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Exit, Devaluation and Haircut for Greece

Press article by Hans-Werner Sinn, SZ International, 06.08.2015.

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I have enormous respect for Jeffrey Sachs as an able and thoughtful economist. Yet I believe that he misses a historical reality. His comparison with Germany under the Weimar Republic is askew. First of all, Germany then was groaning under the burden of paying reparations, while Greece today has received vast rescue sums from other countries — and will continue to do so. Secondly, Germany headed straight for catastrophe because it was not allowed to devalue its currency. A haircut for Greece, as Sachs demands, would remove the symptoms of its crisis, but would not release the unemployed from their forced idleness. That can only happen if Greece exits the currency union.

The pressure being piled on Germany by articles like Jeffrey Sachs’s and many others was felt already five years ago. At that time, Germany was reluctant to agree to a European rescue architecture because it feared being saddled with other countries’ debts. That was the horror scenario that Germany wanted to forestall with the Maastricht Treaty’s no-bail-out clause (Art. 125 TFEU), and why it made such a clause a condition for giving up the deutschmark.

But when then-French President Nicolas Sarkozy threatened to take his country out of the Eurozone, German Chancellor Angela Merkel caved in. There was pressure also in the summer of 2012, during the debate on institutionalising the rescue architecture through the permanent European Stability Mechanism and the establishment of a banking union. She was literally hounded by the international press until she gave in.

Now the same pattern is becoming evident again. After Greece’s private creditors bolted and unloaded their Greek bonds onto the international community, the call for a fresh haircut is becoming louder. International pressure will pile on until Germany gives in once again.

The aim is to set the stage for a new haircut

Who were the private creditors that got bailed out? Primarily German banks, as Sachs suggests? Not quite. Foremost it was French banks, which had a 53-billion-euro exposure to Greece’s public and private sectors by the spring of 2010, when the rescue packages were agreed. German banks came a distant second, with a 33-billion-euro exposure, followed by US banks with 10 billion, and UK banks with 9 billion.

It is also inaccurate, as Sachs maintains, that the rescue money was used solely, or even largely, to rescue the banks. By June 2015 Greece had received 344 billion euros in rescue credit from the ECB, the IMF and the international community, equivalent to 192 percent of Greece’s 2014 GDP, or around 83,000 euros per Greek household. One-third was used to repay Greek foreign debt that had resulted from excessive consumption before the crisis. One-third served to uphold the Greek standard of living after the crisis hit in 2008 – concretely, it financed the current account deficit – and the remaining third financed capital flight by Greeks. But the argument that Germany has basically rescued itself is too sweet to let it be spoiled by mere facts. The aim, after all, is to set the stage for a new haircut.

I was against the rescue measures from the outset, because I knew they would stoke discord, since friends you lend money to quickly become friends you used to have. The great error was that Germany let itself be talked into standing in for Greece’s private creditors. This removed the natural commercial dispute between creditors and debtors and turned it into a dispute between nations. If the Greek bonds had not been taken over by the international community, Yanis Varoufakis and Alexis Tsipras, or whoever had been in office, would have directed their emotional attacks against private investors around the world, but not against Angela Merkel, Sigmar Gabriel and Wolfgang Schäuble. There would have been no risk of nations locking jaws.

Greece has received the equivalent of 37 Marshall plans

This does not mean that Greece should not be helped. Germany should have offered Greece money to avert the human catastrophe, without conditions and without redemption. Others could have also done as much. Not just one Marshall Plan, but a series of them could have been offered. Help out of its own free will would have been significantly cheaper for Germany and would have cemented mutual friendship between Germany and Greece.

Over the course of the crisis, Greece has received the equivalent of 37 Marshall plans, given the fact that over the years the Marshall Plan was in effect Germany received help totalling the equivalent to 5.2 percent of its 1952 GDP. Ten of Greece’s Marshall plans have come from Germany.

The rescue automatism that was adopted instead has generated a sense of entitlement that time and again besmirches the donor countries as unjust when they do not give as much money as demanded. It has led to the perverse situation that by late June Germany has given Greece 92 billion euros through bilateral credit and its shares in the ECB and the fiscal rescue packages, a sum equivalent to 22,000 euros per Greek household and by far the largest of any country, and yet ranks in Greece as its meanest enemy.

The question begs itself as well of why a haircut is so important, given that Greece pays hardly any interest at all anymore. With the 105-billion-euro haircut it has already received and a zero interest rate for large parts of its rescue credits, the interest burden for the Greek coffers was only 3.9 percent of GDP in 2014, equivalent to an interest rate of only 2.2 percent.

The only reason can be that after a new haircut Greece would be able to borrow anew, first from the IMF and then perhaps from the private sector. The taxpayers of the Eurozone’s still-sound economies could then replace these debts with fresh rescue money, which they would again forgive a few years down the road. This could actually go on forever. The only question is: Where would it lead to? It would create no jobs. It would only provide relief to the government and the associated Nomenklatura. The continued borrowing helps neither the old nor the young unemployed, who lately account for more than half of all the employable youth.

The competitiveness must be restored after a haircut

I am myself also in favour of a new haircut. After the European Financial Stability Facility declared the Greek state officially insolvent on July 3, 2015, it is high time for Greece’s public creditors to face reality. But the competitiveness of the Greek workers must be restored after a haircut in order for the country to get back on its feet and manage without further borrowing.

But that is where the problem lies. During the inflationary credit bubble that the euro caused in Greece, the country’s workers became far too expensive. The credit-financed salary raises of the past are shackling Greece today. Wages in manufacturing, for instance, average 14.70 euros per hour, while in neighbouring Bulgaria, Rumania and Turkey they range from 3.20 to 5.50 euros per hour. Even Poland’s wages are only half as high as those in Greece. Small wonder that Greece does not even register in the radars of international investors looking for good investment locations.

However appropriate Jeffrey Sachs’s call for a haircut is: without Greece exiting the currency union, which is the only way to solve the country’s fundamental competitiveness problem, it would be useless. This is not only maintained by such economists as Joseph Stiglitz, Paul Krugman and Yanis Varoufakis, but also by former ECB Chief Economists Jürgen Stark and Otmar Issing The virtual devaluation of the new currency could occur overnight, by redenominating all wage, price, rent and credit contracts in drachmas, and using the remaining euro banknotes in circulation for cash transactions until new drachma banknotes are printed and distributed. The devaluation would make imports more expensive and thus induce consumers to turn to domestic products, giving an immediate boost to agriculture, the food industry and textiles. Tourism would boom. Wealthy Greeks who have brought their money out of the country would return, hoping to cash in on cheaper property, fuelling a construction boom like the one Italy experienced after the devaluation of the lira in 1992.

The ability to devalue would be the crucial difference to Germany under the Weimar Republic. As stipulated by the Dawes Plan, Germany had to pay reparations in Reichsmarks, which it was not allowed to devalue against the gold standard. Unlike Great Britain, which exited the gold standard in 1931, Germany was locked within the currency system. This forced then-Chancellor Heinrich Brüning to decree an internal devaluation through reductions in prices and wages. From 1929 to 1933, prices fell by 23 percent, while wages did so by 27 percent. Massive unemployment ensued, bringing the country to the brink of civil war and opening the gates to Adolf Hitler.

The lesson from this period is not only that Greece should not be saddled with financial burdens as Germany was. No-one wants that anyway. The real lesson is that Greece should not be held within the gold standard, even if today it is called the euro.

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Harald Schultz

ifo Institut
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