[1987] andré gunder frank. debt where credit is due (in: economic and political weekly, pp....

8/12/2019 [1987] Andr Gunder Frank. Debt Where Credit is Due (In: Economic and Political Weekly, pp. 1795-1799)

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Debt Where Credit Is DueAuthor(s): Andre Gunder FrankSource: Economic and Political Weekly, Vol. 22, No. 42/43 (Oct. 17-24, 1987), pp.1795+1797+1799Published by: Economic and Political WeeklyStable URL: http://www.jstor.org/stable/4377633

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Debt Where Credit Is DueAndre Gunder FrankThereparations ransferout of Germanyafter its First WorldWardefeat reacheda maximum of perhaps 3.5 per cent of GNP and15 per cent of exportearnings n the darkestyears of 1929-31.Inhis "TheEconomic Consequencesof the Peace" Keynes warnedthat this drainwould be unsustainable or Germanyandcounterproductiveor the world.He was provenright by theresultantrise of Hlitler.Yetmany ThirdWorldcountries are todaybeingdrainedat 5 and 6 per cent of their GNP and 30 to 50 percent and more of their exportearningsannually throughtheresource ransferof theirdebt service. And despite this enormoushemorrhageof the ThirdWorld,most proposals to deal with theThirdWorlddebt crisispropose to further ncrease the debt nowand debt servicelater evenmore.

The discovery of America, and that of thepassage to the East Indies by the Cape ofGood Hope, are the two greatest eventsrecorded n the historyof mankind. . . To thenatives, however, both of the East and WestIndies, all the commercialbenefits which canhave resulted from those events have beensunk and lost in the dreadful misfortuneswhich they have occasioned... It is impossi-ble that the whole extent of their conse-quences can have been seen... Whatbenefits, or what misfortunes to mankindmay hereafterresult from those greatevents,no human wisdom can foresee...All European nations have given such ex-traordinary privileges to bills of exchange,that money is more readily advanced uponthem, than upon any other species of obliga-tion... Many vast and extensive projects,however, were undertaken, and for severalyears carried on without any other fund tosupport them besides what was raisedat thisenormous expense The projectors,no doubt,had in their golden dreams the most distinctvisions of this great profit. Upon theirawakening however... they very seldom, Ibelieve, had the good fortune to find it...Each endorser becomes in turn liable to theowner of the bill for those contents, and, ifhe fails to pay, he becomes too fromthat mo-ment bankrupt. -Adam Smith,"The Wealth of Nations", 1776THE real Adam Smith, like his contem-porarycopy, wroteduringa period of longeconomic crisis. He made the two abovecitedobservations,which afford us impor-tant historical perspective on the contem-porarydebt crisis on the occasion of thisyear'sannual World Bank-IMF meeting.One of Smith's observationsreflects thedrain of resources from poor peripheralcountriesto rich metropolitanones, whichis generated during periods of economiccrisis.The 'Rape of Bengal' and the drainfromthe Caribbean slave colonies duringthe economic crisisof the 1760s and 1770sobservedby Smith is an example.Anotheris 'the Drain' from India and other newer

colonies during the period of imperialism

and colonialism in the crisis after 1873.The exploitation of Central Europe byGermany and the 'GreaterEast Asian Co-Prosperity Sphere of Japan in the 1930sare other examples. The contemporary'perverse'flow of capital from poor thirdworld debtor countries to rich creditorones is therefore not exceptional butnormal for periods of economic crisis.Smith's other observation reflects on anormal crisis response, which has alsobecome a mechanism to effect this 'per-verse'resourcetransfer: he excessive crea-tion of credit by drawing and re-drawingbills of exchange, "to which the unfor-tunate traders have sometimes recoursewhen they are on the brink of bankrupt-cy". Smith observed how the Banks ofEngland and Scotland issued "too greata quantity of paper" in the precedingyears.In the centuriesbefore Smith as wellas in those after him, speculative creditcreation and use has characterised eachculminating boom and led to the subse-quent bust, like those of 1620, 1720, 1873and 1880s, 1907, 1929, and the one likelyto come.In the present crisis, this speculativefinancial mechanism is an important in-strument to effect the neo-colonial drainof resourcesand capital from poor to rich,which is analogous to the colonial drainsduring past economic crises. However,to-day's drain is a veritable hemorrhage,which is proportionately greater thansome of the recent past. The reparationstransfer out of Germany after its FirstWorld War defeat was about 2 per centof annual GNP in the late 1920s andreached a maximum of perhaps 3.5 percent in the darkest years 1929-31.Repara-tions payments amounted to about 15percent of export earnings. In his "TheEconomic consequences of the Peace',John Maynard Keynes had warned thatthis drain would be unsustainable forGermany and counterproductive for the

world. He was proven right by the resul-tant rise of Hitler. Yet many third worldcountriesaretoday being drainedof 5 and6 per cent of their GNP and 30 to 50 percent and more of their export earnings an-nually through the resource transfer oftheir debt service. Since the beginning ofthe third world debt crisis in 1982, thethird world has suffered a net transfer ofabout US $ 200 billion through debt ser-viceper se (of which $ 135bn from LatinAmerica, and $ 50bn from Africa),another $ 100bn through capital flight(which increases proportionately to in-coming loans), an additional $ lOObnthrough lower export prices and terms oftrade, plus the usual $ lOObnof remit-tances of profits and royalties on foreigninvestment and technology. That totalsupto roughly $ 5OObnremitted in fiveyears, compared to a total accumulateddebt of $ 1,000bn.Despite this enormous hemorrhage ofthe third world, most proposals to dealwith the third world debt crisis proposeto increase the debt now and debt servicelater evenmore. This is notably trueof the(US TreasurySecretary)Baker plan to in-crease loans to 15 third world countriesand the proposals to cap the interest rateand to add this interest to the principal.Instead, the obvious emergency remedyagainst this hemorrhage is to reduce themassive outflow of resources and moneyfrom these countries. Only a minority ofpolitical proposals advocate this. Theyrange from Fidel Castro's suggestions forunilateral third world debt moratoria oreven default to US Senator Bradley'spro-posal to writedown principal by 3 per centeach yearand PresidentGarcia'sunilateraldecision to limit Peruvian debt service to10 per cent of export earnings. Only thelast of these has receivedeven limited sup-port by the powers that be. Ironically,while such diverse figures as Henry Kiss-inger,Fidel Castro and RaulAlfonsin pro-pose as yet unacceptable political solu-tions to what they see as a political pro-blem, the market has begun to offer defacto modifications. The magic of themarketdiscounts the face values of thesedebts to the estimated realvalues that newpurchasers are willing to pay for them insecondary markets. At the same time,however, it maintains the nominal facevalue of this paper on which the debtorsare spposed to pay debt service to the newowners. This procedure only reduces thedebt service if the debtor buy his ownpaper at a discount or if he defaults onit. Banks have also increased their baddebt reserves to hedge against such possi-ble debtor defaults. However, there arealso a number of as yet unused normallegal practices available to reduce thehemorrhage and complement the realisticmarket write down of these debts. We

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review some of these below under coun-tract law, privatisation, internationalcharters, and bankruptcy.The onset of the debt crisis itself andmuch of the accumulated registered debtis by now due to the sudden spectacularrise in the rate of interest after 1979.(Firstthe American Federal Reserve raised theinterestratefor domestic reasons and thenthe Reagan Administration bid it up evenfurther by borrowing to finance its grow-ing domestic budget and foreign tradedeficits generated by the huge increase inits arms expenditures.) The monetary in-terest rate reached 20 per cent, and dis-counting inflation the real interestrate wasover 10per cent for severalyears.Yetwhenthe money was borrowedin the 1970sthereal interest rate had been negative (andbanks earned their money through fees),and historically the real interest rateneveraveraged more than 2 or 3 per cent. Sothe interest rate has been over three timesits historic norm, which is much higherthan anyone had imagined possible. Deb-tors have been charged this new high rateof intereston previously existingold loansand on new ones taken out to pay thiselevated interest on the old loans. Thecreditors had inserted 'floating' rates ofinterest into the fine print of the originalloan contracts, whose subsequent mean-ing creditors and much less debtors hadnot understood or imagined at the timeof signature. Normal contract law pro-vides that contracts are invalid or can beinvalidated by a court if they were signedwithout full cognisance by both contrac-ting parties. Applying this legal norm tothe floating interest rate small print ofthese 1970sdebt contracts would substan-tially reduce the amounts nominally owed.That is, this interest accrued at rates thatwereunilaterally ncreasedby the creditorsshould have to be neitherpaid nor defaul-ted by the debtors, since under normalcontract law it neverbecame a legally bin-ding part of their debt. Why has thenominally high interest component ofthird world debts, which accrued withoutthe knowledge or knowing agreement ofthe damaged contracting parties,not beendeclaredlegally null and void? Legal pro-visions to do so can and should be made.Instead, so far interest has been piledon top of the debt, and some of both havebeen 'privatised' through debt-equityswaps. Debts that can never be repaid aresold, often at a discount, and then con-verted into local currency, which is usedto buy up equity ownership of local enter-prises and resources. Thus, debt is con-verted into, or swapped for, equity. Thisprocedure has achieved popularity insome circles as a solution to the debt pro-blem. It has several limitations anddrawbacks, however. First, only a fewbillion worth of debt have been so con-

verted. The hills of equity in existence inthird worlddebtor countries is insufficientto be swapped for more than a small partof the $ 1,000bn mountain of thirdworlddebt, or even for any significant portionof it owed to private banks. Second,potential foreign investors are more in-terested in some countries in East Asiarather han in the most indebted countriesof Latin America and Africa. Third, thisproceduredoes countribute no new capitalfor the development of new production,but only transfers old enterprises andresources to new owners. Fourth, this ex-ercise mostly transfers national publicenterprises and natural resources toforeign ownership. Fifth, debt-equityswaps alienate these enterprises andresources at forced sale bargain prices.However, much of the present nominaldebt was not properly contracted and cer-tainly was never received by the debtor asan equivalent flow of real capital orresources from abroad. Therefore, nowswapping this nominal foreign debt forreal national equity amounts to givingaway the family jewels for a mess of por-ridge. Sixth, therefore any possible exten-sion df such debt-equity swapsto the mostvaluable national treasures, such asPetrobras and Pemex, will arouse justi-fiably fierce nationalist opposition.On the other hand, many loans wereoriginally taken out, not by governments,but by private enterprises; and they havesubsequently been socialised. Yetcurrentpolitical wisdom and market logic speakfor the reverse.When the private debtorswere threatened by bankruptcy and wereno longer able to service their debts, theycalled on earlier government guaranteesor asked for new ones. Their loans wereguaranteed or taken over outright by na-tional governmentsor their central banks.If these private and public parties in thethird world did not so agree on their own,creditor banks or governments as well asthe International Monetary Fund (IMF)blackmailed the third world debtors intogovernment guarantees or takeovers ofthese private loans on threat of with-holding further credits.The reason for allthis was simple: private losses threatenedwith bankruptcy as Smith supposed) weresocialised for payment by the public atlarge through taxes and/or inflation aswell as reduced governtent services.There is no political or economicjustification for the all too commonsocialisation oi private osFes. On the con-trary, f privatisation and the magic of themarket offer such surefire solutions tocontemporary ills as President Reagan,PrimeMinister Thatcher, Prime MinisterChiracand others claim, why not privatisepublic loans or at least re-privatise thosethat were socialised? Indeed, the magic ofthe market has itself begun effectively to

privatise some loans by selling and buy-ing them at a discount from their facevalue in the secondary market. However,when Brazil proposed to convert part ofits debt into securities at current marketdiscount prices, creditor banks andgovernments balked. US Secretary of theTreasurydeclared the Brazilian proposala non-starter, and Brazil withdrew it. Ifthe magic of the market s good for all andprivatisation is good for the goose, thenwhy should they not be good for thegander?Unequal treatment of formally equalbut actually unequals is also rampantelsewhere. The IMF (Institute for Miseryand Famine) obliges third world debtorcountries to swallow its 'stabilisation'(read contractive) medicine supposedly toreduce their domestic fiscal and foreignpayments deficits. Large parts of thesedeficits, of course, are generated by thegovernments' debt service in the firstplace; and they are further aggravatedbyswallowing the IMF medicine. Yet theIMF does not even recommend the samemedicine to the United States with theworld's largest foreign debt (by now morethan all of Latin American foreign debtcombined and still growing soon to topthe entire third world debt) fed by amassive $ 200 billion annual domesticbudget deficit and nearly as large a tradedeficit. Nor does the IMP treat thebalance of payments surplus countries,like Germany and Japani. Yet, the IMFCharter provides for - irveillance of allthese countries alike;, 'the Group of 24(developing countries, . ;s long since ask-ed the IMF for equa treatment of alldeficit countries.All pleas for equal treatment have beenof no avail. The IMF Director has alwaysbeen a European, but he only dances tothe American tune. Irnfact, EuropeanGovernorsof the IMF invariablyalso votethe American line. Yet these same Euro-pean governments' finance, trade, agri-cultural and other ministers sustain far-reaching and deep-going economic dis-putes, also about American deficits, withtheir American colleagues. Why are thesenever reflected in European votes at theIMF? If war is too important to be leftto generals, money is too important to beleft to bankers, including central bankers.Perhaps finance ministries or treasuriesrather than central bankers should exer-cise greater prerogatives at the IMF.Finance ministries and treasuries may bemore sensitive to public demands andmore sensible about realworld conditionsthan the isolated bankers' bankers.One real world fact of life (as AdamSmith observed) is bankruptcy.Of course,it is anathema to bankers, except whenthey wish to exercise this privilege forthemselves, as a growing number have

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done in the United States, for instance.There, as in all other capitalist countries,in the name of the public good and capita-list efficiency,bankruptcy aws provide forthe insolvency of private enterprises,private individuals, public institutions,regionaland local governments(New YorkCity nearly went bankrupt), and evenbanks themselves. Both debtors andcreditors are afforded the protection oftheir most essential interests by law andcourt, which (as under Chapter 11of theUnited States bankruptcy code) also seekto enable the enterprises, institutions andindividuals to make structural adjust-ments to re-establish themselves as goingentities by freeing them from unbearableburdens. (New York City, the ChryslerCorporation, Rolls Royce, AEG Tele-funken, etc. and the Continental IllinoisBank and Trust Company among manyothers were all enabled again to set theirhouses in order). Why should this samelegal practice in the public interest bedenied to effectively insolvent 'sovereign'debtors? Instead, the banks encouragethem first to socialise the bankrupt privatedebt. Then, the IMF obliges them to in-creasethe payment of unbearableburdensand take them out of the hides of theirpoorest citizens who are least able to bearthese burdens. And the World Bank calls

for simultaneous structural adjustmentsand economic growth to boot. Thesedemands from the third world, of course,contradict all economic logic and legalprocedure elsewhere. The United NationsCommission for Trade and Development(UNCTAD) in 1985 and Kunibert Rafferfrom Austria more recently haveproposedthe much more logical extension of nor-mal bankruptcy laws and the establish-ment of bankruptcy courts or commis-sions to cover soverign country borrowersas well. There has been no visible or audi-ble response, but there should be.Moreover, sovereign bankruptcy pro-ceedings need only be a last resort afterthe debt burden has already been reduc-ed by declaring the elevated interestcharges as the contractually invalid fineprint that they are and by (re)privatisingsome of the socialised debts, which wouldthereby make them automatically subjectto the bankruptcy laws and proceedingsalready available to the private sector.These are some of the practical logic andlegal practices to stem the hemorrhage ofthirdworlddebtors on an emergencybasisnow. Later we can turn to the task ofreforming the old economic order, beforeit results in benefits accompanied by fur-ther dreadful misfortunes that no humanwisdom can foresee.

Volcker Years at the FedI: Hasty Embrace of MonetarismSudhir SenAt a special press conference on October 6, 1979 Paul Volcker,then chairman of the US Federal Reserve Board, hurled histhunderbolt: he announced that henceforth the Fed would targetonly the money supply but not the interest rates which would beallowed to find their own levels in the market place. So began theera of floating interest rates which, in one form or another,coloured the whole of the Volckerregime at the Fed.ON August 6, 1987, Paul A Volcker,aftereight years of service as chairman of theFederalReserveBoard, stepped down andthe baton was passed on to his successor,Alan Greenspan. There had been wide-spreadpredictions, especially in the finan-cial communities both at home andabroad, about the dire consequences thatwould ensue if Volcker were not reap-pointed to a third four-year term. Accor-ding to many, not to retain a stalwart per-son of such high standing in the world offinance as Fed chairman in these criticaltimes would be both foolhardy and acostfy error on the part of the administra-tion. To them any other choice was justunthinkable.Yet,the unthinkable has happened. Ina terse statement the administration an-

nounced its decision to drop the numberone financial pilot of the nation. The sur-prise jolted the markets; the Dow Jonesplunged 20 points in almost as manyminutes.And then came another surprise.The Industrial Index rebounded almostwith the same speed and ended the dayon the plus side. Heavens did not fall. Theprophets of doom and gloom wereprovedfalse. Soon the Dow Jones gathered freshmomentumand taggedon another coupleof hundred points.Thus, the ctange at the head of the Fedhas, at least so far, barely created morethan a ripple. What was supposed to bea momentous move the markets haveshrugged off almost as a non-event. Oneshould not, however,readto much in theseshort-termreactions. The jury is still out.

Only the future will reveal the full impactof the switch from Volcker to Greenspanand of the wisdom, or otherwise, of themove.Volcker was handpicked by presidentJimmy Carter and installed as Fed chair-man on August 6, 1979 in a desperatemove to calm the financial markets, tohalf inflation, and to restore confidencein the dollar. It was a time of exceptionalturbulence: inflation was raging at an an-nual rate of 13.5 per cent; real interestrates (nominal rates minus inflation) werenegative by several percentage points;there was a borrowing binge by con-sumers; capital was fleeing the country,dollar was being dumped recklessly athome and abroad, bond and stockmarkets were sinking. Against this bleakbackground stood the towering figure ofPaul Volcker, hen chairman of the FederalReserve Board of New York. The marketseagerly turned to him as the only man onthe horizon who could clean up the mess.In that sense it was the market which dic-tated the appointment of Volckerwith theadvice and consent of the president andthe senate.To start with, Volcker tightened themoney supply by a notch or two andmodestly pushed up the interest rates, butin the financial climate then prevailing hemoves looked like mere palliatives. In thewaning days of that summer anotherstorm hit the financial markets accom-panied by furious dollar-dumping.Volcker who was then attending the an-nual gathering of the World Bank and theMF in Belgrade, had to listen patientlyto the charges levelled against the USeconomic and monetary policy by theleading finance ministers of the westernworld. A first-rate crisis was on handwhich brooked no delay. He returnedpost-haste to Washington, held severalrounds Qfdiscussions, and that week-end,on a Saturday evening, October 6, 1979,at a special press conference Volckerhurled his thunder-bolt. He announcedthat henceforward the Fed would targetonly the money supply,but not the interestrates, and would allow these rates to findtheir own levels in the market place. Themonetarists were elated; this is preciselywhat they had been clamouring for withincreasing stridency. Others were flab-bergasted; they could not believe that theinterest rate which is the price of moneyand therefore a key determinant of allbusiness decisions and an all-pervasiveitem of cost, would suddenly be made in-determinate and delivered to the specu-lative forces operating in the so-calledmarket place. But the die was cast. Afateful decision was made. So began anera of floating interest rateswhich, in oneform or another, coloured the Volcker

regime at the Fed.Economic and Political Weekly October 17-24, 1987 1799

[1987] andré gunder frank. debt where credit is due (in: economic and political weekly, pp....

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