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Debt, default and relief in the past – and how we are demanding that the poor pay more this time
Joseph Hanlon
September 1998
Summary and key pointsDebt and default are not new. The present problem of countries not able to repay debts is very similar to the 1930s - and the 1880s and 1840s.
In the 1930s Britain defaulted on its First World War debt to the United States -
AND HAS NEVER PAID. Britain still owes $14.5 bn to the United States for loans during the First World War; only three countries in sub-Saharan Africa have larger debts. The rest of Europe owes another $18.5 bn to the United States. None are repaying this money. If rich Britain believes that it need not repay such a huge amount, what right does it have to demand that poor countries pay?
Not only are we demanding that the poor pay, but we are demanding that they pay far more than we considered acceptable for ourselves and our allies in the past. For example, Britain and Germany are demanding that poor countries pay more than five times as much in debt service as they agreed to pay after the Second World War.
The International Monetary Fund, the World Bank and the Paris Club of government creditors in 1996 set out its initiative for Highly Indebted Poor Countries (HIPC), which involves cancellation of "unpayable" debt, leaving poor countries with debt repayments that are considered "sustainable". This study of historic debt settlements shows that these levels have been set three to five times higher than what was considered sustainable in the past; indeed they are much higher that levels once considered unsustainable.
One HIPC criteria is the debt-service-to-export ratio - that is, what portion of export earnings goes to repay principle and interest on debts. HIPC says 20% to 25% is "sustainable".
By contrast in Germany in the late 1920s, 13%-15% was considered so excessive that opposition to it was credited with having helped promote the Nazi take-over. In 1951, Germany was asked to use 10% of exports to repay debts, but it argued this was unsustainable. Its former enemies agreed, and Germany payments were limited to 3.5%. British repayments to the United States for loans after the Second World War were capped at 4%.
When the West wanted to give political support to Indonesia after the overthrow of a left government, it ignored huge human rights violations (including the massacre of 750,000 people) and granted debt relief. The Paris Club agreed that a 20% debt-service-to-export ratio was totally unacceptable and capped repayments at 6%.
If 10% was unsustainable for Germany and 20% was unsustainable for Indonesia, why is 20-25% now sustainable?
Finally, the study notes that the 1980s and 1990s are very similar to the 1930s and to the end of previous cycles. One writer described the 1980s as "hauntingly familiar to those who have read the history of debt crises." In each case a surplus of deposited funds led banks to substantial international over-lending and "loan pushing" - using cheap interest rates and other inducements to push developing countries to take loans they do not need. Many countries borrowed only to use the money to repay old loans; when the bubble burst, they could no longer obtain loans and could not pay. Many writers argue that the banks and richer countries must take more responsibility for loan pushing, and that it is both impractical and immoral to demand repayments of loans pushed onto the poor.
Historic debt relief tableDebt-service-to-export ratio20-25% HIPC
< 4% UK, 1945
< 3.5% London agreement for Germany, 1952
6% Indonesia, Paris Club, 1970-71
Agreed, but later considered unacceptable
13%-15% Germany, 1924, Dawes Plan
Proposed but rejected because considered unacceptable or unsustainable
10% Germany, Abs, 1951
< 20% Indonesia, IMF, 1970
Debt-to-export ratio
200%-250% HIPC
77% Latin America, 1945
Debt write-off
< 80% HIPC
90% Mexico, 1942
Outstanding debts not being collected
$ 33 bn European debts to US for World War 1, 1930s default,
including UK $14.5 bn
?? Mississippi debts to UK, 1842 default
< = less than
We've been here before
Debt, default and relief
in the past –
and how we are demanding
that the poor
pay more this time
1. 1327 to 1929 & 1979:
manias, panics and crashes
“After King Edward I expelled the Jews in 1290 he needed the Italians to finance his wars . ... To these Italian bankers England was a wild developing country on the edge of the world, a kind of medieval Zaire. Its exports of wool offered prospects of big profits; but with its despotic monarchs, its tribal wars and corrupt courtiers, it had a high country risk,” wrote Anthony Sampson in his prescient 1981 book The Money Lenders. [1] “But after King Edward III came to the throne in 1327 he was confident that he could compel his own English merchants to finance his wars; he defaulted on his Italian debts, and the [Florentine] banks of Bardi and Peruzzi collapsed.”
A century later King Edward IV's War of the Roses took him deeper into debt. “After trying to reschedule their debts with the King, the Medici Bank had to write off 52,000 florins and close their London office. `Rather than refuse deposits,' concludes the historian of the bank, `the Medicis succumbed to the temptation of seeking an outlet for surplus cash in making dangerous loans to princes.' It was a warning relevant to more modern bankers,” comments Sampson.
Four centuries later, London was lending to the new United States. “London saw it as a very unreliable developing country, with a black record of embezzlement, fraudulent prospectuses and default,” notes Sampson. But the bankers made loans in any case. In 1842, 11 states including Maryland, Pennsylvania, Mississippi and Louisiana defaulted. Setting a precedent that would be used often in later years, Barings bank simply intervened in local politics. In Maryland Barings helped to finance candidates in the next election who were willing to repay. “In the elections in 1846 the `resumptionists' narrowly won, and soon afterwards Maryland raised new taxes which enabled it to repay its debts. The campaign had cost Barings about $15,000; it was worth it,” notes Sampson.
Mississippi held out. By 1929 the unpaid debt was estimated at $32 million, and as recently as 1980 London banks were still trying to get Mississippi to repay on the loans it defaulted on 138 years earlier. [2]
Debt cycles
Economics has fascinated historians and philosophers, and disputed interpretation could be seen as one root of the Cold War and of the key conflicts of the second half of the 20th century. But there is a common agreement that business cycles exist and that they are linked to repeated debt crises.
The eminent economist Charles Kindleberger wrote a book whose title, Manias, panics and crashes, [3] captures his view of the cycles. He points to the tulip mania of 1634, the South Sea bubble of 1720, the cotton and railway booms of the 1830s, and so on. Kindleberger says that in each cycle, there is a period of growth involving a rise in profits and a rapid expansion of bank credit. Eventually money growth outstrips production and money goes into speculation. This is often linked to fraud and swindles, as speculators look for ever more profitable investments. This is the period of bubbles or what Kindleberger calls “manias”, and usually involves international lending. In the 1820s, for example, a Scottish adventurer Gregor McGregor raised £200,000 for an entirely mythical South American “Kingdom of Poyais”. [4] Eventually the bubble bursts, prices fall, and investors try to sell or to collect on their loans. This is the period of “panic” as investors all rush for the exit. The panic feeds on itself, leading to the “crash”.
Economists point to both long and short cycles, but it may be useful to look at four long cycles (each of which had short cycles within them.): [5]
1) growth 1780-1820, mania 1820s, crisis 1830s & 1840s.
2) growth 1850s, mania 1860s, crisis 1870s & 1880s.
3) growth 1893-1913, mania 1920s, crisis 1930s.
4) growth 1948-1967, mania 1967-1979, crisis since.
Both the 1870s and the 1930s saw major international depressions.
Each mania involved an international lending boom which overlapped with the end of growth in domestic economies of the then developed countries, as lenders were forced to look abroad for higher profits – just as the Medicis did with Edward IV in the 15th century.
The discussion of cycles leads to a point about the current crisis made by many authors. Extra lending in the 1970s was not created by the 1973 oil price boom, although it did create a further surge in lending. Rather, international lending was already into the “mania” phase and the oil price rises can be seen as attempts by the oil producers to cash in on the speculative bubble. Kindleberger stresses that a panic in inevitable, but the trigger of each panic is different. It seems likely that the second (1979) oil price rise, followed by the 1982 Mexican default, burst the bubble and caused the panic.
Loan pushing
After each cycle, there have been retrospective complaints of reckless lending and of “loan pushing” – banks and lending agencies encouraging foreign governments to take loans they do not need, and encouraging borrowers to live beyond their means. Toward the end of the mania, borrowers are encouraged to take new loans simply to repay old ones. With the panic, lending suddenly stops, borrowers cannot repay, and they default. Kindleberger comments: “Boom loans are undertaken on the upswing, defaulted at the peak, and refunded on the next upswing, which may also lead to new borrowing.”
Francis White, the US Assistant Secretary of State for Latin American Affairs in the early 1930s, commented that “in the carnival days from 1922 to 1929, when money was easy, many American bankers forsook the dignified, aloof attitude traditional of bankers and became, in reality, high pressure salesmen of money, carrying on a cut-throat competition against their fellow bankers, and once they obtained the business, endeavoured to urge larger loans on the borrowing countries.” [6] According to evidence before the Senate Committee on Finance, there were 29 representatives of US financial houses in Colombia alone trying to negotiate loans with the government. [7]
In 1973 the US Federal Reserve Governor Andrew Brimmer noted that “the main explanation” for the sharp rise in lending to less developed countries is the “failure of demand for loans from borrowers in developed countries to keep pace with the expansion of credit availability.” This caused “the Eurocurrency banks (especially in London) ... to push loans to the developing countries with considerable vigor.” [8]
Brimmer cites a particular form of loan pushing, which involves as drastic softening of terms. [9] This is like a drug pusher offering cheap heroin in order to create addiction. In the mid-1970s, international loans had a negative real interest rate – that is, in real terms, poor countries had to repay less than they borrowed. Loan pushers in the mania phase stressed that they were, literally, giving money away. But loans were on variable interest rates, and in the early 1980s those rates jumped dramatically – setting off the threat of default and fuelling the panic. [10]
From a campaigning standpoint, it is important to understand that loan pushing is a normal part of the debt cycle. Even now, the World Bank is guilty of loan pushing – of citing its concessional interest rates to encourage poor countries to undertake excessively large and complex projects which will have very high running costs in the future.
Some of the liability for unpayable loans must rest with the loan pushers. The banks, governments and international financial institutions who encourage poor country governments to take unwise loans must accept most of the risk that those that those loans will not be repaid.
The role of creditor governments
In the 19th and early 20th centuries, lending was often in the form of bonds, which were then sold by banks to individual investors. >From the 1950s, lending was directly by banks, individual governments, and international financial institutions.
In theory, then, debtors in the past had more power because they were negotiating with thousands of individual bondholders, whereas now they face governments. This has led some writers to argue that governments played a lesser role in the past, citing, for example, Sir John Simon of the British Foreign Office, who in 1934 said: “my predecessor Lord Palmerston, who is not generally regarded as having been backward in the defence of British interests, laid down the doctrine that if investors choose to buy the bonds of a foreign country carrying a high rate of interest in preference to British Government Bonds carrying a low rate of interest, they cannot claim that the British government is bound to intervene in the event of default.” [11]
But Barry Eichengreen argues that “the contrast between the extent of government involvement in the 1930s and 1980s tends to be overdrawn.” [12] “Governments have always been intimately involved in the process of debt readjustment.” [13] What is different is that in the 1980s government involvement has been more systematic.
In fact, during the growth phase of the cycle and even sometimes during the panics, governments constantly intervened to try to direct loans to allies. And they tried to block loans to enemies. For example, in the late 1920s the US government stopped private sector loans to Brazil in retaliation for the Brazilian coffee price-support scheme. [14] (Shades of US cancellation of the International Coffee Agreement 60 years later.)
Perhaps the most surprising similarity was the way in which governments in the past tried to impose a form of structural adjustment in exchange for continued lending, to ensure that spending was cut and taxes raised in order to repay the debt. In the late 1920s Professor Edwin Kemmerer became an almost single handed IMF, imposing a line which “enjoyed a degree of intellectual hegemony that has never been rivalled.” He made repeated visits to South America, pressing for fiscal orthodoxy, greater controls over domestic credit, and a return to the gold-exchange standard. Edmar Bacha and Carlos Díaz Alejandro note that this is “the same sort of conditionality imposed ... during the 1970s” and then, as now, countries had little choice but to comply. [15] In the 1930s, as in the 1980s, there was a wide consensus that the measures imposed had been inappropriate and had harmed the economies.
Sometimes there was military action. After Mexico defaulted in 1861, Britain, France and Spain invaded; France installed Ferdinand Maximilian as emperor. (He lasted only four years, and failed to pay the debts.) [16] “The Royal Navy was no stranger to South American waters, once even attempting a naval blockade of Bolivia, and the US Marines were an important presence in the Caribbean and in Central America,” comments Carlos Díaz Alejandro. [17]
In Britain, the Corporation of Foreign Bondholders was set up in 1868 and was given semi-official status by an act of Parliament in 1898. [18]
Comparing the 1980s to the 1930s
“The more recent debt crisis was very much a rerun of that in the 1920s,” wrote Derek Aldcroft in 1997. [19] “The present wave resembled earlier experiences more closely than most participants realised. The onset of the crisis in 1982 again looked hauntingly familiar to those who have read the history of debt crises. It is the official response to the crisis since 1982 that stands in stark contrast to the past,” writes Peter Lindert. [20]
Three differences between the 1930s and 1980s-1990s seem important:
• The industrialised and creditor countries have not suffered much in this depression, whereas the crisis in the south has been very serious. By contrast, in the 1930s it was the industrialised countries which suffered, while Latin America was hardly harmed.
• The creditors are banks, governments, and inter-government agencies, rather than bondholders; interest rates were variable instead of fixed as in the 1920s.
• Governments have worked in a much more coordinated way both to prevent default by individual countries, and to bring collective pressure on debtors.
“What is different about the 1980s is a global official intervention, one shaped at least in part by an unprecedented exposure of a few major lending banks,” especially in the United States, writes Peter Lindert. [21] “In the 1980s, creditor-country governments, motivated by the desire to protect their banking systems, have exerted their greatest pressure on the debtor countries, urging full repayment and macroeconomic adjustment,” note Eichengreen and Lindert. [22]
“With the US banking system more vulnerable to destabilization by default on foreign loans than at any time in the past, the United States has intervened aggressively to ensure the maintenance of debt service,” write Eichengreen and Portes. [23] It has done so largely though its control of the International Monetary Fund, which was only established in 1944 and is, perhaps, the single most important difference between the 1980s and 1930s.
The Paris Club was set up in 1956 as an informal group of creditor governments, with a permanent secretariat in the French Treasury. By the late 1960s, the Paris Club had made all reschedulings conditional on having an agreement with the IMF. [24] Aid, too, became conditional on IMF approval. This package has allowed a slow but steady run down of debt to banks and its replacement with official debt to international agencies and governments, thus ensuring that the banks were not penalised for unwise lending. It has also ensured a steady flow of resources to the northern industrialised countries, thus preventing a financial crisis in the north, and ensuring that – in contrast to the 1930s – the depression is in the south rather than the north. This time, the poor have been made to bail out the rich.
As in the 1930s, settlement has been on a case-by-case basis. But this time the IMF imposes tight control; rather than case-by-case being a way to provide more sympathetic and more appropriate treatment to individual debtors, it became a tactic to divide and rule. The 1996 agreement for HIPC (Highly Indebted Poor Countries) debt relief is being negotiated on a case-by-case basis, albeit within defined parameters. This gives the creditors maximum opportunity to put the blame on the borrowers for taking unnecessary loans rather than on the loan pushers, and to impose additional conditions to ensure that some loans are repaid.
2. Debtors treated better in the past
The HIPC initiative calls for the reduction of debt to what the IMF calls a “sustainable level” – that is, one in which a country can meet its current and future external debt service obligations in full without recourse to further debt relief, although assuming continued aid flows and concessional lending, and “without unduly compromising growth”. [25] Under the HIPC initiative, sustainability is defined solely by two parameters:
• Net present value [26] of debt should be in the range of 200% to 250% of annual exports. That is, the debt should have a value equivalent to between two years' total exports and two-and-a-half years' total exports.
• Annual debt service (interest plus capital repayments) should be 20% to 25% of annual exports.
To meet this:
• Up to 80% of NPV of debt can be written off.
In this part of the report, we look to see if debt relief exercises in the past have been more generous. This is directly relevant, because as we have argued in the first part of the report, the present phase of the debt cycle is very similar to the 1930s and to earlier periods.
Direct comparisons are difficult, however, and certain estimates will need to be made, for four reasons:
• Basing the concept of debt sustainability on a percentage of exports is quite new, drawing on research by the World Bank and others in the 1960s and 1970s. Therefore in very few earlier debt settlements are debts to projected exports calculated in the HIPC format. In the past, negotiators kept one eye on predicted exports or trade surpluses to see if expected payments were plausible, but a debt-service-to-export ratio was rarely made explicit. Therefore, all comparisons of debt service to exports in this paper are retrospective, calculated here from what negotiators at the time would reasonably have expected exports to be, and were not expressed that way at the time (unless noted). Thus, for example, German and allied negotiators in 1952 set annual debt repayments in monetary terms and did look ahead at likely exports; we can use these figures to do a debt-service-to-export ratio and compare it to the HIPC “sustainable” level, even though negotiators 46 years ago were not thinking in those terms.
• Total debt in the past was often much smaller, so smaller write-offs often led to much lower debt service levels. Also NPV calculations were rarely used.
• Negotiations with individual bondholders often meant that there was no consistent settlement or defined settlement date.
• HIPC looks narrowly at exports. Past debt settlements often contained special additional measures to ensure sustainability, and there is nothing similar in the HIPC process. These are important precedents and are noted.
Finally, it is outside the scope of this report to look at the way in which the HIPC sustainability criteria were chosen, but this should be done because their origin is obscure. For example, the World Bank's World Debt Tables 1994-95 says that the “track record of selected SILICs [severely indebted low income countries] suggests that debt service ratios that consistently exceed 15% are high and that debt to export ratios greater than 200% have generally proven unsustainable over the medium term.” Yet the Bank and Fund have agreed to higher levels in HIPC. Furthermore, debt experts disagree. William Cline backs 200%, while Dragoslav Avramovic says “This 200% is an arbitrary number ... and one might just as easily say 100% or 300%.” Indeed, Avramovic rejects debt-export ratios as meaningful indicators of debt servicing capacity. [27]
With these caveats firmly in mind, we now move on to look at historic examples.
2.1 Germany
Germany is important for several reasons. First, it is virtually the only northern industrialised country to have had several 20th century debt renegotiations. Second, post-war rebuilding was an important issue in repayability (as it is for many HIPC countries). Third, as a defeated country, the rest of the international community had much more power than it did over Latin America, for example, in the 1930s. Thus Germany has enough similarities to the present situation to make its history particularly important.
Germany had three debt phases which will be treated separately: 1921-22 reparations, 1924-31 Dawes Plan, and 1953-9 London agreement.
Reparations
After the end of World War I, the victorious governments demanded that Germany pay massive compensation, although the amount was not specified in the Versailles Treaty signed 28 June 1919. Instead a Reparations Commission was established, and at its London conference in May 1921 it agreed Germany must repay 2 billion gold marks (about £100 mn or $400 mn at the time) annually plus 26% of the value of exports. (Note that this is the only historic example I can find for debt service to be explicitly linked to the total value of exports). This was manifestly too high, and Germany never made payments at this level. On 31 August 1922 the Reparations Commission agreed a six month repayment moratorium, but in January 1923 French and Belgian troops occupied the Ruhr, triggering the famous hyperinflation, which lasted until 15 October 1923. [28]
The Dawes Plan
A commission under General Charles Dawes, Director of the US Bureau of the Budget, was directed by the allies to draw up a more sensible payment plan. Announced in 1924, it set a schedule of payments rising from 1 bn of the new Reichsmarks (Rm) in 1924 to 2.5 bn by 1928, and continuing at that level thereafter. The Dawes plan was directly linked to a promise of further loans. Even this proved unsustainable, and by 1928 there were complaints. Renegotiations began in February 1929 with a US industrialist, Owen Young.
The Young Plan was agreed in 1930. It only cut payments by 20% and extended them to 1988, but it also included new loans to be used to pay the debts. Payments were made on schedule through 1929, and on only a slightly reduced level until mid-1931.
But in September 1930 Hitler's National Socialist Party did well in elections, in part because reparations payments were seen as too onerous. “The President of the Reichsbank, Hjaalmar Schacht, resigned in 1930 in protest against the American Young Plan to extract reparations. He put all his faith in getting Hitler elected; and he helped to persuade other banks, including the Deutsche Bank and Dresdener Bank, to finance Hitler's crusade,” wrote Anthony Sampson. [29]
On 20 June 1932 US President Herbert Hoover announced a one-year moratorium, which was extended the following year. In 1934 Hitler repudiated the war debt. [30]
Since the level of repayment under the Dawes plan was considered so high as to be unacceptable (both by Hitler and by post-war debt negotiators, see below), it is worth comparing it to the present HIPC terms. Reparations payments were only 13.2% of exports during 1925-28 and rose to only 14.6% during 1929-31. [31] This compared to the HIPC band of 20-25%. More importantly, until 1930 all reparations payments were paid by new loans; during this period Germany borrowed three times as much as she paid. [32] The crisis only came in late 1930 when, despite the Young plan, foreign lending stopped. [33] So German repayments were “unsustainable” at a far lower level than now proposed under HIPC.
Other Dawes provisions
The Dawes plan had a number of other provisions which look quite remarkable in retrospect. The new Reichsmark was not fully convertible to foreign currency, and the Dawes plan only required the German government to pay in Reichsmarks and deposit the money in a special account in the Reichsbank. A special transfer committee was set up to handle the conversion into foreign currency. The Dawes plan agreed [34]:
• Transfer abroad would only be done when conditions were favourable in the foreign exchange market. In effect, the creditors had to ensure a large enough flow of money into Germany to make all the reparations payments. [35]
• Money which could not be transferred abroad was to be invested in Germany. [36]
In addition, the Dawes plan had two further conditions that could reduce payments:
• If more than two years payments were held in the Reichsbank, reparations payments would be reduced.
• Payments were also indexed to domestic economic conditions, as measured by such items as volume of automobile sales, so that payments would fall it the economy declined.
The importance of these extra provisions was that the creditors took a responsibility to stimulate growth in the economy to ensure repayments. This is in sharp contrast to HIPC, which is linked to what the International Labour Organization calls “structural adjustment through contraction”. [37]
The London agreement
After World War II, reparations were only taken in the form of war booty – actually dismantling and shipping abroad German factories. [38] In London in 1952 a German team headed by Hermann-Josef Abs negotiated with representatives of 24 creditor countries. Abs estimated that if it paid the maximum amount claimed, the new Federal Republic of Germany would have to pay 1.5 bn DM annually to settle pre-war debts. He considered this intolerable. [39] In 1951 this was a debt-service-to-exports ratio of 10%. So Abs considered intolerable less than half of what the IMF and World Bank consider sustainable.
But Abs won. Under the London agreement, signed 27 February 1953, Germany accepted all pre-war debts, but the allies agreed to write off the equivalent of more than two-thirds of what Germany accepted it owed. [40] Remaining payments were to be made until 1978, at 567.2 mn DM annually for the first five years, and 765 mn DM annually after that. Payments scheduled for 1953 were 3.5% of 1952 exports, and were never expected to be more than 5% of exports. [41] This compared to 20-25% under HIPC.
Other London provisions
The problems caused by debt in Germany in the late 1920s and early 1930s led the London negotiators to add a number of special provisions. In particular the agreement includes an annex of principles and objectives. Abs wrote in 1959 that this annex says “that Germany's transfer obligations can only be met from a current surplus on the trade and services balance”. In other words, it could not be met by loans, as in the 1920s, but only by the allies buying more German exports. Abs goes on to note that the annex says “that the problem of our transfer obligations cannot be solved by restricting trade, production and consumption, and not by means of an austerity policy, but can only be solved by increasing and expanding trade though liberalization.” [42] A special arbitration process was established (but never used) to which Germany could appeal in case its growth was not as rapid as expected. [43]
Writing about the London agreement, Thomas Kampffmeyer comments that “policies which were akin, in their approach, to the deflationary policies recommended by the IMF today were found unsuitable for ensuring the Federal Republic's ability to make transfers. The parties to the treaty voted for what would now be called a supply-oriented expansive strategy to ensure Germany's external ability to pay, and creditors accepted ... that German debt-service payments also depended on the liberalization of their own trade.” [44]
The politics of the London agreement
The very soft terms of the London agreement must be seen in the context of the Cold War. By 1951 there had been a total split between the USSR and the three western allies. The Berlin blockade in 1948-9 was followed by the establishment in 1949 of the Federal (western) and Democratic (eastern) republics. Marshall aid was pouring in and the West was anxious to encourage the rapid development of its Germany in competition with east Germany.
Precisely for that reason, the London agreement gives a good picture of what the industrialised countries in 1953 thought was a debt service level compatible with rapid growth. And that level is approximately one-fifth the level set in HIPC.
2.2 Indonesia
Indonesia is next because of the key role of Hermann-Josef Abs, who negotiated what Cheryl Payer correctly called “the most lenient debt settlement which has been voluntarily granted to a Third World government by its creditors.” [45] Debts were to be paid in 30 equal annual instalments beginning in 1970, while interest was only to be paid from 1985. This gives a debt-service-to-export ratio of 6.6% in 1970, 5.4% in 1971, and declining thereafter. [46] In HIPC terms, this gives a debt-service-to-export ratio of about 6%.
Like Abs' previous debt settlement, this was a cold war prize for a new western ally. In August 1965 President Sukarno withdrew from the World Bank and IMF. The army overthrew Sukarno, put General Suharto in power, and massacred up to 750,000 “communists”. Suharto rejoined the IMF and an IMF mission arrived in mid-1966. In December 1996 the Paris Club of Western creditors met and rewarded Suharto by agreeing to a four-year moratorium on all principal and interest payments. Suharto did everything that was asked of him, including accepting an IMF structural adjustment programme with devaluation and free exchange. Suharto accepted an IMF credit squeeze which bankrupted nearly 10,000 Indonesian companies, while returning to the original owners foreign companies nationalised by Sukarno and opening the country to new foreign investors who were given protection not available to domestic firms.
Aid increased rapidly, from $200 mn in 1967 to $600 mn in 1970. New loans poured in, and by 1979 Indonesia owed nearly $12 bn, compared to $2 bn when Sukarno was overthrown. When he was overthrown, however, Sukarno's debt was seen as huge. When the debt moratorium was due to expire in 1971, the Paris Club sent Abs to propose a new arrangement which would further reward Suharto. Abs noted that the IMF and World Bank had come to the conclusion that expected payments of $200 mn per year “will exceed this country's financial capacity for years to come.” [47] That would have been a 19.8% debt service ratio in 1970 and 16.3% in 1971 – both below the current HIPC range.
The Abs plan said that no interest would be charged during the moratorium period, that principal on the Sukarno debt would be repaid in 30 annual payments of $67 mn starting in 1970, and that interest would be paid in 15 annual payments starting in 1985. In addition, the Abs plan said that if the repayment schedule (of one-quarter the current HIPC criteria) was too onerous, Indonesia could defer part of the payments on the principal for another eight years.
Only half of the $2 bn debt was to the Paris Club members, which was another reason they could afford to be generous. The other half was to the east bloc, and the Abs plan was conditional on all countries applying the same terms. They did.
2.3 Latin America
Latin America was a major borrower in the 1920s, mainly paying old loans by taking new ones. But the new loans stopped in 1930, and exports fell dramatically as the industrialised countries became protectionist; by 1935 the total debt (not NPV) to export ratio for all of Latin America was 225% – then considered unsustainable, but still within the HIPC bands. By 1934, Latin America had defaulted on 85% of its dollar bonds. [48]
Because Latin American debt was in the form of bonds, negotiations continued for two decades and involved a range of individual settlements and buy-backs of bonds at reduced prices. Bolivia did not complete negotiations on its 1931 default until 1958.
But by 1945 creditors and bond holders had already accepted settlements which took the stock of Latin American debt down to only 77% of exports [49] – one-third of the HIPC level.
During World War II the United States was anxious to gain support from Mexico, and it intervened in the negotiations with the bond-holders. In 1942, it was agreed that 90% of the debt would be written off. [50]
The first important debt renegotiation in the current cycle was Brazil. On 1 April 1964 the military overthrew President João Goulart. The United States recognised Goulart the next day, and promised that the IMF and World Bank would help, particularly with respect to the debt. In a pattern soon to be repeated elsewhere (but not in Indonesia), Brazil's debt was not significantly rescheduled, but Brazil was given substantial new aid and loans to allow it to repay its debts. The World Bank concluded that from 1965 until the oil crisis of 1974 “the foreign debt parameters did not show any sign of trouble” – even though the debt-service-to-export ratio ranged between 26% and 36% (well above the current HIPC range). But money was flowing in; debt increased from $2.7 bn in 1965 to $12.6 bn in 1973, and this paid the bills. [51]
2.4 Britain, Europe and the US
Although Britain never paid its 13th and 15th century debts, it was by the late 19th century a major lender. However, during World War I it was forced to take substantial loans from the United States. That debt proved to be difficult to repay. In 1923 the US extended the repayment period until 1983, and reduced the interest rate. In 1934, Britain and five other European countries defaulted. [52] No further payments were ever made, but the debts are still on the books. The US Treasury says that as of 30 June 1997, the debt stood at $ 33.5 bn. Outstanding First World War debts to the US include: UK - $14.6 bn, France - $ 11 bn, and Italy - $3.2 bn.
It is perhaps reasonable that some of what Britain owes the US might be written off against the British held bonds of the state of Mississippi, on which no payment has been made since 1842.
First World War debts outstanding are far larger than the debts of the poorest developing countries. If Europe is willing to refuse to pay and the US accepts this, why not apply the same thinking to Africa?
The Second World War was even more expensive, and by 1945 Britain had become the world's largest debtor. [53] Maynard Keynes went to Washington, and in December 1945 negotiated the best deal he could get for Britain – a loan of $ 3.75 bn at 2% interest, repayable in 50 annual instalments from 1951. [54] On 31 March 1997 the outstanding principal was £531 million; in 1996/97 Britain paid £74 million.
Keynes negotaited a remarkable additional condition, that interest due on the loan would be waived in any year in which interest payments were more than 2% of Britain's exports. Prabirjit Sarkar and Hans Singer note that “had there been such a clause of debt relief for the debtor LDCs, it would have meant a relief of about $100 bn during 1984-87.” [55]
Britain still had to make capital repayments, but assuming 50 equal payments, this sets a debt-service-to-exports ratio of under 4%.
However, the Keynes deal had a major sting in the tail – the United States effectively imposed structural adjustment. Britain was required to move quickly to free trade and had to make the pound convertible to the dollar within 15 months The outflow of money was so great that much of the loan was dissipated, and convertibility was abandoned within weeks. [56]
3. Some brief conclusions
Looking at debt history leads to several conclusions.
First, unpayable debt follows the business cycle – we have been here before. And a substantial part of unpayable debt in each cycle comes from loan pushing, in which banks encourage poorer countries to take loans they don't need. When the bubble bursts, as it must, lenders must take a much greater share of the responsibility and accept the losses.
Second, Britain and other European countries, and the US, have often defaulted on debts. Europe still owes $30 bn to the United States dating back to the First World War. It has no intention of paying this, but the sum is much larger than that owed by the poorest countries.
Third, where comparisons can be made, HIPC criteria are shown to be neither sustainable nor payable. Consider just debt-service-to-export ratio, where HIPC considers 20%-25% to be “sustainable”. Historically, levels of 10-20% have been considered unsustainable, and only ratios below 7% have been accepted. Germany and Britain both received ratios below 4% after the Second World War. Why are they now demanding that poor countries pay five to six times as much?
Finally, where creditors have been serious about sustainability, they added a range of measures to encourage growth and to ensure that the debts are repaid only out of growth. In one case, there was even independent arbitration under which the debtor (Germany) could appeal for payments to be deferred if growth was not sufficient. By contrast, HIPC is linked to “adjustment through contraction”, with the poor countries paying their debts through reduced consumption and austerity rather than through growth.
Thus the entire approach of rich countries to poor indebted countries today is the reverse of the way these rich countries expected to be treated when they were debtors.
About Jubilee 2000 Coalition
Jubilee 2000 Coalition seeks to increase education and awareness about the effects of the unpayable backlog of debt of the poorest countries, and calls for the cancellation of that unpayable debt by the year 2000 as a way to mark the new millennium.
Coalition members include 1990 Trust/National Black Alliance, ActionAid, ACTSA, African Justice and Peace Desk, ALISC, Alliance of Baptist Youth, Baptist Missionary Society, Baptist Union of GB, BSR (Church of England), CAFOD, CCBI, Christian Action on Third World Debt, Christian Aid, Christian Socialist Movement, Christians Aware, Christians for Racial Justice, Church of England, Church in Wales, Church Mission Society, Church of Scotland, Churches Commission for Racial Justice, Churches Together in England, Columban Fathers, Comic Relief, CommonWeal, Concern Universal, Evangelical Alliance, Evangelical Christians for Racial Justice, Green Party, Jubilee 2000 Scotland, Jubilee Campaign, Jubilee Centre, MAYC (Methodist Association Youth Clubs), MEDACT, Methodist Church, Methodist Relief and Development Fund, Mid Africa Ministries, Mothers Union, Mozambique Angola Committee, National Assembly Against Racism, National Federation of Women's Institutes, Network for Social Change, New Economics Foundation, NGO Networks Africa, IIED, Nicaragua Solidarity Campaign, One World Action, One World Week, Oxfam, People's Progressive Party of Guyana, Peru Support Group, Quaker Peace & Service, Reform Judaism, RESULTS (UK), Save the Children Fund, SCIAF, Selly Oak Colleges, Tear Fund, Third World First, Tools for Self Reliance, TUC, Tzedek, UNICEF, UNISON, United Nations Association, United Reformed Church, United Society for the Propagation of the Gospel, VSO, War on Want, Women's International League for Peace and Freedom, World Development Movement, World Vision, Y Care International & YWCA.
Jubilee 2000 Coalition, P O Box 100, London SE1 7RT
0171 401 9999 (tel) 0171 401 3999 (fax)
email: mail@jubilee2000uk.org web: http://www.jubilee2000uk.org
Footnotes
Sources [1] Anthony Sampson, The Money Lenders, Coronet – Hodding & Stoughton, London 1981. Following quotes are from pp 29-31 and 54-56.
[2] Financial Times, 22 March 1980, quoted by Sampson.
[3] Charles Kindleberger, Manias, panics and crashes, Basic Books – Macmillan, London, 1978, pp 6-23.
[4] Darrell Delamaide, Debt Shock, Widenfeld & Nicolson, London, 1984, p 96.
[5] See, for example: Barry Eichengreen & Peter Lindert, The international debt crisis in historical perspective, MIT Press, Cambridge (Mass USA), 1989, p 2; William Darity & Bobbie Horn, The loan pushers, Ballinger – Harper & Row, Cambridge (Mass USA), 1988, p 139.
[6] Quoted in Paul Drake, “Debt and Democracy in Latin America, 1920-1980s”, in Barbara Stallings & Robert Kaufman, Debt and democracy in Latin America, Westview. Boulder (Colorado, USA), 1989, p43.
[7] Quoted in Darity & Horn, p 2.
[8] Quoted in Darity & Horn, p 8.
[9] Darity & Horn, p 15.
[10] In the 1970s the real interest rate was -3.4% (world inflation averaged 11.4% while Libor – the London Interbank Offer Rate – was only 8%). By contrast, real interest rates for 1981-84 exceeded 12%. Eliana Cardoso & Rudiger Dornbusch, “Brazilian Debt Crises: Past & Present”, in Eichengreen & Lindert, p 126.
[11] Quoted in Barry Eichengreen & Richard Portes, “After the deluge: Default, negotiation and readjustment during the interwar years,” in Eichengreen & Lindert, p 19.
[12] Eichengreen & Portes, “After the deluge”, p 14.
[13] Eichengreen & Lindert, p 7.
[14] Edmar Bacha & Carlos Díaz Alejandro, “International financial Intermediation: A long and tropical view”, Essays in international finance no 147, Department of Economics, Princeton University, Princeton (NJ, USA), 1982, p 3.
[15] Bacha & Díaz Alejandro, pp 2-3
[16] Vinod Aggarwal, “Interpreting the History of Mexico's External Debt Crisis”, in Eichengreen & Lindert, p 144.
[17] Carlos Díaz Alejandro “Stories of the 1930s for the 1980s”, in Pedro Armella et al, Financial Policies and the World Capital Market, University of Chicago Press, Chicago, 1983, p 25.
[18] Barry Eichengreen & Richard Portes, Crisis? What Crisis ? Orderly Workouts for Sovereign Debtors, Centre for Economic Policy Research, London, 1995, p 20.
[19] Derek Aldcroft, Studies in the Interwar European Economy, Ashgate, 1997, p 121.
[20] Peter Lindert, “Response to debt crisis: What is different about the 1980s?”, in Eichengreen & Lindert, p 227.
[21] Lindert, P 263.
[22] Eichengreen & Lindert, p 7.
[23] Eichengreen & Portes, “After the deluge”, p 13.
[24] Eichengreen & Portes, “Crisis?”, pp 23-24.
[25] IMF Pamphlet 51.
[26] Net present value (NPV) of a debt is the amount of money a debtor would need to have in a bank account earning interest at a market rate to be able to make all principal and interest payments which are due. If the interest on the debt is higher than the market rate of interest, as with a home mortgage in Britain, then NPV is higher than the “book value” of the debt. If interest rates are concessional, as with World Bank loans, and payments spread out over many years, then NPV will be less than book value. Malawi's debt NPV is less than half the book value of the debts.
[27] Quoted in Darity & Horn, pp 21,24.
[28] Arminio Fraga, “German Reparation and Brazilian Debt: A Comparative Study”, Essays in International Finance, Department of Economics, Princeton University (NJ, USA), 1986; Roger Munting & B A Holderness, Crisis, Recovery and War: An Economic History of Continental Europe, 1918-1945, Philip Allan, London, 1991.
[29] Sampson, p 71.
[30] G D H Cole & R S Postgate, “War debts and reparations – what they are, why they must be cancelled”, New Statesman, London, 1932; Barry Eichengreen, “Resolving Debt Crises: an Historical Perspective”, in Sebastian Edwards & Felipe Larrain, Debt, Adjustment and Recovery, Blackwell, Oxford, 1989.
[31] Fraga, p 20.
[32] Fraga; Cole & Postgate.
[33] Note that the world depression hit trade very hard; German exports in 1932 were only 46% of the 1928 level. Under the Young plan annual scheduled payments were reduced to 2 bn Rm, which would have been 20.5% of exports in 1931 (still within HIPC limits) and 34% in 1932. However, the other clauses in the Dawes plan would have reduced the payments. Actual reparations payments were 10% in 1931 and 3% in 1932. Interest and repayments on loans taken after1924 became increasingly important, and 1931 was the first year in which there was a net capital outflow (totalling an unsustainable 28% of exports).
[34] Eichengreen, “Resolving Debt ...”, p 71; Fraga, p 5,
[35] And this happened. In practice, transfers were made up to 1930 because of incoming loan funds.
[36] This is particularly important because many writers note that large debt repayments reduce investment; in this way, repayments were to be recycled as investment. Because of the large loans, this provision was never used.
[37] Jobs for Africa, International Labour Organization, Geneva, 1997.
[38] This proved counterproductive, in that it provided the basis for Germany to install more modern machinery which was the basis for German post-war growth.
[39] Friedel Hütz-Adams, paper for the inaugural seminar of the German Jubilee 2000 Campaign, 12-14 September 1997, translated by Karl-Heinz Wiedemann.
[40] Thomas Kampffmeyer, “Towards a Solution of the Debt Crisis”, German Development Institute, Berlin, 1987, p53 says that pre-war debts were reduced from DM 13.5 bn to DM 7.4 bn and claims for post-war economic assistance were reduced from DM 16.2 bn to DM 7 bn. Hütz-Adams notes that all interest and compound interest unpaid after 1934 was also cancelled, and that this was worth DM 14.6 bn. So of a total claim of DM 44.3 bn, 66% was written off. However Hütz-Adams adds that the remainder was to carry low interest rates, ranging from nothing up to 5%, but averaging well below the market rate. That means that the Present Value of the debt was cut to even less than one-third of the original value.
[41] Hütz-Adams notes that payments in fact never exceeded 3.5% of exports. Strong export growth led Germany to repay all London agreement debt by 1960.
[42] Quoted in Kampffmeyer, p 50. (with slight editing of the translation - jh)
[43] Hütz-Adams.
[44] Kampffmeyer p 50.
[45] Cheryl Payer, The Debt Trap, Monthly Review Press, New York, 1974, p 83..
[46] Figures in this section are from the Economist Intelligence Unit reports on Indonesia (which have many gaps) and from a report “The Republic of Indonesia”, Kuhn Loeb Lehman Brothers, December 1979, which details the debt settlement.
[47] Quoted in Kampffmeyer, p 55.
[48] Drake, p 50.
[49] Díaz Alejandro, “Stories...”, p 27.
[50] Aggarwal, p 148.
[51] Celso Martone, “Macroeconomic policies, debt accumulation, and adjustment in Brazil, 1965-84”, World Bank discussion paper, 1987.
[52] Eichengreen, “Resolving ...”, pp 70, 85.
[53] G D N Worswick & P H Ady, The British Economy 1945-1950, Clarendon, Oxford, 1952, p 65
[54] Richard Mayne, The recovery of Europe, Widenfeld & Nicholson, London, 1970, p 72.
[55] Prabirjit Sarkar and Hans Singer, “Debt crisis, commodity prices, transfer burden, and debt relief”, Institute of Development Studies paper DP 297, Brighton (England), 1992, p 21.
[56] Derek Aldcroft, The European Economy 1914-1990, Routledge, London, 1993, p 49
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