Although the creditor-debtor cards have been reshuffled since 1919, the game remains the same. Creditors want their pound of flesh, and debtors want to avoid giving it. Debtors want their debts forgiven, while creditors fret about “moral hazard” and ignore the destabilizing, contagious effects of making debtor countries poorer. Sadly, the eurozone has not learned the debt lessons of Versailles, or heeded the warnings of John Maynard Keynes.
When World War I ended, the victorious allies were determined that Germany should make “reparation” for the damage it had caused in the war, partly to pay off the debts they owed one another. But they failed to agree at Versailles on a final figure for the indemnity, instead tasking a Reparations Commission to determine the amount by 1921.
The nub of the issue was how much Germany could pay without an allied military occupation. In his 1919 polemic The Economic Consequences of the Peace, Keynes said that if Germany restricted its consumption, it could probably run an annual trade surplus of $250 million, or 2% of its national income, which over 30 years would add up to $7.5 billion.
In May 1921, the Reparations Commission fixed Germany’s indemnity at $33 billion. But the capital sum was effectively reduced to only $12.5 billion, requiring annual repayments of $350 million. This trick was accomplished by requiring Germany to issue three sets of bonds, but to pay interest and principal on only the first two (Classes A and B), consigning repayment of the “C” bonds to never-never land.
The charade of maintaining a large fictional German debt while trying to extract repayment of a smaller “realistic” one continued through the 1920s. In fact, Germany wasn’t prepared to repay the realistic debt, either, and only did so following fresh loans. In 1926, Keynes commented scathingly, “The United States lends money to Germany; Germany transfers the equivalent to the Allies, the Allies pay it back to the United States government. Nothing real passes.”
Then came the Wall Street crash and the Great Depression, and foreign loans to Germany dried up. By raising taxes and cutting public spending, Germany generated the required surplus to meet its annual debt payments between 1929 and 1931, but at the cost of intensifying the slump. The German economy shrank by 25%, and unemployment soared to 35%. The policy of “fulfillment” under Chancellor Heinrich Brüning paved the way for Adolf Hitler, who simply repudiated the debt.
Today’s debt charade in the eurozone has many parallels with post-World War I Europe.
In the run-up to the 2008 global financial crisis, southern European countries steadily accumulated debt by borrowing from northern banks, mainly German, to finance risky construction projects. As long as the boom continued, money kept pouring in. But when the crisis that began in the US hit the eurozone, northern European banks refused to extend new loans – forcing southern European governments to bail out their own banking sectors.
Greece was the most conspicuous victim of this reversal. In 2009, the country’s budget deficit shot up to 15% of GDP, national debt exceeded 100% of GDP, and ten-year Greek bond yields soared above 35%.
In 2010, the Greek government threatened to default. The northern banks agreed to partial debt restructuring – mainly by extending the repayment period – in conjunction with a €240 billion ($269 billion) credit line from a “troika” of the International Monetary Fund, the European Central Bank, and the European Commission.
This funding enabled the Greek government to meet interest payments, but it came with strict austerity conditions: higher taxes, cuts in public spending (particularly pensions), the abolition of the minimum wage, sale of assets, and curtailment of collective bargaining. In theory, these measures would yield a trade surplus that would enable Greece to repay its debt.
Between 2010 and 2015, Greece’s government, like Brüning’s in Depression-era Germany, pledged itself to a policy of “fulfillment.” In January 2015, voters finally revolted, electing a left-wing government headed by the Syriza party, which had promised to fight the cuts. But by August that year, Greece had capitulated to its creditors, enacting the necessary austerity measures in exchange for a new €85 billion loan.
Since 2010, Greece has borrowed over €300 billion. As of January 2019, it had repaid €41.6 billion, with a repayment schedule stretching beyond 2060. Official creditors are unlikely to get any of their money back because the bulk of the Greek bonds are fictional, like the German “C” bonds of the 1920s. Instead, taxpayers in creditor countries will pick up the tab in the form of higher taxes and reduced public spending.
The orthodox view is that austerity worked in Greece. Deprived of private loans, the country balanced its budget and moved in six years from a trade deficit to a surplus.
But austerity has imposed horrendous costs. Some 300,000 Greek civil servants were laid off, the economy shrank by 25%, and the jobless rate rose to 25% (and youth unemployment to over 60%). Homelessness, emigration, and suicide all increased. Greece’s debt-to-GDP ratio rose from 100% to 170%, and the creditors’ cartel will continue to control the country’s economic policy until the debt is repaid.
As Keynes wrote in 1919 “The policy of degrading the lives of millions of human beings, and of depriving a whole nation of happiness should be abhorrent and detestable.” Later, he argued that austerity was also theoretically wrong: cutting incomes in one country causes incomes to fall elsewhere, spreading a depression and ensuring that any recovery will be delayed and feeble.
The moral of these two stories, a century apart, is that countries should avoid getting locked into creditor-debtor relationships. If they cannot, then a fair bargain between creditors and debtors is necessary to preserve social and political peace. The eurozone is having to learn this lesson all over again.