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Debt Relief Should Be Greece's Parting Gift

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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Thomas Piketty, the French economist whose book "Capital in the Twenty-First Century" took the world by storm last year, is back in the spotlight as Greece teeters on the edge of bankruptcy's abyss. Germany, Piketty argued in a recent interview with Die Zeit newspaper, "has no standing to lecture other nations" because it is "the country that has never repaid its debts."

While there's more than a smattering of histrionics in Piketty's comments, there's also a core truth: A chunk of Greece's debts will need to be forgiven in the not-too-distant future to avoid a European democracy joining the ranks of the world's failed states.

The Euro's Existential Crisis

Piketty contends that the 1953 London Debt Agreement, signed at a conference where 20 creditor nations led by the U.S., U.K. and France agreed to write off more than half of Germany's debts, should be a blueprint for Greece and other indebted euro region nations. Germany had debts worth more than 200 percent of its gross domestic product when World War II ended in 1945; a combination of inflation, taxation on private wealth and debt forgiveness shrank that to less than 20 percent in the space of a decade, setting the scene for Germany's rebirth as an economic powerhouse, according to Piketty.

Comparing the war-ravaged German economy with Greece is more than a bit of a stretch. As my colleague Leonid Bershidsky argued in January, half of what Germany owed predated the war, and a chunk of its debt had been imposed in the crippling reparations imposed at Versailles after the first World War. Greece, by contrast, has gotten itself into trouble by living beyond its means, albeit aided and abetted by its membership of the euro.

Still, with Greece's debts worth about 180 percent of its GDP, the country's creditors are unlikely to get all of their money back. French Finance Minister Michel Sapin said Monday on Europe 1 radio that "discussions on the debt are not taboo." Cyprus President Nicos Anastasiades, who knows a thing or three about how capital controls can hurt a country, said he supports changing the terms of Greece's debt load to make it sustainable. It makes sense to start talking about restructuring Greece's burdens.

With curious timing, the International Monetary Fund released a report on Greece's debt sustainability on Thursday, just before Greece's weekend referendum. Greece, which is in arrears to the lending agency after failing to make a scheduled $1.7 billion payment last week, needs at least 36 billion euros ($40 billion) in the next three years from its euro region partners to stay afloat, the IMF said. Looking ahead, a deteriorating economy probably means debt relief will be required, the IMF said:

"If the package of reforms under consideration is weakened further -- in particular, through a further lowering of primary surplus targets and even weaker structural reforms --haircuts on debt will become necessary."

new paper released last week by Carmen Rheinhart of the Harvard Kennedy School and Christoph Trebesch at the University of Munich suggests debt forgiveness can successfully put an economy back on track. Their study of 48 defaults and restructurings in the past century suggests debt relief can boost per-capita GDP in advanced economies by 20 percent in the five years after forgiveness takes effect -- but there's a significant caveat:

"We only find significant improvements in growth and ratings if the deal involves face value debt reductions. Rescheduling operations with maturity extensions and interest reductions were not followed by a significant improvement in economic growth."

I've argued this week that it's probably time for Greece to leave the euro, and that its euro-zone partners should err on the side of generosity in easing its departure from the common currency project. And since Greece's exit would likely mean an eventual default on its debts anyway, it would be sensible for Europe to preemptively offer the country debt forgiveness on its way out the door. A parting gift of that sort could ease the pain of Greece's departure, and put its economy on a smoother road to recovery.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor on this story:
Cameron Abadi at cabadi2@bloomberg.net