Sovereign Debt Crises

Dear Friends,

This morning French President Hollande is quoted as saying that the Greek proposal is serious and credible, while Angela Merkel continues to rule out a reduction in the principal amount of the debt.  Her position is wrong economically and morally.  History has demonstrated that the only viable solution to excessive sovereign debt is to reduce the principal amount.

An article in The New York Times (here) a couple of days ago contained the following paragraphs

The good news is that by now economists generally understand the contours of a successful approach. The bad news is that too many policy makers still take too long to heed their advice — insisting on repeating failed policies first.
“I’ve seen this movie so many times before,” said Carmen M. Reinhart, a professor at the Kennedy School of Government at Harvard who is perhaps the world’s foremost expert on sovereign debt crises.
“It is very easy to get hung up on the idiosyncrasies of each individual situation and miss the recurring pattern.
The recurring, historical pattern? Major debt overhangs are only solved after deep write-downs of the debt’s face value. The longer it takes for the debt to be cut, the bigger the necessary write-down will turn out to be.

Of course the Germans know first hand about having their own sovereign debt reduced.  After World War I, Germany had significant debt from the war and reparations which it could not repay so it defaulted.  Many people believe that Germany's enormous debt was one of the reasons that Hitler could come to power.  After World War II, Germany took on additional substantial debt for reconstruction which it could not pay back and in 1953 an agreement was reached with its creditor nations (including Greece) to cut its debt in half.

Not only did the 1953 agreement cut the principal amount owing in half, it limited the payments to be made on the debt to 3% of export earnings each year.  This deal permitted Germany to build its economy into one of the most powerful in the world.  Now that it is on top of the economic heap, it has forgotten its past and the fact of history that only significant debt reduction can solve a sovereign debt crisis.  There is a great op-ed piece in The Guardian from February, 2013 (yes 2013) that does a great job of explaining the history.

If Greece were to receive a deal like the one that Germany got after World War II, it would have a great opportunity to build its economy and become an important part of the European Union.  Unfortunately not only are the creditors opposed to any debt forgiveness they think that debt repayment is the highest priority of spending and think that 15% to 20% (not 3%) of export profits is sustainable which, of course, it is not.

Unfortunately, Greece is not the only country to be treated in this manner.  As the op-ed in The Guardian points out:

Following the London deal, West Germany experienced an "economic miracle", with the debt problem resolved and years of economic growth. The medicine doled out to heavily indebted countries over the last 30 years could not be more different. Instead, the practice since the early 1980s has been to bail out reckless lenders through giving new loans, while forcing governments to implement austerity and free-market liberalisation to become "more competitive".
As a result of this, from Latin America and Africa in the 80s and 90s to Greece, Ireland and Spain today, poverty has increased and inequality soared. In Africa in the 80s and 90s, the number of people living in extreme poverty increased by 125 million, while economies shrank. In Greece today, the economy has shrunk by more than 20%, while one in two young people are unemployed. In both cases, debt ballooned.

The op-ed piece ends with these two paragraphs:

The German debt deal was a key element of recovering from the devastation of the second world war. In Europe today, debt is tearing up the social fabric. Outside Europe, heavily indebted countries are still treated to a package of austerity and "restructuring" measures. Pakistan, the Philippines, El Salvador and Jamaica are all spending between 10 and 20% of export revenues on government foreign debt payments, and this doesn't include debt payments by the private sector.
If we had no evidence of how to solve a debt crisis equitably, we could perhaps regard the policies of Europe's leaders as misguided. But we have the positive example of Germany 60 years ago, and the devastating example of the Latin American debt crisis 30 years ago. The actions of Europe's leaders are nothing short of criminal.

The economic elite continue to control the fate of all of the people in the world and the inequality in income and wealth continues to skyrocket.  I hope that it will not take the rise of people like Hitler or populist revolutions to take this power away from the economic elite and return it to the people.

Thanks for reading and please comment,
The Unabashed Liberal