The Day After Russia Attacks
What War in Ukraine Would Look Like—and How America Should Respond
It took three years of muddling through crises, near-panics in the financial markets, a million or so jobs lost in the United States, and social unrest in the developing world for the Reagan Administration to recognize the debt crisis for what it is: a long-term economic and political barrier to development that is slowly strangling world economic growth.
Ideology has, at last, given way to pragmatism. At the October 1985 annual meeting of the International Bank for Reconstruction and Development (World Bank) and the International Monetary Fund (IMF) in Seoul, Treasury Secretary James Baker announced that the United States was ready to shift gears and take a more active role in confronting the debt crisis.
Both domestic and international considerations prompted this policy shift. On the domestic front, a slowdown in the U.S. economy has exacerbated the difficulties of American agriculture and manufacturing, thereby stirring protectionist anger in Congress. Protectionism is gaining advocates even though to stem the flow of foreign goods would restrict the exports of Mexico, Brazil and other debtors, and thus prevent them from earning the foreign exchange they need to pay back their loans. The Administration is also increasingly concerned about the political impact in the debtor countries of the strict austerity programs and belt-tightening demands made by creditors.
For months, Fidel Castro has argued for a repudiation of debts, and the newly elected president of Peru, Alan García Pérez, has unilaterally announced that he will not devote more than ten percent of his country’s export receipts to service debt. In his dramatic speech to the U.N. General Assembly, he declared, "It is either debt or democracy. . . . We believe the objective must be the unity of debtor countries and a radical change of the current situation."
Until recently, the Administration has ignored these more "radical" calls, but with Brazil and Mexico pleading for new opportunities for economic growth and Nigeria also questioning internationally imposed austerity programs, the U.S. Treasury fears that a revolt by a major debtor would be enough to threaten most U.S. banks and seriously shake up the international financial system. The case of most immediate concern is Mexico, the third-largest trading partner of the United States. The government there has fallen out of compliance with its IMF program, and thus put its multiyear rescheduling program with the banks at risk. The country has also been ravaged by an earthquake causing at least 7,000 deaths and possibly $4 billion in damages.
Against this bleak background has come the realization that, although efforts at economy in debtor countries are clearly needed, the question is how to distribute the burden of adjustment more equitably between debtors and lenders.
The contemporary debt crisis is new only in its magnitude. In the nineteenth century, nine state governments in the United States suspended their debt-service payments. Britain and France defaulted on payments to the United States during the 1930s, "on the grounds that their obligations to meet the needs of their people were greater than the legal obligations to creditors." A number of Latin American countries defaulted on their bonds in the nineteenth century and again in the 1930s. As recently as 1953, the United States reduced Germany’s debt by two thirds and stretched the repayment over 35 years at a concessional interest rate of only three percent. Although the circumstances were clearly different, this last example shows that the costs of adjustment can be distributed among creditors and borrowers instead of being borne exclusively by the debtors, as is currently the case.
Even during the boom years of 1948-1972, some debtors ran into difficulties and could not service their debts. In these cases, bilateral credits and credits granted by the export agencies of industrial countries were, as they still are, renegotiated under the auspices of the Paris Club, an informal group of creditor governments.
By 1974, developing countries’ debt amounted to $135 billion. Ten years later, according to IMF estimates, the combined debt of capital-importing developing countries was $830 billion. On average, about 60 percent of this new debt (and over 80 percent in the case of Latin America) was loaned by commercial bankers, and for a practical operational reason. During the 1970s, as billions of petrodollars were deposited in Western banks and financial markets by oil-exporting countries, the deficits of oil-importing countries had to be financed. A solution readily presented itself: take the cash from one group of clients and loan it out to the other. Thus was born the process of "recycling." Bankers also invested billions of dollars in newly rich oil-exporting countries.
Only gradually did creditors and borrowers realize that this solution created a new problem, as most countries continued living beyond their means, without recognizing the grim realities of a new external environment. Huge projects were undertaken, standards of living were given an artificial boost and imports became more attractive than more expensively produced domestic goods. Between 1972 and 1979, the indebtedness of the less-developed countries (LDCs) increased at an annual average rate of 21.7 percent. Furthermore, many developing countries permitted capital to leave their borders by maintaining artificially overvalued exchange rates. Money loaned by banks to Third World governments was reexported by the private sector and invested back in the United States, where real estate or other investments appeared more attractive than local opportunities.
Credit was cheap in the mid-1970s; the interest rate charged by banks on dollar loans was often less than the rate of inflation in the United States. With interest rates negative in real terms, why not borrow more? Over time, the relative debt-service burden could be expected to diminish. The reasoning was not altogether flawed, providing the loans were properly invested in productive sectors that would yield a return at least equal to the rate of interest. However, as it happened, only about half the credits extended to developing nations were used in productive investments.
When the second oil shock came in 1979-80, the developing countries continued to borrow, and approximately one thousand banks worldwide were eager to oblige. After all, as one leading American banker used to say, "Countries don’t go bankrupt." The only worry the banks had to face when interest rates fluctuated greatly was that they might have to pay more for deposits than they were receiving from borrowers. So, after having lent for years at fixed rates, banks began lending on a floating-rate basis during those boom years, effectively passing on the interest rate risk to the borrower.
In October 1979, with double-digit inflation raging in the United States, the Federal Reserve Board decided to adopt the monetarist remedy of tightening the growth of the money supply. As a result, interest rates soared upwards and the U.S. economy plunged into recession. The prices of commodities, which give developing countries their main export revenues, fell sharply as the industrial countries’ economies slowed and demand fell. By 1981, bankers switched to shorter maturities that they erroneously believed to be less risky, and eventually started cutting back their loans.
August 12, 1982, proved to be a fatal day. The finance minister of Mexico, Jesus Silva Herzog, made three phone calls to announce that Mexico had run out of foreign exchange reserves and could not continue to meet its external obligations. Herzog’s three appeals for help went out to the managing director of the IMF, Jacques de Larosière, to Donald Regan, then treasury secretary, and to the chairman of the Federal Reserve, Paul Volcker.
Mexico had had problems before, in fact as recently as 1976, and other debtors had run out of foreign exchange at one time or another since 1974, most notably Zaïre, Zambia, Senegal, Jamaica, Peru, Poland and Turkey. However, never before had any country’s debt problem reached the magnitude and complexity of that which Mexico now faced. Mexico’s total debt exceeded $80 billion and almost 30 percent was due within one year. Moreover, the exposure of U.S. banks alone was enormous, equal to 44 percent of the equity of the country’s nine largest banks. It was thus clear that the Mexican crisis, if not handled properly, would create a panic in the financial markets and have serious consequences for the world economic and financial system.
The response was a remarkable cooperation between governments and banks, orchestrated jointly by the IMF and the U.S. government. The assembled rescue package provided for postponing the payment of principal, for new flows of capital and for a drastic belt-tightening program in Mexico. In November 1982, Mr. de Larosière summoned the top executives of the leading commercial banks and, in an unprecedented move, told them flatly that the IMF would not approve a stabilization program for Mexico unless the bankers first agreed to restructure over $20 billion of Mexico’s debt and provide $5 billion more in new loans, a seven percent pro rata increase in the exposure of Mexico’s creditor banks.
The Mexico action set two important precedents. It propelled the IMF to the forefront of the debt crisis, and it set the pattern for all subsequent reschedulings. Since 1982, 38 countries have rescheduled their debts or are in the process of doing so. South Africa is the latest to join the long list of these countries, whose combined debt is estimated at about $550 billion.
The rationale for extending new credits while postponing the payment of principal is that a debtor-nation needs economic breathing space to succeed in increasing domestic savings and to accelerate the growth in production and exports needed to generate foreign exchange. But this scenario works only if one assumes a favorable world economic environment, namely three percent or more in economic growth and a standstill on protectionist tendencies in industrial countries. For debt-service burdens to become more manageable, real dollar interest rates would have to be lower. Finally, banks would have to be prepared to provide new credits, increasing their exposure at an annual rate of five to seven percent from now until the end of the decade.
Since August 1982, a general pattern for dealing with the debt crisis has emerged. When bankers sit down to negotiate with debtors they use Mexico as a yardstick. They claim there now exists a "rescheduling market" in which the terms and rescheduling conditions for each debtor are determined on the basis of its credit rating relative to that of Mexico. Although logical from the bankers’ point of view, this means that those debtors in the worst condition have to pay the highest prices for assistance. Whereas banks, pressured by the U.S. government and the IMF, have lent additional billions to big debtors such as Mexico and Argentina, smaller debtors that do not individually threaten the international financial system have been basically neglected. In sub-Saharan Africa, for instance, only the Ivory Coast has been granted long-term fresh money by the commercial banks in the context of rescheduling operations.
In 1984, Mexico improved the terms and conditions of its own rescheduling over the package of 1982, and most Latin American debtors derived some benefit from this precedent. But sub-Saharan African countries such as Senegal, despite their more difficult economic situations, did not benefit at all, and their rescheduling packages have typically been more stringent than those accorded even to small Latin American debtors. For African countries, banks have not rescheduled anything but arrears and debt payments falling due in one or two years. This means that every year creditors and borrowers must reconvene at the negotiating table. Planning becomes very difficult; the future conditions that may be required for the rescheduling of debts owed by African nations remain uncertain. It should also be noted that the Philippines and Yugoslavia, by contrast, have typically been treated more like the big Latin American debtors; developments in both of these countries could represent a threat to U.S. security interests, as well as to the international financial system, if things were to turn sour.
During 1983-84, the world economic environment proved to be somewhat kinder to Third World debtors than anticipated. Growth within member countries of the Organization of Economic Cooperation and Development averaged more than three percent, fueled by very rapid improvement in the U.S. economy, which grew at 6.8 percent in 1984. The record American appetite for imports helped absorb expanded exports from debtor nations. Virtually all the increase in exports from Latin America between the first quarter of 1983 and the first quarter of 1985 went to the United States.
But the gains made in 1984 concealed some troubling underlying trends for the world economy. General commodity prices linger at an unprecedented low level. Typically, in a period of relatively strong economic growth, commodity prices should increase as demand becomes greater. In fact, however, dollar prices for non-oil primary commodities were about 11 percent lower in 1984 than in 1980. Oil prices, critical for countries such as Venezuela, Nigeria and Mexico, dropped 16.6 percent from 1981 to 1985.
Although nominal interest rates have declined from their peak in 1980-81, they remain about six percent higher than inflation, making the cost of servicing debt extremely high in real terms. Finally, the rate of increase of new credits has been shrinking as banks have been reluctant to lend to those LDCs that are encountering debt-servicing difficulties. The only exception to this trend has been multibillion-dollar packages of credits organized under the auspices of the IMF. But even taking into account these arrangements, the rate at which new credits have been granted comes nowhere near satisfying the call of the IMF and the Bank for International Settlements for a five to seven percent annual increase.
The IMF predicts that the main industrialized countries will grow in 1985 at a rate of 2.8 percent, and the United States at only 2.6 percent. Furthermore, non-oil primary commodity prices are forecasted to decline by as much as 11.2 percent in 1985. Under such constraints, and coupled with a rise in protectionist tendencies, it will be difficult for debtor countries to increase their exports.
Against this background, the debtors’ general capacity to implement strict austerity programs has been remarkable. According to the IMF, capital-importing countries reduced their current account deficits from $112.5 billion in 1981 to $37.9 billion in 1984, and this despite ever-increasing interest bills as principal went unpaid and new credits boosted the total amount of debt. Looking at the merchandise trade balance alone, these countries’ efforts appear even more impressive: moving from a trade deficit of $65.1 billion in 1981 to an aggregate surplus of $15.2 billion in 1984.
This turnaround was the result of harsh austerity measures intended to reduce consumption. Under the auspices of IMF programs, developing countries devalued their currencies, phased out subsidies, increased prices of public utilities, restrained wage increases, tried to reduce the size of the public sector, increased interest rates, and slowed down the rate of credit growth. Trade and investment practices were somewhat liberalized and more market-oriented policies were adopted. In some countries, serious efforts to convert large parts of the public sector to private ownership were undertaken. Some countries—Mexico, Argentina, Chile, Costa Rica, Ecuador and Ghana—have done much more than others, where rhetoric and reality have not always matched.
But the record of these IMF-inspired programs is not altogether positive. A large portion of the trade account improvement was due to sharp curtailments of imports, a step clearly unsustainable over a longer period of time. Exports by debtors, which got an initial boost from currency devaluations, are beginning to contract in some countries, such as Mexico and Brazil. In others, for example Argentina, the growth of exports is stagnant. Competition among LDCs for export markets is getting tougher, especially as world economic growth slows down.
Production in most developing countries has also been running below capacity, partly because of constraints on the importation of raw materials and equipment, partly because the private sector has been left with insufficient funds with which to operate. Huge currency devaluations, and thus increased costs of material, labor and debt have depleted working capital. In addition, investments needed to maintain infrastructure—roads, telephones and other services—have often been postponed, hampering production efficiency.
Within the developing countries, high inflation and slow growth have become the norm. According to the IMF, inflation in Africa in 1981 averaged 21 percent, and still amounted to 20 percent in 1984. And in Latin America, despite a short-lived improvement in some major debtor countries, inflation for the area as a whole more than doubled during the same period, averaging a staggering 117 percent in 1984. In both Africa and Latin America, inflation will probably be higher in 1985 than in 1984.
Economic growth in sub-Saharan Africa continues to lag seriously behind the high rate of population increase, further reducing already meager per capita income. Not until 1990, at the earliest, will Latin America recoup its 1980 standards of living. Unemployment and underemployment are widespread. Health and education services have declined dramatically; malnutrition and infant mortality have increased. The average citizen in developing countries today consumes fewer calories daily than in 1975.
With double-digit unemployment, more than half the working population holding only part-time jobs, and no social security safety net, the governments of debtor nations are clearly sitting on a social powder keg.
The IMF is often unfairly blamed for the harshness of these austerity programs. The uncertainty and shortage of funds received from both private and official sources is what constrains these countries’ growth. The IMF staff has to deal in the real world, in which commercial banks are unwilling to lend additional money following a decade of mistaken enthusiasm and the U.S. Congress and public are reluctant to support increased multilateral and bilateral financial assistance. The IMF was created to finance temporary balance-of-payments problems. Long-term development and project financing was to be the responsibility of its sister organization, the World Bank.
The World Bank has been accused of sleeping soundly through the events of the last three years. That too is unfair. The Bank has been seriously hampered in its capacity to innovate and launch new projects by the skeptical attitude and suspicion of its main shareholder, the U.S. government. Some members of the Reagan Administration considered the World Bank too "socialist."
This was the situation that greeted James Baker when he became secretary of the treasury in January 1985. Ever the pragmatist, it took him only a few weeks to understand the gravity of the debt crisis. Mr. Baker was concerned about the stability of the U.S. banking system and possible repercussions on the world financial markets. He also saw the negative impact of prolonged stagnation in debtor nations on U.S. exports, and thus on employment. The possible political ramifications of a slow disintegration of debtor nations must have also been on his mind when he determined that the United States would take a more active lead.
On October 1, he and Mr. Volcker met with the chairmen of America’s major banks, in itself a highly unusual step. The bankers were informed of Washington’s new game plan and were sounded out as to the amount of credits they could provide to debtor nations. On October 8, Mr. Baker took the rostrum at the IMF-World Bank annual meeting in Seoul and told 9,000 delegates from 149 countries that the debt crisis could only be solved by an even closer cooperation of all parties concerned, more money from commercial banks, an enhanced role for the World Bank and more growth in the developing world.
The Baker declaration is significant. For the first time the Administration officially recognized that the debt crisis is here to stay, and that austerity has to give way to growth. Furthermore, the chief financial officer of an Administration hitherto hostile to the World Bank stated that the Bank was ideally suited to provide support for medium-term economic reforms.
The commercial banks were asked to continue to lend to 15 heavily indebted countries, and to increase their exposure by at least 2.5 percent per year. This falls between the older proposals for five to seven percent growth in credits and the current reality of no spontaneous credit growth. In total, the banks will be asked to contribute $20 billion over the next three years. The list of countries includes Argentina, Brazil, Mexico, Venezuela, Uruguay, Chile, Ecuador, Colombia, Peru, Bolivia, Yugoslavia, the Philippines, Nigeria, the Ivory Coast and Morocco. Mr. Volcker, who helped in the design of the plan, has himself been urging banks to pledge these additional funds.
In addition, Mr. Baker called for the World Bank and other development banks to provide more assistance to debtor nations. Both the Inter-American Development Bank and the World Bank were asked to increase their disbursements to major debtors by roughly 50 percent, to $9 billion. The total package would thus amount to $29 billion.
Mr. Baker appealed to the World Bank to streamline its operations in order to reduce the time necessary to negotiate a program with borrowers and hence speed up actual disbursement of loans. He also proposed that the Bank provide direct assistance to the private sector of indebted countries.
Two other specific schemes were endorsed by Mr. Baker: the World Bank’s Multilateral Investment Guarantee Agency is to provide guarantees for direct investments in developing countries, and $2.7 billion is to be recycled by the IMF Trust Fund, a facility extended to the IMF’s poorest members in the 1970s. Debtors will have to make firm commitments to further strengthen their economies by adopting additional market-oriented economic policies, relying more heavily on supply-side actions such as tax and labor reforms, transference of inefficient state enterprises to the private sector, liberalization of trade practices and adoption of policies to attract more foreign investment.
Both bankers and debtors have responded cautiously to Mr. Baker’s program. Bankers are wary of lending more money to countries already strapped for cash without receiving explicit guarantees from the governments of industrial countries. Most debtors are concerned about additional new conditions that will be imposed and by the prospect that the IMF and the World Bank will combine forces against them. Small and poorer debtors are concerned about being left out.
An increased role for the World Bank is clearly needed. But unless the United States openly backs both an increase in the World Bank’s capital and changes in its lending practices—which so far it has refused to do—the Baker plan will fall short.
The World Bank should take a larger role in reviewing member countries’ investment strategies and advising on structural reforms needed to increase production, exports and employment in the medium and long term. It has a unique expertise and a highly qualified staff in this field, and in fact, has already started working in this direction.
Conservative lending practices need to be relaxed, especially if increased capital contributions continue to be resisted by key shareholders. For example, the ratio of World Bank loans to its capital could be increased from its current conservative level of one to one. (This "gearing ratio" is typically twenty to one for U.S. commercial banks,) More financing could also be provided if the Bank switched emphasis from its traditional role of lending for specific projects to more structural adjustment loans. In cases where local currencies are difficult to mobilize, the World Bank should be permitted to lend one hundred percent of the cost of a project. Finally, the World Bank should put more emphasis on low-cost housing programs; such programs have a welcome democratic angle, usually have a very high local content, are low cost, and are typically very labor-intensive and thus will create new employment.
The U.S. proposal encourages World Bank co-financing with commercial banks, and this is already being tried in various forms. The World Bank may participate directly with commercial banks in syndicated loans; or it may join commercial banks in offering a floating-rate credit with a level payment similar to domestic mortgage arrangements in the United States. In the latter case, borrowers are in effect protected against rising interest rates since the periodic payments remain constant. When interest rates increase, a larger proportion of each debt-service payment is taken up by interest, and hence principal is repaid more slowly. The World Bank then refinances any principal still outstanding at the end of the loan’s original life, and thus ensures banks of timely payments. This creates, in effect, a cap on interest.
Another, and so far less frequently applied, alternative is for the World Bank to guarantee portions of a loan, particularly in the tail end of the maturities due. This guarantee applies to principal only. In order to obtain such a guarantee, bankers pay a fee which effectively reduces their rate of return. Such guarantees in fact reduce the risk that a debtor country will default, because the commercial banks are more willing to lend the amounts required. Provided such financing and guarantees are coupled with strict monitoring of the economic performance of the country, the chances of success increase significantly.
Collaboration between the World Bank and the IMF, as proposed in the Baker program, is not a new idea. Informal contacts have always existed between the two institutions, located across the street from each other in Washington, D.C. Their boards of governors hold concurrent annual meetings, and both institutions have evolved toward greater similarity to one another. The IMF, conceived as a vehicle for temporary relief, has adopted longer loan-adjustment periods, while the World Bank, in 1980, adopted measures to encourage macroeconomic reforms and supply-side measures. The IMF has also become operationally interested in investment and production and often asks the World Bank’s staff for an evaluation of a country’s investment program. The World Bank and the IMF have tried to coordinate more closely their approach to member countries and, in some cases, have undertaken joint missions.
But despite all the talk of cooperation, serious differences remain. The IMF generally confines its policy recommendations to macroeconomic policy; as such it operates more rapidly than the World Bank, which is more concerned with the details of how an economy functions. For example, the IMF typically recommends that the aggregate budget deficit be reduced, while the World Bank recommends specific cuts.
The fundamental point is that Mr. Baker’s scheme can only work if it is lubricated with enough credit. The goals in his proposal are modest. Yet, even the proposed 2.5 percent increase in bank lending to the 15 debtors on his list may prove difficult to mobilize. The idea, floated for the first time in Seoul, of letting small banks opt out of new Third World exposure altogether, leaving about one hundred international banks to shoulder the burden of future lending, is anathema to most major banks. Even the largest banks, mindful of their stockholders, have so far been reluctant to guarantee any plan for stepped-up lending, asking instead for concessions from the Treasury and banking regulators.
So far, Washington has insisted that no special treatment would be granted for these loans. Instead, Mr. Baker argues that banks should cooperate in their own interest: "They have got loans in trouble. It’s possible that reflows will make bad loans into good loans," he stated before the House Banking Committee.
European banks would also prefer not to lend more money. They would rather capitalize interest; a practice that goes against U.S. regulations. Banking and tax legislation in a number of European countries encourage the establishment of sizable loan-loss provisions; in addition, some countries have developed generous accounting rules which allow banks to form what are called "hidden reserves" that amount to the retention of untaxed cash. Thus, most European banks are sufficiently cushioned to absorb potential losses, in contrast to their U.S. counterparts. This is especially significant since at least one third of the $20 billion in new loans is to be provided by European banks.
The United States must now show the bankers that it means business and gain the cooperation of other industrial countries. Export credit agencies need to increase their lending and guarantee programs; bilateral assistance should be increased significantly. Japan, which has the world’s biggest current account surplus, clearly has a role to play, for its banks have the second-largest exposure in Latin America.
The Reagan Administration is considering Mexico as a candidate for trying out its new stepped-up international debt strategy. Mexico’s gross foreign financing requirements for the rest of the year and 1986 are usually estimated at about $7 billion, and some analysts’ estimates are much higher. Mexico clearly must remain a top priority; but with only $20 billion available for the debtors on Mr. Baker’s list, will there be enough left for others? And are the others to wait on the sidelines while the strategy for Mexico is worked out among the concerned parties?
Mr. Baker’s strategy is geared mainly toward dealing with the big debtors, those few that can hope for a resumption of voluntary credits. But what is the strategy going to be for smaller and poorer countries which should never have borrowed so much on commercial terms in the first place? Unless explicitly guaranteed by the World Bank or the U.S. government, credits to these countries will remain scarce.
Even the small debtors’ relationship with the IMF is strained. Nineteen of these countries had arrears of about $400 million outstanding to the Fund at the end of August 1985. There must be a mechanism to clean the slate. These smaller countries need adequate financing if structural changes and investments in quick-yielding projects are to be implemented. One way of doing so would be to consider a formula which would establish a country’s debt-service payments as a function of its export receipts and non-tied capital inflows. During the 1970s, a debt-service ratio of 20-25 percent was considered very high. Today the debt-service ratios of most small debtors are in the 40-50 percent range (even after rescheduling takes place). But the fact that such levels have become a sort of norm does not mean that they are sustainable. Under a flexible formula a country would allocate a portion of its foreign exchange receipts to debt service. The details of the formula and the exact percentages should be established on a case-by-case basis. The difference, if any, between the payments dictated by the formula and the interest actually due could be capitalized.
To stimulate growth, an additional portion of debtor countries’ export receipts could be set aside in a trust fund either in local currency or in foreign exchange. The debtor government would use the money in this fund to make investments in productive sectors, to complete priority projects, and to inject capital into the private sector. In return for the reduction in debt-service payments, the debtor would allow a mechanism to be put in place to monitor the allocation of money in the trust fund, to ensure that it is invested appropriately.
Promising though it may sound, however, this scheme does not address the fundamental problem of many debtors: their debt is growing faster than their net export proceeds; they will simply never catch up. Reducing the rate of interest to be paid, whether by setting ceilings on the percentage of foreign exchange allocated to debt service or by arbitrarily setting the interest rate below the market level, will not suffice.
For these countries, the banks and industrial governments should consider writing off part of the debt. There would not be any major consequences for banks or governments provided that countries benefiting from such a "radical" treatment do not present a risk to the system. The difficulty of such an approach is to find criteria to determine where the borderline should be drawn. In fact, a number of banks have already written down, though they have not written off, a sizable portion of their exposure to small debtors. These countries still have a contractual obligation to pay interest on the total amount of debt outstanding. A write-off by the banks for some countries would obviously have to be reviewed carefully, to examine the possibility that the debtor could further reduce imports, adjust its economy, or generate additional exports. To avoid any abrupt reduction of bank earnings, U.S. regulators and Congress might have to allow an extended period for the banks actually to write off such loans. A clause to guard against free rides would have to be included. Such a clause would stipulate that in the event a country enjoys a sudden, unexpected increase in foreign exchange receipts, for example because of a jump in copper prices, debt cancellations would be reviewed.
On balance, the U.S. recognition that the debt crisis is threatening the international financial and trade system as well as the political stability of debtor nations is a giant step in the right direction. Mr. Baker’s bold initiative to launch a "Program for Sustained Economic Growth," with the U.S. government playing a more active role, needs some time to be fully assessed. But unless funds are mobilized to facilitate the process, the appeal for more cooperation among creditors and debtors may give way to a more confrontational stance. Expectations have been raised high; now they have to be fulfilled.