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European Debt Crisis: The Lessons of John Maynard Keynes

In his latest investment blog, our Investment Manager, Colin Moore, looks to the lessons of famous economist John Maynard Keynes in relation to the current European sovereign debt crisis.

Are you sitting comfortably?

Most people I would hope have heard of the pioneering economist John Maynard Keynes (hereafter ‘JMK’) and even though he died in the 1940s many economists and investment managers still cite him as a major source of influence. His thoughts can be easily paralleled with economic events that are occurring at this very moment.

JMK actually had no economics qualifications but still became a lecturer in Economics at Cambridge University at the age of 26 (he was a superlative mathematician). He was seconded by the British Government during the outbreak of the First World War to help in the Treasury. When the war was eventually won he heavily opposed portions of the Treaty of Versailles – which crushed the German economy and people by imposing compensations that were set too high. Additionally, his views on writing down War Debt were ignored. As it turned out his predictions were all too accurate:

“If we aim deliberately at the impoverishment of Central Europe, vengeance, I dare predict, will not limp. Nothing can then delay for very long that final war between the forces of Reaction and the despairing convulsions of Revolution, before which the horrors of the late German war will fade into nothing.”

While I don’t believe such threats exist now there can be similarities seen in the story of modern day Greece as their sovereign bond holders (in the private sector) refuse to relax the unsustainable debt conditions and tolerate some form of debt write-down. This has caused nigh-on poverty in the country and youth unemployment of around 50% for the past few years. This will inevitably cause unrest – which happened in Germany between the wars.

Additionally, in 1925, the then Chancellor Winston Churchill returned sterling to the gold standard at pre-war valuation, against the advice of JMK who argued that it could force deflationary policies just when expansive policies were actually required. This was a bold and prideful statement that the UK was as strong then as it was before the war – which it was not. This effectively fixed the UK exchange rate at too high a level, causing a depressing effect on British industry which could have been mitigated with the ability of currency devaluation. Subsequently the gold standard was abandoned in 1931.

Direct parallels can be made with the euro, where the exchange rate is largely fixed by Germany. When the currency was set up, the value was too high even for Europe’s strongest economy but they managed in the early part of the 21st Century to cut costs and wages to regain their competitive edge. Peripheral European countries now find themselves in a position where they cannot devalue their currency and are meant to follow the German model but are unwilling or unable to reduce costs at such a level. One wonders about the fate of the euro with such imbalances.

It looks as though JMK would have had much to say about current economics and as George Santayana once famously wrote: “Those who cannot remember the past are condemned to repeat it.”