Price Vs. Policy: A Tale of Two Markets

Wriston, Walter B.


Sound Banking vs. the 'Experts'


In the first oil crisis six years ago, there was immense anxiety over the process that came to be known as recycling. The oil-exporting countries suddenly found themselves with the greatest surge of surplus funds in history, and almost everyone else found himself vastly higher prices for imported oil. What happened, of course, is that the OPEC countries put their surpluses in American and European banks, which relent them to borrowers in other countries, especially less developed countries (LDCs) that had no other means of meeting their increased oil bills. It was only a matter of time, according to front-page stories, until the LDCs defaulted on their loans and roofs began falling in on financial institutions all over the world.

Members of the international banking community became the recipients of much gratuitous advice, usually from the same people who were devising still new ways to regulate the oil markets and urging us in the financial markets to follow their example. Had we done so, the world's financial markets would have become as chaotic as the world's oil markets, and it is entirely possible that everyone's worst fears might have been realized. Instead, we adhered to what we know to be traditional principles of sound banking, and the result is now a matter of record.

Let's look at that record.

The successful adjustment to the quadrupling of oil prices in 1973 and 1974 is one of the most dramatic developments in economic history and should be a source of renewed confidence in the international financial system. The immediate consequence of the price increase was to raise the OPEC current-account surplus more than tenfold in a single year. There was no historical precedent for such a massive transfer of financial assets. The majority of commentators, including most of the "experts," were pessimistic, not only about the prospects for ever reducing the OPEC surplus, but about the future of the world international monetary system.

The world, however, refused to follow the doomsday scenario. The OPEC surplus began declining almost immediately and had disappeared almost entirely by the end of 1978. After the initial jolt, the developing countries' economies were soon growing nearly as fast as before. No one foresaw the oil-price shock before the 1974, and economists are still debating how much it contributed to the depth and duration of the worldwide recession that followed. But the widely prophesied catastrophe failed to materialize, and the banks remained solvent.

Those who predicted six years ago that the end of the world was at hand are standing by their revelation to protect their heavy investment of intellectual capital. Rather than change their minds, they keep changing the date. Winston Churchill once described this phenomenon: "Man will occasionally stumble over the truth, but most of the time he will pick himself up and continue on."

Prophecies of calamity always get a good press. But to support this one, it is necessary to ignore several inconvenient facts. One is that there are some eleven countries that account for three-fourths of all private debt outstanding to all of the developing countries, and their situation is far from desperate. In 1972, before the first oil shock, the average deficit on their current accounts--the excess of what they were paying for their imports over what they were getting for their exports--was running about 2 percent of their gross national product. That might be considered the normal situation of the more-successful LDCs before the price of oil went up.