The Global Zeitenwende
How to Avoid a New Cold War in a Multipolar Era
During the past year a great deal of attention has been devoted to the accumulation of debt by the less-developed countries (LDCs). One recent publication estimated that the long-term public debt of 86 LDCs (including undisbursed amounts) exceeded $200 billion at the end of 1976; and that short-term and private debt amounted to another $50 billion for a total of $250 billion.1 Another publication estimated that the combined long-term, short-term, public and private debt of the non-OPEC LDCs (not including amounts undisbursed) would total $180 billion at the end of 1976, of which $75 billion was owed to commercial banks.2 About $45 billion of this is said to be held by the U.S. banks. These figures are generally 20 to 25 percent higher than comparable figures for 1975; indeed, they have been growing at such rates or higher ones since 1973.
For the first time in many years, a large number of people have begun to worry whether the countries could service all of the debt they are incurring and whether the banking system, particularly the large, international U.S. banks, could go on accommodating their increasingly strained financial position. One can reach different conclusions on this issue by pointing to different factors.
Those who are relaxed on the subject, including most of the largest banks, point to historical experience and case-by-case considerations. They note that very few losses have been incurred up to now in LDC lending, though billions have been written off in domestic real estate, corporate and personal loans. They note that the debt servicing burden of LDCs is proportionately not much greater today than five years ago. They show important distinctions within the total figures: some of the debt is short-term and self-liquidating; some is guaranteed by the Export-Import Bank (Eximbank) or its European or Japanese counterparts; much of the balance is guaranteed by or loaned to sovereign governments in the upper tier of the developing world. While certain problem areas can be identified, they are a small fraction of the total picture.
Those who see a gloomier scenario point to future considerations and macroeconomic trends. In particular, the more-or-less permanent annual OPEC surplus amounted to about $38 billion in 1976; the corresponding deficit falls principally on the non-OPEC LDCs - $32 billion in 1976.3 Although the developed world is a larger oil consumer, it has the resiliency to balance its affairs through increased exports. The LDCs, now important purchasers of those exports, are left holding the deficit. Borrowing another $30 billion in 1977 to cover the deficit would increase the $180 billion figure cited above by 17 percent. Increments of even 15 percent per year in LDC debt cannot be matched by comparable growth in their economies, so that events seem to be on a collision course regardless of how favorable experience has been so far.
There are really two problems. The first is the overall imbalance and the total indebtedness of LDCs. The second is the role of commercial banks, and U.S. banks in particular, in mediating the imbalance by accepting OPEC deposits and lending to LDCs. Some well-meaning proposals envisage solving the problem through new lending institutions - International Monetary Fund (IMF) facilities, governmental "safety nets," etc. These may help the banks but they do not get to the heart of the matter, which is the too-rapid growth of total LDC debt compared with their ability to pay. If the total indebtedness gets out of control, all lenders could be in trouble.
There are worlds of differences among developing countries. One can travel to many parts of Latin America and find regions closely resembling Western Europe. One can also travel to parts of the world where the poverty is so extreme and the resources so limited that the situation seems quite hopeless. Yet all of these are referred to collectively as the "less-developed countries."
The first step toward understanding the LDC debt problem is to realize that the poorest countries have very little of the bank debt, basically because no bank would lend to them. It happens that Brazil and Mexico taken together represent about half of all the LDC bank debt outstanding. Nine countries account for more than 80 percent of such debt, namely: Brazil, Mexico, South Korea, Taiwan, the Philippines, Argentina, Peru, Colombia and Israel. These countries are quite well along in terms of development. The most severe problems occur in countries that have accumulated debt and do not have the development level to carry it.
Broadly speaking, one can draw a line between the commercial developing countries which have regular access to commercial banks and the aid-dependent countries which cannot attract much bank lending and mainly depend on foreign aid for their survival. Banks are generally reluctant - and properly so - to get involved in aid-dependent countries. Such countries would not be well served if they could get commercial bank financing, for such financing would be for relatively short periods of time and at relatively high rates of interest. Aid-dependent countries need and should get long-term, low-interest loans through mechanisms other than the commercial system. Alternatively, they should be given outright grants. When aid-dependent countries announce that they are unable to repay their official debts, they are in effect saying that the official loans should have been grants in the first place.
The difference among types of borrowers is mirrored in a difference in type of creditor. About 60 percent of all LDC debt is official (government-to-government) debt, generally foreign aid loans to countries deemed to need such assistance. The other 40 percent is bank debt to countries deemed creditworthy by commercial banks. The really severe problems arise on the boundary between these two categories, e.g., in Zaïre. Banks, impressed by that country's natural resources, extended large five to seven year credits at market rates of interest. In retrospect, Zaïre should doubtless have remained longer in the sphere of long-term development lending and concessional foreign aid. The passage from the "Fourth World" to the "Third World" can be hazardous for all concerned.
The difference in behavior between commercial countries and aid-dependent countries was brought out dramatically by events surrounding the UNCTAD IV conference in Nairobi in May 1976. In preparation for this meeting, a group of developing countries gathered in the Philippines and issued the so-called Manila Declaration. This document called for "waivers or postponement of interest payments and/or amortization, cancellation of principal, etc. of official debt to developing countries seeking such relief. In that framework the least developed, the developing landlocked and the developing island countries should have their official debts cancelled." The reaction against this proposal by banks and, more significantly, by commercial countries eager to maintain their credit standing, was dramatic.
The U.N. staff paper on policy issues facing the UNCTAD conference greatly softened the Manila proposal in response to the strong desire of commercial developing countries to dissociate themselves from it. In this paper a clear distinction emerged between "most seriously affected" countries and the rest: "The most seriously affected countries should have their debt-servicing payments on official assistance loans waived for the remainder of the decade. . . . With regard to other developing countries whose debt relates mainly to guaranteed or unguaranteed private loans, the problem arises from the short-term structure of the debt. Many of these countries do not appear to be in need of concessional debt relief nor do they wish to engage in multilateral negotiations that would affect their continued access to capital markets. But these countries will clearly benefit from arrangements that would iron out the 'bunching' of private debt over a longer period."
So there is the real distinction: very poor countries are pressing for general waivers of official assistance, i.e., aid repayments. Such countries will always need to feed their people before making debt service payments and may never be in a position to pay their debts. But the maximum risk in a commercial developing country would appear to be rescheduling. Such countries appear to be resilient enough to eventually balance their current accounts, as the developed world has generally done, if given enough time.
To be commercially creditworthy, a country should be in a position to balance its current account within the time frame of the loan, i.e., five to seven years for typical bank loan maturities. This is not to say that the current account will be balanced in that time frame, but the potential for eventual balance must be visible. This is indeed the criterion for distinguishing between commercial countries and aid-dependent countries. In the latter category, there is simply nothing visible which could possibly redress the balance in such a short time frame; therefore these countries ought not to receive commercial loans and should instead have long-term loans or grants.
The current account of a commercial developing country can often be brought into balance if growth is slowed. Capital goods imports account for 30 to 40 percent of total imports in most commercial developing countries. For example, capital goods imports represent 33 percent of total imports for Brazil, 37 percent for Turkey and 39 percent for Algeria. Capital goods are generally a discretionary import as opposed to items such as food and raw materials necessary to keep the economic machinery running. When it is said that creditworthiness depends on the ability to right the current account, this means that growth may have to be curtailed.
However, some countries are unwilling to slow their rate of growth in order to maintain their access to credit. They are developing so rapidly that they risk reaching a point of congestion in which the difficulty of obtaining enough new loans imperils prompt payment on the old loans. The typical problem of the commercial LDC is not poverty and stagnation, as in the aid-dependent countries, but excessive borrowing for too many projects, all of which cannot be implemented at one time.
Let us examine closely the possible scenarios resulting from such congestion. Here is a list of possibilities:
(A) The country could attempt to renounce its debts and not pay at all.
(B) The country could begin lagging payments, paying obligations behind schedule or sometimes partially.
(C) The country could warn the banks of impending congestion and ask for a rescheduling of debts.
(D) The country could request new loans for the purpose of avoiding a rescheduling.
It is option A which many people have in mind when they sound alarms over LDC lending. The Manila Declaration conjured up the vision of LDCs banding together in order to renounce their debts jointly. As noted above, however, this was principally an effort on the part of aid-dependent countries to convert official aid loans into grants or at least to eliminate payments on them through the rest of the decade. Renunciation of bank debt by commercial countries seems exceedingly unlikely.
There are, of course, some situations in which renunciation could happen, such as a communist takeover of the country concerned. Some of the true bank losses in LDC lending have occurred in Cuba and Southeast Asia, where ties with the Western financial community were totally severed following the installation of a communist regime. This kind of radical break can and has caused actual losses. Yet some day, however long it may take, these countries may wish to normalize relations with the United States. When they do, settlement of these long-defaulted loans will be an item on the agenda, so part or all of the loss may indeed be recoverable.
Short of a total break with the West, debt renunciation is not likely to be a workable solution for the over-extended government of a commercial LDC. Most governments depend quite totally on the international banking system to handle their flow of trade. The sale of a country's products abroad can hardly be handled entirely on a barter basis; it will require deposits of money, checks, transfer of funds, short-term trade credit and other bank operations. The banks would surely pursue remedies such as attempting to attach assets and products of the country through legal channels. The LDCs cannot afford to flout the banks. Indeed, the tendency in real life is for the banks and the troubled LDC to draw closer together. As we shall see from examples below, the real danger is not that the LDC would walk away but rather that the banks could get too deeply entangled in the country's internal policies.
Option B - lagging payments - might succeed briefly, but is at best a temporary measure. Furthermore, it damages a country's reputation for the longer run. It only postpones the day of reckoning, and makes the reckoning more severe when it comes. One sees this form of behavior principally in the "borderline" countries between the aid-dependent group and the commercial group; those which perhaps should not have attracted commercial lending in the first place.
Option C - seeking rescheduling - is a more sophisticated alternative. While banks do not welcome reschedulings, they can live with them quite well provided interest is kept current, i.e., only principal repayments are deferred. Current payment of interest has characterized the great majority of (but not all) country-wide reschedulings during the past 20 years. If interest remains current, the loan remains profitable, and the difference between it and an unrescheduled loan is not great. The great majority of LDC loans rescheduled during the past 20 years have been paid promptly as due.
Rescheduling is acceptable to the banks because, in a total sense, banks do not wish to be repaid at all. Bankers would never phrase it quite this way, but the fact is that they wish to keep their money working. The softness of loan demand in the past year has been a problem for most banks. Correspondingly, most corporations and virtually all LDCs are more or less permanently in debt. Although the amount of indebtedness rises and falls in accordance with the economic environment, it is expected that any company or country which is rapidly growing will always require some amount of debt financing.
Banks, however, like to keep a short maturity on their loans. For most customers they will offer five years and for certain customers they will extend to seven years, but rarely is a commercial bank willing to accept a longer payment term. This policy is based in the liability structure of the banks themselves. The banks lend money deposited with them principally as demand deposits and relatively short-term time deposits. Depositors need to feel that their deposit can be withdrawn at will, so the banks require a significant fraction of their loan portfolio to come due each year. As a practical matter, it is unlikely that deposits in the aggregate will be withdrawn or that new loans will not be made to substantially the same group of customers. What the bank needs is assurance that the borrower can pay back as necessary. Only if the bank were to doubt that the borrower could repay would it be likely to resist rolling forward the loan. It is entirely a game of confidence: the depositors must feel confidence in the bank, and the bank must feel confidence in its borrowers. If the confidence is sufficiently strong, it will never be tested. In banking, as in military matters, the ideal is strength sufficiently great that no one would feel the need to test it.
Because of the need to maintain confidence, the banks would rather accommodate option D - a new loan - than any of the other alternatives, provided some showing of creditworthiness can be made. The banks have no interest in forcing confrontations involving defaults and reschedulings, with consequent shaking of confidence not only in the borrowers but more particularly in the banks themselves. That was the rigid path taken in the 1930s, with disastrous consequences for both borrowers and banks. Rather, the banks have learned to exercise statesmanship and leadership in helping customers through liquidity crises by offering new loans, albeit on tougher conditions. This pattern of behavior has applied not only to LDCs but also to domestic customers during the recent recession. This is one important reason why the recent recession did not develop into a full-scale disaster like that of the 1930s.
What is the difference between a rescheduling of debts and a new loan? It is nearly metaphysical. The economics are the same - money is repaid later rather than now. It is the psychology which differs - a rescheduling is a confrontation, an admission of failure, an emotional catharsis, while a new loan is business as usual.
I do not mean to imply that banks make new loans blindly or as a cover-up for past sins. Each new loan must be negotiated at considerable length, and each negotiation is a forum for discussing the borrower's financial condition and measures that must be taken to improve it. New loans to distressed borrowers are typically accompanied by certain conditions or targets which the borrower is expected to meet. These may be informal or written into the loan agreement. The more distressed the borrower, the more aggressive and formal are the conditions likely to be. Finally, there is a level of distress beyond which most banks simply will not go on any conditions.
Three examples drawn from 1976 may help to clarify how these principles work out in practice. The three are Argentina, Peru and Zaïre.
Argentina was near economic and financial collapse when a military government assumed power in March 1976. Wholesale prices were rising at a 2,000 percent annual rate, real GDP had fallen two percent during 1975, and the 1975 current account deficit had reached $1.3 billion. Foreign exchange reserves were virtually exhausted as only a small part of the current account deficit could be financed. Commercial banks were not prepared to lend any further amounts because of lack of confidence in the economic and financial management of the country. Loans outstanding to Argentina from U.S. banks, however, stood at more than two billion dollars. None had actually defaulted, although it was clear that the situation could not continue for long.
The first instinct of the new government was to try option B to gain time; banks were quietly asked to exercise patience and not press too hard should some payment delays be experienced. The banks, however, wished to regularize any deferral of payments, and before long a six-month deferral of payments had been agreed upon. Thus the country moved toward option C. It was reluctant, however, to face a full-scale Paris Club rescheduling - which it had gone through in 1962. Moreover, its new Finance Minister perceived the advantages of option D. By June he was in the United States soliciting additional loans in lieu of rescheduling. The key to his success was his comprehensive economic program and its full acceptance by the military government. The U.S. banks were sufficiently impressed that they granted $500 million of new loans; the Europeans quickly followed with $350 million; the Japanese loaned $75 million and the Canadians $70 million.
By the end of 1976, a large current account surplus had been recorded, reserves were back up to $2.2 billion, and some progress was made in shaping up the domestic economy. Because the government's program seemed so well conceived, the new loans carried very few special conditions. The country seemed to have passed through its worst point and to be on the road to recovery. The speed with which new policies had been able to turn Argentina around illustrates the basic resiliency of commercial countries.
Peru followed a similar path in 1976, although with some significant differences. It had a current account deficit of $1.5 billion in 1975 and had virtually exhausted its international reserves as banks became increasingly unwilling to lend further amounts without economic reform. Existing bank lending to Peru stood at just under two billion dollars by mid-1976. The military group which came to power in August 1975 attempted to raise $400 million of new loans in the spring of 1976, but an impasse soon developed. The banks refused to lend without very significant economic improvement, while Peru maintained that a rescheduling would be necessary if new loans were not forthcoming.
In June 1976 the Peruvian government announced a new economic program including a 31 percent devaluation of the sol, higher excise taxes and higher prices for transportation and electricity. The announcement of the program was followed by riots in Lima, a national emergency and dismissal of the Prime Minister and two other members of the junta.
Nevertheless, the stabilization program was maintained substantially intact. In August an agreement in principle was reached for a $220 million loan from a group of U.S. banks. The loan was accompanied by a side letter setting down the policy understandings on which the loan was granted, including periodic reporting on economic progress. The arrangement broke new ground in the field of LDC lending. Not in recent memory had the banks been so fully drawn into the policymaking process within an LDC.
This example illustrates vividly the thesis referred to earlier: the real risk in LDC lending is not that the countries will walk away from the banks, but rather that they will draw the banks too deeply into their own internal affairs, making them a target of popular resentment over conservative economic policies. Such policies are not actually "imposed" by the banks; indeed certain members of LDC governments may feel strongly that such policies are appropriate, and they may welcome the presence of the banks as an excuse for adopting politically unpopular policies. Some local politicians may like having a lightning rod to draw off the adverse reaction of the people. But this carries a clear political risk to the banks and to the United States generally.
Zaïre is an even more interesting case. Neither Argentina nor Peru actually defaulted in any significant way. Zaïre, on the other hand, began in early 1975 to lag on payments or ignore a number of debt service billings. It pressed option B to its limits. Pressure on the country to normalize its finances built up rapidly through 1975 and early 1976 from both banks and creditor governments.
Zaïre's problems were also deeper and more intractable than Argentina's or Peru's. Its per capita income and general level of economic development would not have attracted much bank lending except for its considerable natural resources, including some of the world's richest copper deposits. The economy of the country thus depends heavily on copper mining, particularly for the provision of foreign currency needed for imports and for debt service. Copper production was severely disrupted by the war in Angola, which cut off the Benguela Railway, a major artery to and from the copper mining region. The war also drained resources directly from the government, which was supporting one faction. In addition to this, copper prices fell drastically in 1974 and 1975. Finally, the government had embarked on a number of non-productive projects and had nationalized most of the private sector in 1974-75, without having the capacity to operate it. By late 1975 the economy was in severe disarray and foreign exchange reserves were exhausted. Banks avoided any new exposure and were delaying the signing of a previously committed large loan for a new copper mine. Then, in early 1976, the shareholders of the new mining project suspended further construction and the related loan was abandoned. Commercial bank loans to Zaïre were estimated at about half a billion dollars, although poor record-keeping made an exact determination impossible.
In the spring of 1976, after more than a year of defaults on both principal and interest, Zaïre announced an economic stabilization plan, conceived in cooperation with the IMF, and requested a general rescheduling of its debts. It moved, in effect, from option B to option C. The major creditors gathered in Paris, as is the custom in such cases. Principal and interest in default to governments, or to banks guaranteed by governments, through June 1976, was rescheduled over a ten-year period, together with principal due in the second half of 1976. Interest due in the second half of 1976 was expected to be paid currently. A further rescheduling of principal due during 1977 was expected to be discussed during 1977, although it was hoped that interest payments could remain current.
The commercial banks were then invited to reschedule on similar terms, and to share with the governments in a special fund equaling 10 percent of export receipts, which would be set aside for service on rescheduled debt. The banks, however, resisted the ten-year stretch-out and came up with a different plan: option D.
In November 1976 an agreement was reached with four features. First, Zaïre would bring current all overdue interest to the banks. Second, it would make the 10 percent fund available to cover interest due on bank debt, and also possibly bring principal current in due course. Third, Zaïre would accept conditions proposed by the IMF for its second and third borrowing tranches from the IMF. Such conditions are usually considered very stringent. Fourth, after the first three steps were accomplished, Citibank agreed to use its best efforts to arrange a $250 million new loan. It was anticipated that the new loan would be placed primarily with those banks already committed to Zaïre, whose loans would have to be rescheduled if the new loan did not succeed.
Like the Peruvian arrangements, this was hailed as a new model, a pattern for other troubled countries to follow. Rather than abandon financially pressed LDCs, the banks would stick with them and show them how to restore their creditworthiness. This was the boldest experiment yet in redirecting a country's internal policies. The assistance of the IMF in defining appropriate economic policy was a key factor, though the IMF may have been somewhat reluctant to assume this leading role.
As of this writing, the above program has not been implemented. The incursion into Shaba province has raised new uncertainties, so that the debt problems of Zaïre are far from settled.
The experience of 1976 has been quite favorable. Crises have been deftly handled as they arose: defaults have been consolidated into reschedulings, and reschedulings have given way to new loans. Only the case of Zaïre remains unresolved. If it were not for the continuing surplus on the Arabian peninsula, one could see equilibrium before long as the world moves out of recession.
Unfortunately, the persistence of the surplus makes it very likely that LDCs' debt will continue to grow, in the aggregate, much faster than their ability to carry it. The pressure caused by this imbalance will first affect the weaker of the commercial LDCs, but in time is bound to cause problems for more.
The most likely expression of this problem, as noted above, is nothing so dramatic as debt renunciation and the collapse of banks. Rather, banks will be increasingly reluctant to lend and will put greater pressure on the LDCs to slow down their rate of growth and initiate austerity programs. Some such austerity may be prudent economic management, but stronger doses of it could be dangerous both politically and economically.
Belt-tightening can be practiced by developed countries and perhaps by the wealthiest LDCs, but most LDCs are on the last notches of their belts already. The riots in Lima following the new austerity program in Peru during 1975 were noted in the last section. More recently, an austerity program was announced in Egypt at the instigation of the IMF as a condition of a new loan. It involved cutbacks in food and fuel subsidies; its announcement was followed by three days of rioting in which 78 people died. The austerity program was withdrawn following the riots, and the loan went forward on softer conditions but at a smaller amount. There are internal political limits beyond which austerity cannot be pressed without upheaval.
Furthermore, as noted in a recent congressional staff study, reduced LDC demand could have a recessionary impact on our own economy. Austerity programs urged by the banks mean fewer orders for our own manufacturers.4 There has been an element of this in the international economy during the past year. Recessionary trends in the United States in turn reduce U.S. demand for LDC products and further aggravate the LDC current account deficit.
The risk, then, is that excessive LDC debt will lead to pressures by lenders to reduce economic growth, and that this will cause political disruption and be economically recessionary. This is already beginning to happen in a few countries; it could well happen in others.
No problem as large as $200 billion has a single solution. Rather, many efforts must be combined to prevent it from getting out of hand. Some of these are within the control of OPEC, whose high prices have clearly caused the bulk of the present imbalance:
- The OPEC countries could reduce their prices. Unlikely as it may seem today, pressure for relief may build from the LDCs. It is astonishing to see how little the LDCs have done to press for lower prices, given the central role of high oil prices in their financial difficulties. Moreover, Saudi Arabia shows definite signs of understanding the dangerous consequences of ever-higher oil prices.
- The OPEC countries could spend their surplus. Indeed, they have spent far more than anyone imagined possible in 1973. Most OPEC countries not on the Arabian peninsula are in balance or slight deficit. Saudi Arabia, Kuwait and the United Arab Emirates, however, because of their small populations, have a clear limit on spending ability. Their growth programs are limited by their capacity to implement new projects, which now may be nearly reached.
If the surplus cannot be made to disappear, the next question is whether it could be recycled to the LDCs without major U.S. banks acting as intermediaries. Here are two possibilities:
- The surplus countries could lend their surplus directly to the LDCs. They would assume direct responsibility for the creditworthiness of the LDCs and perhaps acquire greater interest in the problems caused to them by higher oil prices. Except for a few aid funds, however, the surplus countries have shown little interest in taking a risk with their money.
- The banks could insulate themselves by accepting deposits from the surplus countries (or deposits beyond a certain limit) only in special subsidiaries or consortium banks which could be in the sole business of LDC lending. While this would require an unprecedented degree of self-restraint and cooperation among normally competitive banks, it would have the effect of segregating LDC risk and holding it for the surplus countries' own accounts. To be effective, this program would require broad support by the governments of the developed countries.
These measures, if they could be implemented, would definitely be constructive. They would ease some of the burden on the banks and provide some relief to the LDCs. Perhaps most important, they would further draw the surplus countries into the comity of nations, giving them a more direct responsibility for the health of the world economy. By lending directly to the LDCs, the surplus nations may become more keenly aware of the dangers of global financial imbalance.
Like the banks and like the IMF, the Arabs would doubtless seek to impose conditions on their lending if, as is likely, they wished to protect their surplus. This would have all the political and economic consequences of conditions imposed by other lenders, although a sharing of the inevitable criticism might be welcome. Furthermore, extensive lending to LDCs directly by certain Arab countries would give them a political weapon they do not now possess. The West might not entirely welcome the addition of financial power to their already awesome oil power. Thus, there are limits to the policy of direct recycling away from the banks.
Various governmental "safety nets" or expansion of the IMF's lending role have also been proposed to provide additional funds for the LDCs. If governments are prepared to contribute capital for this purpose, such measures could provide some relief to both banks and LDCs. Such relief, however, is likely to be temporary. When the funds have been loaned out, we return to today's situation except with higher debt levels. Since high aggregate debt levels are the essential problem, we do not necessarily improve matters by making the levels higher yet.
There is, however, a policy direction which goes to the essential problem and would definitely alleviate it. The United States, joined perhaps by Germany and Japan, could run a deliberate current account deficit designed to partly or fully offset the surplus so that the rest of the world could come more nearly into equilibrium. Obviously this deficit could not come from buying more oil, which would increase the surplus by a like amount. Nor could it come from reducing U.S. exports, which would be recessionary. Rather, it would have to come from increased purchase of goods and services from non-surplus countries, which would have a stimulative effect on the international economy.
This policy, of course, would involve easing many tariffs, quotas and other important barriers. It is politically unrealistic to imagine that such a policy could be implemented during a recessionary period. Organized labor is currently pressing in the opposite direction, for increased protectionism. As the recovery proceeds, however, the anti-inflationary bias of a more liberal import policy could provide welcome relief from the overheating pressures associated with strong economic growth.
After all, a current account deficit is not a penalty or a cross to bear, at least for a moderately healthy U.S. economy. It means that we get more goods and services from others than we ship to them. Most countries would be only too happy to run current account deficits if they did not have to borrow to finance them. The United States would not borrow explicitly but simply accept foreign claims in the form of bank deposits or foreign purchase of its Treasury bills and notes. This is the benefit of having the U.S. dollar used as the world's principal reserve and payment currency.
A deficit of this sort would not be likely to depress the foreign exchange value of the dollar. This would occur only if the surplus countries decided to convert a significant portion of their dollar holdings into European currencies. But we run such a risk in any event because the dollar surplus already exists, regardless of whether we hold the corresponding deficit or the LDCs do so. Only if the deficit were perceived as a sign of mismanagement would it cause the selling of dollars.
Trade policy is a complex area in which many factors combine to produce particular actions. The LDC debt problem has not generally been uppermost in the minds of those responsible for trade policy. Yet it should be at least one factor in the equation arguing with increasing force against the rising demand for protectionism. Efforts to cut off LDC access to our markets can damage us in ways not often discussed - by reducing LDC purchasing power for our manufactured goods and by making more difficult the repayment of LDC debts to our banks.
We cannot be both internationalists in finance and protectionists in trade, accommodating the LDCs' borrowing needs but denying them the means to earn their way out of debt by providing us with goods and services. The linkage of our banks with developing countries not only makes it difficult for them to walk away from us; it also makes it unlikely that we could walk away from them.
1 Donaldson, Lufkin & Jenrette Securities Corporation, The Banking Industry Lending to Less-Developed Countries, December 1976, p. 6.
2 Morgan Guaranty Trust Company, World Financial Markets, January 1977, p. 1.
4 The International Economy and the Federal Budget, prepared by the staff of the Senate Budget Committee, December 1976.