The German Transfer Problem, 1920-1933: A Sovereign Debt Perspective

The severity of the Great Depression in Germany has sometimes been blamed on reparations in simplistic fashion. Alternative interpretations relied on American capital exports, the demise of the Gold Standard, or on malfunctions of the domestic economy, such as excessive wage increases during the 1920s. This paper argues for a more subtle link between Germany's slump and these policies. I explain Germany's foreign borrowing rush before 1929 from transfer protection under the Dawes Plan, which gave commercial credits seniority over reparations. I argue that the Young Plan of 1929 implied a reversal of this seniority scheme, causing a sudden stop and reversal in the German balance of payments that lasted throughout the Great Depression. Invoking basic results of sovereign debt theory, the paper identifies a sequence of reparation regimes with varying degrees of relaxation of Germany's participation constraint in international credit markets. Transfer protection under the Dawes Plan created an incentive for Germany (and her commercial creditors) to drive out reparations. I conclude that the Young Plan could only have worked in the absence of an international recession, and that attempts to salvage it in 1931 were necessarily futile.