Minerd: Winning the War in Europe
In centuries past, there have been many wars fought to bring Europe under one economic and political union. The Napoleonic Empire, the Prussian Empire, the Third Reich, and even the Ottoman Empire further to the east ultimately failed to achieve this goal. Today, in many ways, Europe is engaged in another war – a war to preserve the hard-fought gains of monetary and fiscal union built over the past five decades beginning with the Treaty of Rome in 1957.
The battles of this conflict, like previous European wars, are being fought across a broad theater. The Argonne, Waterloo and Normandy are among the many famous battlefields of the past. Greece, Portugal and Ireland are among the theaters of war in which European Union is currently engaged.
Just as past European conflicts resulted in grave economic costs and massive amounts of debt, this fight has taken a similar path.
In the latest incursion, Greece has obtained a temporary cease firein the form of a new €130 billion bailout plan, once again dodging an immediate threat of default and destabilization. Yet this plan will only reduce Greece’s debt to approximately 120% of the nation’s gross domestic product. Waiting in the wings are Portugal and Ireland, Italy and Spain – and later down the road, Belgium, and who knows what other European states – which may soon require their own restructurings.
Highly indebted nations as a result of war are common in the European experience. In fact, today’s experience doesn’t look all that different from another period in history when European nations were saddled with huge debts, had little means to repay them, and stumbled through a series of bailout plans that ultimately failed to solve the fundamental problems.
The Interbellum
As the clouds of conflict lifted in 1918 and the Great War came to an end, the victorious Allies embarked on a plan – several plans, actually – to force Germany to pay for the incalculable destruction throughout Europe. The initial bill for war reparations was set at 269 billion gold marks, an amount that dwarfed the size of the German economy at almost 300% of GDP.
Other European nations had borrowed heavily to fight the war. Many ended it with astronomical amounts of debt, including Great Britain (132% of GDP), France (185% of GDP) and Italy (142% of GPD). Then, as now, there were strict demands for austerity measures, flat refusals to accept losses on certain debts, and constant infighting over bailout plan after bailout plan.
Without the realistic ability to pay its enormous war debt, Germany spent the next 14 years on a path of multiple restructurings, occasionally paying installments (often in coal and timber) but more often defaulting on its financial obligations. Other European nations, particularly war-ravaged France, demanded full payment from the fledgling Weimar Republic.
The Dawes Plan
In August 1924, the Allied powers approved the first major restructuring package for Germany, known as the Dawes Plan. It was named for its principal architect, Charles G. Dawes – an American financier and later U.S. Vice President during Calvin Coolidge’s second administration. The Dawes Plan outlined a series of financial reforms, including currency stabilization, new taxes, and massive new loans primarily through American banks to help stimulate economic growth.
Within four years, however, it became clear that more needed to be done. In 1929, American businessman Owen D. Young (co-author of the Dawes Plan) led another restructuring effort. The Young Plan called for a more than 50% reduction in Germany’s reparations debt, extended the payments over a 58-year period, and imposed additional taxes.
But this success was fleeting. Even with the substantial debt reduction under the Young Plan, Germany’s debt remained far too high at 123% of GDP. Then, just a few months later, everything went to hell with the stock market crash of 1929 and the onset of the Great Depression. All reparation payments were halted. A plan to eliminate Germany’s war debt was proposed, but it was contingent on the United States agreeing to forgive debts owed to it by other European nations. The U.S. Congress flatly rejected that idea – which, today, sounds somewhat like the European Central Bank refusing to take a loss on its Greek debt holdings.
Looking back at the interwar period, it was primarily a time of very easy monetary policy and robust economic expansion in the 1920s – despite the structural problems associated with the over-indebted nations of Europe. That also sounds a lot like today, with the Fedpledging to keep interest rates zero bound until 2014 and to provide whatever liquidity is necessary to support economic growth. In Europe, the ECB seems to be reading from the Fed’s script, providing the banking system with low-interest loans that now top €1 trillion.
For now, we have postponed the immediate crisis. With unsustainable debt levels throughout Europe today, in all probability it is just a matter of time before the serial restructuring saga resumes. How long will it take to resolve? Well, Germany did eventually pay all of its remaining reparations from World War I. The final payment of $94 million was made on October 3, 2010 – 92 years after the last shot was fired. Perhaps that gives us some sense of how long it can take to restructure the debts of Europe.
Scott Minerd is the Chief Investment Officer of Guggenheim Partners, LLC, a privately held global financial services firm with more than $125 billion in assets under management.