The Pandemic Depression
The Global Economy Will Never Be the Same
Almost exactly a year ago, the members of the Organization of Petroleum Exporting Countries (OPEC) raised the price of their oil sharply. With subsequent adjustments, the average price of Middle East oil stood in late 1974 at about $10 per barrel, roughly four times the mid-1973 price.
Accordingly, over the five years 1975 through 1979, the oil-importing countries of the world will pay these OPEC countries a total of at least $600 billion (in 1974 dollars) subject to four conditions:
(1) that the importing countries individually can find the needed means of payment;
(2) that their average annual economic growth continues close to the estimated global rate of about four percent for the next five years, or about two percent per capita;
(3) that there are no major changes in the structure or stability of international political relations;
(4) that the price of Middle East oil remains near the $10 level.
Whether or not any of these conditions can be fulfilled is, to say the least, problematical. The first raises the specter of the possible inability of existing international institutions and payments mechanisms to cope with a financial problem of staggering proportions. It is to that problem that we will address our more detailed suggestions further on in this article. The importance of the second speaks for itself; prolonged stagnation of the world economy would surely have most serious human and political consequences. The third, if it were not fulfilled, raises even more nightmarish possibilities, on which one need not dwell here. Among them, the first three assumptions may seem to many to be on the optimistic side. In contrast, some would argue that the fourth assumption ignores the possibility of some drop in the oil price, say to $8 per barrel (in 1974 dollars) or even, a few think, to $6 per barrel. Without judging the likelihood of such changes, let us only note that they would change the volume of the required payments from something over $600 billion to around $500 billion (at $8 per barrel) or to roughly $400 billion (at $6 per barrel)-even if there were no increases in the volumes bought at these lower prices. Or, in the opposite direction, if the price were again to be raised in real average terms, the amount of payments could actually be greater.
The point is, that on any remotely realistic price assumption the scale and abruptness of the contemplated payments to the OPEC countries-ranging from $100 billion to $135 billion each year over the remainder of this decade at the assumed $10 price-present a huge transfer problem. Indeed, in 1973 the sum of all merchandise exports by all non-OPEC member countries of the International Monetary Fund was less than $500 billion. How can the enormous camel of oil transfer payments pass through the eye of that needle?
Certainly conservation of energy and conversion to alternative fuels cannot contribute importantly to the answer over the next five years. At most, the gain from conservation can be expected to slow the growth in uses of energy, so that after the initial reductions of 1974, the rate of use of OPEC oil over the remainder of the decade will probably grow slowly, averaging close to the 1973 volume. Nor is there much scope for early reduction of the dependence on OPEC oil through conversion to alternatives-not even in the United States, with its vast reserves of coal and its potentialities both for more oil and for producing oil from shale. Lead times are simply too long, and needed environmental constraints too complex, for major adaptation before the 1980s.
Nor can increased trade with the OPEC countries provide more than a fraction of the answer. The oil-producing countries cannot absorb such an inundation of goods and services, nor can the rest of the world physically divert one-quarter of all the goods that move in trade out of present channels and into the OPEC countries. The oil-importing countries will just as certainly, however, be competing with each other to earn as much as they can to help meet their oil deficits, and the question will be, as they reach desperately for each other's markets, whether they will also erect more menacing barriers against each other's exports. At best, the most they can earn from each other and through added sales of consumer and capital goods to the OPEC countries would appear to be only one-quarter to one-third of the total transfer that has to be made, if the four opening assumptions hold over these next five years.
The remaining $400 to $450 billion will have to be settled through transfers of claims rather than through the current movement of goods. The OPEC countries will become investors in either the productive real assets of the oil-importing countries, or in intangibles representing future claims on the producing assets and real income of the importing countries. Such massive shifts of debt and ownership to the OPEC countries may be theoretically conceivable for the oil-importing countries as a group, if their aggregate wealth were brought to bear on the problem on a totally unified basis. In practice, if they act individually, it is simply not conceivable that most of the importing countries can find matching inflows of funds, from OPEC countries at least, that would enable them to meet their oil deficit needs for very long.
This conclusion has been concealed, at least from the public, through most of the past year. Indeed, 1974 will surely prove to have been the easy year, not only because the payments themselves had not reached full magnitude until late in the year, but also because many old or new facilities could be called into initial use for channeling these growing payments flows, and because most oil-importing countries still had relatively large reserves of funds or borrowing power to draw upon-capabilities which are being rapidly exhausted in many countries.
Now a denouement, or a succession of denouements, is rapidly approaching. A looming problem is the ability of the major banks to continue to accept such a large volume of funds in the form of short-term deposits. In all likelihood, unless further approaches to cooperative action are made within the next few months, some oil-importing countries will have run out of goods to sell, or markets to reach, or capacity to borrow to cover their deficits, and a number may become unable to meet the servicing on the enlarged debts. Whether that would result in currency devaluations, in defaults by banking and business firms in those countries, in national debt moratoria, or in political revolution and debt repudiation, the entire structure of world payments, and of trade and financial relationships, would certainly be fractured.
Thus there is the immediate danger of progressive collapse triggered by defaults both by individual industrialized countries and by developing countries lacking natural resources. Yet, paradoxically, there is a great opportunity also, which lies beneath the surface of this immense "recycling" problem. In essence, the world today is starved for capital. Greater investment, not only in OPEC countries but everywhere, is an essential (though not in itself a sufficient) condition for the enlargement of output and lowering of real costs that offer the most effective counterforce to persistent worldwide inflation. In this situation, consumer payments for high-priced oil in the importing countries represent a diversion from other forms of consumption, in effect a form of forced saving, with the proceeds of these payments becoming, at least in part, investible funds in the hands of the OPEC countries. If the OPEC countries in turn had the proper outlets and were ready to employ their investible funds, they could make a crucial contribution to the capital formation that the world so urgently needs.
To date, the funds flowing to OPEC have not been truly effective in this investing function. To be sure, much has been done through creative private and governmental efforts to attract OPEC investors directly, or in roundabout ways, into useful investments in countries that need those proceeds to help pay for more oil. And much more can be done through diversified, disparate efforts. Yet it is surely too much to expect that the impending massive quantities of investible funds, becoming available at an unprecedentedly rapid rate, can all be distributed by an invisible hand into productive uses that will happen to occur in, or spill over into, the countries that need more wherewithal for making their oil payments. Thus the ultimate solution-a situation in which oil-importing countries, both individually and as a group, have developed the additional capacity to produce, export, and thus pay for their oil through the normal operation of the international economy-remains distant.
The astonishing fact, in the face of the largest single mutation in payments patterns that the modern world economy has ever experienced, short of war, is that so little dialogue about the problems ahead has yet occurred among the countries principally concerned-in the spirit of responsible nations consulting together over a staggering common problem. The questions of oil price, of goods availabilities and of potentials for lending, investing, or outright aid are all inexorably interrelated. Yet they are all being addressed separately, and even then not in a mutual exploratory appraisal by representatives of all three major interests-the oil-producing countries, the more developed oil-importing countries, and the oil-importing less-developed countries (LDCs).
The OPEC countries meet each other often, usually to take decisions with respect to reduced output or higher prices. The larger consuming countries have, each in its own way, worked out bilateral deals with individual producing countries, aimed at temporary improvisations to cover a few months' needs. A loose confederation has been formed among 11 or 12 of the consuming countries for the purpose of sharing absolute shortages in the event of another embargo against one or more of the group by the OPEC countries, and as this article went to press this was officially converted into an International Energy Agency of 16 nations, all members of the Organization for Economic Cooperation and Development (OECD). The International Monetary Fund has established a special "Witteveen facility" for borrowing modest sums from some OPEC members to be reloaned to Fund members suffering acute oil deficits. But apart from an "Interim Committee" within the IMF structure, there has been no joining of representatives of all sides of the problem, in a comprehensive exploratory review of the practical possibilities, and limitations, on all sides.
To be sure, several OPEC countries (notably Iran, Kuwait, and Saudi Arabia) have themselves already extended beyond their own contributions to the IMF facility by beginning direct assistance to some of the needier developing countries. However, the need for such funds is well beyond the contributions made thus far. The forces of private initiative have been well represented, too, in quite another form of "recycling," as droves of salesmen with attractive investment opportunities to offer have swarmed through the OPEC countries.
Impressed by the variety and relative adequacy of the improvisations occurring in 1974, the United States has, however-until the Kissinger address of November 14 and the Simon address of November 18-avoided generalized consultations to deal with any major part of the transfer problem, apparently believing through most of 1974 that a hands-off approach of laissez-faire would suffice.1
Even as it shifted in mid-November to propose heroic but vague new plans for $25 billion annual recycling arrangements among the consuming countries, however, the United States seems to expect consuming countries to shrink their consumption of oil quite naturally as they proceed further in adapting to the increase of the oil price. It also apparently expects that the producing countries will be unable to agree on shares of a shrinking market and will consequently begin competing among themselves at declining oil prices-that the "cartel" will break apart. On the ground that extensive planned arrangements, even on a contingency basis, would merely delay the force of market pressures toward lower oil prices, the United States was, until November, extremely cool toward any proposed multilateral efforts to "recycle" the oil funds-that is, organized methods for routing some part of the OPEC oil receipts (through trade, investment, loans or aid) back to the countries which urgently need more funds to use for financing continued deficits and development. And even now, the United States proposes to organize the developed countries first, as a prerequisite to other contacts and negotiations involving either the developing countries or the oil-producing countries.
We believe that if this approach ever had merit, its usefulness is now at an end, for three interrelated reasons:
First, as already noted, the danger that one or more importing nations will simply not be able to pay for oil is immediate, within a matter of months. To be sure, following the lifting of the embargoes early in 1974, supplies have been adequate and payments strains moderate-a lull made possible by the various bilateral improvisations, by IMF or particular relief efforts, by some initial shrinkage in oil consumption, and by inadvertent OPEC financing arising from transitional delays in the actual transfer of funds through the major oil companies to the OPEC countries. The public alarm of a year ago has consequently waned. Yet several observers who have tried to work out projections of balance-of-payments and debt-carrying potentials cannot see how some important countries, even in 1975, can finance the scale of impending payments that each of them must somehow transfer across its own exchanges if oil is to flow, if the world economy is to have its prime energy supply, and if the four conditions stated at the outset of this article are to be fulfilled.
Second, brinkmanship is simply not a workable approach. It assumes an ignorance or susceptibility to pressure that does not exist among the OPEC countries; and most of all it postulates, or appears to postulate, an irreducible conflict of interest between oil producers and oil importers. Obviously, on the narrow question of price, their interests differ. From the standpoint of the consumers, it is argued that a reduction in the oil price would scale down the transfer problem; and that adaptation by the oil-importing countries would be relatively much less disruptive if the price were then to rise subsequently in modest increments from an adjusted lower level. But it is also argued, especially by producer countries, that continuing increases in the prices of their major imports, not entirely attributable to the increase in energy costs, should be taken into consideration in any discussion of the stabilization of future oil prices. Whatever chance there is for resolving the price question must surely depend, however, upon the development of much closer understanding, and the articulation of mutual interests, among the oil producers and the oil consumers. And the first step toward any such understanding must just as surely lie in beginning to discuss, together, the problems of transferring payments and the opportunities for constructive investment in the setting as it actually exists at the end of 1974. In the end, all the countries will have to act in a reasonably concerted manner if solutions are to emerge.
Third-and the most fundamental thesis of this article-progress toward effective solutions almost certainly requires major new methods and institutions. These cannot be created overnight. Yet they must be in place and in operation before the crisis becomes more serious. Even after giving effect to all other approaches or arrangements already under way for the transfer of capital and claims, as a supplement to the flow of goods and services to OPEC countries, a staggering $60 billion or more annually will remain unaccounted for.
In the effort to reach a basic understanding, two central points must be fully accepted on both sides. The first has already been noted-that the oil-consuming countries must recognize that a reduction of the representative Persian Gulf FOB price from $10 down to $8, or even $6, per barrel, would still not reduce their transfer burden to the OPEC countries to readily manageable proportions. In annual gross payments, before any offset for sales of goods to the OPEC countries, or for any aid they may extend, the ranges would drop either to about $90 to $105 billion at the $8 price or to about $75 to $95 billion at $6. Taking account of other changes as well, that would only cut the "unexplained" annual residual to the $40 to $60 billion range.
The second point calls for oil producers to recognize what is at least the menacing possibility that, over time, the full impact of continuing the present prices of oil deliveries would be in effect to take, in gross payments from the consuming countries as a group, the greater part of any real growth in their per capita gross national product over the remainder of the seventies. Arithmetically, for example, the transfers from the industrialized OECD countries, by far the greatest consumers of oil, must amount to a continuing charge of three percent of the present total gross national product of this group of countries (roughly $3 trillion currently).
Static arithmetic is not, however, the real measure of the problem. On the one hand, the producing countries may well note that only a fraction of the required payments will be in the form of real resources. On the other hand, as seen from the consuming countries, the picture contains the threat of a freeze on growth that could be even more serious than the arithmetic would suggest. The diversion of a significant proportion of the income stream out of immediate consumption is bound to have a cumulative deflationary potential. And, as already noted, this deflationary potential could very well be compounded by the efforts of each nation to eliminate or at least reduce its oil-induced current account deficit. The resulting restrictions on trade could lead to a cumulative contraction of both domestic and international economic activity in which the damage would become very great.
From these points of analysis there emerges a central conclusion already touched on: that the resources diverted from consumption must be quickly channeled into real investment expenditures. Only those capital inflows to the OPEC countries which are attracted to productive investment elsewhere address themselves to the dual requirements of sustaining economic activity in the consuming countries and generating the ultimate means of payment. And only the availability of this kind of financing can reduce the pressure on individual countries to follow restrictive and combative current-account policies which would be detrimental not only to other consuming countries but to the world economy as a whole.
Thus, to both producer and consumer countries, each for their own reasons, the case for finding productive new investment for one-half to two-thirds of the proceeds of OPEC oil sales would seem to be compelling. Even if the oil price were to fall back as far as $6 per barrel, and if oil continued to flow on the present scale and with comparable distribution, no more than half of the indicated transfer to the OPEC countries as a group over the next five years could, in all probability, be met by sales of consumer or producer goods to them, or offset by direct OPEC grants-in-aid. The rest would have to be settled in claims of some sort, either simple interest-earning IOUs, or actual investments.
In the short term, there is no escape from the necessity of substantial borrowing to pay for current consumption. This is what in fact is happening, most notably in the case of Italy, and, over the next two years at least, the process of borrowing must continue and at a significantly increased rate. The problem here, as we shall see in more detail later, is to provide adequate means so that the less fortunate industrialized countries in particular will be able in practice to borrow effectively and thus keep themselves afloat.
But in the longer run, borrowing cannot do the job. Unless the borrower is able to achieve offsetting gains in production and rising current account earnings, he is bound in time-and despite any method of guarantees by others that may be devised-to lose standing as a borrower. The lender will have a deteriorating credit on his hands. The interests of both sides really require-whatever the probable price of oil may be-that the bulk of any oil payments that exceed the domestic import requirements of the OPEC countries be put back into the oil-consuming countries in the form of investment. Only in that way can the additional productive capacity of the oil-consuming countries be increased in order to generate the real current account surplus needed to service the continuing payments to the OPEC group.
That is, of course, much easier said than done. The individual OPEC countries differ widely among themselves in capacity to absorb consumer and capital goods, over the coming five years, and they differ correspondingly in the amounts left over for aid or investment elsewhere. The oil-importing countries differ, if possible, even more widely in their potentials for using new investment; and those potentials may have only slight relationship to the shortfall in particular countries' ability to pay for oil. As yet, no approach has been made to forming an overview, indicating where the more significant opportunities and gaps are, after taking account of everything else that energetic separate efforts may have done. And, of course, should there ever be agreement on the usefulness of an overview, and on how to go about making it, the questions of implementation-through multinational action or continued individual reactions-would still need exploration.
Nor can preoccupation with an overriding oil-payments problem be allowed to disguise the persistence, underneath, of all the same questions of balance in the payments flows among nations that have occupied the IMF and its Committees of Ten and of Twenty for several years. The "adjustment process" may have acquired new dimensions, but it is still there, with the issues of relative burdens of adjustment among countries still to be resolved. It is puzzling that the United States, which had taken a very positive role in earlier work on the adjustment process, should have stepped aside at the present critical stage when active, informal discussion among oil exporting and importing countries-to survey and appraise, well in advance of any negotiation-would have seemed an imperative prerequisite to finding viable solutions.
If and when an overall appraisal is attempted, it will (1) have to start with an outline of the shortcomings of financing arrangements thus far attempted, in terms of the more lasting needs and interests of both the OPEC and the oil-consuming countries, and indeed of sustainable order in world affairs. It will also (2) have to consider the various ways in which an informational overview could be organized, carried on and made meaningfully available to the countries and international organizations involved. And it will (3) want to explore new methods for bringing about results that can help assure the continued functioning of the international payments system and promote the further balanced growth of the world economy.
Without presuming to imagine the full scope of possibilities that could emerge-if leading representatives of the OPEC and the less developed and the more developed oil-importing countries were to fuse their experience in intensive informal and preparatory discussions of present shortcomings, of the scope of an overview, and of the usefulness of various financing methods-it is possible to suggest illustratively some of the considerations that might belong on the agenda.
Perhaps the most conspicuous shortcoming, late in 1974, is the heavy overburden already placed on the commercial banking systems of Europe, North America and Japan-to help finance and to transfer payments from importing countries to the major oil companies; to service the companies' transfers to the OPEC countries; to hold the balances acquired by the OPEC countries; and to redistribute the counterpart of those balances as credit-worthy loans, the proceeds of which might hopefully flow onward to start the cycle over again. This process already has meant not only a ballooning of banking balance sheets, to the point of jeopardizing sound ratios of deposits and credits to capital, but it has also increasingly led to the dangerous extension of loan maturities beyond the maturity of deposits as well as a clogging up of the banking systems with purely "balance-of-payments" loans, often to governments or their agencies, at the expense of failing to serve traditional domestic credit needs.
Increasingly, as the oil payments reach cumulatively larger totals, individual banks and banking systems will become exposed to transfers among currencies in magnitudes far beyond established capabilities, and beyond prudent limits as to individual accounts or currencies. Even more critical than the breaching of operating norms is the increased sensitivity to the risks of fluctuation in foreign exchange rates, and vulnerability to deposit shifts that may impair functional liquidity-risking technical insolvency. To be sure, the central banks of most leading countries are working together to check any domino effects, should failures occur. And in time, sizeable OPEC balances will no doubt move on into other financial or investment instruments, whose markets do have a resilience and absorptive capacity that have not yet been fully used. But even in the broadest markets for equities, or bonds, or real property, the impact of amounts as sizeable as those in OPEC hands-or even rumors of OPEC interest-can have disruptive effects on the orderly pricing procedures through which values are determined.
In OPEC eyes, it would already appear, there are at least three serious shortcomings ahead, as the scale of receipts continues at the late 1974 pace: (1) limited liquidity, if the movements of these funds are not to disrupt banking systems and money markets which the OPEC countries themselves also need; (2) risks of loss through wide fluctuations in exchange rates, unless the OPEC countries, at the expense of some loss in their own flexibility, act to help assure the exchange-rate stability of the currencies they need and use; and (3) the erosion brought about by inflation in the prices of assets which they purchase, or in the value of the money in which they receive the earnings of the investment they acquire-unless they find some hedge against inflation that is more reliable than merely limiting their future production or spacing out the sale of their oil at inflationary prices.
The oil-consuming countries face the other side of these three risks, for they depend upon the same international banking facilities and financial markets, and are equally buffeted by inflation. But the overriding concern for many is how, during the months ahead, to earn or borrow enough hard currency to pay for their minimum oil requirements. Import quotas, export subsidies, exchange-rate depreciation, IMF drawings, crisis borrowing, or a moratorium on external debts are all among the possibilities. For some further time these extremes may be averted by the organizing of ad hoc rescue parties, either by particular OPEC countries, or by some more developed countries, or both. But unless prospects are opened for the deficit countries to earn their own way out eventually, or at least to earn the servicing on whatever debt can be obtained from somewhere, the further risk of debt repudiation and political overturn is grave.
Such, then, are the obvious shortcomings of the present institutional structure. Some of them, but by no means all of the critical ones, have been encompassed in the financial outline presented by Secretary Simon on November 18. His "financial safety net" approach for the guarantee of market borrowing, or for direct government loans, though extremely useful as a temporary expedient, should be designed to evolve into arrangements for sustained productive investment. The need of each oil-importing country over time is to develop a viable balance of payments, not to go on accepting improvised relief at the cost of future interest and amortization burdens. And there are, in any event, many unanswered and difficult questions of allocation, and of risk-sharing, in the Kissinger-Simon proposals which may take some time to sort out.
The next question concerns how a systematic overview of the interrelated problems of all oil-importing countries could be conducted. Since the problem on the surface concerns the approach of each individual country toward balance-of-payments equilibrium, one obvious candidate for the job is the International Monetary Fund. The hazard, for the OPEC countries which understandably feel underrepresented, and for many oil-importing countries which feel unappreciated, is that the IMF will be inclined to overdo its role. Instead of reporting on what is happening, the IMF will be tempted to tell countries on both sides what each country ought to do.
To get away from these difficulties, while at the same time taking advantage of the important resources of the IMF, a useful approach might well be to establish a special group, affiliated in some way with the IMF's "Interim Committee of Twenty," but structured to provide roughly equal representation of the OPEC countries, the oil-importing LDCs (less-developed countries) and the oil-importing industrialized countries. Such a group would be charged with monitoring the Fund's data gathering and alarm signaling efforts.
This group, or any other mutually agreeable arrangement that may be worked out for providing the continuous overview of payments patterns and strains, will presumably give close attention to the many roundabout ways in which deficit countries may, in the manner characteristic of a multilateral trading and payments system, gain a part of the OPEC reflow through sales or borrowing derived from OPEC purchases or investments elsewhere. But it will also have to be particularly alert to identify any sizeable gaps or lacunae which occur, or seem about to occur, after all practicable trade, investment and aid have been generated by existing markets and institutions, or by any new arrangements that may emerge either from the d'Estaing or Kissinger-Simon proposals of November. These gaps are likely to be of at least three kinds. It is surely not too early for a preliminary canvassing of views as to how each gap might possibly be filled.
The first major gap, already all too evident, concerns the position of the less fortunate LDCs which lack oil or other natural resources and are thus by far the hardest hit of all consuming countries. For these countries, some needs will exist outside the usual bounds of lending by the World Bank or its affiliates, or by other regional development institutions. If their hopes for primary development are to survive the impact of increased oil prices, they will need funds to be committed on a long-term basis, with an indefinite postponement of servicing requirements and other highly concessional terms. Their ability ultimately to develop the current account surpluses that will be needed to service any loans depends, at least in part, on continuing modest inflows of oil, such oil derivatives as fertilizer, and other basic materials. Any aid they receive as loans must, consequently, be only slightly distinguishable from grants. No contributing country could expect more than nominal servicing, many years in the future, with the prospects for eventual repayment quite distant indeed-clearly not a "commercial proposition."
To be sure, some bilateral assistance programs by individual OPEC countries, as well as the aid efforts of several industrialized countries, are already temporarily reaching some needs of this extreme kind. But there would seem to be great advantage-both in the screening of these unusual recipient requirements and in the administering of loan programs-in a pooling of capabilities and resources by the leading OPEC and industrialized countries. Any arrangement for such purposes, while falling outside the scope of present IMF or IBRD activities, would necessarily depend heavily on coordination with the staffs of these organizations and of the United Nations Development Program. Whether any of the existing agencies should become more directly involved would also surely deserve consideration. In any case, whatever the arrangements, there would undoubtedly have to be special provision for representation more closely related to proportion of contribution. It might be expected that OPEC countries would contribute at least half of the comparatively modest sums that a supplemental emergency aid program of this kind would entail.
The gravity of the need in this area has already been recognized. The Witteveen facility of the IMF, thus far amounting to $3.4 billion, is in part directed at this need, although it is also available to hard-pressed industrial countries. Moreover, a more detailed proposal has been made by His Majesty the Shah of Iran in which equal numbers of OPEC, industrial, and developing countries were invited to establish a fund for the provision of aid to the developing countries. The financial contributions, which were to be made in equal amounts by the OPEC and industrial members, were to provide an annual aggregate addition to aid availabilities of approximately the same amount as the Witteveen facility. Each partner, of all three groups, would be represented by a governor, and the governors would select several executive directors, purely on their professional merits, to manage the fund, using the staff services of the World Bank. One of the objectives of such an organization would be to supplement existing aid programs without introducing any political biases.
Secretaries Kissinger and Simon have now endorsed a "separate trust fund" directed to this problem, with national contributions especially from oil-producing countries. Although lacking in full details, this is an important step toward the necessary new arrangements to meet this gap.
The second great gap, suggesting the need for new facilities, concerns the industrialized countries for which oil imports are essential in sustaining overall productive capacity, but which cannot be expected to enlarge production and exports fast enough to pay fully for minimally needed oil imports at the new prices over the five years immediately ahead. Debt obligations of the governments of these countries would represent no risk of moratorium or repudiation, provided that they could place their debt with sufficiently long maturity to bridge a period of gradually enlarging export capabilities adapted to the changing markets of the world.
In such countries there are already substantial export earnings available to pay for imports, including a significant part of the oil imports; and there would undoubtedly be many individual firms capable of attracting outside financing in long term or equity form. But there would still be a missing critical margin which the various entities within the private sector could not be expected immediately to fill. Yet in the national interest there would be a justifiable public responsibility for filling that margin through government borrowing, in order to support the nation's overall economic performance. Instead of mere borrowing to pay for consumption, this would be borrowing to help maintain national viability, to obtain the added margin of oil needed for fuller use of a nation's potential. The results should appear, too, in balance-of-payments earnings on a scale sufficient to cover the servicing on such a debt of moderate maturity.
Virtually all of the industrialized countries, as well as most of those well along in the developing phase, could be expected to fall into this pattern of requirements at some time within the next five years. France, Italy, Japan and the United Kingdom, for example, have already arranged individually to borrow from OPEC and other countries, as well as from the commercial banking system. Some of these countries have also borrowed from international institutions. The United States, thus far apparently without governmental initiative, has already received several billion dollars as various OPEC countries purchased its government obligations in the public market. And indeed, OPEC purchases of government or other securities in the larger financial centers are likely to result, to some extent, in further passing along of loanable funds to still other oil-importing countries.
This is the process which the Kissinger-Simon $25 billion proposal for a "system of mutual support" would seek to help along by setting up "a common loan and guarantee facility" for the industrialized countries. And the two suggestions made earlier this fall, Helmut Schmidt's proposal of a multi-billion dollar international investment bank and Denis Healey's proposal of a $30 billion loan facility within the IMF, both address themselves to the same issue, from slightly different perspectives.
None of these proposals, however, engage the OPEC countries in a responsible role, nor envisage that they would share in the risks which inevitably inhere in loans on such a vast scale to countries with widely varying economic prospects. A question well worth exploring, therefore, would be whether an additional facility, perhaps in the form of a mutual fund for OPEC investors, might add importantly to useful "recycling" machinery. An "OPEC Fund for Government Securities," attracting funds from any OPEC country wishing to utilize such a supplemental facility, might, for example, purchase only special direct issues of various governments. The terms of the instrument issued to OPEC investors in such a Fund would include orderly redemption features to prevent sudden withdrawal and resultant dislocation of the financial markets in the countries underwriting the issues.
The designing of such a Fund would have to recognize several limitations and several requirements. The terms of government issues offered to the Fund could not be so attractive as to compete unfairly with the variety of private activities, including the promotion of trade and the funding of loans or equity issues, that should be encouraged in order to evoke the maximum contribution by all other elements of each national economy, short of government financing. Nor should the availability of funds be such as to give undue preference to particular countries, or permit delays in needed domestic economic adjustment, or interfere with appropriate exchange rate changes.
Alongside limitations of this kind with respect to the borrowing countries, the OPEC countries would undoubtedly have several requirements. They will want a dominant voice in the administration of a Fund and may find difficulty in agreeing on the roles each of the OPEC countries should play. In order to minimize exposure to exchange rate variations among countries whose bonds are held, they may wish to have principal amounts, or interest payments, or both, indexed to some common market-basket of currencies such as the SDR, or possibly a basket of Middle Eastern currencies. They also presumably wish to hedge against inflation risks in the future by having some adjustment for sustained changes in the price levels of the world as a whole.
There will undoubtedly be other limitations and requirements-perhaps so many as to defeat a project of this kind. Yet even a sustained discussion of the various elements, and of their potentially conflicting interactions, could contribute importantly toward a mutuality of understanding among OPEC and oil-importing countries, as they participate together in attempting to evolve workable arrangements.
The third sector of activity in which additional facilities-beyond those already proposed by various governments-might help would be that of assisting the direct flow of OPEC funds into the capital formation that the world so clearly needs, through guiding new investment into private enterprises or joint ventures. Here there might be scope for an investment trust, or a family of trusts, which would place funds principally in new or outstanding issues of equity or debt, by going concerns of established capacity anywhere in the world. As a supplement to the bewildering array of individual deals already in progress, investment trusts could provide a particularly effective outlet for investing the funds of national governments, whose officials might welcome an opportunity to share a part of their responsibility for appraisal of investments with trust managers of the highest competence and integrity.
Once organized and staffed by selected experts or firms with broad and tested investment experience, an "OPEC Mutual Investment Trust" could concentrate its purchases of equities, for example, on new issues authorized by the existing stockholders of incorporated companies in the oil-importing countries. The issuing corporations, by making a special offering of their stock, would be inviting OPEC participation in their shareholdings in a proportion judged appropriate by existing shareholders and management. The proceeds would clearly be available for needed capital formation, while also enlarging the equity base on which additional borrowing could be arranged in the future. Similarly, private placements of debentures could be made by the Investment Trust, although presumably there would be a preference for convertibles in order to share more fully in growing earnings, and in the implied partial hedge against inflation that equities offer over longer periods of time. Particularly at presently depressed levels of equity prices, there is an almost unprecedented opportunity for capital appreciation, as an offset to the erosion of inflation, through the purchase of shares in the leading concerns of Western Europe, North America, Japan, Australia, and others. Diversification among firms and industries and countries should provide the greatest practicable assurance to the OPEC investors that their principal values can be maintained and earnings perpetually assured.
From the side of the oil-consuming countries, and the companies within them which might receive the OPEC trust investments, there is clearly an advantage in the trust form. It provides a buffer against the direct holding of voting stock by OPEC governments. The OPEC investors, in turn, can have the satisfaction of acquiring investments purely on their merit as sound earning assets, removing any possible implication of political motives or a desire to control the industry of another country. Moreover, the specialized management of these OPEC purchases and sales will shield the shares of companies in consumer countries from some of the sudden swings in price that could otherwise be set off accidentally by investors unable to devote full time to gauging factors affecting the timing and amount of transactions. A well-selected trust management should also assure OPEC investors the best possible combination of limited risk and moderate return available anywhere. The inescapable burden of owning capital is, of course, the taking of some risks-there is no "sure thing" for any investor, and no way of approximating risklessness for investors with funds as large as those of the OPEC countries-but diversification can balance risks and gains.
Purely as an indication of possibilities, a very tentative outline of some elements to be considered in designing a trust fund approach might be:
In the interests of the OPEC investors:
1. There might be several trusts for several different objectives, such as one for capital appreciation, another for income, and another a balanced fund; or there could be a separation as between real property and intangible property; or according to the country or group of countries in which investments are to be placed.
2. Depending on the nature of the assets, and the degree of liquidity required by provisions for redemptions, anticipated total return on average might range between six and eight percent.
3. As a guide to diversification, percentage limits within the total of a given trust fund might be set for holdings in a given country, or currency area, or individual company. Companies might be rated, with minimum or maximum percentages for holdings of Class A, or AA, or AAA, for example; or limits could be placed on size of capitalization, say a $10 million minimum.
4. Individual trusts could be open end or closed end, but presumably shares of the trusts would not be listed on any public exchanges as they could only be traded among the relatively small number of OPEC countries. Since OPEC countries may wish to repatriate holdings as added investment opportunities become available domestically, trust shares should be redeemable according to terms related to the kinds of assets held by a particular trust.
5. Risks of nationalization of assets held by the trusts would be minimized by virtue of the fact that there would be a majority of shareholders or bondholders or partners from the private sector in non-OPEC countries. However, some consumer countries might consider giving guarantees against nationalization, and many would probably permit exemption from domicile taxation on dividends transmitted to the trusts.
6. Exposure to changing rates of foreign exchange would be minimized both through diversification and through specific guidelines set for the trust management.
7. Establishment of the trusts can be handled by a management company in which the nominal stock ownership would be held by each interested OPEC country and, if desired, by the leading investment institutions in key countries which the participating OPEC governments choose to provide advisory services and to assist in selecting the full-time staff of the management company. The company and trusts could be organized under the laws of Switzerland, or the United States, or elsewhere as desired. The Board of Directors of an "OPEC Investment Trusts Management Company" would presumably consist of at least one member from each participating OPEC country, with additional directors added according to a formula related to size of participation. Advisory firms might also have seats on the Board, or alternatively on an Advisory Board, authorized to consult directly with and review the performance of the active management. The Board should have authority to establish additional trusts for specified purposes under the laws of any country designated in the bylaws, and to change any operating guidelines by a two-thirds vote.
8. The initial size of a trust might be set at $1 billion with share units of $1 million each. As all expenses of the management company, including custody and transfer of securities, should be a first charge on earnings, there need be no "load" on the actual subscription to any trust.
In the interests of the oil-consuming countries:
1. No trust should hold shares in any company which would bring the known total holding of such shares by OPEC governments or their agencies above, say, ten percent of the total outstanding, unless specific approval is obtained both from the management of the company and the government in which its head office is located.
2. The trusts should undertake to buy or sell shares (or debentures) in amounts above, say, one million dollars (or the equivalent in other currencies) only with the knowledge of the company. In this way the company may have first refusal of an opportunity to offer stock (or debentures) directly at the going market price or, if it wishes, to buy back such instruments at the going market price. This would help protect the trusts against creating an undue movement of the market price against their interests, and would assist the company in maintaining an orderly market for its obligations.
3. The trusts should undertake to give prior notice to the affected central banks whenever they contemplate transfers into or out of a particular currency in amounts of, say, five million dollars or more (or whatever benchmark each central bank wishes to set). In this way, undue disturbances to exchange rates could be avoided, as desired by the affected central banks, to the advantage of everyone, including the OPEC investors.
4. The directors should agree that voting shares in companies will be exercised by the management with a view solely to protecting the value of the investment, in a manner comparable to the normal exercise of such rights by leading trust companies in behalf of their clients, and not for any other purpose.
Should any measure of interest emerge for a trust fund approach among the OPEC and consumer countries, a more fully articulated prospectus would, of course, have to be developed to test its feasibility. On the basis of limited preliminary inquiries in the investment banking community, it would appear that an aggregate magnitude of $10 billion would not be out of the question in the first full year for trusts of this kind-at least in terms of the availability of acceptable investment outlets.
The OPEC countries, whose principal product has been for so long underpriced and overused, must be able to convert their exhaustible oil into permanent capital and perpetual earnings, at home and abroad. They need, and undoubtedly want, both the enduring goodwill and the continuing economic prosperity of the oil-importing countries. They surely recognize their large stake in the economic prosperity of the world. They undoubtedly want capital markets of their own, and ready access to flourishing capital markets in other countries, to provide an assured base for the economic growth they rightly expect for their descendants.
The suggestions made here are meant only to illustrate the breadth and variety of the approaches and opportunities that should still be explored, before the world teeters any closer to the edge of an unnecessary stalemate-locked between rightful aspirations of the OPEC countries and limited capacity of the oil-importing countries to meet those aspirations rapidly. The urgent need is to begin a mutual exploratory process. Confrontation between oil-producing and oil-consuming countries has already produced a gulf of misunderstanding, both as to motives and as to potentialities, on both sides.
In the year that has been so largely lost, confusion and differences have multiplied while underlying economic tensions have, though subdued for a time, been inexorably moving toward crisis. There is barely enough time for a quiet sorting out of the interacting influences of trade, prices, aid, and investment. Informal exchanges, with the blessing and in time the participation of heads of states or governments, could still avert impending calamity during the remainder of this decade and begin construction of a viable system for the decades ahead.
[Authors’ note:] The group responsible for this article, listed alphabetically, comprises five individuals, acting in their private capacities. The ideas expressed were developed in a series of meetings through the fall, and the text has been reviewed by each of the five authors. While not necessarily endorsing the text in every detail, all the members of the group fully subscribe to its central points and proposals. Many individuals from other OPEC and OECD countries who were consulted cannot be given individual acknowledgement here. The authors are indebted to Keith Josephson for extraordinary help in the task of intercontinental coordination.
1 Since the proposals by Secretaries Kissinger and Simon were made as this article was in the press, it was not possible for the authors to review together their reactions. Accordingly, all references to these proposals on this and the following pages are the responsibility of Mr. Roosa.