Capitol Ideas / Third World Hydraulics

...Sjaastad, Brazil "is not servicing" its debt...

...And Peru, of course...

...As I write, Mexico is being heralded everywhere (including the Wall Street Journal editorial columns) for its reforms, which happen to include wage and price controls...

...Major price gains" were reported for Chase Manhattan, Manufacturers Hanover, and Chemical Bank, smaller gains for other banks...

...The main problem with the analysis of the debt problem is that mainstream economists still don't understand the importance of the institutional arrangements that permit our economy (and a few others) to work satisfactorily...

...A "competitive" exchange rate is one that pushes out exports which suck in hard currency, which in turn drives the turbines of the imaginary machine called "the economy...

...Nations are now securely beyond the reach of gunboats, Tom Bethell is The American Spectator 's Washington correspondent...

...makes much the same point...

...All they have to do is stop paying...

...Amidst the deception, an outstanding article about the debt appeared in the Wall Street Journal, by Larry A. Sjaastad of the University of Chicago...

...We are told that the issue is above all one of debt reduction...

...In a particularly mindless editorial, the New York Times expressed frustration at "the reckless destruction of the Amazon rain forests," and concluded that "given its $115 billion foreign debt, Brazil needs special help...

...But this still leaves the Latins short of new spending money...

...But he didn't know how these institutions could be quantified...

...There's no question that the biggest single stimulus to capital flight is an overvalued exchange rate, which everyone can see is going to be devalued in the future," Williamson said...

...The issue never was "debt reduction...

...A few paragraphs further on, however, we were told that "creditor banks must continue new lending...

...In the long run it will be a good investment for us all...

...Indeed, if the U.S...

...I countered that the secondary market discount meant that the countries were not, in fact, paying their debts...

...Originally it wasgoing to restrict the payment of interest to 10 percent of export value...

...Burning up the forests, building roads whichencouraged people to burn up the forests . ." In the end, the problem is that the World Bank, IMF, Fred Bergsten & Co...

...It is not so much a question of helping out the debtor countries, but rather reimbursing, after the fact, the stockholders of the creditor banks for losses already acknowledged by the market," he wrote...

...Third world economies are like skyscrapers without foundations...

...And fiscal deficits, because they are likely to lead to monetary expansion...

...The key point about Third World debt is this: Latin American countries were already enjoying debt relief before the Brady plan was proposed...

...I'm not saying that all the investment was the very best," Williamson said when I raised the point...

...On an accrual basis, this amounts to an approximate $370 billion transfer to the debtor countries...

...By and large they have been paying," he said...

...Oh, they have been paying the interest...

...He added that since the Mexican default in 1982, "the book value of the developing countries' capital-market debt, both short and long term, rose to $610 billion from $472 billion...

...In order to "grow," then, the Latin economies needed more loans from the U.S...

...Unless the Bush Administration accelerates its promised debt relief proposals," the New York Times urged within three days of the Caracas riots, "the flames could spread to many other Latin American democracies...

...Writing it down doesn't give any benefit to the debtor unless the debtorcan buy the debt back in the secondary market," he said...

...Fred Bergsten, John Williamson, Hobart Rowen & Co may believe that a large chunk of money labeled "capital," when it leaves the computers of Citicorp, remains "capital" and will be "invested" when it arrives in Mexico City or Brasilia...

...are the slaves of a defunct economist—John Maynard Keynes...

...Yet we hear never-ending laments about the 'burden' of that debt, when one might well ask: When in history have debtors had it so good...

...But in the absence of the rule of law (holding government officials to the same standards of accountability as ordinary citizens), the money will in the end simply be consumed...

...Under it, the banks would merely be "as well off as they were before...

...Costa Rica has only been paying about 40 percent...

...One central reason is a drastic drop in investment—and investment is down because of the enormous flows of money outward to service the debts...

...As seen by the Treasury (or perhaps more accurately, Treasury Undersecretary David C. Mulford and his assistant Charles Delarra), the World Bank, the International Monetary Fund, and their media flacks, the real issue is: How are we going to persuade the big banks to go on shoveling more money into Latin America, given those countries' obvious reluctance to repay their existing debts...

...Next month, let us take a look at Mexico in more detail...

...As for which countries in Latin America particularly needed to address the security-of-property issue, Williamson was unsure...

...That's important, too," Williamson conceded, adding that he didn't have "as good a fix on that as I do on the macroeconomic issues...

...I found out the next day that Venezuela suspended payments in December, and according to Prof...

...What about such legal institutions as private property, and the rule of law, holding officials accountable for their actions and restraining them from stealing money and sending it abroad...

...There was a lot of waste in Amazonia...

...I don't deny the importance of a role for property and incentives for honest behavior," he said...

...Negative real interest rates are another element which drives capital out...

...Those democracies down there are fragile, remember, so pay up gladly...

...Which amounts to relief...

...For the sake of appearances, its expenditure will be termed "investment," but in practice payrolls will be padded, roads built into the midst of the Amazon jungle .. . (How come the left, which is so exercised about Brazil, has not yet made the connection between erroneously labeled "investment"—Brazil using money provided by Western banks—and the destruction of the rain forests...

...I think now it is paying less...

...The economy" of a nation is the smallest unit of economic activity they can visualize...

...In the absence of these institutions, you do not really have any such thing as an "economy...

...Until economists recognize this they will be wasting their time and our money...

...What about capital flight, I asked...

...A Brit, Williamson went to the London School of Economics in the mid-1950s, did graduate studies at Princeton, worked at the IMF, has been with Bergsten since 1981...

...He joined in the general chorus of approval of Mexico...

...On April 10 journalist-advocate Jonathan Fuerbringer recommended in the New York Times's news columns that "new loans must be made even as old debt is forgiven...

...So then you want to get your money out before it happens...

...No such "reforms" can possibly succeed...

...Most countries have not announced this as policy, however, because their office-holders enjoy spending the dollars that Americans keep sending them (under the mistaken impression that the money is "capital" and that it will be "invested"), and they would like to receive more such dollars in the future...

...Here the outmoded theories of economists have come to the rescue...

...and if they want debt relief, they can have it any time they want...

...Meanwhile it has become increasingly clear that the commercial banks will not renew lending to the debtors on anything approaching the scale necessary to ensure growth there...

...Look at the discounts they trade at on the secondary market...

...The market value of that debt, however, has declined to probably less than $240 billion...

...whereupon they have been permitted to renegotiate their debts and more money has been forthcoming to pay old interest...

...Congress were to come up with $75 billion tomorrow to write off the entire external bank debt of Brazil themoney would never leave New York...

...Since Brazil is not servicing that debt, it would be little better off, but bank shares would soar on Wall Street...

...They have learned that all they have to do is wring their hands and promise to make reforms...

...Translation: more money...

...1=1 THE AMERICAN SPECTATOR JUNE 1989 11...

...Because, through the engines of hydraulic transmission (the model these people unconsciously carry about in their heads) consumption itself will drive the turbines of production...

...At the moment, then, the markets perceive that with the Brady plan in place the banks will take less of a beating on their Third World loans than if their debts are simply written down by voluntary agreements between lenders and borrowers...

...It now had a "competitive exchange rate" and a reduced budget deficit, he said...

...I asked...

...Brazil had a moratorium for a few months...

...Melanie Tammen of the Competitive Enterprise Institute in Washington, D.C...

...How do you stop that...

...THE AMERICAN SPECTATOR JUNE 1989 9 "These debts are already being written down," I mentioned to Williamson...

...There are several countries that are seriously in arrears...

...There are countries in arrears...

...Keynesian theory equates new spending with economic growth...

...Michael Quint reported that the stocks of "big bank lenders to the Third World have increased by more than 10 percent since the Treasury plan was announced" in March...

...Just when official intervention has less justification than it ever did," she wrote in CEI's Update, "Brady would use official assistance (through the World Bank and the IMF) to 'facilitate' what has been under way since the mid-1980s—the bargaining process between debtors and creditors...

...Believing that the exchange rate is the most important determinant of capital flight, as Williamson does, is like believing that a skyscraper should function satisfactorily if its elevators are in order, and dismissing as relatively unimportant the question of whether or not it has foundations...

...This grave error explains why such economists favor free tradebetween nations, but are indifferent to free trade between people...

...Note the way "growth" is made dependent on "lending," which is conflated with "investment...

...We wouldn't want to see the return of the caudillos, would we...

...But during the past year, all the major debtors have been sinking toward stagnation...

...They are paying interest on the face value of the debt, not on its market value...

...This denies individuals the right to trade freely with one another...

...Williamson said the Brady plan was "clearly designed for Mexico in the first instance...

...In the first year it actually paid more than that...

...To a Hydraulics practitioner these are the key variables...

...Is this Brady plan not simply a scheme to bail out the banks...

...Stripped of all obfuscation, the purpose of the plan is to reach into the pockets of American taxpayers and use their dollars to repay old loans made by the New York banks, who will then be encouraged to make new loans...

...Banks are being encouraged to swap "high risk, high return debt for low risk, low return debt," he said...

...I sought a comment on this from John Williamson, a senior fellow at the Institute for International Economics, C. Fred Bergsten's shop (high-profile advocates of World Bank and IMF policies and Hydraulic Economics in general...

...With the help of huge transfers from the IMF, he might have added...

...With most Latin American debt now valued at ten to forty cents to the dollar and still falling, new-fangled World Bank 'guarantees' on commercial bank debt . . . will only provide a further boon to Western banks...

...The Washington Post stressed the need for "a continued flow of new lending...

...Here is a relevant paragraph from a Washington Post editorial (April 5), possibly written by Hobart Rowen, a tireless exponent of what I call Hydraulic Economics: Up through 1987 it was still possible to hope that, with enough new lending, the Latin debtors could grow out of their troubles...

...Bolivia has not paid since 1985...

...No," he said...

...It should of course be the individual...

...Ecuador has not been paying interest...

...This had been obtained by the simple expedient of nonpayment...

...And Argentina is in arrears as well...

...It's something which economists have neglected...

...For in the Keynesian scheme, which reverses Say's Law, standing economics on its head by asserting that demand creates supply, it really doesn't matter if "investment" turns out to be mere consumption after all...

...Treasury Secretary Nicholas Brady uttered the magic words last week: 'Debt reduction,' " the New York Times editorialized in mid-March...

...The debtor countries get no benefit from the fact that the debts trade at a discount...

...T he next day there was a story in the 1 New York Times business section 10 THE AMERICAN SPECTATOR JUNE 1989 headlined "Brady Plan Lifts Big Bank Stocks...

...The IMF should be thought of as a mechanism for transferring money from Washington to New York...

...Riots in Venezuela at the end of February provided the convenient rationale for promoting the Brady plan...

...That pretty much leaves Mexico, which, Wil liamson said, "has serviced everything punctiliously since 1982...

...To an amazing extent, Keynesian economists are still in control of international economic policy—one of the main reasons why the Third World remains in such a mess year after year...

...In short, "macroeconomic policies must be in order...

...He conceded that Third World countries, heavily in debt to Western banks, needed relief...