The World Debt Crisis; H. Sennholz

Many economists are fearful that the international debt crisis is more than the bankers can handle. They liken the global debt burden to a pyramid that is weak, getting weaker and heading for collapse. They draw ominous analogies with the finanTHE WORLD DEBT CRISIS 77 cial crisis of the early 1930s that greatly contributed to turning an economic slump into the Great Depression. Other economists, espe cially in government, reject such pessimism. They argue that the sys tem is strong enough to weather a default of several major debtors, that the creditor banks have adequate reserves to cover .any serious de fault, and that central banks would protect any individual bank from failing and thereby avoid a panic on the international markets. They also point to the International Monetary Fund-the lender of last resort which can be expected to bail out countries in payment difficulties. They speak of a "safety net" that is protecting the world financial struc ture from falling apart.

The Safety Net In fact, the safety net may be very comforting to overextended debtors and their lenders, but its very exis tence may have invited the overex tension in the first place by encour aging bankers to loan more money than their foreign customers were able to repay. No matter how much money the banks would lend to "developing" countries-sometimes recklessly and foolishly-there was always the IMF to pick up the pieces. Surely, IMF and government offi cials are convinced that the world financial system needs more such safety nets that would prevent it from plunging into a serious crisis. But all such devices constructed by gov ernments merely cushion the fall, they do not prevent it. The safety-net advocates like to point to the lack of safeguards in 1931 when, in the midst of financial disorder, Austria, then Germany, and finally Great Britain defaulted in their payment obligations. In many respects the situation then was sim ilar to that of today. Under the im pact of a great flood of bank credit generated by easy-money policies of the Federal Reserve System in 1924 and thereafter, bank credit was su perabundant in New York. High yield foreign bonds were in great de mand, which led many New York banks to extend loans to foreign bor rowers, especially German states and municipalities. The funds were of ten spent on current consumption, called social service, that permitted the people to live better today at the expense of tomorrow.

There was no safety net, no inter national cooperation or institution that would come to the rescue of a small Austrian bank, the Credit Anstalt, when foreign funds were suddenly withdrawn. The panic gai;ned strength and spread from Austria to Germany, to London, and finally New York. Surely, prompt banking cooperation might have avoided the debtor collapse, but it could not possibly correct the great harm inflicted by the credit expan78 THE FREEMAN February sion. Billion-dollar loan funds had been squandered, the capital mar kets had been disarranged, prices and production disorganized. The seeds had been sown for a worldwide depression. The Current Situation What of the situation today? The credit expansion of the 1970s dwarfs that of the 1920s. It had its begin ning in the United States and then spread like wildfire to all capital markets in Western Europe and Ja pan. It flooded the world with easy credit that amounted to hundreds of billions of dollars rather than a few as during the 1920s. It led to the de fault of dozens of sovereign coun tries, which wasted the funds on grandiose political schemes de signed to glorify government and make socialism work.

But the present situation differs from the 1931 crisis in one impor tant respect. In the 1920s and early 1930s the world money consisted of gold. The world was on a gold stan dard and all international payments were made in gold. Today, the world is on a U.S. dollar standard and most international payments and debts are settled in dollars. While it may be very difficult to construct a safety net of gold, it is rather simple for the U.S. government in cooperation with other governments to weave safety nets of paper money. Governments cannot manufacture gold; they can print ever larger quantities of paper money. But how safe are such paper nets? The International Monetary Fund Most international bankers and government economists look upon the IMF as the primary net that was woven at Bretton Woods, New Hampshire, in 1944. Its stated ob jectives are to promote international monetary cooperation and currency stabilization, which means the pro motion of international government cooperation in matters of money management. The amount any gov ernment can borrow from IMF is in proportion to the amount it has de posited, which in turn is determined by the country's world trade, output, and the like. Debtor governments usually favor a large "quota," which they may establish by contributing primarily their own weak curren cies and then draw hard currencies, such as U.S. dollars, German marks and Japanese yen. They are press ing for significant increases of their quotas so that they can borrow more and spend more. Many want their quotas trebled; some industrial countries (e.g., West Germany and Great Britain) merely favor a 50 per cent rise. The Reagan Administra tion is considering a $25 billion emergency fund, administered by the IMF, to help countries with cash crises.

For the most part, newly created 1983 THE WORLD DEBT CRISIS 79 central bank funds are used in IMF transactions, which makes the Fund an exchange for self-created and de teriorating currency and an inter national engine of worldwide infla tion and currency depreciation.· It is forever pursuing the spurious no tion that the policy of inflation can be made to last indefinitely through cooperation of all member govern ments. It acts like a governmental cooperative with 146 members that tries to coordinate the inflationary policies of its members. Governments that inflate and de preciate their own currencies at reckless rates and, therefore, face international payment difficulties, such as Mexico in recent months, are rescued immediately with billion dollar loans. At the same time IMF imposes "conditionalities" that are supposed to correct the causes of the payment difficulties. But the condi tionalities are usually taken from the armory of government control over the people. They include such de vices as restrictions of imports, pro motions of exports, tax increases, and so on. Rarely, if ever, does IMF rec ommend a reduction in the scope and function of government.

The U.S. Dollar Standard The U.S. dollar as the world stan dard currency occupies. the central IMF position to which all other cur rencies must adjust. But this central dollar position grants an ominous privilege to the U.S. government as the primary supplier of world cur rency. It permits the U.S. to inflate the dollar with a certain degree of immunity and to suffer painless bal ance-of-payment deficits because millions of people all over the world are eager to accept and hold U.S. dollars. The rising quantity of U.S. dollars gushing from Washington is met by a rising world demand, which keeps the dollar depreciation at a minimum. But even this pleasant privilege that permits the American people to enjoy foreign imports without pay ing for them with American goods, is subject to certain limits. When, despite the privilege, the U.S. gov ernment manages to inflate the dol lar at rates higher than the going world rate and thereby floods credi tor countries with dollars, the dollar exchange rate tends to fall in inter national money markets, inflicting serious losses on countless dollar holders. Finally, when these dollar losses become unbearable, they may trigger a worldwide flight from the dollar, which would signal the end of the world dollar standard and the beginning of hyper-inflation at home.

The dollar panics of 1978 and 1979, when President Carter had to raise $30 billion of hard foreign currency in support of the sinking dollar, re vealed the very limit to which the dollar inflation could be carried without upsetting the world mone80 THE FREEMAN February tary order. U.8. monetary policy has been more restrained and conform able to IMF standards ever since. The World Is Gasping for Liquidity Third World debt has more than quintupled in a decade, half of which is owed to private banks. Repay ments falling due in many cases ex ceed the debtor's foreign exchange earnings. In 1982 alone some $30 billion in payments falling due had to be rescheduled, which is three times the amount that were not paid on time in 1981. Cash-flow squeezes and debtor defaults may become worse in 1983 and 1984. The 1970s witnessed the greatest credit boom the world has ever seen. There had been some credit expan sion before August 15, 1971, when President Nixon unilaterally abol ished the last vestiges of the gold standard. Credit expansion acceler ated dramatically thereafter when the U.8. government flooded the world with U.S. dollars. Central bank reserves now consisting primarily of paper dollars expanded from $92 billion in 1970 to more than $800 billion in 1981. Commercial bank credit expanded two or three times faster than before. The Eurodollar market, which recycled the flood of petrodollar· deposits to debtors all over the globe, grew from some $100 billion in 1970 to nearly $2 trillion today. All these credits fueled an in flation the likes of which the world has never seen before. The abund ance of credit and bargain interest rates below inflation rates seduced many governments, companies and individuals to live beyond their means until they could borrow no more.

With the help of foreign loans and domestic credits many governments indulged in popular subsidy and transfer programs, consuming in come and wealth at unprecedented rates. The foreign credits raised the levels of living of the debtors, espe cially government officials and their political beneficiaries, while they lowered those of the people of credi tor countries. But the shock of de fault is signaling the end of the wealth transfer process from credi tors to debtors, from capitalistic countries to socialistic and commu nistic countries. The consumption of capitalist wealth is finally drawing to a close. Consequently the levels of living in debtor countries are tumbling, transfer programs are failing, and the political forces that depend on the economic transfer are falling into disrepute. Politicians are calling it a "liquidity crisis"; in real ity, it is a shock which spendthrifts usually suffer when called upon to make payment.

Seeking Security Abroad Many debtor countries received large amounts offoreign credits that could not be invested productively 1983 THE WORLD DEBT CRISIS 81 under the given conditions. Where governments control and regulate every phase of economic life there are few opportunities for individual investment. Where governments in flate and depreciate their currencies at horrendous rates, the people seek escape from destruction by hoarding foreign currencies that are likely to depreciate at lesser rates. They are hoarding U.S. dollars or investing them abroad. Millions of Mexicans, Argentin eans, Chileans, Uruguayans, and many others, found U.S. dollars and u.s. investments extremely advan tageous. They rushed to their banks loaded with dollar credits and bought U.S. dollars for depreciating pesos. The banks acted as turntables, bringing dollars in and lending them to people who would take them back to the U.S. Many a Florida condo is owned by citizens of bankrupt debtor countries. Their politicians call it a "liquidity crisis"; in reality it is a flight of private capital from govern ments that would consume and de stroy it.

The soaring inflation of the 1970s naturally raised interest rates which together with the rise in total in debtedness raised the interest bur den. In the debtor countries a large portion of income now goes to pay interest on foreign debt and to roll over old debt at rising interest rates. Interest payments have doubled in recent years, which without the injection of new loans are squeezing the life out of borrowers. To meet pressing payment obligations many resorted to short-term borrowing, which is squeezing the debtors harder still. Many countries are de facto bankrupt-Mexico, Argentina, Chile, Costa Rica, Bolivia, Poland, Ru mania, and several African states. Others may fail to make interest payment when it falls due-Peru, Venezuela, Yugoslavia and, most important, Brazil. They all blame the liquidity crisis; they should decry their own policies that would cir cumvent reason and inexorable eco nomic law.

The Call for "Reactivation" The international banking system is under great strain. There is little hope that many foreign debtors will ever repay their debt. Creditor wealth has been wasted in public works and social service, lost on countless schemes of government welfare and development, which were to create a better world through po litical action or outright socialism. The experiment, which is costing the capitalist countries hundreds of bil lions of dollars, is failing visibly as poverty and misery are descending on the debtor countries. But spendthrift politicians rarely learn from their own experience. One political party may replace another, one junta may overthrow another, but the economic policies may re82 THE FREEMAN February main unchanged because the no tions and doctrines that are breed ing the policies are not changing. The bad debtors of the world now are calling for "reactivation" which is more of the same. They want "rein flation" on a global scale, to bailout governments and companies wal lowing in bad debt. Even U.S. poli ticians are talking about "reactiva tion" through legislation that would lower interest rates, create more credit, or force the Federal Reserve System to stimulate the economy through more dollar injections.

The wide road ahead leads to "ac tivation," which in time will rekin dle the economic boom and save many debtors through monetary de preciation. It is protected by many safety nets designed to cushion the fall of the most reckless debtors. But it is also a downhill road on which inflation will accelerate, the U.S. dollar will suffer worse panics and crises than in 1978 and 1979, and the world economy will slowly dis integrate and sink into permanent despair. The road to peace and prosperity points in the opposite direction. In the words of an 18th century French philosopher, Charles de Montes quieu, "countries are well culti vated, not as they are fertile, but as they are free." On the road to free dom government powers and func tions must be reduced in every sphere of individual life, and politicians be separated from the economic activ ity of the people. Above all, the po litical apparatus must be completely segregated from money and fi nances; the power over money must be taken out of the hands of politi cians and returned to the people.

Any MajorNationMay Lead the Returnto Freedom Anyone of the principal countries can lead the way. It would immedi ately restore the individual freedom to choose any currency and medium of exchange, and remit the freedom of contract in all monetary matters. In a country racked by chronic infla tion, such as Mexico, Argentina, and other Latin American states, finan cial stability would soon return through the development of a par allel standard of pesos and world money, that is, U.S. dollars. If two or more currencies are freely usable and exchangeable in all transac tions, at free and unhampered rates, the people will prefer the most sta ble and reliable currency, which in many countries would be the U.S. dollar. Thus, the legal parallel stan dard would probably become a de facto dollar standard in many parts of the world. A dollar standard in Mexico, Ar gentina, Chile, and Bolivia, would bring immense improvements to economic life and well-being. But the dollar standard would merely be an interim step on the road of monetary 1983 THE WORLD DEBT CRISIS 83 freedom. In time the dollar stan dard, which, too, is a political stan dard managed by spendthrift politi cians in Washington, would be found wanting and, therefore, be replaced by the only natural standard, the gold standard. If people were free to choose they would prefer non-politi cal money, honest money, the money of the ages, which is gold.

Monetary Stability If the U.S. were the leader toward world peace and prosperity, it would point the way toward monetary sta bility through the gold standard. It would shun the temptations and privileges of a world dollar standard and lead the way by bringing its own house in order. It would restore in dividual freedom in money and banking by repealing the myriad of laws and regulations that engulf the financial institutions. Instead of purging gold from the financial sys tem it would encourage the use of gold in all exchanges and clear the way for a parallel standard of dol lars and gold. If the U.S. government were a fi nancialleader toward monetary sta bility and economic prosperity it would set an example to the rest of the world by balancing its budget this year and every year, and abstain from any further currency and credit expansion. And once the dollar ceases to lose any more purchasing power, not even 5 per cent, 3 per cent, or 1 per cent, it would be made redeem able in gold. In short, politicians and government officials would surren der their power over money and banking to the people who would be free to choose.

As a world leader the U.S. govern ment would withstand the tempta tion to rekindle the world paper boom through more inflation and credit expansion. It would refuse to join the Third-World search for more bank credits, to build more safety nets for reckless debtors and irresponsible lenders, grant more quotas or for eign aid to socialist and communist countries, and cooperate in any in ternational scheme that would deny monetary freedom to individuals. It would withdraw from the Interna tional Monetary Fund and the World Bank, and cease to cooperate with any government that seizes, blocks, or confiscates American property. As true leaders of the free world Americans would have no need to lead-they would be content to set an example and point the way. i New Revised Edition DEATH & TAXES by Hans F. Sennholz 109 pages $5.95 Order from: The Foundation for Economic Education Irvington-an-Hudson, N.Y. 10533 John K. Williams The Armor ONE of the most dramatic stories in the Bible is the story of David and Goliath. Goliath, almost ten feet tall, was truly a fearsome figure. Every morning and every evening he, the champion of the militant Philis tines, hurled his challenge at the Is raelite army: Send one man out to do battle against me! If the repre sentative of the Israelites won, the Philistines would become slaves of the Israelites. If he, Goliath, won the Israelites would become slaves of the Philistines.