Almost 100 years ago, a young official in the UK Treasury sought to advise European policy makers on how daunting external debts might best be managed. There was, he argued, a limit to the national capacity to service debts. Those expecting further payments were bound to be disappointed. More than that, efforts by creditors to insist on further debt payments would be politically dangerous. “If they do sign,” he wrote to a friend, “they can’t possibly keep some of the terms, and general disorder and unrest will result everywhere.” He recommended a round of debt cancellation among European countries, a plan that would – at the stroke of a pen – remove much of the problem. When he was ignored by creditor governments, John Maynard Keynes quit his post to write the Economic Consequences of the Peace.
In today’s Europe, of course, the tables are decisively turned. It is not Germany that is suffering under an unsustainable sovereign debt burden, but its southern eurozone partners.
The economic effects of this policy are becoming clearer by the day: unlike the US, unlike the Bric countries (Brazil, Russia, India and China), Europe has essentially stopped growing – and there is little hope of growth resuming in the near term. Nor, evidently, have the debt problems been solved. Since the collateral for sovereign debt is citizens’ capacity to pay tax, recession and unemployment undermine the capacity to service debts and national credibility in capital markets, as shown again this week by rising yields in southern European debt markets.
The political consequences are, if anything, worse. Talks to form a Greek government have collapsed. This is unsurprising: no government pledged to unalloyed austerity in response to its debt obligations can face its voters with confidence.
Yet Greece is only an extreme example. Centrist governments across the Mediterranean are increasingly seen by their citizens as powerless. They have no independent monetary policy; no capacity to devalue; no right to impose capital controls; limited ability to support failing national enterprises; and now they are mandated to tighten fiscal policy. When moderation fails, the time comes for citizens to turn to those promising to take power into their hands, be they from the right or the left – anything but the pusillanimous centre!
That is what happened in the 1930s. It is a historical irony that European countries that avoided a repeat of the Great Depression after the banking crisis are now driving into the blind cul-de-sac that led to extremism in that earlier disaster. German historical memory has vivid recall of the hyperinflation of 1920-23. But it is possible to forget it was deflation and the Great Depression that brought Hitler to power in 1933.
One of the lessons of history is that sovereign debts must be managed in ways that do not destroy either the economy or the political centre ground. Europe hosts some of the best – and best paid – financial experts in the world; let their talents help governments shake off their paper shackles and devise ways of reducing debt without austerity.
If this means project spending – financed off-balance sheet by jointly guaranteed liabilities or by higher taxes, so be it. If it means substantial restructuring of sovereign debts swapped into indexed debt or growth bonds, or with grace periods until countries resume growth, so be it. If it requires shifting some of the burden of debt finance on to older generations who own the debt, that political issue must also be faced.
Eurozone countries must be allowed to grow again. For a country in such desperate straits as Greece, however, orderly exit from the euro to regain competitiveness looks to be the best option. But it is in the interest of both Greece and its creditors that the resulting devaluation be controlled. We must not add currency wars to our present pile of problems.