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Banks: The Coming Crisis

Report on Developing Countries’ External Debt and Debt Relief Provided by the United States

US Treasury

International Financial Cooperation for Development TD/188, TD/188 Supp. 1, Add. 1

United Nations Conference on Trade and Development, UNCTAD IV.

Foreign Assets and Liabilities of US Banks Multinationals Corporations

US Senate, Committee on Foreign Relations, Subcommittee on

I

There is a view, quite widely held, that the events of the last two years prove the fortitude of the international financial system. None of the largest banks in the world failed in the economic crisis of 1974-1975; no countries went broke. The neurotic episodes of 1974 and 1975 did not become a psychosis of the entire system, from Nassau and Liechtenstein to Chase Manhattan Plaza.

The fear is largely behind us,” one prominent American banker sighed in 1975. International banking has come through “this period of uncertainty,” Mr. Richard Debs of the Federal Reserve Bank of New York noted, toward “the emergence of an even healthier and stronger system.”1 This view, or optimists’ position, is not ridiculous. Since 1973, the worst and most widespread international recession since the 1930s has taken place. At the same time, there was the greatest movement of financial resources—from oil importing to oil exporting countries—since the years of reconstruction after World War I. The modern financial order survived these changes without a breakdown comparable to that of the early 1920s and the Depression.

The optimists see further, positive signs of fortitude. “Despite the dire earlier predictions,” Mr. Debs writes, “the system has not only survived but has contributed in a significant way to coping with the problems of ‘recycling’ [oil revenues].” Banks, that is, have borrowed money from oil-exporting countries and loaned it to countries which import oil. Money was recycled through the intermediation of private banks.

David Rockefeller explains the procedure as a question of destiny. “Multinational financial services corporations,” he has written, “were called upon not only to expand their more traditional activities, but also to take on important new responsibilities as well.”2

All the same, one great crisis is still to come. A prospect of unprecedented peril for hundreds of banks and for the system itself, it promises misery and destruction; and with the most profound political consequences.

This is the crisis of the developing countries’ debts. During the 1970s, the developing countries, oil-exporting countries aside, have borrowed more money than in their entire previous history. They now owe some $100 billion to the rest of the world.3 Together, they are spending more than 15 percent of all the money they earn from exports to meet interest and service payments on their external debt.4 By far the fastest increase has been in debt to private banks.

The question for the financial system is not whether these debts will be dishonored. Rather, it is an issue of when, and how, and where. It is certain that at least some of the developing countries’ debts will be rescheduled; that at least some countries will find themselves unable to repay their loans on time, or to meet interest payments. Several countries—Chile and Zaire are notable examples—have renegotiated debt payments in the past year. The new military government of Argentina last month arranged a respite or “roll over” of 120 days on some of its foreign obligations.

The peril to come—the big fear—lies in the conditions of the rescheduling. A debt crisis in one country may lead to further difficulties. One country’s crisis may bring other derelictions: one, two, many Zaires. It may bring the failure of banks, and the breakdown of the system.

The next few months are critical. Even the US Treasury, which takes a resolutely sanguine view of the debt question, sees trouble for several countries later in 1976. Eight countries, according to a recent Treasury study, deserve to be “watched very closely,” including Chile, Peru, Argentina, and Zaire.5 Until the world economy recovers, both the banks and their debtors are in imminent difficulty.

Beyond 1976, there are further problems to come. For the rest of the 1970s, debt reschedulings will be a perpetual chorus in international relations. Several countries will find themselves paying ever more of their earnings as debt “service”—payments of both principal and interest—in 1977 and 1978. The costs of the bank lending boom are only now beginning to come due.

The origins of the debt crisis lie deep in the financial history of the past ten years. The developing countries greatly increased their debt in the recession of 1974 and 1975. This was the recycling process, where banks financed the import of oil, food, manufactured goods. Yet even before 1974, several countries were borrowing unprecedented sums from foreign banks. There was a “good” bank lending boom which preceded the “bad” boom of the recession. For US and foreign banks, the early 1970s were a time of euphoric expansion in Brazil, Peru, the Far East. In the next few years, countries will be paying interest and principal on each set of loans: on both booms.

The debt question will engage the deep political and economic interests of the rich countries, and above all of the United States. Debt is one of the ways in which the developing countries reach out into the banks, the banking system, the national interest of industrialized countries.

Statistics released recently by the Subcommittee on Multinational Corporations of the Senate Foreign Relations Committee provide a view of what is involved for the largest US banks. In Latin America, the twenty-one largest US banks together have made loans now worth more than five billion dollars to Brazil, and another five billion dollars to Mexico; they have claims of more than one billion dollars on borrowers in Argentina and in Peru.6 These figures cover only part of the US banks’ claims, in that they exclude all loans guaranteed by the US government and by US corporations. Yet the banks’ total profit, by contrast, amounted to a little over two billion dollars in 1975.

The involvement of the banks brings political consequences. The relationship between creditor and debtor countries has changed since 1970, and in a way which is as yet scarcely acknowledged. The change goes beyond the increase in borrowing to the new conditions of debt. Ever more of the developing countries’ debt is owed to private banks, as official aid fails to keep up with the growth in the world economy. The distribution of resources is determined, increasingly, by the lottery of private lending, with Brazil or Zaire the big winners. The lasting question for debtor and creditor countries is whether this new order—the new financial basis of development—can be and should be sustained.

These issues are of particular importance for the United States as the largest creditor, with the most claims on developing countries and the most banks at risk. In the next few years, the US government will be confronted again and again with the question of the extent to which it will stand behind its private lenders. Will it assist foreign borrowers, in order to help US banks? The choice will influence US foreign relations. Public munificence would amount to an endorsement, after the fact, of the pattern of lending determined in the bank bonanza of the 1970s; it would mean a further public commitment to Brazil and to the other big borrowers.

There is already an embrace of mutual terror which binds the United States to the creditors of its private lenders. The client countries have a counter-power of their own. Chile is a case in point. The United States was able to wound the Allende government by limiting public and private credit to Chile. Now the US is bound to the Chilean junta not only by political will but also by the loans of American banks. When US officials agreed last year to reschedule Chile’s debts to the US government, they explained that “the choices open to the creditors were either to reschedule or to accept default.” “Cognizant of the unfavorable financial precedent that would be established by default,” they wrote, the creditors therefore agreed to reschedule.7

The change from aid to private lending is part of a quite general change in US policies in the last ten years. In all its involvement with foreign countries, the US has ceded more and more license to private enterprise. The US now earns more dollars from private arms sales than it spends abroad for all military purposes.8 Government-financed exports of food account for an increasingly tiny fraction of all US agricultural exports, amounting in 1975 to less than 15 percent of the value of US farm exports to developing countries; the rest consists of private sales.

As in arms and agriculture, the shift to private bank lending will have consequences for US foreign policy. There will be wars fought with American arms; shortages of food; debt crises. These consequences are nowhere more important, and more unknown, than in the question of debt.

The years since the mid 1960s have been among the great eras of bank expansion: a time of euphoria that can be compared with the bank boom of the 1860s in France and Britain. International lending increased enormously, as banks flourished from Nassau and London to Singapore. The US banks, in their multinational operations, were leaders in the boom.

For most of this century, the foreign business of US banks was leisurely, with Chase Manhattan on the rue Cambon an attraction much like American Express by the Place de l’Opéra As late as 1964, only eleven US banks had overseas branches. By 1974, according to a congressional study, “there [were] 125 banks and 732 branches overseas, and branch assets [had] grown from $6.9 billion in 1964 to $155 billion.”9 Chase Manhattan, now, has branches in twenty-eight countries, with subsidiary banks from Nigeria and Malaysia to Belize.

The new business has been lucrative. In 1975, each of the five largest US banks made more than 40 percent of its profits from foreign operations. Chase was an extreme case. It earned 64 percent of its profits abroad, as compared to only 22 percent in 1970. Its foreign earnings had increased more than 300 percent in the previous five years, while its domestic earnings were lower than they were in 1970. After ten years of boom times, the foreign business of the US banks was vast, and had increased very fast. It was of great importance to the banks’ profits, and thus to the US banking system. It was also free of government controls, at least by the standards of the regulations imposed on US domestic banking.

The banking boom corresponded to real changes in the world economy. In the expansion that began in the 1960s, the US economy grew less fast than the economies of Europe, Japan, and of some developing countries. People borrow money when times are good, and in the world outside the United States times were better for longer than ever before.

Many US multinational corporations increased their foreign investment faster than they increased their domestic spending. The US banks followed their multinational customers to London, Brussels, Brazil.

The boom in overseas lending also corresponded to needs more peculiar to the banking business. For the US banks, foreign expansion has been a way of avoiding the more exigent of US government regulations. Since the banking reforms of 1913 and 1933, US banks have been subject to fairly strict controls in their domestic operations. The Federal Reserve, which has prime responsibility for the banks’ foreign operations, is much less demanding in its supervision of what US banks do abroad, and how they do it.

  1. 1

    G.A. Costanzo, Vice Chairman of Citicorp, January 27, 1975; Richard A. Debs, Monthly Review of the Federal Reserve Bank of New York, June, 1975.

  2. 2

    Report from Management,” The Chase Manhattan Corporation Annual Report, 1974.

  3. 3

    This figure covers only those external debts which are guaranteed publicly in the borrowing country. It also covers only debts for terms of more than one year. Private and short-term debts might add another $30 billion to the total figure.

  4. 4

    UNCTAD IV International Financial Cooperation for Development, supporting paper, TD/188/Supp 1.

  5. 5

    US Treasury, “Report on Developing Countries’ External Debt and Debt Relief Provided by the United States,” January 1976.

  6. 6

    United States Senate Committee on Foreign Relations, Subcommittee on Multinational Corporations, March 11, 1976.

  7. 7

    Quoted in the US Treasury study, op.cit., p. 88.

  8. 8

    Economic Report of the President, January 1976. “US Balance of Payments,” p. 274.

  9. 9

    US House of Representatives, Committee on Banking, Currency and Housing. “Financial Institutions and the National Economy, Discussion Principles.” November, 1975.

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