What Germany and Greece tell us about the future of Europe


D J Webb

Dear all,

I’m lucky enough to have been phenomenally busy with work over recent months, and will be very busy for at least another month. But I want to comment on Greece.

Now, it must be understood that all loans are risk products. The nature of the “business” is that the interest rate charged reflects the risk. Consequently, it is not the case that all loans have to always be repaid. The interest rate reflects the possibility that some loans will have to be written off.

German banks who invested in Greek government bonds before 2008 took the risk. The interest rate on the bonds was low–reflecting market presumptions that, now that Greece was in the euro, it would never leave, and so its market interest rates needed to be only slightly higher than those of Germany.

The risk was a political risk. Deutsche Bank and the others believed the statements of European government leaders and invested accordingly. However, at the end of the day, it was a risk.

Those loans should have been written off at the height of the global financial crisis. Deutsche Bank may have collapsed and Germany may have had to launch its own rescue of its own banking system. However, at the time, the concern was for the health of the global economy. A collapse of the euro in 2008 might have led to a global depression–and so the concern was to save, not Greece, but the European banking industry.

Consequently, the loans were not written off. Instead, in the so-called “bailout”, the IMF, the European Central Banks and other EU governments lent Greece the money to pay back its private-sector loans. Deutsche Bank quite wrongly wriggled off the hook. Germany’s banking industry was bailed out.

Please note for those who claim that the Germans are “sticklers for the rules”, that this is not the case where their own interests are directly threatened. The rules stated there should be no bailouts–and that Deutsche Bank should collapse. All of a sudden, the German obsession with rules evaporated! Funny that!

What happened was therefore that private-sector debts were replaced by official-sector debt. Very little of the bailout money went to Greece directly. Some of it went to recapitalise the Greek banking system (which should have been allowed to collapse too), but most of it went to recycle loans elsewhere in the EU. All this talk of how Greece is a bottomless pit is quite off the mark: the money did not go to Greece!

But official-sector debt is harder to get out of. For a start, the German government, the IMF and others are in a position to inflict revenge if Greece repudiates official-sector debt. And so the problem for Greece was compounded.

In order to maintain the fiction that Greece can afford to pay back these loans, the creditors are insisting on huge primary budget surpluses. This phrase refers to the budget surplus before debt servicing is taken into account. By 2018 Greece has now agree to run a budget surplus of 3.5% of GDP.

This is nonsense, of course! The effort of running such huge surpluses will depress economic growth, and the fall in economic growth will in itself prevent a fall in the debt-to-GDP ratio. This is because the economy is a fluctuating organism: it can grow and contract. After 20 years of fairly rapid economic growth, an economy can become two or three times its original size, thus sharply reducing the stock of debt as a proportion of GDP. Economic growth is the main mechanism by which Greece could shrink its debts relative to GDP. However, frenetic efforts to run huge surpluses will prevent that–and possibly counteract the effect entirely. Greece has seen its public finances come almost into surplus owing to wave and wave of austerity–but the effect since 2008 has been approximately a 28% fall in GDP, which means that the debts are a larger proportion of GDP regardless of its heroic efforts to cut expenditure and raise revenue.

A far more appropriate approach would be to run a primary surplus of less than 1% of GDP, allowing rapid economic growth to do most of the work. However, this would defeat the object of meeting heavy repayments. To allow Greece to run a small budget surplus and grow its way out of the debt burden, a lot of the debt would need to be cancelled now.

Greece weakened its hand by refusing to countenance an exit from the eurozone. Only by threatening to leave the euro and repudiate its debts entirely–thereby crystalling in excess of €300bn in losses elsewhere in the eurozone, plus untold billions in credit default swap liabilities (insurance against a Greek default sold as a financial instrument)–could Greece negotiate from a position of strength.

That would require a willingness to undergo initial pain in the transition to a national currency, before fully regaining national control over their economic affairs. Had the Greek government elected in January placed capital controls on the banking system immediately to prevent capital flight the banks would be in a better position today, and they could have ordered the printing of drachma back then, and defaulted on all the debt repayments they have made this year (repayments that they made only by raiding the national pension fund and local government surpluses).

They played a weak hand atrociously, and are left only a day or two away from total collapse of the banking system, without having any drachma printed, without adequate plans for the issuance of temporary coupons or “scrip”, and having lost their pension funds and surpluses in state-owned companies and local government.

So it seems they tossed away all the advantages they could have exploited, and they have now agreed to cut pensions, raise VAT, run surpluses of 3.5% of GDP, place €50bn in a fund to be overseen by European creditors, allow international supervision of the government, legislate to provide for automatic budget cuts if revenue fails to meet expectations, and much else…

Many of these reforms are desirable in themselves. Privatisation is a worthy aim, although better undertaken in circumstances other than a firesale. Slashing unnecessary spending is also a desirable aim. But in the context of a 28% fall in GDP, and in the context where these reforms are being implemented in a non-fiscally neutral way, in order to achieve a large primary budget surplus, this is simply madness.

Bitterness in Greece is quite justified. They have been shabbily treated. It doesn’t really make any difference that corruption in Greece is part of the reason why they got themselves into difficulties. In the end, their debts should have been written off in 2008–with Germany bearing the brunt of the unwise investment decisions of its banking industry.

Consequently, the wider issue for me is the position of Germany. It seems to me that following the reunification of Germany, and particularly with the eurozone crisis, Germany has unwisely been engaged in tearing apart the legacy of Adenauer in rehabilitating Germany as a normal country.

Think about the Irish bailout, where Irish attempts to “burn the senior bondholders” in Irish banks (German and French banks) were not accepted. Instead, the foolish investment decisions of German and French banks became an obligation of the Irish taxpayer, with Irish budget plans being sent first to Berlin–not even Brussels–for approval. Reunited Germany has effortlessly slipped back into imperial mode. The rules are all jettisoned when German interests are threatened, it seems.

I am dismayed by the attitude of the German government, which has sought to pile up difficult demands on Greece in a way that would force its exit from the eurozone. In the end, Greece has meekly complied with everything. But the likelihood is that the issue is not solved. We will be back here again in 2018, with an even larger debt pile to be written off.

Partly for these reasons, I was surprised and taken aback by the Queen’s comments in Germany on the complete reconciliation between Germany and Britain. Germany is a strategic rival of Britain. It is naive to view international relations in any other way. The period of German quiescence lasted from 1945 until 2008. That is now over. We must not view international relations in a childish manner.

I feel instinctively that the Western Alliance survives through inertia: why are we in NATO? why are we in the EU? Why do these organisations exist at all? I have recently stated that the referendum to leave the EU is a trap for patriots, because it is designed to consolidate our membership, and because it relies on the fact that eurosceptics have not agreed on a libertarian economic policy that alone could make a British exit from the EU a success. But let’s face it! NATO and EU won’t last for ever–and I look forward to their collapse!

13 thoughts on “What Germany and Greece tell us about the future of Europe

  1. I agree David.

    Regarding the alliances you mention near the end, I am reminded of the Delian League, which began as a voluntary alliance of mutual protection against the Persians, but once the Persian threat waned, those poleis that tried to leave found that Athens wouldn’t let them, and it became the Athenian Empire instead.

    Your description of debt is absolute right, and I’ve been saying much the same elsewhere. Every debt is a risk or, more to the point, a gamble by the lender. You wager a profit (the interest) against a loss (the debtor cannot repay). This is why every modern nation has bankruptcy of some kind, as a recognition that many debtors cannot repay. We even find primitive debt cancellation systems in the Ancient World, though generally more ad hoc. The idea that debts are absolute and must be repaid at any cost is a fallacy. Interest rates should reflect the risk, spreading the costs of the inevitable defaults (which may be few, or may be many).

    Furthermore, libertarians should all recognise (Austrian economics, and all that) that a “crash” or “bust” is a radical readjustment of the price system in the economy due to the recognition that catastrophic malinvestment has occurred previously. The consequence is thus always liquidation of the malinvestments- factories close, businesses stop trading, workers are made redundant. The banks have, in practical terms, refused to accept their part in that necessary liquidation (other than the symbolic sacrifice of Goldman Sachs’s arch rivals Lehman Brothers by Goldmans alum Ben Bernanke, of course, heh). The point being that old debts carried on beyond the crash represent a persistence of the old price system, not the radically new one that has come into being due to the market readjustment. These debts are relics of a value matrix that no longer exists, because everyone’s values (in this case, the value of Greek capacity to maintain their debts) has changed.

    These debts are unpayable. They need to be cancelled and those who loaned to them, take the hit. This should have happened years ago. The Statist financiers believe that they are above the markets and should not thus be subject to their forces; and the ordinary Greeks are paying for that delusion. People talk of the “pain” of default and leaving the Euro. There is no evidence that this “pain” would be worse than- or even as bad as- staying inside it, trapped in debt slavery to a Central Bank they have no political power over.

  2. Good article, and I agree that the Greek Government has behaved with singular stupidity. However, I disagree that Germany is our rival. It is potentially our best friend in the world, and our foreign policy should be determined by the need to ensure that our interests never again diverge to the point that we stop being friends.

    The Germans made a serious mistake when they decided to build a big navy. Our response – jumping into bed with the French and Russians – was equally misguided. The result was a suicide pact between the two great powers of the world.

    I suggest that Mr Cameron and Mrs Merkel should be made to attend a performance of Tristan und Isolde, after which they can sit down and sort out their disagreements.

    • Sean, I would be happy for EFTA to provide for free trade and free movement of people in Europe – and not much else. It would be a better basis for European unity, in fact. I refer really to unity among the peoples and not the governments!

    • That’s a most interesting observation. I also agree about their big-navy-building, which as you will find when your daughter gets to about year-9 or 10 in British schools, is presented as a simple “Arms race, driven by the British Empire”. (She’ll be told that Germany felt it needed the ships because Britain was building so many.) You’ll need to stride in and have a go at her teachers about that one, but you’ll really only get her and yourself into trouble so it’s up to you.

      Oh, and “Discuss why the sources “A” to J” showing that Haig was the Butcher of the Somme, were correct.”

      • I think Haig was the Butcher of the Somme. It was a gross error to send the flower of our youth into the mincing machine without a Plan B – especially when it was already plain that the battle tactics commonly used could only succeed by attrition.

        However, I most blame the politicians, who refused to look for a negotiated settlement. I particularly blame Lloyd George, who kept the War going nearly two years longer than needed, because he was skimming off from the cost-plus contracts he splashed to all his big business friends. Indeed, you may recall he wanted to keep the War going even longer, with interventions in Russia and attempted interventions in Turkey.

        However, incompetently and inhumanely, Haig was only following orders. It was those worthless politicians and their demand for a military victory which could only be had at disastrous cost.

        I think of Kipling’s lines on the political leadership in the Great War:

        I could not dig: I dared not rob:
        Therefore I lied to please the mob.
        Now all my lies are proved untrue
        And I must face the men I slew.
        What tale shall serve me here among
        Mine angry and defrauded young?

        • It was certainly wrong to try to assault deep prepared positions full of concrete. I recall that Haig, finding himself politically-forced to mount a vast attack to take pressure off France’s Verdun hellhole, would have preferred alternatives that would have succeeded much more clearly and quickly. Even Ypres/Passchendaele if carried out in summer 1916 instead of the awful rain-drenched year of 1917 would probably have given Haig far better results. But also in 1916 still nobody really knew how to overwhelm and neautralise the huge dug-in armies of powerful industrial nations.

          OK, so we got stuck with WW1 (no use crying over spilt blood now) owing to our useless politicians, and stupid underhand and informal arrangements with France in the early 1900s. That said, and given that in the Western Theatre the Central Powers could afford to simply stand on the defensive until Britain ran out of food, and then overwhelm France at a walkover and fortify the entire Channel-Atlantic coastline,throwing us out in the process, we had to keep digging deeper in order to get out.

          From my studies of this conflict, I cannot find evidence that the Central Powers would have ultimately stopped at this example point of negotiation:-
          (1) The British Empire leaves the War now,
          (2) We take NE France especially the Briey iron-ore region and Lille,
          (3) We _run Belgium_ within our_ defence/foreign policy/customs Union,
          (4) We (Imperial Germany, that is) keep all our overseas colonies,
          (5) We take the western parts of “Russian Poland” (see “Belgium” above)
          (6) We promise not to interfere (for now) in the affairs of British Imperial territories (see “South Africa” et al.,)

          If this had been accepted (it was mooted by Berlin at one point, to Woodrow Wilson)
          by Britain, France and Russia, what then would the Kaiser have desired to do with his very large Blue-Water-Navy and hundreds of submarines? What then would they be for, and since they were his personal toys, what would his reaction have been to a “mutual disarmament conference”?

          I agree that WW1 was the largest individual disaster ever to befall the British People and the Empire, and whose totally baleful after-effects are yet felt. But we found ourselves where we were; and we were “there because we were there because we were there because we were there…” (as the sad song goes.)

  3. Agreed. There is an obvious case for the peoples of Europe to regard themselves as branches of a single family, with common interests. That means much greater integration than was the case before the EU came along, but doesn’t mean the EU as it actually exists.

    As for governments, they exist and need to be taken into account. I’d like to see a close relationship between the British, French and German Governments, to create a common sphere of influence through the current EU, and to keep the Americans and Russians at an equal distance.

  4. We should remember the old adage that nations do not have friends we have interests. This continuing nonsense about alliances and memberships of this and that is all unnecessary. We do not need to be a member of supra national organisations to be friends, to trade or to cooperate. Except perhaps NATO – and only then because it is a good idea to have undertaken training so forces can work together at short notice against a common foe – not so it can go around beating up smaller nations.

    To return to the economic point: 3.5% is untenable of itself, not because of any effect it might have on economic activity. I do not know of a single government which has achieved a 3.5% surplus, after paying interest on its debt, for 5 years let alone the decades it would take to pay-down the Greek liabilities.

    We know that EZ banks are busted but we know many things which the political class and their friends in the media pretend not to be so.

  5. How about a world of city states with no man’s land separating them, where you can vote with your feet to useful effect. As for Germany, it should have been staked through the heart at the end of WW2 and shouldn’t exist today.

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