Viewpoint: The World in Arrears


The long shadow of insolvency is hanging over world financial markets. It appears likely that 22 nations, which owe American banks alone more than $52 billion, won't have the cash by the end of 1982 to pay their debts. In 1983, the problem will be worse. And worse still in 1984.

The question is, What is to be done? Judging by reports from the recent meeting of the International Monetary Fund, that question at present takes only one form: "How much money should be given by the taxpayers of the rich nations to the IMF so that it can grant subsidized loans to the poor countries so that they, in turn, can repay commercial banks that have for years been pressing high-cost credit on the Third World?"

It is a measure of our sorry predicament that most taxpayers, who are the unwitting cosigners for this mountain of bad debt, have given almost no thought to the pending bailout. The same is true of members of Congress. Usually quick to take offense at any real or imagined usurpation of their policy prerogatives, they don't seem to have noticed that they have forfeited to a few large commercial banks de facto control over foreign aid and much of foreign policy.

President Reagan has been praised for helping to pour $2.9 billion into Mexico (while turning his back upon the expropriation of $12 billion in nonbank American assets) and chided for his reluctance to immediately raise the bailout by a factor of 10 by approving a geometric boost in the IMF quota and a variety of other cash transfers to bankrupt countries. By the time the IMF Interim Committee meets in April, it is widely assumed the US government will be ready to join other nations in approving tens of billions of taxpayer dollars to be shuffled between the insolvent governments and the banks. Instead of giving in to the pressure for bailouts, Mr. Reagan should realize what is really at stake: world economic recovery and the credibility of anti-inflation programs in the industrial nations.

For more than a decade, there has been an orgy of reckless international lending. At a time when American industry has been starved for capital, our largest banks have been shoveling cash into practically every mercantilist and state socialist enterprise in the world from Poland to Togo.

The banks were willing to lend large sums, usually for projects that made little economic sense, because they believed, and correctly until now, that they could capture higher-than-ordinary interest income by financing risky loans—without bearing the costs when loans went bad. Either tax money would be sent to replenish the treasuries of the bankrupt governments, or they would be bailed out indirectly through more inflation.

What has happened, in effect, is that the banks have brokered a gigantic "short" position against the US dollar, a speculation against the future that can only be validated by inflation at ever-higher levels. But as inflation has slowed, the problems have set in. During the inflationary Carter years, rescheduling by underdeveloped countries averaged only a little over $3 billion annually. In 1981, 14 countries were obliged to reschedule a total of $10.7 billion. For 1982, it appears likely that at least 22 countries will have failed to pay a substantial portion of the $140 billion due.

In 1980 the Federal Reserve System obtained the legal authority to monetize the debts of other countries by buying foreign government bonds or obligations guaranteed by foreign governments. More than $2 billion in Federal Reserve Notes were issued upon such collateral in 1982, including some backed by Italian lira bonds. Since early September, the Fed's collection of foreign paper has included $300 million in freshly printed Mexican pesos. Now that the Mexican banks have been nationalized, their obligations, too, could be monetized by our central bank.

The mechanism is in place for a worldwide inflation of unprecedented proportions. If we do nothing and allow the debt problem in the underdeveloped countries to become a crisis in our banking system, it may become practically impossible to find a happy solution. If the choice is narrowed to one of two alternatives—printing money at whatever rate necessary to preserve the entire world's debt structure or falling into a deflationary collapse—the government will print money.

For all the legitimate criticism raised against the old system of anchoring monetary values in gold, it did successfully restrain the creation of debt and excess liquidity. In the 11 years since Richard Nixon repudiated the last link to gold, Euromarket debt has exploded from $83 billion to about $2 trillion.

This unsound leveraging of the monetary system has shortened the investment horizon. Not only has it made inflation more likely, it has also made the threat of any contraction more costly. As the leverage has increased, even a small possibility of runaway inflation or deflation has come to weigh heavily upon investors.

Instead of making a bad situation worse by trying to pay every overdue bill that has piled up from Patagonia to Phu Bai, we should use the present crisis as an opening for real reform. Congress and the president should find the cheapest and least inflationary method of patching up the American banks, then go to work for a long-overdue overhaul of the entire world monetary system.

Jim Davidson is founder and chairman of the National Taxpayers Union and author of The Squeeze.