The Economic Consequences of Greece

“I wish I could tell you every evening the twists and turns of the day, for you’d really be amused by the amazing complications of psychology and personality and intrigue which make such magnificent sport of the impending catastrophe of Europe.”

The words are John Maynard Keynes’s, in a letter home from the Paris peace conference of 1919, but they might just as easily apply to the euro crisis.

When it comes to analogies, where does one begin? With a continent tearing itself apart; with the belief that a country should be expected to pay out enormous reparations/debt repayments while its neighbours do nothing to allow it room to export; with the refusal to forgive debts until the very last minute or the denial that the dominant monetary system tying the countries together has broken down?

And then there are the personalities. Instead of Wilson, Lloyd George and Clemenceau, we have Merkel, Strauss-Kahn and Sarkozy (I’d say in terms of pure histrionics the modern day would give 1919 a run for its money). Instead of the fights in hotel lobbies in Paris we had blazing rows in the Frankfurt Opera House.

The main difference, such as it is, is that this time around Germany is the one calling for the reparations rather than having to pay them herself.

The key to a good tragedy is that the audience knows from the very start that the protagonists are deluded and doomed. That’s what happened in 1919, when Keynes pinpointed the problems with Versailles: that the French and British (egged on by the Australians) demanded more reparations from Germany than it could ever afford, threatening to send the entire continent towards a self-inflicted depression, not to mention a second war.

That’s what happened in 2010, when Eurozone leaders, egged on by the European Central Bank and assisted by the International Monetary Fund, imposed a bail-out on Greece that the country simply couldn’t afford, triggering a continent-wide recession and social breakdown throughout the periphery.

Out of somewhere between the personal, the political and the institutional, a poisonous policy emerged. The troika imposed a bail-out on Greece in 2010 that was deeply inappropriate for the situation the nation was facing. This was obvious to many of us at the time. The normal prescription for a country facing a current account crisis of the sort plaguing Greece would have involved not merely an IMF bail-out but a devaluation. It would at least have involved some form of debt restructuring.

It is striking that it is only now (and only after its private report was leaked by the Wall Street Journal) that the IMF has admitted in public that it made some awful mistakes back in 2010. The “mea culpa” published last night [pdf] acknowledges that it was vastly overoptimistic about the country’s capacity to improve its competitiveness, not to mention its debt trajectory. The initial Troika forecast was that Greek net debt would peak at just over 150% of GDP in 2013; in the event, it was 170% of GDP by then.

We all know what happened next. That initial €110bn loan, of which IMF provided €30bn (proportionally its biggest bail-out ever) was followed by another series of renegotiations, and then another €130bn bailout – as well as a massive debt restructuring operation, which amounted to the biggest sovereign default in history.

The IMF’s useful cut-out-and-keep timeline of the crisis, as told by Greek bond rates

More bluntly, the Troika could hardly have got things more wrong. Now, on the one hand, no-one can predict the future; perhaps the Greek economy would always have faced an even deeper recession than predicted. However, as the IMF just about admits, it also made some horrific misjudgements.

The biggest admission of the document is that it should, perhaps, have allowed the country to default on some of its debt back in 2010 (instead of postponing this until it became unavoidable in 2012). The excuse is that the Fund did suggest this at the time, but was overruled by Eurozone politicians. However, that begs the question of whether the Fund committed a dereliction of duty by allowing them to do so; whether it went along too freely, in so doing putting its own money at risk, and lending credibility to a badly-constructed deal.*

The admission that’s missing from the document is that some in the Fund (and some in the Greek government) also considered the option of leaving the single currency. The issue that even today dare not speak its name in official documents is that the euro project itself was largely responsible for the mess Greece is in today.

While it is mildly gratifying that the IMF has owned up to some of its mistakes, this does not make the experience any less worrying, nor does it reassure us that it won’t happen again.

When Keynes wrote The Economic Consequences of the Peace back in 1919, he was writing with international macroeconomic analysis still in its infancy. That he nonetheless produced a book whose analysis was spot-on (and was a great read) was a testament to his genius. Moreover, he pinpointed the problem we have wrestled with ever since: that when you’re trying to impose debts or reparations on a country you need to do so with reference to that country’s ability to pay.**

The difference this time around is that, theoretically at least, we ought to know better. We have suffered countless crises such as the Greek one. The IMF has been involved in countless programmes (albeit none of this size). It has even made almost identical mistakes before (it’s worth reading the mea culpa following the Argentine bail-out and comparing and contrasting it to the Greek one).

And despite this aggregated sum of knowledge and experience, it made the same old mistakes over again. It was over-optimistic, it wasn’t rigorous enough, it failed to follow its own rules, it ignored the debt dynamic spirals that were always likely and was way too craven to its political masters.

Back in 1919 Keynes wrote that there was one fortunate side to the terrible mess of Versailles: “We may still have time to reconsider our courses and to view the world with new eyes.” Unfortunately today’s political and economic masters have proved only too willing to commit familiar errors, causing economic and social pain throughout Europe, and rarely own up to them and change course.

* There’s also an interesting lesson about institutions in the document. As with the tripartite system during the 2008 financial crisis, it’s clear that the Troika’s divided structure caused further dysfunctions in the way Europe dealt with its crisis. Consider the following line from the report: “from the Fund’s perspective, the EC, with the focus of its reforms more on compliance with EU norms than on growth impact, was not able to contribute much to identifying growth enhancing structural reforms. In the financial sector, the ECB had an obvious claim to take the lead, but was not expert in bank supervision where the Fund had specialist knowledge.” Just as there was a lack of leadership in the tripartite system, it appears there was a sorry lack of leadership within the Troika.

** As he put it, “There will be a great incentive to them [in this case France, Italy and Russia and, by extension Germany] to seek their friends in other directions, and any future rupture of peaceable relations will always carry with it the enormous advantage of escaping the payment of external debts, if, on the other hand, these great debts are forgiven, a stimulus will be given to the solidarity and true friendliness of the nations lately associated.” (The Economic Consequences of the Peace, p128)