International – Death by Debt – My Response to The German Finance Ministry

I have enormous respect for Dr. Schuknecht as an able and thoughtful economist. Yet I believe that he misses a historical reality. While his policy prescription is certainly correct most of the time – countries should repay their debts and take the reform actions necessary to do so – it is also sometimes wrong.  It is wrong when debt servicing, combined with other economic ills, can push society to the breaking point.  The wisdom is to recognize the times that it is wrong and to act creatively at those times.

It was wrong in the case of Weimar Germany in the 1920s and early 1930s, when Germany was pushed into hyperinflation and then depression. Germans pleaded to the US for long-term financial relief from reparations and debt payments, but didn’t get it in time.  First came the hyperinflation; then mass unemployment; then a banking collapse; and then a full run on the German banking system in 1931, leading to a closure of the banks (as in Greece today).  President Herbert Hoover eventually granted a debt moratorium but too late: Hitler came to power in January 1933.

It was wrong in the case of many Latin American countries in the 1980s.  During the 1970s, unwise US bank lending and unwise borrowing by Latin governments led to the calamitous Latin American debt crisis of the 1980s following the sharp rise in US interest rates in 1981.  For several years in the 1980s, the US insisted on a policy of “extend-and-pretend,” that is, to lend the debtor country the money needed to pay debt service. Yet these countries tumbled into high inflation and political instability.  Eventually, the US brokered a package of reforms and debt relief.

It was certainly wrong in Poland in 1989, when Soviet-era debt was killing hope, creating high inflation, threatening to kill the nascent post-communist democracy in the crib.  I was Poland’s economic advisor at the time, and I strongly urged that the G7 countries grant debt relief to Poland.  The US quickly and wisely agreed. The other G7 countries soon joined the US.  Germany joined last, but Poland did get its debt relief, and its economy recovery and new democracy thrived.

It was wrong to insist on full debt servicing by Russia in 1992, when Yeltsin inherited a bankrupt post-Soviet economy.  As in Poland in 1989, I strongly urged debt relief for Russia.  Yet this time, the US, Germany and others rejected the advice. The consequence was that Russia experienced several years of financial upheaval and instability, resulting in the public’s loss of faith in the new and fragile democratic institutions. The West’s approach towards Russia fostered a nationalist backlash inside Russia, similar to the backlash in Weimar Germany to the harsh postwar reparations.

My point is that believing that indebted sovereign governments should always service their debts is a good working principle nine-tenths of the time, but can be a disaster the tenth time around.  We must not push societies to the breaking point, even when they have only themselves to blame for their indebtedness.

Did postwar Germany “deserve” the Marshall Plan?  No.  Was the Marshall Plan and the 1953 debt agreement wise policies to give Germany a fresh start?  Yes.  Did Russia “deserve” debt relief in 1992?  No.  Would it have been wise to offer Russia such relief?  Yes.

Does Greece “deserve” debt relief?  No.  The Greek economy has been badly managed for a long time.  Would debt relief for Greece be a good idea?  Yes.  

International – Death by Debt – My Response to The German Finance Ministry.

 

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