Echoes Dispatches From Economic History
A poster declares Germany's intention to honor the interest on its war bonds, ca. 1919. Source: Library of Congress Prints and Photographs Division
Germans Taking the Wrong Lessons From History of Default
Germans complaining about how Greeks, Italians and Spaniards aren’t paying their debts is a recurring feature of Europe’s debt crisis.
In May, German Finance Minister Wolfgang Schaeuble declared in a radio interview that “We Germans show that it’s possible to have solid fiscal policy and generate growth at the same time. We have the lowest unemployment. Those recipes that work for us must be applied in other countries and not the opposite.” A month later, he complained that Greece’s crisis was due to “decades of economic mismanagement.” And this week, he said U.S. President Barack Obama “should, above all, deal with the reduction of the American deficit.”
An earlier generation of investors would be shaking their heads. Germany in the 1920s was synonymous with default. After suffering serious hyperinflation following World War I, Germans received the kinds of loans and debt- restructuring plans from the U.S. that Schaeuble and the German parliament are furious about offering to Greece and others today. Germans were considered the unhealthiest borrowers in the world, though that didn’t stop American companies such as National City Bank and Dillon, Read & Co from lending in what historians call “the great bond boom” of the 1920s.
Herbert Hoover, then the U.S. secretary of commerce, was troubled by what seemed like reckless lending to German municipalities. But, perhaps believing in German “recipes” for sound fiscal policy, he gave official consent to more than $1 billion a year in foreign, high-yield, dollar- denominated loans from 1924 to 1928. Hoover’s office even issued a covering letter for these risky loans, asserting that since they didn’t affect government policy, the U.S. government had no objection to them.
Most of these loans went to fund construction projects throughout Germany. They ended the hyperinflation, and U.S. savings banks quickly snatched up the high-yield bonds, confident that thrifty Germans would repay their debts. Repayment plans were left sketchy at best.
Meanwhile, the German government still resented the costly reparations imposed on it for World War I. In October 1927, Seymour Parker Gilbert, the U.S. official charged with extracting reparations, complained to the German government that in taking on billions of dollars in municipal loans while still owing so much money, Germany was “living beyond its means.” Gilbert criticized Germany’s system of tax payouts to its states, and warned that the loans might never be repaid.
German political parties quickly dismissed Gilbert as ignorant and disrespectful, and then used his report to attack one another. The burghers of 1920s Germany would be shocked today at Schaeuble’s demand for Italy to install a technocratic government or for Greece to postpone its elections.
But Gilbert was right; the Germans couldn’t repay their loans. By late March 1928, German Finance Minister Heinrich Koehler publicly confirmed what Gilbert had guessed the year before: The billions borrowed for German municipal loans might never be repaid. Koehler then said local loans threatened to jeopardize the stability of the new German currency. The bond market responded rapidly: By the middle of 1928, values on U.S. loans to German municipalities and corporations declined even faster than Greek and Spanish bond prices have in recent months.
U.S. banks holding toxic German debt hastily bought up long-term Treasury bonds. This created what economists call an inverted yield curve, where the rates demanded for long- term U.S. government debt were lower than those for short- term debt. Inverted yield curves revealed borrowers’ fears about the future; they signaled a coming recession.
Koehler’s dire pronouncement about Germany’s ability to pay, his call for fiscal austerity, and the drastic drop in American lending to Germany led to the collapse of Germany’s Centre Party -- a political reaction not unlike what we saw recently in France and Greece. On June 28, 1928, Socialist Hermann Mueller became chancellor at the head of a “grand coalition” of social democrats.
By then, the U.S. market for German bonds was quite weak. And as the Great Depression intensified, bad German debt continued to act as a drag on the American economy.
Worse, it was a continuing source of instability. In September 1930, when Adolf Hitler testified in defense of officers tried for treason in Ulm, he was asked what would happen in Germany if he became chancellor. Hitler said “heads will roll,” a new Supreme Court would be created that would reassess foreign debts, and the fascist party would “repudiate and smash all treaties forced on us. Then revolution will be here.”
When this statement reached the U.S., German bonds that had once sold at heavy discounts became worthless. When Hitler came to power three years later, his government did repudiate its public and private debts, claiming that reparations combined with foreign debt had caused widespread unemployment. Greek fascists today are making a very similar argument.
The German government under Chancellor Angela Merkel has drawn a shallow lesson from the country’s own past as a defaulter. It fears only deficits and inflation. But there were other lessons that Germany learned in the 1920s that are returning painfully in Greece, Spain, Italy and Ireland today. The threat of debt default opens a sovereign state to creditors who will demand changes to its internal workings and undermine the legitimacy of its ruling parties. It can also encourage politicians to embrace the most reckless plans.
Today, the unraveling of political coalitions across the European Union and a surge of right-wing parties doesn’t suggest a replay of hyperinflation -- it suggests a real threat to sovereignty. What hurt Germany most in the 1920s was not hyperinflation but the government’s own doubts about the loans it received. Those doubts destroyed the Centre Party and scared off international lenders, which helped bring ruin to the world economy.
It has become a cliche to cite Hitler in arguments about Europe’s future. But austerity laid the groundwork for a man with a scapegoat, easy answers, and solutions more horrifying than unpaid debts.
(Scott Reynolds Nelson teaches history at the College of William and Mary. He is the author of “A Nation of Deadbeats: An Uncommon History of America’s Financial Disasters,” forthcoming from Alfred A. Knopf in September. The opinions expressed are his own.)
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