Piketty's argument about Greece's debt has three massive holes in it

Piketty ThomasREUTERS/Charles PlatiauFrench economist and academic Thomas Piketty, poses in his book-lined office at the French School for Advanced Studies in the Social Sciences (EHESS), in Paris May 12, 2014.

In a recent interview with German newspaper Die Zeit, Professor Thomas Piketty made a comparison between Greece’s debt today and Germany’s debt after the Second World War.

Piketty wrote the celebrated “Capital in the Twenty-First Century,” a tome on wealth and income inequality and their driving forces. He’s been rightly credited with helping to bring economic history back into the mainstream of academic economics.

But I think that he fluffed the historical part during his recent interview.

Much of Germany’s national debt was wiped away in the London Debt Agreement of 1953. Piketty thinks European elites are displaying a “shocking ignorance of history” by not taking more insights from this event, and wiping away a lot of Greece’s debt.

You can see a cached, translated part of the interview here. For what it’s worth, this isn’t a comparison of Piketty’s making — it’s become a popular but spurious comparison to make.

I think he, and the other people making this argument are wrong for at least three reasons.

1. The circumstances are completely different

Piketty examines the German situation and sees a big reduction in national debt. He says that “after the war ended in 1945, Germany’s debt amounted to over 200% of its GDP. Ten years later, little of that remained: public debt was less than 20% of GDP.”

But for starters, Germany’s debt was not meaningfully worth 200% of its GDP, since it wasn’t servicing it. In fact, it hadn’t been doing so for about two decades. In the early years of the Nazi government, Germany defaulted on most of its foreign loans.

What’s more, there’s a huge event being completely ignored here. In 1948, Germany reformed its currency in a spectacular fashion, giving birth to the Deutsche Mark. The change wiped out “approximately 90 per cent of Germany’s cash holdings and deposits” according to economist H. J. Dernburg, who was writing in 1954. It was that event, not the 1953 agreement, that provided the most dramatic reduction to German debt levels — but not without the extreme pain for anyone with any savings.

WikipediaHermann Josef Abs, centre, signing the debt agreement in 1953.

The equivalent for Greece would be returning to the drachma (or some other new currency) and enacting colossal haircuts on private deposits, the very thing that the current discussions are aimed at avoiding.

The new West German government, which in the early 1950s was only tentatively regarded as a nation-state, was resuming debt repayments, not having them cut away. Of course, the Allies could have been more demanding in the negotiations, but on the understanding that the alternative might have been years more of Germany making no payments whatsoever.

In the end, Germany reduced its debts by about half — those incurred after, not before the war got the biggest haircuts, but the interest rates on lots of interwar debts were cut, and the maturities extended.

Yale economic historian Timothy Guinnane noted in his own paper that “from the viewpoint of fifty years later it is probably difficult to imagine that Germany was viewed at the time as an international deadbeat.” One of the reasons that a 50% reduction in debts appears so large is precisely because the government had been in a state of non-payment for so long, and the creditors didn’t ask for 20 years of compound interest payments.

Greece has not been in default for 20 years, and the actions of its creditors, even when misguided, have been directed towards resuming the Greek government’s access to international capital markets (while reducing what they themselves are owed as modestly as possible) on much the same terms that it did before 2010.

Athens would almost certainly have been offered much more generous debt relief had it defaulted dramatically. Even BILD, a conservative German tabloid, suggested a debt haircut of 50% in the case of Grexit. But that’s something that each successive Greek government has instead tried hard to avoid. The prospect of entirely rebuilding the country’s global market access from the ground up, even with a lower debt burden, is not particularly inviting.

2. Germany’s ability to repay was far better than Greece’s

One element of the deal with Germany certainly looks inviting from the Greek perspective. Repayments were intended to be loosely tied to Germany’s ability to produce a trade surplus.

Alexis TsiprasREUTERS/Francois LenoirGreek Prime Minister Alexis Tsipras may be right to push for debt relief — but the comparison with Germany is wrong.

So the idea was that Germany would repay debt only so long as it was internationally competitive.

But unlike in Greece, that was a realistic prospect. German exports by 1953 were already 58% larger by volume than they had been in 1938, the last pre-war year. The country had started generating surpluses (which has continued effectively from then to this day), and kept repaying. It’s sometimes referred to as a “surplus monster,” because within the eurozone, a German surplus means other countries must run deficits.

By contrast, Greece is a deficit monster. That’s something that was undoubtedly exacerbated by the euro (which is too strong for Greece, and encourages the country to import goods from countries with cheaper currencies). Even after five years of severe depression has slashed the country’s import demand, it’s still running a trade deficit — importing more than it exports — because the euro is so strong.

But even when the country had the drachma, its economic history was plagued by a chronic and constant imbalance that favours imports over exports. It would be fair to conclude from the perspective of Greece’s creditors that, with drachma or without drachma, the country will not turn itself into a trading powerhouse.

West Germany didn’t even get an clear guarantee on the fact that it would only repay if it ran a trade surplus. Negotiators from Bonn (the West German capital) wanted an explicit brake on debt repayments if Germany wasn’t running a surplus, but the creditors reserved the right to keep demanding payments.

What’s more, the nominal interest rate on German debt rose above 6% by the mid-1950s and largely stayed there for the next 15 years. This was outstripped by rapid nominal GDP growth (a combination of real growth and inflation).

Greece’s interest rates today are actually lower than that. In fact, they’re lower than Portugal’s, Ireland’s or Italy’s as a proportion of those countries’ economies. The problem is that the country’s growth is not nearly so rapid. But not even the most committed europhiles believe that the country will ever achieve 10% nominal GDP growth within the euro.

3. And Germany’s creditors had things other than money to gain

Piketty argues that the post-WWII period can be compared to the post-financial crash period today:

To deny the historical parallels to the postwar period would be wrong. Let’s think about the financial crisis of 2008/2009. This wasn’t just any crisis. It was the biggest financial crisis since 1929. So the comparison is quite valid. This is equally true for the Greek economy: between 2009 and 2015, its GDP has fallen by 25%. This is comparable to the recessions in Germany and France between 1929 and 1935.

Tsipras MerkelREUTERS/Hannibal HanschkeThe relationship between Greece and Germany is already complicated enough without bad history.

But Guinnane rightly argues there were two unique circumstances in 1953, neither of which are true of Greece today:

  • “Increasing tension with the Soviet Union had led to a strong desire to rebuild a sound, democratic Germany. Harsh repayment terms would not serve that end”
  • “Prior to World World I, the German economy was central to the European economy as a whole; a healthy Europe could not exist alongside a sick Germany. The same held true after World War II.”

West Germany would prove to be a useful ally, economically and politically, against the Soviet Union. Greece’s international position is of no such use — even if its European creditors had significant geopolitical goals, which they don’t seem to. The creditors in 1953 were reaping a benefit in kind by reducing the debt, since German economic growth could be funneled into military expenditure. They were the country’s occupiers, and to defend Europe they would otherwise have to make that spending themselves.

On the second point, though ministers in the current government believe a Greek exit from the Eurozone would be disastrous for the entire union, that’s extremely dubious. Greece is not at all central to the health of Europe’s economy in general.

The cautious political wrangling of the German situation took years too — meetings began in the summer of 1951 and weren’t concluded until two years after. Similarly, the kaleidoscope of desires and positions across different European countries can’t be settled in a couple of months, or less. Greece has immediate financing needs that simply can’t be attached to this sort of process.

The 1953 example is only a good analogy for the current negotiations in ways that put the current Greek government in a bad light. They show the importance of negotiating in good faith and with patience, even where the circumstances make that extremely difficult.

In every other way, the German circumstances have much less in common with the Greek circumstances today. There are other, good arguments for cutting the country’s debt burden — but Professor Piketty chose a terrible historical example.

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