The beginning of the unwinding of a European tragedy?

Posted on January 26, 2015 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

While the results of the general election in Greece are not known at the time of writing this Blog, it is clear that the tectonic plates of political affiliation and sentiment are shifting dramatically almost everywhere. The unthinkable suddenly becomes thinkable and the thinkable becomes irrelevant. Where market sentiment rules popular sentiment offers a counter weight.  Echoes of this are evident even in Ireland where, following 7 years of unrelenting austerity and pressure on living standards, employment and public services, popular sentiment is in the ascendancy.

Last week, at a conference held by the Irish Central Bank and the IMF I could not help think that the very fine surroundings of Dublin Castle complete with regal splendour and historic significance would be a suitable venue for the 2015 Dublin Debt Resolution Conference at which Europe would begin to face up to the delicate balance of democracy, markets and debt. Fiscal policy in European member states has been driven by a narrow focus on the size of Government debt (some of which is socialised private debt and recession driven surpluses in the corporate and household sectors as they stop spending and investing). 

There are historical precedents for such an event. In 1953 the London Agreement on German External Debts brought together a number of countries including West Germany – as it was – the UK, France, the USA and others including the Republic of Ireland. Yes, Greece was party to these negotiations in which Greece offered debt forgiveness to Germany notwithstanding some unhappy memories only a few years prior to 1953.  A total of €32 billion deutsche marks debt pile was the subject of negotiations. Half of this resulted from the infamous Treaty of Versailles and which Nazi Germany defaulted on in the 1930’s while the other half was made up of loans from the US Government in the aftermath of World War

The parties eventually settled on a debt write down of 50% with a sum of 15 billion deutsche marks in loans stretched out over 30 years.  Let’s say that, in the 1953 talks, minds were concentrated by (i) a Europe devastated by war and in which the US economy had an interest in seeing recovering, (ii) the emerging political realities to the east of the new ‘iron curtain’ and (iii) the rise or renewal of mass communist party movements in France and Italy. Britain had seen the election of a Labour Government which, among others things, introduced a National Health Service in 1948 and undertook widespread nationalisations and other social reforms in 1945-1950.

The debt deal in conjunction with other factors such as Marshall Aid provided a crucial breathing space for Germany to recover and rebuild. It is also significant that a number of agreements between 1946 and 1956 allowed for postponement of principal and interest payments by Britain subject to certain conditions (known as the ‘Bisque provision’). The context was set by a very large public debt level of over 250% of GDP in the immediate aftermath of World War 2. 

Thankfully, Europe has not been passing through a major war in recent times (apart from the wars associated with the breakup of Yugoslavia in the early 1990s and the recent conflict in the Ukraine). But, the fall-out from the 2008-2012 financial and fiscal crisis has been profound. The clumsy, ham fisted, incompetent and doctrinaire response, at the European level and often at the national level too, to the crisis which has characterised much of the recent period has exacted a huge burden on the ‘debtor’ nations.  Lazy stereotypes and fundamental misdiagnosis of the causes of the current economic malaise and growing political crisis in Europe have not been helpful. A full-scale humanitarian crisis in Greece has provoked an upheaval in political loyalties. Something similar may be in store for Spain and, here in Ireland, shifts are taking place in the political landscape that would have been unthinkable only a few years ago. Last week’s data released by the Irish Central Statistics Office are truly shocking (rising poverty, children in poverty, poverty among those in work).

‘Buying time’ is the title of a rather gloomy book on the state of Europe written by German political scientist, Wolfgang Streeck, in 2013. In his book, The Shifts and the Shocks, Martin Wolf does not mince his words (page 291):

Europe is under the sway of the ideas of Heinrick Bruning, German chancellor between 1930 and 1932, whose disastrous policy of austerity prepared the way for Adolf Hitler’ (page 291)

Is there a way forward? Can a candle be lit somewhere? Time will tell. But, time is not unlimited because the growing disconnect between citizens, national governments and technocratic elites in Frankfurt and Brussels presages trouble ahead. Hideous political forces are at work even in traditionally stable and moderate political cultures of Northern Europe.

Time is running out
Public debt is not the first problem facing Europe. Lack of legitimation is the pressing problem and this, in turn, is linked to catastrophic levels of unemployment (especially among young people), precarious work, rising poverty including poverty in work.

However, public debt and its financing is a big problem just as it was in the 1940s and early 1950s and, because of the drive to implement fiscal rules that make no sense and miss the causes of the crisis, such debt is triggering damaging fiscal policies in many member states. 

Clever and courageous responses are called for
Chart 1, below shows the total level of general government debt as a % of GDP in 2013 (see NERI Quarterly Economic Facts, indicator 6.4). Greece, Portugal, Italy and Ireland (Republic) have the highest debt levels as % of GDP in 2013 (2014 would suggest no major change in the broad picture). 

General government debt as a % of GDP, 2013

Monday blog: Chart 1, GGB

 A recent proposal was raised by economists, Dimitris P. Sotiropoulos, Yiannis Milios and Spyros Lapatsiora, suggesting that a significant part of that national government debt was bought up the European Central Bank and ‘parked’ until debt fell to below 20% of GDP. Their paper ( An Outline of a Progressive Resolution to the Euro-area Sovereign Debt Overhang: How a Five-year Suspension of the Debt Burden Could Overthrow Austerity which is available in full here ) sketches out a plan for the ECB to acquire a significant part of the outstanding sovereign debt crisis in the euro area converting it to ‘zero-coupon bonds’ (in other words not charging interest). No transfers between countries would take place Now, here is the rub - debt would not be forgiven: rather it would be parked on the basis that individual States will agree to buy it back from the ECB in the future when the ratio of sovereign debt to GDP has fallen to 20 percent. Countries would be given some breathing space to ramp up investment, restore living standards and help reboot economies. Of course, there would be an element of forgiveness to the extent that repayment are postponed (with a dramatic impact on the ‘present economic value’ of future payments conditional on debt being reduced to 20%).

Supposing the ECB bought up €4.5 tillion in sovereign debt in the Eurozone area (roughly equivalent to 50% of total sovereign debt) we could envisage a cap on the ‘active’ debt of member states. 

General Government Debt as a % of GDP with debt in excess of 50% of GDP bought up by ECB

Monday blog: Chart 2, GGB

 Whatever the outcome of the Greek elections and subsequent coalition forming if such is required it seems unlikely that Greece will exit the Euro any time soon or that the creditor nations will allow Greece to implode. Writing in the Irish Examiner last week (“ Greece is counting the cost of a possible EU exit: Heading for a stalemate or a bright new dawn? ”) Ann Cahill quotes Marco Giuli, a researcher at the Madariaga foundation in Brussels:

Talk of a Grexit by Germany and others is a bluff .… such a move would have serious implications both economically and politically for the entire EU, he argues. It would see Greece defaulting on its debts which would cost German and other taxpayers dearly since 62% is owned by eurozone states and the ESM bailout fund, 8% by the ECB and 10% by the IMF. It would also call into question the legality of the bailout fund as the system was deemed legal by Germany only on condition it would not burden taxpayers. And failure to pay the debt would be a violation also of the ‘no bailout’ clause. Restructuring and providing Greece with longer maturities would be the better option, he says.

The reality is that there are no easy options for Europe or its member states. A solution will have to be found that allows enough space for recovery. More flogging to improve morale through the euphemistic phrases of ‘structural reform’ and ‘wage flexibility’ will not work in today’s Europe where inequality, precariousness, instability and rising poverty is shattering the threads of European solidarity and support for Governments. Governments, elites and markets cannot continue to rule indefinitely without the consent of the governed. At some points citizens must take back the power they own as democracy. May be this is where the demos will break out again and the krinein or ancient Greek word for crisis will involve a separation – literally – of those debts that can be borne from those that cannot.

Over to you Dublin? A conference in the castle would be good for image, business and, ultimately, the fourth highest debt pile in Europe thanks to the bail-out of US, UK, German and French banks by the Irish taxpayer.

The Confederation of German Trade Unions, DGB, have outlined a European plan for recovery called, A Marshall Plan for Europe

I discussed the lessons Ireland can take from the recent crises and the desirability of a debt forgiveness conference on Morning Ireland last Tuesday.


Posted in: Macroeconomics

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