John Maynard Keynes’ first great polemic, The Economic Consequences of the Peace, estimated the reparations required by the Treaty of Versailles at $40 billion, about 16 times the pre-war value of Germany’s annual exports. The debt would generally be subject to compound interest at 5 per cent and so would accrue faster than any likely repayments.
The parallel between then and now is a precise one. The economic capacity of the so-called PIIGS (Portugal, Italy, Ireland, Greece and Spain) is such that they will not be able to trade their way out of their debt obligations, and their debt burden is subject to interest at penal rates. (That is to say, market rates but only in the sense that these rates reflect the market’s judgment that they cannot easily be repaid.)
Keynes’ summary of Versailles was that ‘Germany has in effect engaged herself to hand over to the Allies the whole of her surplus production in perpetuity’. But just because Germany could not pay the debt did not mean that the Allies would not try to extract it. The Treaty established a multinational reparations commission to calculate the precise amount of the debt, and find ways of enforcing it. Keynes quoted with sympathy the vain protest of the German delegation:
‘German democracy is thus annihilated at the very moment when the German people was about to build it up after a severe struggle – annihilated by the very persons who throughout the war never tired of maintaining that they sought to bring democracy to us. ... Germany is no longer a people and a State, but becomes a mere trade concern placed by its creditors in the hands of a receiver, without its being granted so much as the opportunity to prove its willingness to meet its obligations of its own accord. The Commission, which is to have its permanent headquarters outside Germany, will possess in Germany incomparably greater rights than the German Emperor ever possessed; the German people under its regime would remain for decades to come, shorn of all rights, and deprived, to a far greater extent than any people in the days of absolutism, of any independence of action, of any individual aspiration in its economic or even in its ethical progress.’
For Germany after the first world war read the PIIGS today. European Union institutions, aided by technocratic governments where elected politicians will not oblige, will impose limits on fresh state borrowing, requiring old debt to be paid out of current living standards. Democracy is not as recent among the PIIGS as it was in Germany in 1919, but in a historical perspective it is not so long ago that they were dictatorships (or, in Ireland’s case, under British rule). Nazism grew out of the punitive treatment of Germany nearly a century ago, and today extremist parties are growing in strength in euroland, as the recent French and Greek elections showed.
Is political integration the answer?
Some people say that successful monetary union requires political union, so that closer political integration will resolve the euro’s problems. The United Kingdom is pretty much a currency union – there isn’t much more, nowadays, to the sterling area. In our political and currency union the annual government budget deficit is about 10 per cent of GDP – but that is very much an average. London and the south east run a surplus of 10 per cent or so, while the north east of England and Northern Ireland run deficits in the 25–30 per cent range, with other regions sitting somewhere in between. Taxes are raised in London and sent north and west to be spent. As Mitterrand described de Gaulle’s constitution as a permanent coup d’état, this is a kind of permanent bailout.
It’s not just the UK that this happens. Within Germany, a real political union, redistribution goes from west to east. In the supposedly un-egalitarian United States, it goes from New York and California to Mississippi and West Virginia.
The proposed euroland political union is a little different. The European Stability and Growth Pact – as it is known with Orwellian irony – will be given more teeth. The effect is that the PIIGS will be economically reliant on and subservient to Germany. While these countries retain their own parliaments, they will hardly be more powerful than regional assemblies would be in the UK. Whoever is voted into these national seats, it is Euro-commissioners and technocrats who will call the shots, rather as the reparations commission dictated matters in 1920s Germany.
Keynes meticulously demonstrated that Germany’s (likely futile) efforts to pay its reparations could only even theoretically succeed to the extent that they displaced Allied production, either in their domestic or export markets. Just so today, the PIIGS can ultimately only repay Germany by selling more to Germany then they buy from it. Unfortunately, Germany isn’t planning to increase its spending anytime soon. As a result, it is more likely that the PIIGS will be forced to impoverish themselves with ‘cuts’, so they end up buying less – from Germany, from each other, from anyone. Whichever way it worked, Germany would have to lose market share to the PIIGS if it were ever to be paid back a single euro.
Keynes called for large-scale debt forgiveness, and for measures to stimulate new trade – for example, between Germany and newly Soviet Russia – to entice it back into the family of advanced trading nations. So today, only expansion – Germany (and anyone else who can) being ready to spend and buy more – offers a route to correcting imbalances without everyone seeing their income cut.
Of course, no historical parallel is exact. Keynes was concerned, in 1919, with the inflationary consequences of post-war governments struggling to meet impossible demands by printing money beyond the productive capacity of their countries, a concern validated by German hyperinflation in the early 1920s. By contrast, today there has been some reluctance to use 'quantitative easing', even in the UK, US and other countries free of the constraints of euroland, even to the extent necessary to fill the hole in the money supply left by the collapse in bank lending and to prevent a growing shortfall of GDP from productive capacity. This only increases the risk that austerity for the PIIGS will lead to depression for all.
But hasn’t Germany helped the Greeks?
More fundamentally, some may argue, Greece at least has seen most of its debt effectively written off, in contrast to the Allies' vindictiveness in 1919. But this difference is more apparent than real. Ultimately reparations were abandoned, but it was the attempt to extract them that was so damaging, and now the Greek and other PIIGS economies are being devastated by the attempt to service even that part of the debt which has not yet been written off.
Moreover, the existing PIIGS debt is only part of the story. They are chronically net importers from Germany, and those net imports can only be financed by new debt. It’s like a monopoly game, where Germany has luxury hotels on Mayfair and Regent Street, and Greece a couple of houses on the Old Kent Road. In the game, and playing by the rules, Greece would be knocked out and Germany would win. In real life, it needs Greece and others like it in the game to keep paying its rent. The only way forward – as happens in the UK and US currency unions – is to let the weaker players take the money from the bank to pay it over.
Mrs Merkel, and others like her, say that cannot go on for ever. The PIIGS must restructure their economies to become more competitive. The problem is that we cannot all be competitive with each other. And to pay Germany back, the PIIGS need to be more competitive against Germany specifically. The normal way of achieving this would be to allow their currencies to reduce in value relative to Germany’s and so to price themselves back into work. But they and Germany share the same currency – the euro. So how do you become more competitive when your currency is fixed at too high a value?
The answer can be found in Keynes's second great polemic, The economic consequences of Mr Churchill, written in 1925, when Churchill took Britain back on the gold standard – that is, tied sterling to the price of gold, at the pre-WW1 exchange rate, well above its then current value.
Like many otherwise courageous and independent-minded people (indeed, he once iconoclastically described the City as 'the glittering scum on the broad stream of production'), Churchill lacked confidence in his judgment on economic matters and was vulnerable to the conventional ‘wisdom’ – which is sometimes lunacy – of establishment economists. No doubt Mrs Merkel has much in common with him. As Keynes put it:
‘Why did he do such a silly thing? Partly, perhaps, because he has no instinctive judgment to prevent him from making mistakes; partly because, lacking this instinctive judgment, he was deafened by the clamorous voices of conventional finance; and, most of all, because he was gravely misled by his experts.’
Keynes set out what Churchill’s experts should have told him about the path to competitiveness on a fixed and overvalued exchange rate:
‘To begin with, there will be great depression in the export industries. This, in itself, will be helpful, since it will produce an atmosphere favourable to the reduction of wages. The cost of living will fall somewhat. This will be helpful too, because it will give you a good argument in favour of reducing wages. Nevertheless, the cost of living will not fall sufficiently and, consequently, the export industries will not be able to reduce their prices sufficiently, until wages have fallen in the sheltered industries. Now, wages will not fall in the sheltered industries, merely because there is unemployment in the unsheltered industries. Therefore, you will have to see to it that there is unemployment in the sheltered industries also. The way to do this will be by credit restriction. By means of the restriction of credit by the Bank of England you can deliberately intensify unemployment to any required degree, until wages do fall. When the process is complete the cost of living will have fallen too; and we shall then be, with luck, just where we were before we started.
‘We ought to warn you, though perhaps this is going a little outside our proper sphere, that it will not be safe politically to admit that you are intensifying unemployment deliberately in order to reduce wages. Thus you will have to ascribe what is happening to every conceivable cause except the true one. We estimate that about two years may elapse before it will be safe for you to utter in public one single word of truth. By that time you will either be out of office, or the adjustment, somehow or other, will have been carried through.’
Keynes predicted labour unrest. The General Strike duly followed in 1926. Unlike the pronouncements of conventional finance, Keynesian warnings have this curious Cassandra-like quality: they come true.
Again, there is a parallel with today. I have been among those issuing warnings for some time that premature debt reduction would damage recovery – and now of course we are in a double dip.
The UK finally abandoned the gold standard in 1931, early in the Great Depression. Ramsay MacDonald’s National government, formed for the express purpose of saving the gold standard, abandoned it a few weeks later under pressure of events. A former Labour minister, Sidney Webb, complained ‘no one told us you could do that’ – just as no one is telling anyone they can leave the euro now. Though the UK suffered in the 1930s, it did so less severely than other countries which clung to the gold standard. France, one of the last to abandon it, fared worse.
Then has the UK got it right?
We should be pleased not to be in the euro, but certainly not complacent. The eurozone with all its problems still grew by more than UK has done in the last year or so. We may be bailing out our ‘periphery’ more than Germany is, but still by not enough to utilise the productive capacity of the whole currency zone. We may not have joined the euro, but within our own little zone we voluntarily pursue austerity as if we had.
Some Londoners in fact share Mrs Merkel’s approach to these matters, and complain that the peripheral regions of the UK have economies dominated by the public sector. The only scaleable way of stimulating the private sector in the UK’s periphery (without the state itself providing the stimulus) would be to let them have their own currency. No longer buoyed up by the City’s invisible earnings, it would fall in value and price regional private businesses into work. The south east could fork out less in tax – but it would see its businesses lose out to northern and western competition, both in its domestic and export markets. You take your choice, and you pay your money, one way or the other.
What is the way forward now?
What should President Hollande do now? What should the PIIGS governments do? What course should progressive people be urging on them?
The overriding priority must be a return to democratic and full employment policies. If the euro is to stay, the states of Europe must spend enough to ensure that there is sufficient effective demand to get the economy working at its full productive capacity. Until then, all the pressure must be on the stronger countries to expand, rather than on the weaker ones to contract. The European Bank must print the money, and buy up the debt, to accommodate the growth that is required. The European Parliament needs to be in charge of this process, not Mrs Merkel.
The French and the PIIGS must assert themselves even more than they have just lately begun to do – the concessions at the last summit will barely reduce the pace of decline. If they cannot get German agreement to these essential conditions for a resumption of growth, they must pull out of the euro and so recover the ability to maintain and finance the required levels of spending at national level. They must stop losing at monopoly, and start winning at poker.
The European project has some huge achievements, and if Germany does not back down, this setback will be a severe one, but ultimately economic and political structures are there to serve humanity, not the other way around.
And what advice should we give Mrs Merkel? Once again, I leave the answer to Keynes (but read ‘the PIIGS’ for ‘Germany’, and ‘Germany’ for ‘ourselves’):
‘I cannot leave this subject as though its just treatment wholly depended either on our own pledges or on economic facts. The policy of reducing Germany to servitude for a generation, of degrading the lives of millions of human beings, and of depriving a whole nation of happiness should be abhorrent and detestable – abhorrent and detestable, even if it were possible, even if it enriched ourselves, even if it did not sow the decay of the whole civilized life of Europe. Some preach it in the name of Justice. In the great events of man’s history, in the unwinding of the complex fates of nations Justice is not so simple. And if it were, nations are not authorized, by religion or by natural morals, to visit on the children of their enemies the misdoings of parents or of rulers.’
If Keynes could be so liberal toward Germany after such a destructive war, can all the Mrs Merkels not be equally indulgent to those whose only crime is to spend the excess savings which Germany has proved chronically unable to spend for itself?