Google analytics

Friday, July 10, 2015

Grexit, the Sinking Fund Act of 1790, and the unraveling of the European project

by John MacBeath Watkins

A friend from New South Wales asks, if Europe can't resolve the debt crisis on its periphery by means of the sort of fiscal union that would have a central authority bail out banks, why can the U.S. do so?

I've been following the Grexit controversy (potential Greek exit from the Euro zone) with interest, since it has the potential to disrupt one of the great internationalist projects of the last century, the European Union. I think I have the answer to my friend's question.

First, Americans identified with each other culturally much more than Europeans do. Second, we've had real fiscal union since 1790, thanks to the genius of Alexander Hamilton.

After the Revolutionary War, the original 13 colonies had quite a lot of debt, much of it owed to foreign banks and investors (primarily in the Netherlands.) Many were in a poor position to pay back the loans, and there was talk of default.

Hamilton pushed through the Sinking Fund Act of 1790, which was somewhat misnamed for political reasons. It didn't really pay down the debt so much as fund it, so it could be turned over periodically and become the basis for a market in securities that would help provide the financing to develop industry in the new nation.

But equally important was its political role. Hamilton saw that if the federal government took over the war debts and financed them through taxes, the states would be dependent on the federal government and the federal taxing authority to pay off their debts. This cemented the nation into one political and financial unit.

Not that this happened without difficulties or entirely peacefully. George Washington led a militia to put down the Whiskey Rebellion (1791-1794,) an insurrection against federal taxes on corn whiskey. This happened while George Washington was president, and he became the only sitting president to lead troops in the field while suppressing it.

Jared Bernstein writes that a German economist asked him,  “How do you think the people of Manhattan would like bailing out Texas?” And Paul Krugman points out that it did, big time, during the Savings and Loan crisis.

As it happens, I was there, as the business reporter for the Odessa American, a daily in West Texas. Bankers were getting convicted of crimes and sentenced to brief incarceration at hard summer camp in low-security prisons, the Resolution Trust Corporation was shutting down S&Ls and the federal government was guaranteeing the deposits, and we never heard a peep out of those parts of the country that contributed money to resolve the situation.

Krugman points out that the resolution of this crisis cost about $125 million "back when that was real money," and about $75 million went to Texas. It didn't go in the form of loans, it went in the form of outright transfers from areas like Manhattan that weren't having a banking crisis.

If the powers that be in Europe wanted a United States of Europe, they would act as Hamilton and Washington did to make sure the debts of the weaker states got paid off by a central authority. But they didn't, and they can't, because Europe is not about to become a United States of Europe. German voters won't stand for bailing out Greece, there is no central taxing authority and is not likely to be one, and a central European authority invading an area that rebelled against a centralized taxing authority is unthinkable.

All of which is why the Euro was a bad idea to start with. There are those in Europe who think that forcing Greece to exit the Euro will make the rest of the Euro area stronger, but actually, it demonstrates why the Euro can't work, and why the project to make a United States of Europe is a doomed enterprise.

America works as a currency area, in part, because large and ongoing transfers of wealth happen between productive states like Massachusetts and New York on the one hand, and low productivity states like Mississippi and Arkansas on the other.

Those wealth transfers go on year after year, in the form of welfare spending, federal unemployment insurance, social security, disability benefits, and other programs. Most of this is so invisible to recipients that they vote for people who want to cut the federal budget.

It's taken a long time for us to evolve our financial system, and there have been some pretty rough patches along the way. Andrew Jackson, one of our worst presidents, refused to renew the charter for the Bank of the United States, leaving the country without a central bank from 1836 to 1913. Between the end of bank's charter and the beginning of the Civil War, state banks were issuing currency, and how much it was worth depended, among other things, on how close you were to the issuing bank. Repeated financial crises between the 1870s and 1913 convinced the powers that be that we needed a central bank. We didn't get centralized deposit insurance until the bank failures of the 1930s demonstrated how badly that was needed.

But at least we had the basic ingredients for a proper currency union, even when we didn't have a workable currency system thanks to Old Hickory. And the basic principle that we were a nation was settled between 1790 and 1794, with the Sinking Fund Act and the suppression of the Whiskey Rebellion.

Europe is currently demonstrating that they do not have the unity the Sinking Fund Act of 1790 represented. Any attempt to set up such a mechanism would probably produce the European equivalent of the Whiskey Rebellion, and there is zero chance that Europe would put up with the military suppression of such a reaction.

Try to imagine German troops marching into Belgium to suppress a tax revolt. It would be déjà vu, and not in a good way. I feel confident that the German people would stand with the Belgians against such an action..

Perhaps there was a gentler path to a fiscal union, one in which the burden was shared without a central authority. For example, the banks that owned most of the Greek debt were Greek, German, French, and Italian. Each country could have bailed out its own banks. Instead, the troika (the European Central Bank, European Commission, and the International Monetary Fund) chose to paper over the issue, pretending that Greece suffered not from insolvency but from a liquidity problem. Some private lenders took a bit of a haircut, then the private debt got converted into ECB and IMF debt. In the end, Greece is on the hook to pay back all the debt, rather than having defaulted, as logic said they should, and having each country bail out its own banks.

We know that Angela Merkel has been saying privately since at least 2011 that the Greek debt was unsustainable, that they would, in the end, default. And yet the policy of the German government was and still is that Greece must pay back every penny with interest. This means that the German government has been pursuing a policy that they knew wouldn't work, so there must be some sort of hidden agenda served by this hypocrisy.

That agenda could be as simple as an unwillingness to face German voters with inconvenient and unpopular truths. The longer Merkel continues to fail to tell the German people the truth, that the Greek crisis will not be resolved by making them pay back every penny, the harder it becomes for her to tell them.

Or it could be that there is some other goal. Yanis Varoufakis, who until recently was the Greek finance minister in charge of negotiating a resolution to the crisis, recently wrote an op-ed piece in The Guardian claiming that Germany wants to scare the bejesus out of France.

"Based on months of negotiation, my conviction is that the German finance minister wants Greece to be pushed out of the single currency to put the fear of God into the French and have them accept his model of a disciplinarian eurozone," he wrote.

No doubt there is more than one reason for the policy of the German and other governments on the Greek debt crisis. Whatever the reasons are, they seem impervious to evidence. Had the initial bailout worked as the troika said it would, the crisis would be over. Here's a chart from Paul Krugman's blog showing the difference between the IMF's economic projections for Greece and what actually happened:

It's pretty obvious that if the Greek economy were the size the IMF said it would be at this point, they would have far less trouble paying back the debt. But after five years of failure, the troika offers nothing but more of the same policies.

These policies have resulted in the Greek economy shrinking more quickly than the debt is paid back. More of the same can be expected to have more of the same result, which means that the Greek ability to pay back the debt is undermined to the extent that the whole exercise is futile. It also means that since the denominator in the debt/GDP ratio is sinking, a Greek government that started with a debt of 100% of GDP now has a debt of about 170% of GDP, despite paying back billions of dollars.

It's not like the Germans should be unfamiliar with how this works. Debt forgiveness and the Marshall Plan following World War II rebuilt the German economy.

This is covered in a paper by London School of Economics Professor of Economic History Albrecht Ritschl

http://www.lse.ac.uk/researchAndExpertise/researchImpact/PDFs/germany-hypocrisy-eurozone-debt-crisis.pdf
"In a telling comparison Ritschl showed that the debts racked up by the struggling Eurozone economies – Portugal, Italy, Ireland, Greece and Spain – were equal in size to Germany’s current gross domestic product. In other words, debt cancellation for the Eurozone would be equivalent to the debts that were cancelled by the Allies after World War II. "
In addition, the Marshall Plan injected $17 billion -- equivalent to roughly $160 billion in today's money -- to rebuild the country we had spend so much money reducing to rubble.

The debt cancellation, by the way, was supposed to be temporary -- only until Germany was unified. But Germany was unified in 1990, and Germany has still not been required to repay the debt.

Having itself relied upon the kindness of foreigners, Germany seems disinclined to pay it forward, and make no mistake, Germany is the driving force in negotiation over the Greek debt.

 I can only think that Germany is disenchanted with the European project, and has no wish for a stronger union. It seems they wish to make Greece an example, but what will Greece be an example of?

I think they will be an example of the fact that Europe, despite all the years of the European Union, does not wish to be a true union. Grexit is the beginning of a great unraveling of the dreams of the European elites.


No comments:

Post a Comment