The euro-crisis and the Greek crisis

And they effectively shut down discussion about the EU’s grave economic problems. Unemployment in the euro area in the past two years has been almost 12 percent. That is two percentage points higher than in the years following the financial crisis.

History is illustrative for our current problems.

Marshall Aid

While Germany bore great responsibility for both WWI and WWII, it was nevertheless (fortunately) decided to help the country - at least West Germany - out of its economic chaos after WWII.

The Allies realised that the huge damages imposed on the country on after WWI contributed to the rise of the Nazis.

Essentially the lesson learned was: Debt enforcement can be very dangerous if accompanied by harsh austerity that impoverish the people, while not delivering the promised results.

The gold standard

To get some perspective on the current situation in the euro area, let’s look at the gold standard – which many European countries decided to return to after WW1.

The first goal was to return to the fixed exchange rate system. To obtain this several countries, especially if they opted to return to the pre-WWI exchange parity, had to pursue a very harsh austerity policy first to reach and then to maintain the chosen parity.

Austerity was followed by excessively high unemployment and associated political and social unrest.

Most countries in Western Europe reintroduced the gold standard system in the mid-1920s: The UK in 1925, Denmark in 1928, Germany in 1924 and the Netherlands in 1925. In the first few years, the cost of this policy was limited.

Wall Street

The US, which emerged as the economic and political superpower after WWI, lent significant amounts to several European countries, especially to Germany.

This put limits on the necessary austerity policy connected to the return to the gold standard.

As stock prices in Wall Street started to take off from 1928, which The Federal Reserve System, the central bank in the US, tried to dampen by raising interest rates, capital injection from the US to Europe dried up.

And after the stock price crash on Wall Street in October 1929 capital movement reversed.

Germany and several other countries, including UK, were then forced to an even more draconian austerity policy if the gold standard was to be maintained. Consequently unemployment rocketed – especially in Germany and the US.

But the gold standard system broke down in September 1931, when the UK left. London's move was then followed by almost all countries.

The costs linked to the attempt to restore the gold standard system, which only lasted a few years, were therefore very large. This was known then. It is known now too

The IMF, for example, in the World Economic Outlook October 2012 made the following observations on the economic policy in the interwar period in the UK:

"If the policy pursued had successfully reduced debt and restored British growth and prosperity, the short-term costs perhaps would have been acceptable. Unfortunately, they did not. In fact, the policies had the opposite effect: the British prosperity was hampered by the dual pursuit of prewar parity and fiscal austerity. "

Political extremism

In Germany the austerity policy that followed the chosen exchange rate policy, forced the then Social Democratic government that took office in 1928 to resign at the beginning of 1930.

This paved the way for the Bruening government, which tried to defend the gold standard using even more drastic austerity measures. This meant the country’s unemployment rate increased further, from 10 percent in 1928 to 30 percent four years later.

With the Social Democratic opposition not providing any real alternative, there was favourable breeding ground for political extremism in Germany.

The Nazi Party (Nationalsozialistische Deutsche Arbeiterpartei) took advantage of this.

In 1928, the party had 2.6 percent of the vote, in 1930 it had 18.3 percent support, and in 1932 respectively 37.3 and 33.1 percent of the votes.

Adolf Hitler became chancellor in January 1933. The link to mistaken economic policy is all too obvious.

Greece

Policy and political responses to the Greek government – which was after all elected on a strong mandate in January – should be considered in light of this background.

It is both depressing and infuriating that Germany has been the main architect of the harsh austerity policy in the eurozone.

It is precisely German politicians who should know that this can pave the way to political extremism. Yet, the main person behind this policy, German Chancellor Angela Merkel, is almost always met with admiration and respect.

This must either be due to a neglect of history or the convenient submission to the prevailing view. Or possibly both.

Political extremism has already taken hold in some corners of Europe. Last year’s election to the European parliament is testimony to this.

The Greek government is signalling it is willing to fight hard to get the eurozone’s prevailing economic policy changed. Greece should be supported in its opposition to this policy.

A change of policy

When it comes to euro membership, the most favourable solution would be that Greece remains in it. Not least because Greeks themselves want to stay in the currency club.

But if this is to happen, euro countries need to meet Greece on two issues – debt and general economic policy.

As happened with Germany after both WWI and WWII, substantial debt reduction or debt concessions have to be given.

This could be done without a formal debt write-off. Interest payments could be cancelled or reduced, and repayment could be made conditional on the level of Greece’s GDP coming back to 2007 levels.

Second, economic policy must be changed.

EU countries that are able, such as Germany, Denmark, and the Netherlands, should pursue a more expansionary fiscal and employment policy. This would ease pressure on Southern European countries.

In return, Greece should commit to eliminate tax evasion and corruption.

Grexit

If Greece does not remain in the eurozone, which surely is an obvious risk, there should be a controlled exit to avoid other countries in the euro area to be unnecessarily affected by it.

Other southern European countries are most at risk. It will certainly require the other euro countries to guarantee repayment of the Greek debt and further support the exchange rate policy which Greece follows.

In short, history shows us that it would be exceptionally unwise not to support Greece in achieving a sustainable debt reduction. History also shows that democratic countries cannot keep on pursuing a policy that meets growing popular resistance,.

Christen Soerensen is Professor in Economics and former chairman of The Council of Economic Advisors in Denmark