There is a big difference between the Vietnam War and the euro battle: it is hard to think that the former could have been won whatever the means deployed. But as regards the latter Larry Summers is right to point out that instead of acting promptly with overwhelming force, Europe has consistently been one day late and one euro short. The Greek crisis was after all a very small problem when it emerged. Denial, procrastination and parsimony have now led to contagion to the core.
Bygones are bygones, however, and the only question that matters is, what to do now? Summers advocates a bold view of the future, a swift recapitalisation of banks and a reversal of the macroeconomic policy stance. All three are necessary, with the important caveat that most euro-area countries cannot afford a fiscal stimulus. Among the significant players only Germany has the possibility of changing course, and it will not do it. It may, at most, slow down consolidation, and this only will not change the landscape.
The proposed recipe is furthermore incomplete. The two immediate urgencies are to extinguish the Greek fire and to contain the rise of Italian and Spanish spreads. To achieve the former, a debt relief for Greece should be organised, over and above the voluntary and limited private sector involvement initiative agreed upon in July. Ensuring that Greece remains solvent over a wide range of macroeconomic and financial scenarios would help address lingering market concerns. Obviously, such an initiative would require to be accompanied by bank recapitalisation. As soon as ratification authorises it, the European financial facility should be used to this end – especially in Greece itself.
To stabilise Italy and Spain, the euro area should make clear that it will do whatever it takes to quell self-fulfilling debt crises. At present this is the task of the ECB, but it has no explicit mandate for it and central bankers are divided about bond purchases. This leads markets to doubt its resolve. In a few weeks, hopefully, the baton will be passed to the EFSF, which will have a mandate. But it lacks significant firepower. The solution is to leverage the EFSF by giving it a credit line from the ECB and the possibility to repo sovereign bonds purchased on the secondary market. A scheme of this sort would give it at least two trillion in firepower, perhaps significantly more. Secretary Geithner alluded to the idea in Wroclaw last week. The Europeans should seriously consider it.
A version of this column was also published on the Financial Times A-list