German war debts and the Greek debt problem

While revising my manuscript I came across this tidbit:

The impact of floating the dollar went far beyond simply providing more flexibility to the Fed. When the war debts issue resurfaced in mid-June [1933], the NYT observed that:

“Wall Street notes a remarkable contrast between the attitude toward the war debt question last December and that at the present time.  Last year, financial circles began to become apprehensive about the war debt question long before Dec. 15. . . . At the present time, although the war debt payments are due by next Thursday, there has been almost no discussion of the subject in financial circles, and the possibilities of wholesale default have left the markets unperturbed.” (6/11/33, p. N5)

This is important because it shows that it was not the fiscal, but rather the monetary aspects of the war debts problem which was of greatest concern to the markets.  Now that the dollar was being devalued, the markets no longer had to worry about the possible deflationary impact of a war debts dispute.

If Greece were not part of the euro, then Greek debt problems would probably not be impacting Wall Street.  I’m not certain exactly why they have recently affected Wall Street, but I would guess that there is worry that the debt problems in Europe may impact the stance of world monetary policy.  Perhaps there is fear that a eurozone crisis would make the dollar stronger, and that this would slow the US recovery.  In the early 1930s the war debt problems made gold stronger, and delayed recovery for any currency still tied to gold.

BTW, nominal rates were still near zero in 1933, but markets recognized that the adminstration was committed to reflation.  The fact that interest rates are near zero is not a reason to assume monetary policy is ineffective.  It is effective if the policymakers have the courage to make it effective.



10 Responses to “German war debts and the Greek debt problem”

  1. Gravatar of q q
    12. April 2010 at 17:21

    the greek debt problem is affecting wall street mostly because how europe deals with it sets a precedent for much larger problems in portugal and especially spain. if greece weren’t part of the euro they wouldn’t be in the news any more than estonia and latvia are at present.

  2. Gravatar of Doc Merlin Doc Merlin
    12. April 2010 at 22:51

    You separate the fiscal and monetary too much. There is no real separation, fiscal profligacy eventually lead to monetary effects, always. In a gold currency, it happens through devaluation in an attempt to keep the gold from fleeing the country. In a sovereign floating exchange currency it happens through inflation. In a fixed exchange system, it happens through default. \

    Anyway, my point is that the buildup of the problem is what creates the monetary problems, and they continue building up over time. The default/inflation/devaluation is just how the problem gets corrected.

  3. Gravatar of scott sumner scott sumner
    13. April 2010 at 04:23

    q, I agree.

    Doc Merlin, Everyone agrees that fiscal profligacy will eventually lead to monetary expansion. The question is when. If it doesn’t affect current expectations of inflation, then it won’t have an expansionary effect during the Great Depression. My focus in this study is the factors that caused inflation and deflation during the Great Depression.

    In 1933 the dollar was not devalued because the US had fiscal problems, but rather because unemployment was very high.

  4. Gravatar of Why do we care about Greece? – Economics – Why do we care about Greece? - Economics -
    13. April 2010 at 06:33

    […] SUMNER writes:If Greece were not part of the euro, then Greek debt problems would probably not be impacting Wall […]

  5. Gravatar of Why Focus On Greece? | Why Focus On Greece? |
    13. April 2010 at 06:33

    […] Focus On Greece? 13 april 2010 av admin Stefan Karlsson's blog On the Free Exchange blog and Scott Sumner's blog it is asked why there is so much focus on Greece despite the fact that the Greek economy is […]

  6. Gravatar of azmyth azmyth
    15. April 2010 at 11:10

    Do you think there will be a move to shrink the Euro zone? It seems to me that a decent way to ensure national bailouts don’t lead to moral hazard is to kick them out of the Euro and let them inflate away their debts next time it occurs.

  7. Gravatar of ssumner ssumner
    16. April 2010 at 04:44

    Azmyth, Yes, that would be logical, but I am a bit doubtful that it will happen. If it were easy to do than I think it would occur. What makes me doubtful is that leaving the Euro is actually quite tricky–and could lead to a fiancial panic. Depositors are already fleeing from Greek banks. I’d say the odds are 70-30 against, but to be honest this is just a guess.

  8. Gravatar of Don @ currency day trading Don @ currency day trading
    25. April 2010 at 11:24

    This isn’t going to work out for the Euro-Zone. In my opinion they made a huge mistake when choosing for one currency.

    You can not have one currency, If all countries in the Euro_Zone keep there own governments.

    Now every government/country has to be successfull to push the Euro up. Which is impossible, so the weaker countries will always pull the strong countries down.

    If you have 1 currency you need ONE central government and one monetary pollicy. You would have to have a set up like the USA. 1 president leading all the separate states.

    For Europe and the EUro the only way is down. THe issue that countries can not print more of their currency to solve or help with their deficit problem will show to be a economical fatality.

  9. Gravatar of ssumner ssumner
    28. April 2010 at 13:39

    Don, Your argument is looking stronger every day. I must admit that I didn’t expect this, although I obviously knew it was a theoretical possibility–especially if the ECH ran a deflationary monetary policy.

    I thought the euro made a lot of sense for the inner core of Europe (France, Germany, Benelux, etc) but never gave much thought to Portugal and Greece. I thought Britain was very wise to say out.

  10. Gravatar of TheMoneyIllusion » Do you remember when low inflation was good news? TheMoneyIllusion » Do you remember when low inflation was good news?
    13. June 2012 at 06:52

    […] than two years ago I did a post on Greece that is actually far more relevant today.  I’ll just summarize the post below, but I […]

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