At length. Because haven’t you heard?
Germany is a hypocritical creditor.
It won’t give Greece the debt relief which it received itself in the 1950s.
Thomas Piketty said it. So it must be true:
When I hear the Germans say that they maintain a very moral stance about debt and strongly believe that debts must be repaid, then I think: what a huge joke! Germany is the country that has never repaid its debts…We never would have managed this unbelievably fast reduction in debt through the fiscal discipline that we today recommend to Greece… Think about the London Debt Agreement of 1953, where 60% of German foreign debt was cancelled and its internal debts were restructured.
Sure, let’s think about it — and about how mistaken this view is. Update: OK guys, seriously. This post isn’t to join in the Piketty debate. We like Piketty, really. We just think sovereign debt restructuring is a bit complicated, and actual lessons here for Greece are interesting but need some context.
Update: Mike Bird also nails three big problems with the analogy (which is beingmade elsewhere), particularly on Germany’s growth potential in 1953. Read that, then come back here.
The charge of historical hypocrisy will grow even stronger if there is no deal with creditors and Greece leaves the euro. Not least, it will then need EU official loans in even direr straits, while the eurozone loans will probably be goners. The official creditor politics will fire up all over again. So it’s important to note that this charge iswrong.
And, if a deal is possible, there actually is a useful lesson from Germany’s agreement when it comes to designing a Greek official debt restructuring, and how to move on from the creditors’ absolutely massive mistakes of the last five years while giving them the political cover to do so.
It’s just not one you’ll get from Piketty.
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1) The background
Let’s begin with a hopefully obvious point.
Germany was still an occupied country in 1953. It had been so from 1945, first under Allied military government, then under commission. In the west, even after the creation of the Federal Republic in 1949, occupation remained in effect until May 5, 1955. Restructuring debt and regaining sovereignty were part of the same process.
Even the hardiest Syntagma Square placard-bearer would have to admit ‘the institutions’ haven’t controlled Greece’s geopolitical destiny in the same way.
West, that’s the other thing. By 1953 Germany had traumatically broken in two.
That year, the eastern half — the German Democratic Republic — was busy putting down an uprising with Soviet tanks. (Pictured right.)
More to the point, it wasn’t interested in external debt. The FRG had already decided to assume it all, public and private, before talks began. It was, and wished to be recognised as, the legal successor to the former Reich, including those debts. The alternative was accepting the GDR’s legitimacy.
Which is why Chancellor Adenauer refused to pro-rate the assumed debts to the FRG’s rump territory — and therefore why relief became urgent. It’s a bit like how Ukraine’s debt problems now are partly the result of losing economic control of its east.
One other thing. Germany’s break-up was also still in train in 1953 — the Wall would not go up in Berlin until years later — and as we’ll see, the debt relief was designed partly to come to terms with the realisation (relatively fresh in the early 1950s) that reunification would be a long wait.
Given those unique circumstances, already the analogy perhaps doesn’t get off the ground.
Still, let’s keep going.
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2) The conditionality
The kind of conditionality being asked of Greece in return for debt restructuring is cited as big problem by those who use the German analogy.
It is a big problem. It feels pretty ludicrous that the European project could go into historic reverse over the exact amount of value-added tax in Greek hotels. Even the recent IMF analysis of potential debt relief assumes highly questionable projections for indefinite primary surpluses to be borne by the Greek economy.
The particular point seems to be that it’s unfair Germany achieved debt relief without a similar weight of conditionality, therefore Greece deserves fewer conditions — or ‘prior actions’ in Brusselsese.
This depends on your definition of condition.
One relevant point, we think, is that well before relief, the Allies had already ensured their debtor had undergone a somewhat thorough process of lustration. That would be because the people who used to run its government were Nazis.
Nor is it irrelevant that the counterpart of the London agreement was theLuxembourg agreement, in which the FRG committed to paying the state of Israel a considerable sum in reparations to integrate Jewish refugees.
Reparations: another keyword here indicating German ‘conditionality’ in 1953 had something else unique about it. We’ll return to this shortly.
Another might be Währungsreform. One Sunday in 1948, the German government switched currencies from the Reichsmark to mop up the money sloshing around its post-war economy. Savings deposits were converted at a 10 to 1 ratio into Deutsche Mark. Haircutting depositors is, naturally, a touchy subject in Greece today. Imagine burning bank depositors years before sovereign debt relief and you may get a sense that, again, Piketty’s analogy is leaving just a little bit out.
There were also what we could call the ‘geopolitical’ conditions of German debt relief.
Half the debt Germany restructured in 1953 after all was Marshall Plan lending or post-war economic assistance. The Marshall Plan had its own conditionality of course (though we tend to forget this now): it wouldn’t go to communists. Update: to correct this point, as noted in comments, the US offered Marshall Plan aid to communist countries including Yugoslavia (which received the aid), although the USSR refused it. Our point was more about western democracies in transition such as Italy and Germany that took Marshall Plan aid. In Italy’s case for example, communists were booted out of coalition before aid really got going.
Also, in the late 1940s and early 1950s American and European politicians had to think about ways to manage a reviving Germany — enlisting it in the response to the Soviet threat, but not letting it go rogue and dominate Europe again.
Hence the gradual restoration of sovereignty, hence the first attempts at European union, and Nato’s creation; hence debt relief the way it worked out. All part of the same process. Above all, this was all predicated on the belief that the German economy couldn’t be kept down for long.
US postwar aid, incidentally, helps explain this photo, which you’ve no doubt seen on Twitter:
One reason Greece could be generous was because the US had already been funding it through the Truman Doctrine — effectively, paying it to contribute to a German debt write-off. (H/T Alan Beattie)
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3) The terms
Considering that, for about twenty years, payments on German external debts have not, in general, conformed to the contractual terms…– Preamble to the London Agreement
DM13.5bn prewar debt –> DM7.5bn restructured
DM16.2bn postwar debt –> DM7bn restructured
(Approximate amounts; DM = Deutsche Mark)
DM16.2bn postwar debt –> DM7bn restructured
(Approximate amounts; DM = Deutsche Mark)
Another way the German analogy seems attractive to use for Greece today is its roughly 50 per cent writedown of German debt’s value. For why shouldn’t Greece receive the same face value haircut on its €320bn pile of debt?
Because of the irrelevance of a nearly all officially-held debt stock, next to ensuring Greece’s actual debt servicing cost is sustainable, perhaps, or because the EU Treaty’s anti-bailout clause would (somewhat ridiculously) leave direct haircuts in a tricky legal position. But also because the haircuts in 1953 were highly tailored to Germany’s situation.
Despite the geopolitical impetus for German debt relief in the early 1950s, negotiations weren’t easy. That’s because of those reparations we mentioned.
The Federal Republic initially tried to get these talks to include offsetting assets seized by the Allies against its reparations obligations.
It failed. Nevertheless reparations from the First World War did become central to the debt restructuring. It included bonds issued under the Dawes and Young Plans of 1924 and 1930. Both rescheduled reparations payments — effectively privatising them via the bonds. Both were ultimately politically disastrous within interwar Germany given that their long maturities implied decades of ‘bondage’, though.
Which is why Germany had been in default on them for two decades. Amazingly, however, 1953′s deal did not reduce the Dawes or Young debts’ face value.
Instead the 50 per cent reduction came from reducing interest, kicking out maturities, and (a neat trick) calculating the arrears on the basis of simple versus compound interest. Post-war arrears moreover were deferred — until reunification. Germany’s relief was being tailored to its unique political situation.
Repayment of the restructured debt was also tailored to Germany’s economic situation. The London Agreement assumed Germany could generate trade surpluses out of which it would repay its debts.
This looks incredibly generous by the creditors: if no trade surplus, no repayment. It was a little bit fuzzier than that. Article 34 of the Agreement merely provided that the Federal Republic could ask for ‘consultations’ with creditors if it ran into trade problems.
It also tells you something about the sequencing of ‘conditionality’: the creditors were clearly betting that German trade had already turned around enough to be confident of these surpluses. Hopefully it’s not a spoiler alert that Germans went on to call the next decade the Wirtschaftswunder.
Anyway, there’s a good idea here that Greece’s creditors might think about stealing.
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4) The actual lesson (maybe)
By linking trade to repayment, and deferring some payments to reunification, Germany had ended up with outcome-contingent debt, tied to how its economy or politics performed.
A similar concept is at work in GDP-linked warrants — something Greece already issued in its last, private-sector debt restructuring in 2012. They’re not worth a whole lot and the technical triggers matter immensely. Greek growth is now absolutely in a hole, while creditors failing to predict its true course since 2010 is a huge part of why they’re in so much trouble. As Gabriel Sterne of Oxford Economics notes in the chart below, the IMF has rowed its projections for Greece’s nominal GDP in 2015 back by a third since 2010:
In the meantime, creditors get madder and madder about the Greek government backsliding on reforms, and Greek voters become madder and madder about losing their dignity. There has to be a better way.
Or as Anna Gelpern has put it:
One way to mitigate the democracy mismatch would be to link debt repayment at the outset to the achievement of agreed policy objectives, so that creditors designing the policies would share some of the risk with the debtor. The debtor would get a modicum of financial relief if its economy fails to recover, though any such relief would be too small to justify sabotaging its own recovery. The amount of outcome-contingent debt can be small because the principal goal of risk-sharing is political accountability for the creditors.
And if policies aren’t possible in the first place, maybe it’s a cue to begin serious restructuring anyway.
This is complicated to do at scale. Small countries tend to go furthest with outcome-contingent debt. Grenada this year promised its creditors payments tied to revenues from selling citizenship, and included a clause allowing it to suspend servicing debt after a hurricane, in its restructuring. But that also shows the scope for creativity.
There’s one other feature of the German debt agreement which is of interest, lastly.
Any sovereign debt restructuring should really be about finding the upside, since what pays creditors back in the end is growth once the debt’s cleared. This is the ‘life goes on’ principle behind why private creditors often agree to restructure.
Germany’s official backers embarked on relief in 1952 for a similar reason — to establish the new nation’s credit as fast as possible given the challenge of the Cold War. It was better to let private creditors resume the burden of refinancing.
That included this signal, in the London agreement’s preamble (emphasis ours):
Considering that this Commission informed the representatives of the Government of the Federal Republic of Germany that the Governments of the French Republic, the United Kingdom of Great Britain and Northern Ireland and the United States of America were prepared to makeimportant concessions with respect to the priority of their claims for post-war economic assistance over all other foreign claims against Germany and German nationals and with respect to the total amount of these claims, on condition that a satisfactory and equitable settlement of Germany’s pre-war external debts was achieved…
Giving up priority would be unusual today, but it’s not too far from Lee Buchheit’srecent suggestion that Greek official lenders subordinate their claims to bondholders, as a way to catalyse private finance.
What’s the alternative in Greece? Leaving it to become an angry ward of its official lenders?
Even Grexit, if that’s the path chosen, will have to involve debt restructuring and ongoing official credit in some form, considering how badly Greece’s economy will respond.
EU officials then probably could profitably consider the German history in the next few days. Not to go searching for simplistic haircuts or moral point-scoring. More to think about just how many — complicated — ways there are to marry sovereign debt restructuring and politics.
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