We have made a labyrinth and got lost in it. We must find our way out.
The first oil price rise at the end of 1973 led the less developed countries of the world to begin borrowing very heavily from the governments, private markets, and banks of the West. Much of the money they borrowed came from the surpluses of the OPEC nations and was recycled to them by Western banks. They now probably owe around $800 billion, something under half of it to private banks. The bankers gave little serious consideration to the inability of the less developed countries (LDCs) to pay the interest on the debt or make payments on the principal. The LDCs were sovereign countries, and for the bankers default was unthinkable; new credit would therefore always be available. But the process of snowballing debt made these confident assumptions harder and harder to believe.
For some time now most of the LDCs have been unable to raise the money on private markets to meet their debts to the private banks: they have been obliged to renegotiate them, usually after agreeing to alter their economic policies. This process, known as “rescheduling,” is simply an agreement on the terms for deferring capital repayment obligations and interest payments.
All of this has been done on a “pragmatic,” case-by-case basis, which means that the creditor banks and governments have dealt separately with each debtor country’s situation. Where you are dealing with the difficulties of an individual debtor this response is all that is required to provide the necessary breathing space within which resumed payment can be organized. But where most of the debtors cannot meet their obligations punctually there is a generalized international debt problem, and a more fundamental analysis is required to discover what has gone wrong and how to put it right. Unfortunately no such analysis, or outline strategy derived from it, has been attempted by the leading governments concerned.
The central question that must now, belatedly and explicitly, be asked is whether a system of large-scale, purely commercial lending by the private banks to poor countries can be sustained. Commercial lending is based on the assumption that the transfer of resources that it makes possible will sufficiently strengthen the ability of the borrower to create wealth that will allow him to pay interest on his loan and ultimately repay the capital; the lender would correspondingly come to enjoy the interest—“rentier income”—until the repayment occurs.
When the lending is across frontiers, the borrowing country usually starts off with a deficit in its overall trading accounts, reflecting the inflow of imports obtained on credit. If the debt involved is to be repaid, the borrower must at some future time achieve a trading surplus. The current practice of rescheduling payments could only provide a solution if we believe that the debtor countries will at some point start to run large and continuing trading surpluses with the developed world.
But the sums to be repaid are already gigantic, and the “rolling over”—or rescheduling—of interest payments adds to them enormously. Recently the problem has been aggravated by the steady rise of US interest rates. In addition, many of the borrowers need fresh capital in order to resume development. No one has so far been bold enough to estimate the date when it would be reasonable to expect these debtors to achieve the export surpluses required to meet their ever-increasing interest payments, let alone repayment of the debt. This is no surprise, because the size and duration of the surpluses required are historically unprecedented and the countries involved—including Zaire, Brazil, Argentina, and Mexico, for example—are exactly those that have the least chance of producing them.
Achieving a trading surplus is a much more complicated and costly process than neatly depriving a country’s citizens of an equivalent amount of consumption. The entire economy has to be bludgeoned into spending less, and even the best-run societies suffer a loss in wealth production that is far greater than the surplus required. France today provides an instructive example as did the United Kingdom in the 1960s and 1970s. The LDCs are not among the best administered societies, and the degree of real control that governments have there is tenuous. The notion that they could generate the surpluses required to service existing debt is, in my view, in the highest degree improbable. The performance will vary from country to country, but the result for most can be in little doubt.
There is a second problem. However vigorously their economies may grow, the debtor countries will in the foreseeable future always have an average income per person very much less than that of their creditors. Will it be politically feasible, on a sustained basis, for the governments of the debtor countries to enforce the measures that would be required to achieve even the payment of interest? To say, as some do, that there is no need for the capital to be repaid is no comfort because that would mean paying interest on the debt for all eternity. Can it be seriously expected that hundreds of millions of the world’s poorest populations would be content for long to toil away in order to transfer resources to their rich rentier creditors?
But let us make the assumptions that the debtor countries will at some distant date be able to pay, and that their people will over a lengthy period assent to the exactions required. There is still a third difficulty. Can the lending countries themselves deal with the problems of becoming rentiers on this scale? The required trading surplus of the debtors could be obtained only by a major reduction in their imports of manufactured goods and by a vast increase in their manufacturing exports. This would create adjustment problems for the developed world much larger even than those raised by the present Japanese export surplus. The structural changes that would be required inside the advanced countries to accept a continued export surplus in manufactured goods from their debtors would be very great indeed. Even the bonanza income from the discovery of oil in the North Sea—income which we are free to spend as we choose—has raised serious problems for the economies of Britain and Holland. An interest income that would perforce come back to us in the form of goods manufactured abroad would create problems of adjustment recalling the reparations that bedeviled the world economy after World War I.
These are not fantasy problems. Even now, the relatively modest attempts by the LDCs to eliminate their current account deficits have raised very great difficulties for them and for us. They have suffered a fall, in some cases a sharp fall, in living standards. For countries like Brazil and Mexico real living standards have dropped by 15 percent during the last three years and in other countries it is much worse. In the developed countries we have felt acute pressures on some industries from the arrival of cheaper goods on the international market and we have seen a rapid increase in protectionist sentiment to put up tariff and other barriers against them. Any movement toward protectionism would, of course, make the ability of the LDCs to achieve a trading surplus even more hopeless. But what we have seen so far is as nothing compared with what would be needed by both of us in order to achieve the volumes of trade required to service these debts in the future. Anyone who has studied the experience of recent years will not find credible the proposition that either party can make the necessary adjustments without enormous mutual injury.
I judge, then, that most of the debtor countries will be unable to pay back most of their loans and that, even if they could, their people would not allow them to make the payments. Further, even if these countries could and would be able to pay, I do not believe that the developed countries have the ability to cope with the demands and burdens of being rentier nations on the scale that would be involved. For the most part, the reality for the poorer nations is that they can’t pay, won’t pay, and major efforts to repay couldn’t be accommodated in any case. In short, the modern world’s arrangements do not permit lending of this size to poor countries to be repaid, in real terms, within a commercial time scale.
None of this necessarily means that a transfer of resources to the LDCs should not have taken place. Nor is it to deny that the best, and perhaps the necessary, way of doing so was through commercial agencies. But there should have been, at the outset, government involvement to determine the size and conditions of the lending and to prevent the misdirection that was the fate of too much of it, whether in the form of unnecessary arms purchases or currency conversions or megalomaniac projects. What the situation I have described does mean is that our governments and central banking authorities should belatedly recognize that the commercial bank lending that they encouraged and permitted must now be supported by them, after the event, in order to preserve the proper functioning of their banking systems, to avoid serious disruption of world trade, and to help support the political and economic development of the LDCs.
The first of these, the proper functioning of the banking system, is now urgently coming under question. The nine biggest banks in the US have lent to risky countries in South America and elsewhere sums amounting to more than 250 percent of their capital and reserves. If less than half of this money were to prove irrecoverable they would be without any capital at all. But even if a very much smaller percentage were suddenly lost, the impact could endanger their stability and ultimately that of the entire American banking system. Their position to a lesser extent applies to all the great banks of the world. We are not dealing with the isolated misjudgments of a few banks but with the worldwide overcommitment of an interlocking banking system. Moreover, the banks did not act in isolation. Their decisions were approved and encouraged by their governments. The governments and banks were in this system of lending together, and only together can they come out of it without major damage to the financial and economic system.
A number of proposals to relieve the situation have been made. These range from rather vaguely formulated international guarantees of existing debt to transfers at a discount of some or all of the bank debts to an international institution. This is not the place for a detailed criticism of these proposals, but few of them envisage a sufficient release for the banks from the dead weight of existing debt, and most assume unrealistic demands on the LDCs.
In my view, the minimum required to preserve the effective functioning of our banking system is that the leading governments should create the machinery, and provide the funds, whereby current interest on the debts can be paid by the debtors to the banks. One way to achieve this would be for the export credit insurance agencies of the creditor countries to be authorized, on the advice of the IMF, to guarantee new lending equal to the total interest payments required. The cost of these guarantees would ultimately have to be met by the concerned governments. It would amount to a maximum of $35 billion to cover the first year, and would diminish each year thereafter as the debts were written off.
This is less than half a cent per dollar of the creditor countries’ annual income—and less than one-tenth of the potential annual growth of that income. It is a small price to pay to reduce the jeopardy to the global economic and political interests now at risk. Such a plan would enable the LDCs to modify the policies that are now producing net transfers from them to their creditors, because they have achieved a trading surplus but not enough to pay the whole interest on their debt. Such net transfers are in effect partial payments of interest. They are bought at the cost of economic stagnation and political destabilization. They cannot in any event be sustained.
Given a guaranteed flow of interest for a sufficient number of years, the banks could cope with the necessary write-off of bad debts. Precisely how much it will be necessary for them to write off is not yet clear but it follows from the foregoing that I would judge it to be a very considerable proportion of the whole. In my view, a realistic write-down over an extended period of time—perhaps ten to fifteen years—is the maximum burden that can be safely imposed on the banks.
This process should not be conceived simply as bailing out the banks. Rather, it is an attempt to protect the basic financial and economic structures of the developed world and of their debtors from the consequences of the imperfect emergency measures taken to deal with the oil price rises of the 1970s. Without bank lending there would have been a world crisis long ago. That is why the lending was approved by the creditor governments in the first place. It was by no means ideal for the OPEC surplus to be recycled to the poorer nations chiefly through loans from Western commercial banks. The fact is that no other method was available at that time.
In addition to securing the soundness of the banking system, the authorities must also decide what genuinely new funds should be provided to the developing countries to enable them to resume some economic growth. I am not here attempting to assess what is required but I am urging that, for the first time, the political leaders at the summit come at least to outline decisions on (1) whether new funds should be provided, (2) if so, how much, on what terms, and how they should be apportioned, and (3) the mechanics to achieve such transfers. In my view, there ought to be such transfers but on a much smaller scale than that of the last ten years. Further, the funds should not be made available on conditions designed to secure early repayment. The transfer should be exclusively conditioned on their being used productively to strengthen the economies of the debtor countries. I believe that these terms could be acceptable to the borrowers and would be in the interest of both lenders and borrowers and could be monitored by the IMF with a somewhat modified mandate than it has had up to now.
Many still live with the comforting assumption that the present method of taking piecemeal action is enough to deal with the threats to the financial systems of the creditors and debtors. I believe this proposition to be manifestly unsustainable. We have created a time bomb of debt because we too readily accepted the false assumption that the risk of lending to sovereign countries was no risk and that indefinite refinancing would be available to the debtors. We are now living with the illusion that emergency patchwork measures will prove adequate to sustain a dangerously unsound edifice. So long as we leave the central issues untackled, far from solving the problem we are deferring it and allowing it to grow bigger as the debt mounts.
Unfortunately, the difficulties that deterred the Western governments from making a long-term analysis in 1974 exist with even greater force now, since they have to deal with the huge past debt as well as the future investment needs of the LDCs. Moreover, the problems can be solved only by cooperative and collective action by the OECD governments. This is wholly at variance with the preference of the Western governments, which is to act as case-by-case crisis managers. Only a shift in their position will offer protection from the very grave dangers that threaten us.
If we are told that there is insufficient political will available to move to an intelligent, coherent, and sustainable solution to our problems, then for my part I must warn that this is equivalent to being told that there is insufficient political will to avoid an impending series of the most dangerous financial, economic, and political crises that have faced the world since World War II.
June 28, 1984