By Jeremy Warner 06 July 2015
In citing the example of German debt relief to justify another bailout for Greece, the French economist Thomas Piketty fails to see that you cannot have debt cancellation without asset write-downs, which devaluation would deliver in the least painful way
London Conference of 1953 saw Germany's external debts substantially written off
For a change, I find myself in some agreement with the French economist Thomas Piketty, at least in terms of what he has to say today on the Greek debt standoff, if very little else. However, he’s also missed one rather vital point about debt cancellation which goes to the heart of why this crisis cannot be resolved within the straightjacket of monetary union.
One man’s debt is another man’s asset – they are two halves of the same coin. It follows that for the debt to be cancelled, the asset must also suffer a substantial devaluation. This is what many Greeks, including apparently the Greek government, fail to understand, or rather refuse to acknowledge. They want to be forgiven their debts, but they also want to remain within European Monetary Union, with the luxury this provides of a German exchange rate, which in effect underwrites the value of their assets and purchasing power abroad.
The two things are completely incompatible, for as long as Greece remains part of the euro, there is no market mechanism for imposing the haircut on assets prices that must accompany any write down of debt. Here's an example of what I mean. At the height of Britain's financial crisis, lots of wealthy Italians - and Greeks - came and bought prime London property, and it is easy to see why. Sterling prices had fallen around a quarter in nominal terms, and the pound had fallen by a further quarter against the euro. In effect, the euro buyers were getting the properties for around a half what they would have had to pay prior to the crisis. By the sake token, the vendor was in euro terms accepting a 50pc haircut.
With much finger pointing, Professor Piketty makes a lot of the tired old truism that Germany had a great deal of debt forgiveness after the second world war, allowing the defeated nation to wipe the slate clean and begin again. France similarly managed to wriggle out of many of its debt obligations. Britain, it should be said, had no such debt relief, which arguably explains much of its post war economic malaise. Europe has failed to learn the lessons of its own history, Professor Piketty insists.
"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. It has no standing to lecture other nations".
Mmmm. In fact, the two situations are completely different. Under the London Agreement on German External Debts of 1953, around a half of Germany's external debts - substantially the legacy of the first world war - were written off and extremely generous terms were granted for repayment of the balance. Yet the assets that notionally backed these debts had already suffered a calamitous meltdown, having been all but wiped out by the destruction of the second world war and the post war hyperinflation. The debt write-off merely recognised the underlying reality of a severely depleted asset base. This has not happened in Greece. Membership of Europe's currency union prevents it. Inflation is non existent, and asset prices are sustained by the homogenising effect of the single currency.
The trouble with the European take on the Greek debt crisis, and this applies even to those like Professor Piketty who recognises that something has gone seriously wrong, is that nobody can bring themselves to accept that monetary union has failed. The upshot is that ever more contorted thought patterns and solutions are required to reconcile the irreconcilable.
Does Greece need debt relief? Obviously so. All its creditors know this, and have already reconciled themselves to having lost most, if not all, their money. Does austerity need to be eased to help the Greek economy get back on its feet? Of course it does. But can this be achieved within the confines of monetary union? With generous creditors, temporarily perhaps, but it can never be a long term solution. Instead, any asset write-downs will have to be done cruelly, by haircutting the depositors of Greek banks. Since the rich ones have already got their money out, it will be the middle and lower classes that will be hit most by this process.
There is a good reason why sensible countries have free floating exchange rates – it is because they provide a natural market mechanism for hair cutting external creditors, restoring competitiveness, and adjusting the external value of assets appropriately. Once these adjustments have been made, foreign capital will come flooding back in search of a bargain. And it is why the Greek debt crisis has become so intractable. It cannot be solved in a monetary union of fiscally sovereign states.
Unintentionally, Greeks have done themselves - and perhaps the rest of Europe too - a favour by voting no. They have been misled by their Government, not to mention a whole host of famous American, salt water economists - Sachs, Krugman, Stiglitz - into thinking they can somehow bring the rest of Europe to heel by facing their creditors down. They cannot. (To be fair, Krugman seems to appreciate better than the other two the vital importance of exchange rate in debt relief). By voting no, they have put themselves on a path to exit and the unilateral debt relief of default. Like Germany in 1953, this offers Greeks the possibility of a new beginning, and with a bit of luck, they might also have fatally wounded the entire euro project. It's been a long time coming, but there's a good chance that economics is finally about to triumph, as inevitably it always does, over delusional political will.
