Sydney Morning Herald: When Greece Forgave Germany’s Debt and Why Greece’s Debt Should be Forgiven too

Germany once benefited from other countries forgiving its debts and should have sympathy for calls to do the same for Greece today.

Forgiving debt, if done right, can get an economy back on its feet.

The International Monetary Fund certainly thinks so, according to a new report in which it argues Greece should get help.

But Germany, another major creditor to Greece, is resisting, even though it should know better than most what debt relief can achieve. After the hell of World War II, the Federal Republic of Germany – commonly known as West Germany – got massive help with its debt from former foes.
Among its creditors then? Greece.

The 1953 agreement, in which Greece and about 20 other countries effectively wrote off a large chunk of Germany’s loans and restructured the rest, is a landmark case that shows how effective debt relief can be. It helped spark what became known as the

German economic miracle.

So it’s perhaps ironic that Germany is now among the countries resisting Greece’s requests for debt relief.

Greek Finance Minister Yanis Varoufakis claims debt relief is the key issue that held up a deal with creditors last week and says he’d rather cut off his arm than sign a deal that does not tackle the country’s borrowings.

The IMF backed the call to make Greece’s debt manageable with a wide-ranging report on Thursday that also blames the Greek government for being slow with reforms.

Despite years of budget cuts, Greece’s debt burden is higher than when its bailout began in 2010 – more than €300 billion ($435 billion), or 180 per cent of annual GDP – because the economy has shrunk by a quarter.

Here’s a look at when Germany got debt relief, and how such action might help Greece.
Forgive us our debts

The 1953 London Agreement, hammered out over months, was generous to West Germany. It cut the amount it owed, extended the repayment schedule and granted low interest rates.

And crucially, it linked West Germany’s debt repayment schedule to its ability to pay – tying repayments to the trade surplus it was running and expected to run. That created an incentive for trading partners to buy German goods.

The deal effectively blocked claims for reparations for the destruction the Nazis inflicted on others.
But it wasn’t a one-way street.

“The London Agreement gave Germany sweeping debt forgiveness and protection from creditors, in exchange for pro-market reforms,” Professor Albrecht Ritschl, of the London School of Economics said.

West Germany was able to borrow on international markets again, and, free of onerous debt payments, saw its economy grow strongly.

Development activists cite that case when arguing for easier terms for troubled countries today, including Greece.
“The same opportunity should be given to Greece that was given to Germany in 1953,” said Eric LeCompte, executive director of the debt relief organisation Jubilee USA.

Greece has had some relief. Private sector bondholders lost 53 per cent of face value in a 2012 restructuring, and remaining debts have been stretched out.

Now most of Greece’s debt is owed to its bailout creditors. While the creditors, notably the IMF, have indicated that the debt load should be made more manageable, they’ve taken no action for years.

Not charity

The German debt forgiveness was driven by the United States, which pressed others to get a deal – British creditors gave up two-thirds of what they were owed.

It wasn’t charity. The US needed a strong West Germany as an ally against the perceived threat that was the Soviet Union.

Yale University professor Timothy Guinnane warns against making too many comparisons, partly because Germany was so much more important in global geopolitics than Greece today.

And Germany had economic pedigree, being a big exporter. Greece, on the other hand, hasn’t. That’s partly why Germany in particular is insisting on reforms to make Greece more competitive.

“The US was basically the last man standing after the war and essentially decided to cut Germany’s debt in half,” Professor Guinnane said. “It was a hard-nosed decision … it’s wrong to say it was an act of generosity.”

Lessons learned

Still, there are echoes from the German case that are relevant to Greece today.

The deal to help Germany was based on a realistic way for the country to pay its debts – Mr Varoufakis has suggested debt repayments be linked to growth. Over the bailout years, Greece has had to meet debt commitments even though its economy was in a depression.

Germany’s deal also acknowledged that mistakes after World War I in imposing punitive conditions helped boost extremists. In its misery, Greece has seen votes go to radical parties of left and right, including Nazi-inspired Golden Dawn.

“It’s deeply ironic that it’s forcing Greece into a position that’s prompting the rise of extremist parties,” Professor Guinnane said.

Change ahead?

One of the reasons why relations between Greece and European creditors deteriorated is the disagreement over what to do about the country’s debts.

Still, there are signs of hope for Greece.

Cyprus has said it could consider writing off €330 million ($480 million) in rescue loans to Greece. The US, while not directly involved, has consistently advocated debt relief.

The IMF came out most forcefully on Thursday, arguing in a report that Greece needs large-scale debt relief alongside €50 billion in new financing through 2018. That sum could be even higher given the economic pain of the recent limits on money withdrawals controls and the increased uncertainty.

It blamed the current government for being slow on reforms and privatisations, but said it was clear that the debt needed to be made more manageable.

“A significant haircut could possibly do it,” an IMF official said, on condition of anonymity in line with department rules. “So could an extension, so Greece would not have to go back to the markets for a very long time.”

One option the IMF mentioned was doubling the grace period on Greece’s loans from EU countries to 20 years and the subsequent repayment period to 40.

“Greece needs a sort of breathing space,” the IMF official said.

From the Sydney Morning Herald.