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History rhymes on Greek debt

History rhymes on Greek debt

Just about everyone agrees that the Greek problem has been kicked down the road again, and probably not even very far. 

The fantasy nature of the 'agreekment' is clear. Let's put to one side, for instance, a structural reform program which demands that Sunday be mandated as a work-day. This might remind some readers of a more joyful time in Greece, as portrayed in the 1960s film Never on Sunday: a gorgeous, fun-loving Greek prostitute, played by Melina Mercouri (who later became Greece's Minister for Culture), wants Sundays to herself. 

Let's just keep our minds on the debt.

German bankers Karl Klasen, Hermann Abs and Franz Heinrich Ulrich, 1967. (Wikipedia Commons.)

Coinciding with the latest agreement, the IMF announced that the debt is 'highly unsustainable' under the most optimistic forecasts. Even if demonstrated good behaviour earns the Greeks another round of debt tweaking, this sort of piecemeal rescheduling won't do the job. It leaves a persistent unpayable overhang that will act like a wet blanket on investment and growth. 

Many commentators (including rock-star economist Thomas Piketty) have made pointed references to Germany's debt history – not just to the lessons of Versailles but also the London Debt Agreement of 1953, which left Germany with a light debt burden (and, incidentally, no 'conditionality' to tell them how to revive their economy). The London Agreement recognised that the issue was not a moral one, but about capacity. Thus repayment was linked to Germany's trade surplus, giving everyone an interest in Germany's economic success.

There is a less well known, but even more relevant, historical link here. The German delegation at London was led by Hermann Abs, one of Germany's most illustrious bankers. Thirteen years later, it was Abs who was given the task of sorting out Indonesia's unpayable debt legacy resulting from President Sukarno's profligate expenditure.

Most of the money had been spent on Russian military hardware, but there were also substantial debts to Western countries and Japan. [fold]

By 1966, Soeharto's 'New Order' was beginning to come to terms with the economic collapse. Inflation that year was around 1000%, the currency valueless, exports had collapsed and the foreign debts were in default. Abs was appointed mediator and persuaded the creditors that they would have to give generous debt rescheduling (not, it is worth noting, haircuts that diminished the nominal debt figure). The debt relief came in the form of rescheduling over 30 years interest-free and with the option of delaying the first eight years of repayments. 

It is worth noting that this result was not achieved in the first meeting. It took three time-consuming annual meetings before this long-term solution was reached, allowing Indonesian policymakers to devote their full attention to the economy. They did this with extraordinary success, aided by the supportive guidance of the IMF and the World Bank ('conditionality' hadn't yet been invented).

The Indonesians were also inventive in offering private sector creditors some value. They offered to swap debt for new investment expenditure and explored the possibility of debt-for-equity swaps. Foreign companies which had been nationalised under Sukarno were given back to the original owners.

This highlights the big difference between Indonesia in 1966 and Greece in 2015. In Indonesia, there was full agreement and 'buy-in' on what should be done, and the key objective was to get the economy functioning normally. There was also a realistic view of how much 'structural' reform could occur. The answer was 'not much'. Three decades later, when Indonesia got into trouble again during the Asian financial crisis, the IMF identified many still-unfixed structural faults: cronyism, inefficient state-owned enterprises, an ill-supervised banking system and of course the famous clove monopoly. But in 1966, it was enough to get the economy moving forward again at a brisk pace (7% per year for the next three decades).

Greece will need something like the solution Indonesia developed after 1966, although the poisonous negotiating climate makes it impossible for the moment. There are some similarities with Indonesia:

  • The money Greece borrowed has been largely wasted and so has not created any capacity to repay.  So it makes no sense to develop detailed time-profiles of debt-to-GDP ratios, as the debt will not be repaid. It makes even less sense to calculate the required budget surplus on the basis that this surplus is needed to repay the debt, when everyone knows it won't be repaid. Instead, the budget should be set to foster medium-term sustainable GDP growth.
  • The country involved has a small economy but is important in geopolitical terms, with Western creditors unwilling to see it drift under the influence of Russia.

What is missing in this case is assurance that the Greeks will do the necessary reforms. In the Indonesian case, there was full 'buy-in', although it was still a brave gamble; there was no guarantee that an army general and a few inexperienced academic economists could fix the mess.

Let's leave the last word on debt repayment to Hermann Abs, quoted towards the end of his long career in banking:

I remember speaking some years ago on the same platform to the Association of Young Bankers. "When I was a young banker," Abs said, "we were taught to ask two questions of any borrower: what is the loan for, and how will it be repaid? Today we know the answers without asking: the purpose of the loan is to repay an earlier debt, and it will be repaid by another loan."

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