Peace Magazine Feb-Mar 1990, page 19. Some rights reserved.
Search for other articles by Morris Miller here
In 1932 at the depth of the Great Depression, the U.S. President Franklin D. Roosevelt said, "We have nothing to fear but fear itself." Today a different message is appropriate: We have nothing to fear but lack of fear itself. Anxiety can be good for you; self-deceiving illusions can be dangerous. When surgery is needed, aspirin is no cure. We are living an illusion and must act to counter the global malaise that now afflicts us.
The popular term for that sickly condition is "the global debt crisis." Debt reflects a pervasive disfunctioning of the global economy, which also takes other forms-notably a growing polarization of incomes between rich and poor nations. The trends are worrisome, but there is no need for despair, if we summon an imagination equal to the challenge.
The global condition is deplorable and getting worse. From one-third to one-half of humankind is not getting enough to eat, or to clothe themselves, or to live in pride, hope, or human dignity. In fact, their conditions are worsening.
The word "crisis" should not be used loosely. It is defined as a condition that cannot be continued, a condition that in its dynamic portends a radical change. The global debt crisis is just such a situation. Let me sketch its key features. In 1982, Mexico and Brazil said they could not continue with business-as-usual in servicing their foreign debt. The world became aware that there was a crisis. Creditor banks were threatened on a scale that evoked fears of a breakdown akin to the Great Depression. Since then the Third World debt, most of which is owed to private commercial banks, has almost doubled-from about $700 billion to about $1.2 trillion by mid-1989. The debtors have been unable to service their debt, so the unpaid interest has been added to it.
Just to pay the interest (let alone the principal) they would have to devote on average over one-third-and for some, all-of their export earnings. Under the rescheduling arrangements, they have been obliged to cut back on their imports and devote their output to exports at the expense of their domestic market and basic domestic needs. This has severely damaged their productive infrastructure-their roads, bridges, and power systems, as well as health and education systems.
The negative transfers (that is, from the poor to the rich) are now running at a level of $50 billion a year-a magnitude that exceeds the flow of official development assistance (ODA).This is lowering the already low standard of living in debtor countries. Africans have suffered a drop in average incomes of about 25% over the 1980s, Latin Americans, over 10%. This understates the impact on the poor of those nations. In Brazil, the largest Third World debtor nation, the poorest fifth of the population receives only one fiftieth of the nation's income. If one looks at the "misery index," shortening of life, infant mortality, and other morbidity indicators, the picture is horrendous. They are cannibalizing their economy to survive at a level that can hardly be called living. Worst of all, they do so in the knowledge that they are foreclosing hope for their children and grandchildren.
Is it any surprise that these nations are tinderboxes, ready to explode into rioting and civil breakdown? At the end of last year, 24 nations were waiting in line for the excruciating ordeal of debt rescheduling. In the last decade, fifteen African countries have rescheduled their debts over 50 times. After the riots in Caracas last March, Venezuela's President said, "The problem that we face can be spelled out in capital letters: FOREIGN DEBT."
The creditors are content to continue playing this tragic game of brinkmanship, the debt rescheduling. They ask themselves: What is the breaking point? The idea is to get as near to that point without going beyond.
This is played out in an environment that-to put it mildly-is not congenial for the recovery of debtor nations. The suffering is not symmetrical on the sides of creditors and debtors. The industrial countries accept muddling-through on a case-by-case basis rather than seeking a general debt relief.
The G-7 meetings-where the leaders and finance ministers of seven major industrialized nations get together-are "dog and pony shows." Their post-meeting declarations endorse muddling through. When it becomes clear that some countries cannot pay, some of the G-7 leaders magnanimously announce some forgiveness of debts owed their governments. On one occasion, the gesture was blazoned in large headlines. The debt forgiveness amounted to $12 billion, which is 1% of the $1200 billion.
There is method to this madness. What they are doing is buying time for their banks to build their reserves. The banks had been in jeopardy with the dubious assets labelled "accounts receivable" amounting to a sum several times larger than their capital assets. This threatened the solvency of many major banks. Time was needed to bring down the ratio to manageable levels by building reserves against the day of eventual default or drastic write-down of these questionable receivables. By increasing their reserves against bad debt, the banks reduced their profits and their taxes, effectively making the public pay for their horrendous mistakes in judgment. We have yet to see one bank president sacked for aiding and abetting the build-up of the global debt crisis.
Yet what have the G-7 leaders proposed in their plans, labelled "Baker" and "Brady"? They are still relying on these culpable bankers to help solve the crisis. But these bankers, once bitten, are twice shy. They will not lend to Third World countries except to reschedule debt-that is, forgive a little of the interest due by adding it to the debt. The bankers are being asked to exercise social responsibilities. You might as well ask cats to bark. Banks are not in the business of providing charity. They are getting out from under an uncomfortable situation by building up their reserves against bad debt as fast as they can. This reduces their tax obligations and the leverage that governments can use to pressure them to do what they are unwilling to do voluntarily.
Historically, commercial banks have not been the main instruments through which money was transferred to these countries. They got into this act in the early '70s, by virtue of the decision by the governments of the industrialized nations to keep the World Bank and the IMF from playing a principal role intermediating petrodollars-the huge profits reaped by the new oil cartel. The banks went in to fill a vacuum. This historical aberration proved to be the beginning of a global disaster. But it should have been anticipated by a priori reasoning: Developing countries cannot rely on borrowing from private banks as a major source of funds for general development purposes. If they want to borrow for investment in strengthening their infrastructure, their education, their health, and all of the things that make it possible to be a productive country, they cannot pay interest rates of more than 1 to 2% in real terms. That's what we paid when we were in our early developing phase. Developing countries in recent times have been paying rates several times higher. It takes only simple arithmetic to reveal that if you borrow at a higher rate than the productivity of the capital for which the funds were borrowed, there will be a default or rescheduling. The Lester Pearson Commission, in its 1969 World Bank Report, Partners in Development , forecase a debt crisis by the mid-'70s. That outcome was aborted by the impact of the oil shocks of 1973 and 1979. The private bankers were left to handle the recycling of petrodollars until the summer of 1982! Having lent on the assumption that sovereign debtors don't go broke, the bankers are not prepared to forgive. With a few notable exceptions, they insist that debtors must take their lumps-whatever cost that this implies in terms of human suffering.
What will it take to get out of this mess? There are four minimum conditions that are required:
Let's look at the record. Global growth? The average rate of growth over the last decade has been below 3% and, according to OECD forecasts, will likely grow by 2.3% next year (Canada, 1.9%). The growth rate is dampened by the fact that the debtor developing countries have to cut back on their imports from the industrialized countries. It is estimated that in the U.S. one out of six manufacturing jobs depended on Third World countries buying manufactured goods from the U.S. This interdependence is a vicious circle.
Primary commodity prices and the terms of trade? The prices of key commodities on which the economies of many developing countries depend are still at a level not seen since the Great Depression of the 1930s. In 1986, for example, The Economist estimated the loss from deteriorating terms of trade at $65 billion-which is more than 50% higher than official development assistance (ODA) of that year.
Interest rates? They are now 3 to 4 times higher in real terms than the sustainable maximum, and show little prospect of returning to that historically lower level.
Financial flows? Until 1982, capital flowed at a rate of about $150 billion per year-counting ODA, private lending, and investing-and since then turned negative. Cumulatively since 1982, over $140 billion has flowed from the poor countries, increasing over time until this last year alone it reached $50 billion, higher than the flow of ODA.
The first order of business is to stop the perverse direction of this capital flow. This will be very hard to do, but drastic debt relief would be a necessary beginning. Beyond that, attracting capital will be hard and slow. Look at Argentina, a country from which I have just returned. Their economy is in a sorry state, as capital leaks (or "flies") out. Capital flight is hard to stop when an economy has a gigantic debt; the uncertainty makes it foolhardy to invest there. Inflation in Argentina runs at over 300% per month.
A few debtor nations are recovering some of the capital that had flown into Swiss and American bank accounts in previous years. They are doing so by trading debts for equity-transactions called "debt-equity swaps." A veritable smorgasbord of options is being offered to tempt investors to accept deep discounts on the debts, which are kept on their books at fictional face value. Such financial arrangements are of limited potential. Meanwhile, the negative flow continues.
If private bankers and investors won't play ball, what about the international financial institutions: the IMF, the World Bank, and the other regional multilateral development banks? The IMF is now taking in more than it lends, despite the establishment of new lending facilities and an increase in its capital quotas. The World Bank is lending at a rate in excess of $15 billion per year and is barely able to disburse more than it is receiving because of the reflow from loans it made over the last few decades. Capital increases have recently been authorized and further demands are being made of the creditor nations for interest-free loans and grants. But, given the political climate, such increases in the sustainable lending levels and granting programs will go only a short way to providing the quantities of capital required.
Clearly, there is an urgent need for sweeping structural changes. The debtor developing countries are said to merit debt relief if they undertake "structural adjustments."
But what is needed is a structural adjustment of the global system. Avoiding breakdown is too modest an objective. The present system maintains poverty in an age when it is technologically possible to eradicate poverty. The rich are getting richer and the poor, poorer-even inside the richer countries. The real standards of living for most of the population have been falling since 1982, especially in countries such as the U.S. and Canada.
Over the past few years, some proposals have come forward for providing the required capital. They include the following:
Interest rates globally are high mainly because the U.S. absorbs over half of the world's available capital. As everyone knows, if supply remains fixed and demand increases, prices go up. The price of capital is high because, although Americans are not saving, they require capital to maintain their economy. They prefer to use the savings of foreigners. For every $3 of imports, they pay with $2 of exports and $1 of IOUs. The IOUs or debt is increasing at the rate of $150 to $170 billion a year. They are not merely living off the savings of foreigners, but in the process crowding out the Third World from the capital markets by raising the price of capital to a point that is beyond their reach.
This trade deficit has persisted despite the fact that the U.S. dollar has dropped in value by 50 percent over the last three years. This should have made U.S. exports cheaper and imports more expensive, which in turn, should have helped bring down the trade deficit. Why hasn't this happened? Because they United States's productivity has been increasing at a slower rate. The U.S. economy has become McDonaldized; it has become a service economy. And it shows the signs of mis-directed investment, going particularly toward armaments and conspicuous consumption. This misallocation needs to be changed or the U.S. will remain part of the problem, rather than the solution.
The real danger of the "international debt crisis" is less the threat of Third World defaults than the incapacity of the U.S. to help steer the global ship through the storm. U.S. policymakers are between a rock and a hard place. If they try to lower interest rates, the Japanese and others won't buy enough of their treasury bonds and other assets to sustain the economy. If they raise interest rates to keep foreign funds flowing in, the Third World countries cannot service their debts, which dampens American economic growth.
This situation is unsustainable and in danger of collapse. Here's one possible scenario of breakdown. The Japanese continue to resist the temptation of spending their surplus on themselves and instead leave much of their surplus in the U.S. by buying Rockefeller Centers and Hollywood studios. These investments in symbols of American pride touch raw spots in the American psyche. Political pressure builds up to limit these foreign investors. Although Americans argued that Canadians ought not review foreign investment takeovers, they may do exactly that themselves, now that the shoe is on the other foot. Such regulations could lead to a sudden drop in the willingness of foreigners to spend their U.S. dollars in the U.S. The balloon would pop. Without that inflow of funds, the U.S. economy would collapse-and the global economy with it.
You may think that we have institutions that can prevent this from happening-that we have built barriers against another Great Depression. Not so: The current situation is as fragile as it was then. In the early 1970s, much of the banking industry's operations went off-shore to escape the regulatory framework of their national governments. This enabled bankers' syndicates to lend to the Third World in an orgy of petrodollar recycling. Today over $400 billion each day is transferred electronically between the major capital market centers. When the G-7 nations want to stabilize their currencies by buying or selling in the currency markets, they cannot affect more than 10% to 20% of this amount. This is like a loose cargo on a ship at sea. One day it will go through the hull. The stock market tremors of October 1987 showed what might happen.
The U.S. is a linchpin in any solution. It must increase its productivity. However, this requires a cultural revolution that would increase savings, either voluntarily or through taxation, and reduce its demand for capital from abroad. The demand for capital is enormous, given the neglect of the country's infrastructure. About three out of every four bridges in the U.S. need massive repair. Look at their needs in health care, education, and research! With interest payments so high and military expenditures so sensitive regionally, there is little room for discretionary savings. The taxation route is politically taboo, Read-My-Lips Bush having painted himself into a corner, so there is little chance of reducing the budget deficit and, with it, the trade deficit. So interest rates will remain at their unprecedented high levels, and Third World debtors will remain under continued strain.
There is a chorus of calls for a new "Bretton Woods," the system of rules for international trade and capital flows that prevailed from 1944 to 1970. This system was designed mainly by U.S. and U.K. officials at the end of World War II in Bretton Woods, New Hampshire. While it prevailed over a quarter century, it brought stable exchange rates and growing volumes of trade. The income grap between rich industrialized nations and poor developg ones was closing. The Bretton Woods system, like the Gold Standard system before it, came to an end when the leading economic power refused or was incapable of respecting its obligations as a reserve currency country. It was President Nixon's decision that spelled the collapse of Bretton Woods when, in the late 1960s, the U.S. Administration chose to finance the Vietnam War by printing money rather than raising taxes. There ensued a loss of confidence in the U.S. dollar. The U.S. closed the gold window where paper dollars could be traded for gold. The price of gold shot up from $300 to $800 per Troy ounce. The collapse of the system led to volatile exchange rates, growing income polarization, and finally the debt crisis that still hangs over our heads.
Some means must be found to reimpose discipline on the world's major economic players. The G-7 meetings are harbingers of an arrangement that will in time include the Third World. There have also been calls for a new Marshall Plan-the arrangement whereby the U.S. lent (and later forgave) over 2% of its GNP for the rebuilding of Japan and Germany. That impressive effort contrasts sharply with the 1/5 of 1% that is now the extent of U.S. aid. If the U.S. would multiply its allocation for aid ten-fold, and if the Japanese, Germans, and other trade surpcountries would also contribute more, the flow of capital would be enormously increased. Diversion from arms expenditures would make it politically feasible.
Given the technological breakthroughs of our era, there is no reason why every single person on earth could not enjoy those things that are required for human dignity and well-being. If we were to contribute a small fraction, say 10% of the incrementi our standard of living, to funding Third World development, they could enjoy a rising standard of living again.
Morris Miller is Adjunct Professor, University of Ottawa, and formerly Executive Director, World Bank.
Peace Magazine Feb-Mar 1990, page 19. Some rights reserved.
Search for other articles by Morris Miller here