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WORLD POLICY JOURNAL
The Rich
Borrow and the Poor Repay: The Fatal Flaw in International Finance
No national legal system allows debtors to offload their debts onto others. Internationally, however, this happens frequently, with appalling consequences for the poor in developing countries. It happens when nations assume liability for the foreign debt of their corporations, as in International Monetary Fund (IMF) bailouts and other debt workouts, and when portions of national borrowings go directly into the pockets of politicians and senior civil servants. The socialization of private-sector debt will be examined within the context of the three most serious financial crises of the past 30 years: the African and Latin American debt crisis that commenced in 1982, the East Asian economic crisis that began in 1997, and Argentina’s current economic crisis.
The 1982 Debt
Crisis The borrowers failed to put the borrowed funds to work to earn a return higher than the interest rate on the funds—as required if debt is to be repaid. Much of the lending was for poorly conceived infrastructure projects, such as steel or gas works that were unlikely ever to be efficient, or for funding budget deficits. The lenders lent knowing that the funds, in the main, were not being put to productive use and were often indifferent to the fact that significant portions of the funds were going directly into the private accounts of corrupt politicians and civil servants. 1 Massive debt flows began in earnest to Latin America and Africa in the early 1970s and continued right through to 1982, when Mexico told its creditors it was broke. The cessation of lending that resulted meant no countries in Latin America or sub-Saharan Africa could continue to service their borrowings. The immediate response of creditors was to reschedule the debt and advance new money to enable the debtors to keep on paying interest. The creditors appointed steering committees consisting of executives of the banks with the largest exposures to represent their interests. This was necessary as, for instance, Brazil had over 1,000 creditors and could not negotiate with each separately. In addition to the debtor nations, there were hundreds of other debtors, including provinces and state-owned and private corporations. The banks persuaded the debtor nations to represent all debtors within their borders, and to bring all their debts under the sovereign guarantee of the state. The first step was necessary. The second was not. But bringing all debts under the sovereign guarantee certainly improved the security of the creditors—particularly those who had made most of the loans to private-sector corporations. And these just happened to be the major lenders—who controlled the steering committees orchestrating the process. 2 If private-sector debt had not been assumed by the debtor nations, many corporations would no doubt have gone bankrupt. The financially strong ones would have repaid their debts. As it was, the debtor nations assumed this corporate debt owed abroad, and then sought to recover payment from the debtors. This attempted recovery of the debt domestically usually met with poor results due to corruption, cronyism, lack of government commitment, and the inefficiency endemic to these economies. The workings of the market were thus short-circuited by a process directed by the International Monetary Fund and the U.S. Treasury. Monies that had not been borrowed by nations ended up being owed by them, and thus assumed by the people of the debtor nations. This situation was made worse by the corruption that siphoned off funds intended for public use. The poor in Africa and Latin America suffered disproportionately as this expanded debt burden was serviced by increasing taxes and reducing spending on education, health care, and other social services.
The East Asian
Economic Crisis Debt did play a role, although this time the borrowers were principally private-sector corporations, not governments. The Asian crisis also differed from the earlier African and Latin American debt crisis in that the debtor nations were running generally responsible monetary and fiscal policies in the context of "a benign international environment with low interest rates and solid growth in output and exports," 4 and, except in Indonesia, there was relatively little corruption in the application of the loan proceeds. This unanticipated crisis caused severe economic dislocation as debtor nations’ exchange rates halved in value almost overnight, thus in effect doubling their foreign debt and rendering many of their banks and corporations bankrupt. It came about mainly because the East Asian nations had allowed their exchange rates to become overvalued, typically by being fixed to an appreciating U.S. dollar at a time when the yen, the currency of one of their principal competitors, was depreciating, and because their financial sectors were not yet sophisticated enough to direct to productive uses the increased capital that poured into these countries from early 1995 onward. Accordingly, foreign capital tended to flow through local banks into the stock and property markets. However, investments in domestic shares and property cannot generate the foreign exchange needed to service foreign-currency loans. Foreign capital was able to flow in so vigorously because the IMF had strongly encouraged the removal of capital controls long before the regulation of domestic banking sectors had been upgraded sufficiently to ensure that the domestic banks could channel the increased capital inflows effectively. While the nature of this crisis was quite different from the debt crisis of 1982, the resolution was the same: the poor in the debtor countries were shafted. However, this time the problem was caused not by the banks themselves but by the IMF bailouts that followed. These were invariably described as bailouts of Indonesia or Thailand or South Korea, and, given the media coverage, it would have been easy to conclude that they were gifts to these countries. In fact, they were long-term loans of from $15 billion in the case of Thailand to $57 billion for South Korea, made on condition that they would be used to repay creditors. These loans thus became debts of the nation and the bailouts were of the creditors. 5 It took four years before these bailouts were generally understood to be "a welfare system for Wall Street." 6 To make matters worse, the creditors with debts due typically held short-term bonds—and short-term debt is particularly destabilizing for developing countries. Long-term debt and direct foreign investment cannot flee as soon as economic storm clouds gather, but short-term debt can, and does. Thus bailouts encourage precisely the type of debt that a stable system would discourage— that is, bailouts encourage short-term debt by repaying it promptly while leaving the holders of long-term debt with only their rights against the debtor. The 1997 bailouts of Indonesia, South Korea, and Thailand encouraged massive capital inflows into Russia in the first half of 1998 in expectation of another bailout. Even when the Russian government was so desperate for capital it was offering 50 percent per annum on its short-term bonds, foreign capital rushed in, looking to the IMF, not the debtor, for eventual repayment. The Russian crisis was eventually made much worse by this radical tampering with the workings of capital markets. The continued coordination and promotion of bailouts by the IMF and the U.S. Treasury makes a mockery of their commitment to free markets. 7 In Asia, corporate debt was turned into sovereign debt through the IMF bailouts. The East Asian nations have since sought to recover the debts they assumed from their local debtors, but, as in Africa and Latin America, the amounts recovered have been low. Argentina’s
Crisis This time, the international financial community, with the assistance of a compliant Argentine government, found two ways to socialize private indebtedness. The first was the familiar IMF bailout, in this case a $40 billion loan to Argentina in late 2000, to be used to repay a mix of public and corporate debt. 9 The second, "pesification," was a new technique with the same old depressing consequence: the burden for the repayment of the debts of others would fall on the Argentine populace. Under pesification, dollar-denominated bank loans and deposits were redenominated in pesos. Banks were required to convert their assets (such as loans) into pesos at a one-for-one rate and their liabilities (such as deposits) into pesos at a rate of 1.4 to 1. The government sought to compensate the banks for the huge losses this engendered by means of a massive issue of government bonds of necessarily doubtful value given the creditworthiness of the government. 10 Thus the circle was completed in the usual way in such crises, with the burden falling on the public purse. In the words of Pedro Pou, former president of Argentina’s central bank, "The government has transferred about 40% of private debt to workers…. We are experiencing a megaredistribution of wealth and income unprecedented in the history of the capitalist world." 11
The Rich Borrow When governments borrow to repay nonsovereign debt as part of an IMF-coordinated rescheduling or bailout, the poor repay these debts through higher taxes, and suffer from reduced spending on health care, education, and infrastructure. 13 The poor throughout Latin America and Africa continue to repay the debt incurred in the 1970s, as well as much of the debt borrowed since. Most Western commentators consider the debt crisis of the 1980s to have been resolved by the Brady Plan, under which the loans of a nation undergoing a Brady rescheduling would be converted into long-term bonds. These bonds incorporated some debt relief by way of reduced principal or interest rates, and included security for the eventual repayment of the principal and sometimes for 12 or 18 months of interest repayments. But this conclusion is purely from the perspective of creditors. What the debtor nations see is that the Brady bonds have to be serviced for another 20 years. The poor also pay for the debt of others indirectly. With negligible or no savings, and little access to social insurance schemes, the poor are particularly vulnerable to the downside of financial crises brought on by excessive borrowing by the governments and elites in their countries. 14 Financial crises in developing countries severely limit a government’s ability to provide education, health care, and other necessities to the poor. Thus the poor pay, even when they don’t have to pay directly. According to UNICEF, over 500,000 children under the age of five died each year in Africa and Latin America in the late 1980s as a direct result of the debt crisis and its management under the International Monetary Fund’s structural adjustment programs. 15 These programs required the abolition of price supports on essential food-stuffs, steep reductions in spending on health, education, and other social services, and increases in taxes. The debt crisis has never been resolved for much of sub-Saharan Africa. Extrapolating from the UNICEF data, as many as 5,000,000 children and vulnerable adults may have lost their lives in this blighted continent as a result of the debt crunch. The Asian crisis plunged millions of people into dire poverty. In Indonesia alone, 30 million more people dropped below the $1 per day poverty threshold from the effects of the crisis. 16 In once prosperous Argentina, over half of the population now exists below the poverty line, and over a third cannot afford adequate food. 17 Argentine children regularly faint in class from hunger, and adults riot and break into supermarkets in search of food. Because the Asian crisis was almost entirely unanticipated, it caused deep consternation in international financial circles, with the result that we have seen a plethora of commissions set up to examine the architecture of the international financial system. Yet none of their publicized findings have focused upon the socialization of private debt. It is the moral ambiguity at the heart of international finance that no one wishes to face. The fatal practice by which private debt is socialized must end. The IMF must stop facilitating bailouts in which anything other than sovereign debt is repaid—poor countries should not be in the business of bailing out their corporate sectors, and certainly not through the subterfuge of IMF-orchestrated loans. Likewise, debtor governments must resist the urgings of the fund and of creditors to socialize private debt. Too often, developing country governments act in accordance with the interests of their elites and global capital, rather than in the interests of the majority of their people. This is partly because politicians and technocrats share the perspectives of the elites and international financiers, and partly because the elites and the politicians benefit from strong capital inflows and are insulated from the devastating effects of financial crises. The issue of developing country debt is responsive to pressure from civil society, as was proven by the Jubilee 2000 campaign— a massive global grassroots movement against the inequities of Third World debt. 18 Jubilee 2000 secured a signal victory in mid-1999 when the G-7 nations undertook to write off some $110 billion of their debt to the most heavily indebted poor countries (typically those in sub-Saharan Africa). The success of this campaign reminds us that if enough people understand and protest against the means by which compliant developing country governments are pressured and manipulated by international banks and the IMF to repay nonpublic debts from the public purse, there is reason to believe the practice will be much reduced. For national governments to assume corporate debt in desperately poor and developing countries is immoral. It rewards the rich in those countries at the direct expense of the poor. The encouragement and development of deeper and more robust democracy and stronger civil society in these countries would bring considerable pressure to bear on governments to govern in the interests of all their citizens. The IMF and the U.S. Treasury need to begin encouraging these governments to do so, rather than to pursue policies that benefit the international banks. Likewise, the IMF and the U.S. Treasury need to discourage the banks from engineering, as they consistently do in these times of crisis, the socialization of private-sector debt. • *Ross P. Buckley is executive director of the Tim Fischer Center for Global Trade and Finance, Bond University, Queensland, Australia. Notes The author would like to thank Steven Freeland for his comments on a draft of this essay. 1. For more on why the banks continued to lend in these circumstances, see R. P. Buckley, Emerging Markets Debt: An Analysis of the Secondary Market (London: Kluwer Law International, 1999), pp. 13–17. 2. Buckley, Emerging Markets Debt, p. 43. 3. The ratio of debt to exports for East Asia and the Pacific in 1997 was 103 percent, compared to 193 percent in Latin America; in addition, the debt export and debt service ratios for East Asia and the Pacific were substantially lower in 1997 than in 1992 (World Bank, Global Development Finance 1998, vol. 1, pp. 33, 124, 128). 4. Ibid., pp. 4, 30. 5. Charles W. Calomiris and Allan H. Meltzer, "Fixing the IMF," The National Interest, vol. 56 (summer 1999), p. 88. 6. According to a senior G-7 official, quoted in Charlotte Denny, "IMF Sheds No Tears for Argentina," The Guardian, April 29, 2002. 7. Last August, the U.S. Treasury supported a bailout package for Argentina, provided certain conditions could be met. 8. Business Monitor International, Economic Outlook, Argentina Quarterly Forecast Report, 2002. 9. Eric Hershberg, "Why Argentina Crashed— And Is Still Crashing," NACLA Report on the Americas, vol. 36 (July/August 2002), p. 32. 10. Andres Gaudin, "Thirteen Days That Shook Argentina—And Now What?" NACLA Report on the Americas, vol. 35 (March/April 2002), p. 6; and "Latin Banks: Eyes on Brazil," Emerging Markets Monitor, vol. 8, August 19, 2002, p. 12. 11. As cited in Gaudin, "Thirteen Days That Shook Argentina." 12. "A Survey of Latin America," The Economist, (U.K. ed.), November 13, 1993. 13. Jorge G. Castaneda, Utopia Unarmed: The Latin American Left After the Cold War (New York: Knopf, 1993), p. 5; Jerry Dohnal, "Structural Adjustment Programs: A Violation of Rights," Australian Journal of Human Rights, vol. 57, no. 1 (1994), pp. 72–74, 77; and Harold James, "Deep Red—The International Debt Crisis and Its Historical Precedents," American Scholar, vol. 56 (summer 1987), p. 340. 14. Nora Lustig, "Crises and the Poor: Socially Responsible Macroeconomics," presidential address to the Fourth Annual Meeting of the Latin American and Caribbean Economic Association, Santiago, Chile, October 22, 1999. 15. UNICEF, "The State of the World’s Children, 1989," reproduced in part in the statement of Richard Jolly, deputy executive director for programs, United Nations Children’s Fund, before the House Committee on Banking, Finance and Urban Affairs hearings on "International Economic Issues and Their Impact on the U.S. Financial System," January 4, 1989, 101st Cong., 1st Sess. 16. "Crisis in Asia Spawns Millions of ‘Newly Poor,’" Wall Street Journal, April 6, 1999. Likewise in Mexico two years earlier, "[t]he austerity program the Mexican government put in place when its economy faltered was a devastating blow to the country’s working poor, but the big investors emerged largely unscathed" (David E. Sanger, "Maybe a Bankrupt Nation Isn’t the Worst Thing in the World," New York Times, October 12, 1997). 17. Mark Milner and Charlotte Denny, "It’s Penalty Time for Argentina," The Guardian, May 8, 2002; and Sophie Arie, "Rich Argentina Tastes Hunger," The Observer, May 19, 2002. 18. Unfortunately, this experience of Jubilee 2000 also proves how intractable these problems are. Of the $110 billion of debt relief promised, less than $30 billion has been delivered three years later. This is completely unacceptable given that canceling debt is as simple as making a book entry. See "What Is the HIPC Initiative?" at www.jubilee2000uk.org/hipc/ what_is_hipc.htm; and Anne Pettifor, "The World Will Never Be the Same Again—Because of Jubilee 2000," at www.jubilee2000uk.org/analysis/reports/world_never_same_again/intro.htm.
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