While the news media and some of our politicians are focused on Occupy Wherever, a bigger story is occurring under the radar in Europe and the United States. While Europe may have solved the Eurozone/Greek debt crisis for now – and hopefully for longer, look at one of the parts of the solution: a call by French President Nicolas Sarkozy for China to support the European Financial Stability Facility. Europe needs money (to support its economy, including importing goods from China), and China has trillions in reserves, so it seems like a match made in heaven – except. Except that the cost of those loans to Europe may be more than just the interest charged.
The United States is in a similar situation. While President Obama talks about how we need another stimulus plan (though it’s not called that), the fact is that we already have a huge federal deficit, and that deficit has to be financed by somebody. In the past, part of the deficit was financed by loans from the Social Security Trust Fund. But with the Trust Fund now paying out more than it takes in, Treasury can no longer borrow from Social Security. Fortunately (I guess), the economic turmoil around the world has made the United States seem relatively secure, even with our S&P credit rating downgrade. But we still need to borrow a lot of money and much of that borrowing has to come from overseas. Once again, the concern is what might come with those loans, especially if they are from China.
But instead of talking generalities, let’s look back a little over 20 years. With the 20th anniversary of the fall of the Berlin Wall, the 20th anniversary of the reunification of Germany and the 50th anniversary of the building of the Wall, I have been reading books on the end of East Germany and the reunification of Germany. There are some lessons to be learned here about over-borrowing, if we want to see them.
First, consider East Germany. By the 1980s East Germany was supporting its lifestyle, and its “really existing socialism,” by borrowing money from the West, including West Germany. In fact, in 1976 East Germany stopped publishing separate totals for its exports and imports and reported only aggregate numbers in order to hide its true situation. By the mid-to-late 1980s, East Germany’s debt was huge. According to one report, the West German government was buying East German debt “in order to put greater pressure on the SED [i.e., the East German communist party] in the future.” By 1988, “[t]he GDR had been living beyond its means for years, and the only way out, [planning chief Gerhard] Schürer implied [in a report to Erich Honecker], was a drastic cut in living standards for most East Germans.”*
We never found out what the political effects of this debt would have been on East Germany because once the Wall was opened on November 9, 1989, the GDR was doomed. Either East Germany was going to go away or the East German people were. The Germans were going to re-unite. It was just a matter of whether East Germany and West Germany were going to become one country or a very large percentage of the East German population was going to move to West Germany.
While we don’t know what would have happened in East Germany, we do know the effect that the Soviet Union’s need for money had on the Soviets’ policies toward German re-unification. In the late 1980s Mikhail Gorbachev was pursing glasnost and perestroika. But he needed money and loans to pursue those policies. And where could he get that money? West Germany. Here is an excerpt from Dissolution: The Crisis of Communism and the End of East Germany by Charles S. Maier:
“The Soviet ambassador in Bonn, [Yuly] Kvitsinsky, returning home after the two plus four [talks] to become deputy foreign minister, was unhappy about the concessions that had been made but also aware that his government’s confusions left little to rescue. Increasingly crucial was the financial calculation. Since earlier calculations of a profitable Soviet, FRG, and GDR ‘triangle’ had been overtaken by events, West German economic assistance seemed increasingly necessary.
Soviet military leaders were scornful of the compromises [Mikhail Gorbachev had made] on Germany, but their pressure was countered by the acute financial realities. Just as it had constrained the GDR and Poland, indebtedness to the West now cut deeply into Soviet options. …
Shevardnadze had been delegated to plead for credits from Kohl on the eve of the two-plus-four meeting of Mary 5: perestroika could not be carried through if the ruble collapsed: might not the Germans therefore, so he had to plead, guarantee loans of DM 20 billion? Kvitsinsky had deep misgivings about undermining the foreign minister’s leverage by making him play the role of mendicant – but the financial plight seemed determinative. …
Less than two weeks later, on May 16, Kohl proposed to Bush that the United Stated join him in economic credits [to the Soviet Union] …. But the president refused in view of the Lithuanian situation and congressional unhappiness with the Soviet pressure on the small emerging nation. …
It was up to the Germans to become the Russians’ bankers. It would not be easy, Bush pointed out, for the Russian supplicants to shut the door on German national aspirations if they hoped to open the purses of the Federal Republic.”**
We know how this turned out: Germany was reunited, it stayed in NATO, and it all happened peacefully. It was an incredibly good result. But in 1990 it was the good people who had the financial leverage. And they were using it for good purposes.
But what about today? Will what China demand from Europe in return for the help President Sarkozy is seeking?
And what about the United States? We need loans, too. In March of 2009, I said that borrowing from China might not affect us too much domestically but that Taiwan should worry (see here and here). Our reliance on Chinese loans might also mean that we cannot support the Tibetans or the Uyghurs if China cracks down on them. Our ability to influence what China does with respect to North Korea and its nuclear arsenal could be reduced. And any chance of our standing up for human rights in China will be gone.
Please understand I am not saying we should isolate ourselves economically from China. Trade and investment are great. What I am worried about is dependence on loans from China. Because the cost of these loans may be more than the interest we have to pay. It may also be the self-respect we have to give up to get them.
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* Jeffrey Kopstein, The Politics of Economic Decline in East Germany, 1945-1989 (1997), p. 84, 101-103, 224.
** Charles S. Maier, Dissolution: The Crisis of Communism and the End of East Germany (1997), p. 271-72. Note that in the book itself, this excerpt was part of one long paragraph. I have divided it into separate paragraphs here to increase its readability on a computer.
Interestingly, Spiegel, a German news magazine, recently reported that, in 1963, then-Chancellor Ludwig Erhard was seriously considering trying to “buy” East Germany from the Soviet Union in exchange for loans of 100,000,000,000 deutsche marks that would never be repaid. In 1963, Nikita Khrushchev was still in power, and the Soviet Union was suffering one of its worst crises, as well as facing a new rival in Mao Tse-tung’s China. But President Kennedy was assassinated before Chancellor Erhard would mention the idea to him, and Lyndon Johnson wasn’t interested. By 1965, Chancellor Erhard decided the plan was no longer possible. Khrushchev was out, and the Soviets’ need for loans was being met by other lenders.
Also with respect to the effects of foreign indebtedness, see this excerpt from In Europe’s Name: Germany and the Divided Continent (1993) by Timothy Garton Ash:
“In fact, Brezhnev was constantly warning Honecker, and other East European leaders, of the dangers of becoming too indebted to the West. The great lesson of what had happened in Poland, he told the Czechoslovak Politburo in spring 1981, was that they should all make sure that their foreign debt ‘did not reach a dangerous level’.” (p.157)
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