"Third World Debt: It's the FED vs. the Bankers," BusinessWeek, January 9, 1984, p. 47.

The Main Point

Volcker wants banks to lower interest rates Third World countries pay to their international creditors (i.e. banks), in order to prevent massive defaults or a debt moratorium.

Summary

The Fed was forced to reflate the US economy in the summer of ’82 to promote a recovery to avoid default and Volcker did not want to undergo a repeat since he was preoccupied with fighting inflation. This is why Volcker is seeking lower rates for Third World countries.

Volcker encouraged the Mexican government to hold out for softer terms to the dismay of the banking system. The Mexican negotiations over terms is important since other Latin American nations were expected to demand whatever terms Mexico is able to secure.

The Fed wants banks to reschedule the debt so that borrowers can absorb future shocks and would like a reduction of spreads on reschedulings. Banks are resisting on a reduction of spreads since they think the next step will be for them to lower the base rate themselves, thus lowering their earnings. Some experts had already called for this, a World Bank official called for “some form of subsidization” when lending proceeds at “unduly high interest rates.” Another proposal would allow debtors to pay partly in dollars and partly in local currency.

Bankers at this time were worried about a debtor cartel to limit interest payments and they believe that Volcker’s attempts to lower rates will give encouragement to this idea of a cartel.

 Summary by N. B. SCHWELLENBACH