The two faces of third world debt: a fragile financial environment and debt enslavement

Monthly Review, Jan, 1984

The tremors that shook the financial world during 1982 and most of 1983 have for the time being subsided. But the ensuing calm is an uneasy one: clearly, the crisis has merely been postponed to another day.

The sense of panic among the financiers and governments of the leading capitalist nations is not the product of idle rumors or vague fears. It has been obvious for some time that the vast expansion of third world debt would sooner or later create serious problems for the international bankers. But the outsize profits to be made in the third world have been too tempting to be resisted by even the most prudent of the bankers. The chickens began to come home to roost in 1982. In that year, 22 countries were forced to negotiate debt rescheduling because they could not meet their contractual payments. And it is evident that the fat was indeed in the fire when the three largest third world debtors--Mexico, Brazil, and Argentina--let it be known that they did not have the foreign exchange to pay interest and amortization due on their loans.

A default by one or a combination of these countries, as will be shown below, could lead to the bankruptcy of some of the biggest U.S. banks. Default was avoided because of prompt and energetic rescue measures taken by the U.S. government, by central bankers, and by the Bank for International Settlements, the IMF, and the World Bank. One thing, however, needs to be clearly understood about these heroic efforts in the heartland of finance: it was the banks that were rescued, not Mexico, Brazil, Argentina, and the other potential defaulters. As a matter of fact, an essential feature of the whole rescue operation consisted of pushing the affected third world countries further down the road of debt enslavement, with a consequent imposition of severe economic contraction and a decline in the already miserable living standards of the masses. Neither was the financial system of the imperialist countries strengthened: a crucial aspect of the rescue operation was a continued increase in third world debt and with it enhanced vulnerability of the international banks. On the other hand, the bankers have done well for themselves, at least for the time being. Not only was their skin saved, but they have managed to use the crisis to squeeze even more profits out of the third world.

Underlying all this is the simple fact that debt, like drugs, is addictive. The more you borrow, the more you need to borrow. A simple arithmetic example (Table 1) explains the logic of the process. We assume that a country obtains each year a foreign loan of $1,000, to be repaid in equal installments over 20 years plus 10 percent interest on the outstanding balance. The net result is shown in the last column. The amount left over after paying the accumulated debt service (return of principal plus interest) gets smaller and smaller each year. By the fifth year, $700 of the new loan is needed just to keep up service payments on the mounting debt. And by the eighth year, borrowing of $1,000 is insufficient to meet obligations on the past debt. Thus if a country's development strategy were to call for a net annual inflow of $1,000 of foreign money, an increase in the rate of borrowing would be needed. In other words, a growing volume of external debt would become a way of life. Moreover, even if the country wanted to abandon reliance on debt, it would be hard put to do so. For unless it had other means of obtaining foreign exchange (say, an expanding excess of exports overe imports), it would still need to keep on borrowing. As shown in the example, in the eighth year $1,060 and in the tenth year $1,125 would have to be borrowed just to meet debt service obligations. and if in the meantime the interest rate on new debt should increase or exports should decline, still more borrowing would be called for.

The foregoing is of course a highly simplified example, but it isn't all that far removed from third world reality. Table 2 shows what has actually been happening to the debt of the third world. As can be seen in the last column, over 56 percent of the new debt undertaken in 1972 by the underdeveloped countries as a whole was needed just to meet debt service obligations. By 1981 this figure climbed to 75 percent. Now look at the third column of the table, which shows what was left over from new borrowings after payment of debt service. The net proceeds did increase from 1972 to 1978, but that was because in contrast with our hypothetical example, new borrowing grew rapidly from year to year. And after 1978 the amount left over after payment of debt service declined each year, even though the amount newly borrowed kept on increasing.

There were three special reasons for this decline in net proceeds, each of which contributed to bringing the third world debt problem to the critical juncture of 1981-82. First, interest rates on new debt jumped substantially. Second, a larger portion of the new debt was short-term, with a consequent increase in annual amortization payments. And third, the banks, anticipating the approaching perils, began to slow down their lending.