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The two faces of third world debt: a fragile financial environment and debt enslavement.

The tremors that shook the financial world during 1982 and most of 1983 have for the time being subsided. But the ensuing calm is an uneasy one: clearly, the crisis has merely been postponed to another day.

The sense of panic among the financiers and governments of the leading capitalist nations is not the product of idle rumors or vague fears. It has been obvious for some time that the vast expansion of third world debt would sooner or later create serious problems for the international bankers. But the outsize profits to be made in the third world have been too tempting to be resisted by even the most prudent of the bankers. The chickens began to come home to roost in 1982. In that year, 22 countries were forced to negotiate debt rescheduling because they could not meet their contractual payments. And it is evident that the fat was indeed in the fire when the three largest third world debtors--Mexico, Brazil, and Argentina--let it be known that they did not have the foreign exchange to pay interest and amortization due on their loans.

A default by one or a combination of these countries, as will be shown below, could lead to the bankruptcy of some of the biggest U.S. banks. Default was avoided because of prompt and energetic rescue measures taken by the U.S. government, by central bankers, and by the Bank for International Settlements, the IMF, and the World Bank. One thing, however, needs to be clearly understood about these heroic efforts in the heartland of finance: it was the banks that were rescued, not Mexico, Brazil, Argentina, and the other potential defaulters. As a matter of fact, an essential feature of the whole rescue operation consisted of pushing the affected third world countries further down the road of debt enslavement, with a consequent imposition of severe economic contraction and a decline in the already miserable living standards of the masses. Neither was the financial system of the imperialist countries strengthened: a crucial aspect of the rescue operation was a continued increase in third world debt and with it enhanced vulnerability of the international banks. On the other hand, the bankers have done well for themselves, at least for the time being. Not only was their skin saved, but they have managed to use the crisis to squeeze even more profits out of the third world.

Underlying all this is the simple fact that debt, like drugs, is addictive. The more you borrow, the more you need to borrow. A simple arithmetic example (Table 1) explains the logic of the process. We assume that a country obtains each year a foreign loan of $1,000, to be repaid in equal installments over 20 years plus 10 percent interest on the outstanding balance. The net result is shown in the last column. The amount left over after paying the accumulated debt service (return of principal plus interest) gets smaller and smaller each year. By the fifth year, $700 of the new loan is needed just to keep up service payments on the mounting debt. And by the eighth year, borrowing of $1,000 is insufficient to meet obligations on the past debt. Thus if a country's development strategy were to call for a net annual inflow of $1,000 of foreign money, an increase in the rate of borrowing would be needed. In other words, a growing volume of external debt would become a way of life. Moreover, even if the country wanted to abandon reliance on debt, it would be hard put to do so. For unless it had other means of obtaining foreign exchange (say, an expanding excess of exports overe imports), it would still need to keep on borrowing. As shown in the example, in the eighth year $1,060 and in the tenth year $1,125 would have to be borrowed just to meet debt service obligations. and if in the meantime the interest rate on new debt should increase or exports should decline, still more borrowing would be called for.

The foregoing is of course a highly simplified example, but it isn't all that far removed from third world reality. Table 2 shows what has actually been happening to the debt of the third world. As can be seen in the last column, over 56 percent of the new debt undertaken in 1972 by the underdeveloped countries as a whole was needed just to meet debt service obligations. By 1981 this figure climbed to 75 percent. Now look at the third column of the table, which shows what was left over from new borrowings after payment of debt service. The net proceeds did increase from 1972 to 1978, but that was because in contrast with our hypothetical example, new borrowing grew rapidly from year to year. And after 1978 the amount left over after payment of debt service declined each year, even though the amount newly borrowed kept on increasing.

There were three special reasons for this decline in net proceeds, each of which contributed to bringing the third world debt problem to the critical juncture of 1981-82. First, interest rates on new debt jumped substantially. Second, a larger portion of the new debt was short-term, with a consequent increase in annual amortization payments. And third, the banks, anticipating the approaching perils, began to slow down their lending.

The nature of the financial dependency of the periphery on the core extends beyond the issue of debt. This can be seen clearly from the data on the aggregate balance of payments of all Latin American countries (except Cuba). Table 3 summarizes the multitude of foreign transactions by Latin American countries, other than capital movements (foreign investment, net new debt), in three categories: merchandise trade (export minus imports); payments to foreign capital; and all other (a miscellany of services, such as tourism, and transfer of funds by migrant labor, missionaries, etc.) The table goes back only to 1976, but the situation it depicts is much older. The persistent deficit in the current balance of payments in Latin America and elsewhere in the third world has been chronic for decades. And the reason, obviously, is the tribute exacted by foreign capital. During the six years shown here, on the average 85 percent of the deficit was accounted for by the need for foreign exchange to pay shippers and insurance companies; dividends, royalties, etc. to multinational corporations and other foreign capitalists; and interest to inteternational bankers.

These huge deficits on current account defines the bind in which Latin American and other third world countries find themselves. Obligations of this kind cannot be ignored or put off to another day. If they are not met promptly, trade will collapse; imports needed to feed the people and keep the wheels of industry turning will dry up. As long as their economies remain wrapped up in the imperialist network, they must obtain the foreign exchange needed to cover the deficits by attracting investment from multinational corporations and by borrowing from foreign banks. But that path leads to even greater deficits. Multinationals invest in order to obtain still more profits, and bankers demand interest. As a result, as we have seen, the deficits kept on growing until a critical point was reached, i.e., the point when the funds obtainable from foreign bankers began to dry up.

This was when the U.S. treasury and the international financial agencies (IMF, Bank for International Settlements, World Bank) jumped into the breach, supplying quick money to avoid immediate defaults and helping to arrange stretched-out schedules for repayment of principal. These stopgap measures provided what the international bankers needed: part of the risk was shifted to the public; and the international agencies applied strong-arm pressure to force potentially defaulting nations to adopt policies of reducing imports and restricting mass consumption. This in turn generated a climate in which the banks were once again prepared to resume their lending operations.

Characteristically, the international bankers made the most of their improved prospects. They collected handsome fees for renegotiating old loans and raised the interest charges on renegotiated and new loans. This contrasts strikingly with their practice when faced with near-bankrupt corporations. In such cases, the banks generally make concessions by reducing interest rates below prevailing market rates. This they consider prudent since what they fear most is that the troubled firms will actually fold up and their debt will be uncollectible. Governments, on the other hand do not become bankrupt, so why not squeeze out still more profits while the getting is good?

The point of view of the bankers was clearly stated by Willard Butcher, chairman of Chase Manhattan, when Mexico's inability to pay shook the markets:

Mexico owes $85 billion. Is Mexico worth $85 billion? Of course it is. It has oil exports of $15 to $20 billion. It has gold, silver, copper. Has all that disappeared over the past week? I expect to be repaid my Mexican debt. (Euromoney, October 1982, p. 19)

But how to make sure that the benefit of those resources will accrue to the bankers and not to the Mexicans and other third world peoples? That is where the international agencies come in. They are the ones who coordinate the programs, oversee the domestic policies, and keep the debtors in line to protect the interests of the bankers. The following from the New York Times (September 19, 1983) sums it up:

"The IMF is certainly running the sow for the sovereign debtors," said Penelope Hartland-Thunberg, senior fellow at the Georgetown Center for Strategic and International Studies.

C. Fred Bergsten, director of the Institute for International Economics, called the peripatetic teams of [World Bank] and [IMF] officials "the new proconsuls," alluding to the governors of the Roman Empire, saying that they represent the world's "increasingly centralized economic management."

The real question is, economic management for what purpose? It is obviously not to help third world countries restructure their societies to become more self-reliant, to raise their living standards, and to free themselves from debt slavery. On the contrary, the aim is to keep the imperialist system as now constituted going as long as possible. And that means, in turn, protecting the profits of the banks and the multinationals and maintaining an environment in which these profits can grow still further. To accomplish this the IMF has been imposing its standard prescription, except that the requirements have become more extreme in keeping with the severity of the of the crisis: devaluation of currencies, liberalization of trade, and reduction of public spending.

Devaluations, however, do not help promote the better utilization of resources needed to escape the debt trap. This is due to the inflexible and backward production structures of the underdeveloped countries. By raising the cost of imports, devaluations make it more difficult to overcome the bottlenecks and rigidities that constrain productive capacity. At the same time they add to inflationary pressures that worsen the unequal distribution of income and reduce internal markets. Trade liberalization weakens local industry and opens the gates wider for entry of the multinationals. Finally, the reduction in public spending means primarily drastic cuts in health, education, and welfare spending. Neither the international agencies nor the domestic ruling classes want government budgets to be reduced by limiting spending on the military and police, for these are more than ever needed to control the unemployed and hungry masses. The overail impat of the imposed discipline is seen in the results in Latin America: real income per capita has declined in each of the last three years. It can also be seen in the food riots which have recently been reported in the cities of Brazil.

The dilemma facing the international enforces of "sound finance" is how far the third world countries can be squeezed without provoking social revolutions that will end up in opting out of the imperialist network and possible debt repudiation. But even if such social upheavals can be avoided and enforced depressions should succeed for a time in reducing the balance-of-payments deficits in many third world countries, this will still be a long way from a solution to the crisis. New debt will need to be created to finance even the smaller deficits; and as the total debt keeps piling up, the payment burdens of the debtors will keep on increasing, requiring still more borrowing.

Even at best, therefore, there is no end in sight of the need for continuing third world borrowing. And this raises the question: How much longer can the banks go on supplying the ever-expanding credit to meet this demand? For even though the banks earn hefty profits from their third world involvement (in 1982, 20 percent of Citibank's profits came from Brazil alone), they too are coming up against limits. That can be seen in Table 4. The first column presents the volume of third world loans on the books of the nine largest banks in the United States, as of June 1982. It shows that $77.7 billion of deposits in these banks have been loaned to underdeveloped countries. Now when a bank lends out depositors' money it naturally assumes that the loans will be repaid and that the depositors can therefore have their money back whenever they want it. In the normal course of events some loans will of course go sour, and for this reason contingency reserves are set up. If worse comes to worst, i.e., if contingency reserves prove insufficient, the banks have to dip into accumulated capital to satisfy their depositors. In order to evaluate the exposure of the large banks to third world debt, the loans to these countries need to be expressed as a percentage of the banks' capital (including contingency reserves) as shown in the second column. There we can see, for example, that if Mexico should default on its loans, or declare a unilateral moratorium, almost 60 perent of the capital of the nine banks would be used up to keep the banks in operation. Furthermore, if both Mexico and Brazil should default, the nine banks could be forced out of business, since over 100 percent of their capital would be needed to keep going (at which time a rune on the banks would be a distinct possibility). Loans to South American countries (including Venezuela) account for 210 percent of the banks' capital, and loans to the third world as a whole account for over 340 percent.

This is, to be sure, a worst-case scenario. Even such major defaults would not force the banks to close, if the Federal Reserve acted promptly as a lender of last resort to keep them afloat. If the past is a reliable guide, it is reasonable to assume that the Fed would indeed act accordingly. But that is only an assumption, as is the eventuality of default by one or more debtors. Under the circumstances, it is no wonder that fear struck the heart of the financial world when the 1981-82 crisis matured and the number of countries unable to meet their service payments grew. And it is against this background of fear that the banks have become increasingly cautious about extending new loans.

Yet lend they must, for otherwise the debtors would not be able to keep up their contractual payments. The banks count on the IMF as the pillar of the whole system. But the IMF has no solutions either. All it can accomplish is to discipline the debtors and supply short-term funds in dire emergencies. Part of the IMF program is to get the third worlds countries to import less and export more. Leaving aside the fact that many of them have to import in order to have the supplies to manufacture exports, how can this be a way out if everyone is at the same time reducing imports while trying to increase exports? The upshot of all the frantic rescue measures is hence more of the same: the third world is driven into further debt enslavement and the financial system remains as vulnerable as ever.

The wiser heads in the business community are fully aware that as things stand the problem is insoluble. The schemes they dabble with revolve around either how to get the U.S. public to pay for putting the banks on a sounder basis or how to convert the debt into increased ownership by U.S. capital of third world assets. What none of them are willing to contemplate is the idea that there is nothing sacred about either the profits or the capital of the banks. Why must the banks continue to charge more than nominal interest on the outstanding loans? Why can't the banks' capital be used to write off a portion of the loans? Why not nationalize the banks and do away with them as profit-making institutions?

Sooner or later questions like these will have to be faced and acted on. The alternative possibility is a collapse of the international financial system and with it the opening of a new chapter in the history of the world capitalist system.
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Publication:Monthly Review
Date:Jan 1, 1984
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