Forgive the debt or earn the wrath of its victims

It could have been staged by the Ghost of Christmas Past. The scene in the Greek parliament on Monday was just the sort of vignette that Dickens’s supernatural hero might have enacted for the betterment of the mean-spirited. Its message: behold the consequences of rigid fiscal rectitude.

The spirit of Scrooge hangs over the eurozone. More than seven years after the onset of the credit crunch, austerity prevails and the threat of deflation looms. Any cost-benefit analysis of post-crisis fiscal stringency is dispiriting. Government debt continues to rise.


As a percentage of gross domestic product, government debt rose across the eurozone from 66 per cent in 2007 to 95 per cent in 2013 — with Greece, Italy, Portugal and Ireland all well above 100 per cent. Yet policy makers remain wilfully blind to the reality that the debt problem is unresolved, and that the eurozone’s outstanding public sector borrowings will never be repaid in full.

Perhaps Greece’s snap election, now scheduled for next month, will provide the necessary wake-up call. If the radical-left Syriza party scores a victory in that poll, it could precipitate a clash with international creditors. Whether or not that happens, the only remaining question on the debt overhang is how far default will occur through inflation, and how much through formal debt restructuring.

The eurozone has, in effect, followed the Japanese model of post-bubble crisis management, a muddle-through process that has saddled the country with gross government debt equivalent to about 240 per cent of GDP.

Despite a resort to quantitative easing on an unprecedented scale by the Bank of Japan this year under Abenomics, it is proving remarkably difficult to stoke up inflation. Some on the European Central Bank’s governing council fear that a proposed move to full QE, involving the purchase of government bonds, would be equally ineffective in imparting stimulus to the eurozone economy.

A reversion to 1970s-style inflation seems unlikely in the immediate future — not least because the present decade looks, in economic terms, like an upside-down version of those days. Back then inflation expectations were low, trade union power was strong, and the share of national income taken by labour was high, while energy and commodity prices were soaring.

Today bond markets are vigilant about inflation, the share of labour in national income is declining, and energy and commodity prices are plunging. At the same time the profit share has risen to record levels and inequality is, rightly, the bugbear du jour.

Low inflation is not cyclical. There are long-term structural issues, notably the decline of the bargaining power of labour, that depress both demand and inflation. This is because workers tend to consume more of their income than the rich. And central bank bond-buying is no panacea: the main effect is simply to raise asset prices, which benefits the rich. An uneven distribution of income and wealth thus makes it harder to galvanise the real economy.

Economists at the Bank for International Settlements, the central bankers’ bank, add that policy has exacerbated the problem because it has failed to lean against booms, and has eased aggressively during busts, inducing a downward bias in interest rates and an upward bias in debt levels. That, in turn, makes it harder to raise interest rates without damaging the economy, thereby creating a debt trap.

If that is where we are now, the logical way forward is debt forgiveness. Yet a moralistic perception of creditors as inherently virtuous and debtors as profligate sinners stands in the way (no matter that such “profligates” as Spain and Ireland entered the crisis with government debt way below the German level). So, too, does a selective German historical memory.

The paradox of the German view on debt is that Germany has been the biggest developed world beneficiary of debt forgiveness in recent memory. In the postwar London Debt Agreement, German external debt was substantially written off or deferred. The West German economic miracle was thus launched from a clean balance sheet while the Allies remained heavily indebted.

Just as Germans are obsessed with the consequences of the Weimar inflation but put less emphasis on the unemployment that brought Hitler to power, many cite the Marshall Plan as an act of American generosity, while the Allies’ larger act of macroeconomic mercy on debt has disappeared from political consciousness.

One result of all this is the rise of extremist anti-immigrant parties such as the French National Front and the Sweden Democrats, along with opponents of German-inspired austerity such as Syriza in Greece. The political consequences of a rise in extremism resulting from the moralistic German view of debt could be profoundly disturbing.


John Plender




Fonte: FT