change in direction but if not, the world can no longer afford the deference that the IMF and non-European G20 officials have shown towards European policy makers over the last 15 months.

Three realities must be recognized if there is to be a chance of success. First, the maintenance of systemic confidence is essential in a financial crisis. Teaching investors a lesson is a wish, not a policy. U.S. policymakers were applauded for about 12 hours for their willingness to let Lehman go bankrupt. The adverse consequences of the shattering effect that had on confidence are still being felt now. The European Central Bank (ECB) is right in its concern that punishing creditors for the sake of teaching lessons or building political support is reckless in a system that depends on confidence. Those who let Lehman go believed because time had passed since the Bear Stearns bailout the market had learned lessons and so was prepared. In fact the main lessons learned had to do with how to best find the exits, and so uncontrolled bankruptcies had systemic consequences that far exceeded their expectations.

Second, no country can be expected to generate huge primary surpluses for long periods for the benefit of foreign creditors. Meeting debt burdens at rates currently charged by the official sector for credit – let alone the private sector – would involve burdens on Greece, Ireland and Portugal comparable to the reparations burdens Keynes warned about in The Economic Consequences of the Peace.