Article for German Publication
Wriston, Walter B.
Article for German Publication by Walter B. Wriston
Article for German Publication by Walter B. Wriston
Sometimes it is difficult to remember what the world was concerned about a year ago, even though each new problem is often hailed as the arrival of Armageddon. In recent times, the OPEC oil embargo fostered a spate of stories ranging from the possibility of a world-wide blackout to speculation that the Arab nations would soon own most of the free world's industries. People who made these predictions never understood how markets work. The market handled the greatest transfer of financial assets, in the shortest time frame, with the fewest casualties in history. Today the world pundits have come full circle and, we are told, disaster looms because oil prices are falling. Perception about the Latin American debt situation have also gone through several phases ranging from world-wide disaster to "The problem is over."
To understand what happened in the Latin American debt problem we must first look at what was going on in the rest of the world. In the 1970s there was a quantum jump in the price of oil, followed by a period of high inflation and high interest rates. Four and one-half years ago, the American Federal Reserve System locked the wheels of the world in a successful effort to bring down inflation. The side effects were tremendous. The '80s opened with a world-wide recession which helped produce an unprecedented decline in world exports. Export ratios that had looked healthy when loans were made suddenly looked poor. All of these things combined to upset the normal flow of capital.
Since the world's financial structure is now a unified system tied together by technology and telecommunications, any shock is instantly transmitted around the globe. The war between Argentina and Great Britain over the islands at the tip of South America was a further unanticipated event that upset markets. It was against that background that many countries experienced financial problems.
Three years ago when Mexico failed to meet its foreign debt requirements and many other Latin American countries began experiencing difficulties, the pessimists were quick to declare the international bank system in peril. The banks of the world had loaned money in Latin America because in their credit judgments these countries had the productive people and natural resources to be worthy of investment. Brazil, for example, had doubled its gross national product in a decade, a record almost unprecedented in human history. Those resources in Latin America, both human and natural, still exist. There is no great mystery about what steps are needed to redress the balance. The debtor country is the only one which can take the proper actions, but the international banking community, working with the IMF, can and did support the necessary adjustment process. The adjustment is not without cost and pain. But it works.
In what is really a remarkably short period of time, many Latin American countries have adjusted to new economic realities. The magnitude of the external adjustment in total LDC debt is impressive. In 1982 the collective deficit of the major LDC debtors was $103 billion. Last year it was $38 billion. The seven largest borrowers reduced their combined trade deficit from $40 billion in 1982 to only $1.5 billion in 1984.
We are now in phase II of the adjustment process and many of these countries will enter into multi-year restructurings that will allow them to repay their principal later in this decade and the next. Mexico, for example, will be entering into the first of the restructurings with a fourteen year package. In the third phase we expect to see many countries make a return to the voluntary markets. While much can and will change in the future, today interest rates are down much more than many predicted: ninety day LIBOR figures are some four or five points lower than only a year ago. Each point of lowered interest will save Argentina $450 million, Brazil $800 million and Mexico $750 million in debt service annually.
In addition, economic growth in the industrial nations, which fuels export resurgence in the LDCs, has not halted as some feared. The IMF's recent World Economic Outlook predicts a 3 percent growth in the developed countries for the remainder of the decade. Both factors, lowered interest rates and OECD growth, auger well for Latin America.
A key lesson many learned from the debt problem concerned the problems created by the lack of private investment in many developing countries. Too much growth was financed by debt and too little by equity. In many cases foreign investment was actively discouraged by a myriad of regulations, and in some cases it was frozen out altogether. The old London School of Economics theory that equated foreign equity with imperialism played a role in shaping some political environments. Without a layer of equity to absorb the massive shock of world-wide recession, projects financed entirely by debt quickly got into trouble. With the blinding clarity of hindsight, bankers, along with many others, made a mistake in not recognizing the seriousness of this structural defect which would become readily apparent at the advent of the recession. For example, during the 1950s about 85 percent of foreign investment in Latin America came from equity, while in the 1970s some 80 percent came from debt. The debtor countries that followed a policy of freezing out equity capital for political reasons made the mistake of assuming that more debt would always be available in world capital markets.
Since many of the world's banks are currently involved in restructuring loans, it is fair to assume that bank lending will continue to be cautious. Much new investment in these countries will need to come from export growth, stronger domestic capital markets and foreign direct investment. Encouragement must be given to governments to improve the climate for foreign direct investment and the development of indigenous capital markets. While only a borrower can take the steps necessary to restore creditworthiness, the industrial nations must also do their share to foster growth in the developing nations by resisting demands for protectionism. Although the industrial countries are still divided by a huge array of problems, it is clear that we can no longer pursue independent fiscal and monetary policies without paying an enormous price. It is no longer possible to enrich yourself by beggaring your neighbor; although many governments--urged on by some of their industries--will continue to try. No matter which way we turn, it is now perfectly clear that we are all in the same boat. The convergence of computers and tele-communications has created a global marketplace that is truly something new in the long history of man. The old gold standard and the Bretton Woods system have been replaced by the information standard. Changes in government economic policy in any country instantly light up the Reuters' screens in the trading rooms of the world and the market makes a judgment which is reflected in the cross rate in that national currency. Unlike the old systems, no one can renounce the information standard. There is no longer any place to hide.
Commercial banks are the conduits through which much of the world's money and credit flows. The most productive role they can play is to keep those conduits open and remind all who will listen that there are no magic solutions to problems brought on by bad monetary and fiscal policies. These situations can be solved only by a return to sound ones.
Many Latin American countries now have recognized that the policies needed to maintain external creditworthiness with private banks are also the very same policies needed to meet their own national development policies. The importance many countries attach to their own external creditworthiness and their ability to maintain it have been demonstrated again and again. When problems do arise, and it is almost certain they will somewhere in the world, the adjustment process that is triggered can and will work. Countries undertake adjustment policies with the expectation that private banks will respond positively to demand for credit from responsible borrowers. This expectation has not been disappointed.
The lesson is as old as history. Any country willing to make the difficult decisions needed to control inflation, adjust its monetary and fiscal policies and open its economy to the global markets--letting the market price mechanism function--will continue to find lending partners among the world's commercial banks.