Banking Against Disaster
Wriston, Walter B.
Banking Against Disaster
Banking Against Disaster
If we had a truth-in-Government act comparable to the truth-in-advertising law, every note issued by the Treasury would be obliged to include a sentence stating: "This note will be redeemed with the proceeds from an identical note which will be sold to the public when this one comes due."
When this activity is carried out in the United States, as it is weekly, it is described as a Treasury bill auction. But when basically the same process is conducted abroad in a foreign language, our news media usually speak of a country's "rolling over its debts," with the implication that the world is about to go bankrupt and take the banking system down with it.
Over the years, a lot of intellectual capital has been invested in the proposition that massive defaults by developing countries will eventually cause a severe world financial crisis. Those who took that view in 1973-74 have been proved wrong, and those of us who believed that the market would absorb the shock of skyrocketing oil prices proved correct. Despite this, the perception remains that some form of disaster is inevitable. It is not.
To see why, it is only necessary to understand the basic facts of government borrowing. The first is that there are few recorded instances in history of government - any government - actually getting out of debt. Certainly in an era of $100 billion deficits no one lending money to our Government by buying a Treasury bill expects that it will be paid at maturity in any way except by our Government's selling a new bill of like amount. These obvious facts suggest two corollaries: first, the holder of the bill has justifiable confidence that the Government will acknowledge the debt; second, the Government will have ready access to a market ready and willing to buy a new piece of paper. These facts suggest that the availability of financing, from commercial banks or official agencies, is the crucial element in assessing a country's situation. When problems arise, they are problems of liquidity, not insolvency.
If a country undertakes policies that contain a formula for solving its balance-of-payments problems over time, it will find that financing for its investment projects and for any temporary balance-of-payments gap is almost always available; however if the adjustment policies show no foreseeable long-term solution, financing will not be forthcoming, but the country does not go bankrupt. Bankruptcy is a procedure developed in Western law to forgive the obligations of a person or a company that owes more than it has. Any country, however badly off, will "own" more than it "owes." The catch is cash flow and the cure is sound programs and time to let them work.
No country will ever succeed in finding a substitute for an adequate program to achieve medium-term adjustment of its balance of payments. But countries with such programs will continue to find that a substantial part of their financing needs can be met by commercial banks.
How all this works in practice can be learned by studying the recycling period from 1974 to 1978. Most would regard that process as generally successful in respect to both adjustment and financing. According to the World Bank, the oil-importing countries' balance-of-payments deficit on current account rose from about 2.3 percent of their gross domestic product in 1970 to more than 5 percent in 1975, but by 1978 it had been brought back to where it was in 1970. That was a first-rate adjustment by any standard.
But many who were sure the market would not be able to handle the oil shock, and were proved wrong, are still not reassured. The world economy that survived the rising price of oil in the early 70s, they believe, will paradoxically be unable to survive its stabilization or decline in the 80s. Conveniently overlooked also is the decline in interest rates that has cut the interest bill of the developing countries by about $20 billion per year.
We should remember that the proposition that commercial banks cannot or should not continue to finance the developing countries is really a disguised way of saying that those countries will not be successful in adjusting to the new challenges posed by a world economy growing much less rapidly, and thus will not continue to enjoy access to the market. That is not a statement of fact but a prophecy - one that has little basis in recent history.
While it is, of course, impossible to prove that something will not happen in the future simply because it has never happened, the fact is that bankers, governments and international agencies such as the International Monetary Fund have far better insights into these problems and how they can be solved now than they had before 1973-74 - and, far better cooperation among themselves. If the world's financial system could cope with the problem then, as it did, it certainly should be able to do so today.
We are also enjoying the benefits of something relatively new: The emergence of a global financial market. This market has created a huge pool of international savings available to any borrower that establishes and maintains creditworthiness. For the first time in history, it is within the power of a less-developed country to obtain from external savings the capital needed for growth. One by one, those countries are finally breaking through the vicious circle of poverty. This is a new and positive development, and one which gives great hope for the future of the developing countries in the remaining years of this century.