A recent paper presented by Carmen M. Reinhart of Harvard University and Christoph Trebesch of the University of Munich focuses on the telling similarities between the current Greek debt crisis and three former instances of state bankruptcy in the country’s modern history.
Presented in mid-September at the Brookings Institution in the United States, the paper by the two economists argues that the present crisis, like the others that came before it, are essentially crises of foreign indebtedness and not simply of fiscal derailment. A common characteristic shared by the four defaults in Greece’s modern history (in 1826, 1893, 1932 and 2012), according to the paper, titled “The Pitfalls of External Dependence: Greece 1829-2015,” is that they followed a period of increased dependence on external financing. This overborrowing eventually led to a loss of trust among private investors and to the involvement of foreign governments, which bailed out private investors by bailing out Greece.
In every case, this involvement entailed mounting interference by official creditors in Greek fiscal affairs policy, and each time the country was shut out of international markets for years (the briefest period was nine years, from 1893 to 1902). The lessons from these past experiences lead the authors to conclude that the only solution to the Greek crisis lies in a “haircut” of its sovereign debt.
As they acknowledge, their analysis goes against the grain of recent calls for a break in the “deadly embrace” between the government and domestic banks. “Bank portfolios were almost entirely domestic from 1945 to 1980, the period in history with fewest banking and debt crises… Also the most prosperous and financially stable period in Greek history, between the 1950s and 2000, was a period with heavy home bias and a comparatively low share of external debt.”
A significant detail in the analysis regards the definition of external debt.
According to Reinhart and Trebesch, the concept of external debt was once limited to instances of debt issued under foreign law, in a foreign currency and held by foreigners. In Greece’s case, “what is domestic in terms of currency and governing law need not be domestic if we look at who holds the debt.”
When external debt swells to unmanageable levels, governments have only limited possibilities to push for a rapid restructuring, the study reminds us. The overindebted nation has no regulatory influence on the holders of the debt and is also unable to use inflation as a means of relieving the real burden of the debt. Furthermore, the holders of external debt, in contrast to domestic bondholders, do not feel as compelled to find a solution. As the writers note, both in the case of Latin America in the 1980s and in that of Greece, while the bankrupt countries sank deeper into recession, the economies of their main creditors (the USA then and Germany today) were experiencing robust growth.
Causes of dependence
The study showcases certain features that paint a portrait of a developed economy different from others. Greece’s current account balance, the authors note, was negative in 93 percent of the years between 1946 and 2014, compared with a 56 percent average among 19 other developed nations.
Part of the explanation is that domestic savings remained comparatively low throughout this period. As the authors note, it is well known – though “difficult to quantify” – that this weakness in savings is in part because “much of Greek wealth is held abroad”: “It is a more or less chronic form of capital flight that intensifies in bad times but is usually present,” they argue.
Another cause of near constant current account deficits they put forward is the large amount of grants Greece received over the course of recent decades, the most notable of which are the Marshall Plan and European Union funds.
But even in the explosion of external borrowing during the eurozone’s years of innocence, Greece led the way. The percentage of Greek bonds in the hands of domestic investors dropped from 75 percent of the total in 1998 to around 30 percent a decade later, just before the crisis erupted. As the study notes, dependence on foreign funds also rose during this period in other nations on the euro periphery, such as Italy, Spain and Portugal – but not to the extent that it did in Greece.
Reinhart and Trebesch’s historical narrative shows that the first period of over-indebtedness began with loans issued in London in 1824-5 to finance the Greek War of Independence against Ottoman rule. Greece became saddled with a debt that by 1833 had grown to 120 percent of GDP as the terms were impossible to meet. Default – on the 1.3 million pounds sterling received out of a total agreed amount of 2.8 million – came in 1826, under the weight of constantly burgeoning military expenses. In other words, the emerging nation-state managed to overborrow and go bankrupt even before it gained independence.
In 1833, as King Otto assumed the throne, Britain, France and Russia agreed to the first Greek bailout by guaranteeing a loan of 60 million French francs (2.4 million pounds) from private investors, with the entirety of Greek state revenues serving as collateral. The strict austerity measures Otto imposed in the early 1840s under pressure from Greece’s official lenders (including military threats from Great Britain) were crucial to the Movement of September 3 against him. Kostas Kostis, a professor of economic and social history at the University of Athens, explains that among the cutbacks made by Otto in order to service the debt, was “a force of 3,500 Bavarian soldiers, whom he paid campaign salaries, and who constituted his personal guard.” Their departure paved the way for the uprising against the king.
Greece eventually gained access to the capital markets in 1879, following an agreement for a write-down of the original loans which came after years of negotiations on overdue interest, which had grown well beyond the amount of the loan principal.
The agreement unleashed another period of frenzied borrowing. Greece, Reinhart and Trebesch tell us, managed to borrow more than 100 percent of its GDP in just a few years – part of which was to service the 1878 agreement. In the early 1890s, a combination of budget deficits, an international recession and the collapse of currant exports due to tariffs imposed by France, Germany and Russia, led to a loss of trust in the markets. The drachma exchange rate dropped precipitously and the external debt could no longer be serviced, leading to the bankruptcy of 1893.
Greece remained in a state of default for five years. After its crushing military defeat at the hands of the Ottoman Turks in 1897, the foreign powers (France, Great Britain, Russia, Germany, Italy and Austria-Hungary) again intervened and imposed a painful deal on the country. In accordance with its terms, there would be no haircut on the nominal value of Greek debt, while the claims of the first three powers from the bailout loan of 1833 were reactivated. Greece continued to service these until the default of 1932.
The 1898 memorandum came with a loan guaranteed by the same powers (France, Great Britain, Russia), which Athens was to use to pay war reparations to Turkey and to service the restructured debts to its private creditors. The loan was worth 6 million pounds, or 26.8 percent of Greek GDP that year. As part of the agreement, however, Greece had to submit to strict supervision from the International Financial Commission, which had almost complete control over fiscal policy. Germany was the main proponent of the idea, with the Brookings paper’s authors suggesting as the reason that many of the foreign bondholders were German. Kostis, however, places great emphasis on Berlin’s effort to ingratiate itself with the Ottomans by taking a tough stance toward Greece.
The bankruptcy of 1932 is directly linked to the Great Depression, which broke out in the US in 1929 and spread to the global economy. After three years of dropping state revenues, significant increases in inflation, constantly shrinking exports and dwindling foreign exchange reserves, in April 1932 Greece left the gold standard. As a result of this “Grexit,” the drachma lost 50 percent of its value and, automatically, the burden of external debt doubled, leading to another Greek default.
The country, however, had been locked out for a significant period before the 1929 crash. It had emerged from a decade of wars (1912-22) deeply in debt and having to face the challenge of absorbing some 1.5 million Greek refugees from Asia Minor.
Beyond the loans received from the allies during World War I, Greece was the beneficiary of funding under the auspices of the League of Nations, in 1923 and 1928. These loans, too, were accompanied by an adjustment program. During that same period, and until the Nazi occupation in 1941, the International Financial Commission continued to exercise tight control over the country’s fiscal policy. After several temporary agreements with creditors, the occupation and the civil war, negotiations on the debt of 1932 finally concluded in 1964, a year after Greece had regained market access.
There are two key questions that emerge from Reinhart and Trebesch’s study: The first is about the nature of the current Greek crisis and what needs to be done so that the country does not find itself in such a predicament in the future. The second touches on the core of the debate regarding whether successive Greek governments are to blame for the 2009-10 collapse or whether the onus lies with international banks and Greece’s official creditors.
As far as the first issue is concerned, the study presented at the Brookings Institution adopts the line of economists such as Daniel Gros and Hans-Werner Sinn, who see Greece’s dependence on foreign capital as the main cause of its fiscal collapse. However, this raises the question: If, in order to avoid overborrowing, Greece needs to depend on domestic funds, doesn’t this strengthen the “deadly embrace” between government and banks, which has been such a major factor in the spread of the crisis?
“The only alternative is domestic savings,” Gros tells Kathimerini. “These savings do not have to transit via banks. It could be corporate sector savings or even, heaven forbid, government savings. Unless Greece gets its savings rate up to over 20 percent it will never be able to grow in a sustainable way. Banks are leveraged institutions. They thus magnify either strength or weakness. But banks do not create the ‘original sin,’ which in the case of Greece is insufficient savings – and was so long before the euro.”
Gikas Hardouvelis, a professor of economics at the University of Piraeus and a former finance minister, says that the low level of savings in the past few decades “reflects the surge in consumption, which to a great degree concerned imported goods. In order to fund this consumption you need inflows from abroad, leading to the big current account deficits recorded in Greece before the crisis.”
The Brookings study argues that to a significant extent, it was the unyielding stance of Greece’s foreign creditors over the past two centuries that was responsible for the length and toll of its bankruptcies. However, despite the similarities, today’s crisis is different in one key respect: The borrowing in the previous cases was predominantly a matter of necessity (to fund a revolution, build an army and infrastructure, manage refugee inflows from Asia Minor). In the 1981-2009 period, and particularly since Greece’s entry into the eurozone, the deficits were bankrolling consumption.
“From a Greek point of view, today’s bankruptcy is the most ‘sinful’ of all,” stresses Hardouvelis.
For Kostis, the recurring pattern is not so much the overly harsh treatment of Greece by its official creditors, but rather the “perennial failure of the Greek political system to deal with problems in the economy in a timely fashion, or to manage the situation when conditions become most dire.” The foreigners therefore, the academic argues, “not out of magnanimity but in order to protect their interests, emerge as forces modernizing the Greek state after every bankruptcy.”
Kostis mentions the founding of the Bank of Greece in 1928, under pressure from Greece’s foreign creditors and particularly the British, despite intense reactions from the domestic political system. He argues that the creation of the central bank was part of the British strategy for regaining economic superiority by linking the drachma to the pound in the framework of the gold standard, with the Bank of Greece acting as the guarantor of monetary stability. For Greek politicians, however, who had become accustomed to using the government’s cash reserves to issue loans through the National Bank of Greece, the idea of a central bank was highly problematic.