*"How an LDC Default Would Hit the US Economy," BusinessWeek, November 7, 1983, p. 118.

The Main Point

The article ponders the damage a LDC default would cause to the US economy. The extent of the damage would depend on how many countries stop paying and the reaction of the Fed.

Summary

Analysis shows that in the case of Argentina defaulting by itself the damage would be minimal since only $6 billion of its $40 billion debt is owed to US banks. On the other hand Brazil would have a much larger effect since it owes $22 billion of its $90 billion dollar debt to US banks. GNP would be nearly $25 billion dollars lower, 400,000 jobs would disappear and the Federal funds rate would increase 0.6 pts in early 1984. If both countries stopped paying the rate would increase 1.5 pts to about 11%. If Brazil and Argentina both defaulted then it would be likely that all of South America would default pushing the US to recession.

South America owes US banks $71 billion at the time of the article. A debt moratorium would frighten credit markets and force an increase in interest rates. This would weaken the auto, housing and other interest sensitive markets. Exports would drop since banks and governments would stop extending export credits.

Few expect a formal default, more likely is a moratorium with a suspension of interest rate payments. In that case, banks would lose $10 billion in 1984. This would force a contraction in the amount of loans a bank can make. Also when interest payments are missed a bank is required to declare the loan “nonperforming” and write off part or all of it and this further adds to bank losses.

How much a moratorium would shrink bank lending and scare capital markets would depend on how the Fed handles reserve requirements and write-offs. If reserve requirements are lowered and time is stretched out for banks to absorb losses the Fed could ease pressure on the banks. Also the discount window could be opened and targeted short term lending to banks could help. Probably no matter what loans would be contracted and force interest rates up. The Fed might take a “shotgun” approach and inject massive amounts of money into the system, but this could backfire if it rapidly increases inflation.

 Summary by N. B. SCHWELLENBACH