1953: cancellation of the German debt

Germany heavily in debt after the Second World War

In 1951, Germany was still heavily indebted to treaties and other agreements. This debt was not only due to the 39-45 war. Germany still had to repay war damage incurred under the Treaty of Versailles, signed at the end of the First World War, as well as international loans contracted by the Weimar Republic, interest payments on which were suspended in the early 1930s. It must also pay for the aid provided by the Allies to rebuild the country after 1945. In all, Germany’s post-World War II debt is close to 40 billion marks: its cumulative pre-war debt amounted to 22.6 billion marks, and its post-war debt to 16.2 billion.

Against this backdrop, Chancellor Konrad Adenauer, head of the new Federal Republic of Germany since 1949, was concerned both with the return of sovereignty to his Allied-occupied country, and with his credibility in the eyes of his international creditors. It was essential for German companies to be able to finance their growth, and this at a time when the balance of trade was heavily in deficit following reconstruction, notably due to food imports.

Negotiations with the Allies and other creditor countries (21 countries in all) began in 1951, and were initially marked by the reluctance of representatives from France and the UK, who were still demanding repayment of pre-war debts never honored by Germany. The negotiating skills of Hermann Josef Abs, head of the German delegation, were put to the test, but experience showed that they were crowned with success.

Over 60% of German debt cancelled

This historic agreement was signed in London on February 27, 1953. It concerned a considerable reduction in the debt of West Germany, the Federal Republic of Germany (FRG). The aim was to enable the development of the German production apparatus. The debt contracted by Germany outside the two world wars was reduced by over 60%, with repayment of war debts and reparations to civilian victims and states postponed indefinitely. These last sums were not paid out until 1990, when Germany was reunified. Nearly 40 years later, inflation had taken its toll and German debts had been sharply reduced.

The reasons for this arrangement are quite simple. Aware that the demand for considerable reparations after the First World War had created a social climate that encouraged the rise of Nazism, the Western powers did not want to repeat this mistake and risk generating instability in Germany. In addition, they wanted West Germany to be economically powerful in the face of the Eastern bloc: this was the viewpoint of the United States in particular, which weighed heavily.

As a result, Germany’s debt burden was significantly lightened in 1953, but that’s not all: economic aid in the form of grants was provided, and Germany was allowed to adopt an economic policy highly favorable to its major industrial groups, whatever their role in the two world wars. This enabled the country to develop a solid public infrastructure and support both its domestic and export markets.

In 1953, it was the will of Germany’s creditors (the United States, the United Kingdom, France, etc.) that was the condition for its rapid reconstruction. Its cumulative pre-war debt amounted to 22.6 billion marks and its post-war debt to 16.2 billion: the agreement reached in London reduces these amounts to 7.5 billion and 7 billion respectively, a reduction of 62.6%. It also provides for the possibility of suspending payments in order to renegotiate their terms in the event of difficulties. And interest rates on the remaining debt are limited to between 0% and 5%.

Strong accompanying measures for West Germany

Moreover, with the aim of enabling the country to repay its debt while improving living conditions for its population, the Allied creditors accompanied this debt forgiveness with a package of measures favorable to the FRG state and companies:

• by accepting that the debt would be repaid mainly in deutsche marks, the country’s new currency, which supported the country’s export power (see the module on debt and the risk of foreign currency debt);
• by encouraging Germany to gradually substitute its domestic production for imports, 66% of which came from the UK, France, the USA, Belgium, Holland, Sweden and Switzerland between 1950 and 1951. While Germany’s balance of trade was still heavily in deficit in 1953, these Western powers were thus depriving themselves of an important outlet for their own production;
• by authorizing Germany to sell abroad in order to re-establish its balance of trade, a condition for the proper repayment of the residual debt;
• by making German debt servicing conditional on the country’s economic capacity. The London Agreement stipulated that West Germany should not use more than one-twentieth of its export earnings to service the debt. In concrete terms, West Germany will never devote more than 4.2% to debt servicing, the amount reached in 1959.

All these measures considerably lightened West Germany’s debt burden, and were taken after the Marshall Plan, when direct US aid in the form of 1948 and 1952 grants amounted to 1.17 billion current dollars. More than $200 million was also provided by the US Development Agency between 1954 and 1961.

Under these very favorable conditions, the “German miracle” could take place. Between 1950 and 1958, the national product multiplied by 2.8, the industrial production index rose from 100 to 274, and exports increased from 8 to 153 billion Deutschmarks. ² . Between the post-war years and the 1980s, the country rapidly became Europe’s leading economic power, and was able to absorb the economy of the former East Germany from 1990 onwards.

An agreement that should inspire us today

The massive debt relief granted to Germany under the 1953 agreement shows that, contrary to popular belief, it is possible and sometimes desirable to free a country from the burden of its indebtedness. This is not only desirable for the debtor (in this case, Germany, whose economy has grown considerably), but also for the creditors. Of course, the latter accept a short-term loss, but find a solvent debtor and a “partner” with whom to trade. All in all, the London agreement was clearly a win-win situation.

A moralistic stance would put forward the argument that accepting such a moratorium might encourage other debtors not to settle their debts. Public debt, in particular, should always be paid. This would be the only way to “discipline” states, their governments and populations.

The London agreement shows that this reasoning doesn’t make economic sense. The situation was also exceptional. The creditors could have limited themselves to considering that Germany should pay its debt all the more because it was responsible for a tragedy.

Since then, this agreement has often been evoked as a possible model during multiple debt crises. This was the case, for example, in the 1980s, when the level of debt faced by many developing countries was revealed. This historical case was also recalled during the debates surrounding the Greek crisis, notably from 2010 to 2012: the comparison shows that the fate reserved for Greek debt is far from that enjoyed by German debt in 1953. But that’s another story…