Almost 100 years ago, a young official in the UK Treasury sought to advise European policy makers on how daunting external debts might best be managed. There was, he argued, a limit to the national capacity to service debts. Those expecting further payments were bound to be disappointed. More than that, efforts by creditors to insist on further debt payments would be politically dangerous. “If they do sign,” he wrote to a friend, “they can’t possibly keep some of the terms, and general disorder and unrest will result everywhere.” He recommended a round of debt cancellation among European countries, a plan that would – at the stroke of a pen – remove much of the problem. When he was ignored by creditor governments, John Maynard Keynes quit his post to write the Economic Consequences of the Peace.

 

In today’s Europe, of course, the tables are decisively turned. It is not Germany that is suffering under an unsustainable sovereign debt burden, but its southern eurozone partners.

 

What is the German counsel? Answer: the economics of austerity. Countries with high sovereign debts must increase taxes and cut spending regardless of the consequences for the real economy. Angela Merkel likes to evoke the Swabian housewife: “In the long run you can’t live beyond your means.”

 

Underpinning the German position is the belief that resolving debt problems is the sole responsibility of the debtor. Keynes, by contrast, held that both creditors and debtors should share the task of getting economies out of holes they had jointly dug. “The absolutists of contract,” he wrote in 1923, “are the real parents of revolution.”

 

The economic effects of this policy are becoming clearer by the day...