“The LDC debt
crisis: How it could be resolved,” Business Week, January 10, 1983, pp.
78-81
Summary:
Near the end of 1982, Mexico and Brazil, the at the time the world’s two
largest debtors, in addition to many other debtor countries sought assistance
from the International Monetary Fund (IMF) and a reprieve from loans.
Brazil
itself narrowly avoided being unable to pay debts due on Dec. 8, 1982, highlighting the potential danger
inherent in impromptu problem solving.
It stresses the need for internationally coordinated approach to managing
world debt.
There are 3 main options left to lenders, borrowers and governments as a
means to help solve the problem:
1.) Lenders can continue to improvise solutions to
debtor problems in the hopes that the system will hold together. The problem lies in the fact that the
world at the time was undergoing a recession, depressing export prices, which
left debtor countries of a means of repaying debt.
2.) A debt moratorium. Debtor nations like
Mexico and
Brazil could
impose austerity measures that could potentially lead to local upheaval, leading
borrows to seek an extended moratorium on debt payments.
3.) Fiscal and monetary simulation: Western governments are favoring this
choice, using fiscal and monetary simulation to pull themselves and the world
out of recession.
Small
Fires
In August of 1982,
Mexico reached a
point where it could not pay off its debts. Although the IMF was able to raise the
funds necessary to avoid crisis, the situation highlights the need for something
better. Although able to help other
Latin American countries from defaulting, Gerard Vila, adviser to
Lombard Odier & Cie. in
Geneva says: “They’re doing little
but putting out small fires one at a time.” A U.
S. official added: “It’s a hell of a way to run
a railroad.”
Due to a lack of a plan for coordinated debt management, rescue
operations are slow to start. No
part wants to step in before the others.
“The bankers want to see the IMF impose economic discipline, the IMF
expects banks to provide huge infusions of long-term cash, and as both parties
delay, central banks and their governments must step in with emergency
financing.” Adding to the confusion
is that neither regulators nor bankers have an idea of how much borrowers really
owe in the short term, nor do they know all of the links between indebted
nations.
Brazil
once owed $30billion short term, not $11.8billion, leading lenders to cut back
on new loans to
Brazil.
Brazil,
the world’s largest debtor, was also
Poland’s
sixth-largest creditor.
A haphazard
approach
The U.S.
government’s approach to debt problems is chaotic as well. Congress complicates the process,
with Democrats wanting an easing of domestic economic policy in addition to
increasing the
U.S.
contribution to the IMF. Rep. John
J. LaFalce commented: “We cannot cal for an activist role on the part of the
government to alleviate the international financial system when we adopt a
laissez-faire policy of economics here.”
Large banks have been unwilling to make loans to debtor countries like
Brazil as
well. Debt rescheduling can also
fail if growth doesn’t increase to help pay. Due to slowing inflation and worldwide
recession, developing countries can’t pay debts that were amassed under the
assumption that inflation would erode the real value of the debt as they
generated revenues to pay it off.
Austerity is too harsh a plan to impose economically and politically,
leaving some to believe that reflation might be the only choice of a cure.
26 economists, from 14 countries concluded that the
U.S.,
Japan,
Germany,
Canada, and
Britain have
enough control of inflation to justify joining in a concerted effort to expand
demand. The
U.S. has taken
steps towards reflation, which shows in the interest rates, which fell steadily
since August of 1982. The Fed is
unable to reflate as well as previously, due to the strictness of markets. However, the Fed was able to increase
nonborrowed bank reserves, a key factor fueling monetary growth at an 18% annual
rate during the last 3 months of 1982.
The Easier
Path
European interest rates have
fallen, budget deficits have grown, and stimulus programs were adopted, leading
to more inflation for 1984. Western
governments have also increased IMF contributions. Increasing price levels would decrease
debts, making debt servicing easier politically. This can also destroy savings and
investment though, so caution is urged.
The Spark
Some economists think that recovery is going to occur without reflation
being necessary. Lamberto Dini,
director of the Banca d’Italia thinks that now it is the wrong time for a change
in economic policies, asking: “How would you have the
United States
reflate anyway? Isn’t the budget
deficit big enough for you as is?”
The
U.S. is still
expected to spark recovery though.
In a speech to the House Banking Committee Treasury Secretary Donald T.
Regan stressed that the
U.S. must try to
spark global recovery without starting more inflation, but there will be
consequences if world leaders don’t solve the world debt crisis. “Were we not to solve it…we could have a
worldwide depression through defaults of many nations….I think it’s avoidable,
but it’s going to take care.”
One big fear is of a repeat of 1930s protectionism. This helped plunge corporations and
countries into bankruptcy and central banks refused to increase liquidity. One of the biggest fears is the disaster
scenario, where protectionism damages the ability of developing countries to
earn funds to pay off debts.
Other worries concern IMF austerity programs. IMF austerity programs could push
borrowers into deeper recession by forcing numerous countries to increase
exports and decrease imports, leaving no countries to sell products to.
Passing the Risk
Floating-rate debt is of great concern as well. Unlike the 1930s’ crisis, the debts of
some of the larger debtors,
Argentina,
Brazil, and
Mexico feature
floating rates that vary with
U.S. rates. Floating-rate debt seemingly shifts the
bulk of risk to countries, leading banks to lend more out of
overconfidence. This type of
situation has not occurred before, and there is uncertainty as to how the added
risk will be handled by countries once it reaches the citizens.
The worst case scenario would be for major debtors to declare a
moratorium on debt payments.
There is fear of
Mexico seeking
this solution due to diminishing oil reserves and increasing poverty.
There are two major differences between the situations of 1982 situation
from that of the 1930s. Almost of
all the debt is concentrated in banks.
This has allowed
Brazil to
assemble 113 of its lenders, holding 90% of its debt for discussions, something
that would have been impossible in the 1930s. The other difference is that governments
can’t allow the world economy to contract.
Traditional approaches might also be what are called for as well. Increase growth, cutting government
expenditures and raising taxes
Summarized by: Donald Ripley