COMMENTS: The Debt Balloon
Lekachman, Robert
Analogies both tempt and mislead. Still, it is hard to avoid recalling the merry 1920s, the last occasion when international and domestic credit stimulated pundits to project endless...
...HENRY LUCE'S AMERICAN CENTURY lasted barely a generation...
...Nevertheless, the conclusion is inescapable that in one fashion or another the sheer magnitude of domestic and international debt will prove insupportable...
...In this country, Florida real estate, much of it better suited to alligators than humans, and stocks and bonds attracted the greed of folks with loose cash, particularly since anyone could play the market on ninety-cent margins...
...When the most casual of observers is aware that the bulk of Third-World debt will never be repaid, the best that can be expected is that the United States and Western Europe, in cooperation with the International Monetary Fund and the World Bank, will cooperate to forgive much, most, or all of this debt over a period of years long enough to avoid mass default on the part of either borrowers or lenders...
...The Third World owes the First World something over $1 trillion, give or take a hundred billion or so...
...Americans happily invested billions of dollars in German bonds...
...The Germans transferred the proceeds to French, Italian, Belgian, British, and other claimants...
...In other words, the analogy between the 1980s and the 1920s falters because our financial leaders remember with proper apprehension the consequences of the debacle of the 1930s and exercise their considerable capacities of invention and deception to keep the rickety structure of debt more or less upright...
...A second OPEC coup in 1979 hyped the transfers...
...A country or a corporate borrower may simply refuse to pay, or lenders may inflate their currencies to allow of apparent payment of debts in currency worth diminishing fractions of the initial value of debts incurred...
...The best that Treasury Secretary James Baker has been able to suggest is new loans to Latin American and other borrowers so that they can pay the interest on earlier loans and avoid outright default on their debts...
...As soon as Americans stopped buying German securities, the Germans defaulted on their reparations payments, the European victors suspended service of their debt to the United States, and the paper inflation collapsed along with the dreams of affluence of many thousands of deluded speculators...
...Our domestic farm debt exceeds $500 billion and family farms are becoming anachronisms in the wake of a surge of foreclosures...
...No sensible financier is tactless enough to mention repayment of principal...
...STILL, THE NUMBERS are oppressive...
...Toward the end of the decade, as all good things must, the charade ended...
...Corporate debt exceeds $1.5 trillion...
...The crash of the 1980s will both resemble and differ from that of the 1930s in ways that I shall not endeavor to guess at...
...To descend to the anecdotal, two or three years ago I happened to be a guest along with Felix Rohatyn on William F. Buckley, Jr.'s "Firing Line...
...Those tens of billions of dollars no longer flow from OPEC and non-OPEC oil producers...
...Its operators are superior con artists...
...If the rest of this decade appears increasingly like a disaster waiting to happen, it is because the recycling process displays ominous signs of unraveling...
...Still larger expansion of money and credit will diminish further the dollar's value and facilitate repayment of external debts in money worth far less than it was when the loan negotiations were initially completed...
...The numbers glaze vision...
...In that circumstance probably inheres the prospect that somehow the economy will stagger through 1986, possibly even 1987 with the more important players in the major financial games able somehow to shore up faltering banks, lend new money to Third World debtors, and avoid a default on the part of either a major foreign borrower or an important domestic financial institution...
...All the same, one must wonder how long this game of financial chairs can continue before the music stops...
...There are two ways to repudiate debt...
...The gung-ho bankers eagerly pressed their new loanable funds on the Zaires, Perus, Brazils, and Argentinas of the globe...
...The process came to be known and loved by financial types as the recycling of OPEC earnings...
...Consumer debt as a percentage of anything you care to compare it with —Gross National Product, disposable income, or consumer assets—is at a record high...
...The Versailles peace treaty imposed upon defeated Germany an enormous reparations burden...
...For starters, OPEC has lost control of oil prices and oil production, so that, according to the analyst one reads, a barrel of oil may by the end of 1986 sell for as little as fifteen dollars, some 40 percent of its peak of thirty-six dollars...
...FEW SIGNS OF SUCH WISDOM are visible on the political horizon of 1986...
...Still, it is hard to avoid recalling the merry 1920s, the last occasion when international and domestic credit stimulated pundits to project endless prosperity premised upon ever-rising stock prices...
...136...
...In 1985, the Federal Reserve increased the money supply by 12 percent and the value of the dollar against other major currencies declined...
...They not only fear repetition of the Great Depression, but they have evolved techniques of cooperation unknown to earlier central and commercial bankers...
...As Keynes memorably warned in his classic polemic The Economic Consequences of the Peace, protectionist barriers to German exports, loss of Lorraine's iron to France and Silesia's coal to Poland, and expropriation of the loser's entire merchant marine made it utterly impossible for the Germans to produce and sell the exports needed to pay the victors...
...Rohatyn cheerfully agreed that in such an eventuality all of the major banks would register negative net worth, which is jargon for liabilities larger than assets...
...And as Keynes presciently added, the vindictiveness of Versailles imperiled the stability of the infant Weimar republic...
...The Saudis and their co-conspirators deposited tens of billions of dollars in American and European banks...
...In retrospect, it's quite clear what first inflated and then pricked the credit bubble...
...NOT TO WORRY...
...Roger Babson saluted Hoover's victory in 1928 as a veritable warranty of good times as far as the prophetic eye could see...
...The managers of these fragile economies shipped the sums they borrowed back to OPEC, less the sums they deposited to their own Swiss numbered accounts...
...For their part, the French and English promptly met installments due on the vast sums they had borrowed to win World War I. So long as American infatuation with dubious German paper endured, all debtors paid up and all creditors were euphoric...
...With the best will in the world, the Federal Reserve could not protect several leading American banks and simultaneously preserve investor and corporate confidence...
...An outright Mexican default, for example, would set off a chain reaction of similar repudiations in Latin America and elsewhere...
...Small corporations swallow much larger enterprises by issuing junk bonds, more courteously termed highyield securities...
...The bull market of 1985 testified in good part to the spendthrift propensities of even affluent Americans...
...It is exceedingly difficult to see how it can be avoided, for it is no easier now than it ever was either to ride a tiger or dismount from the beast...
...American and other 135 banks have less money to lend to Third World oil importers at just the moment when even the oil producers among them, notably Mexico, are strapped for funds and teetering on the edge of default...
...A nasty combination of inflation and unemployment afflicted the United States and Western Europe—stagflation, in Paul Samuelson's coinage...
...The thrifty Japanese regularly save between a fifth and a quarter of their paychecks...
...I idly asked Rohatyn whether Citibank, Chase, and the other Manhattan money market banks would not be bankrupt if they were compelled by the Federal Reserve and other regulators to value their dubious foreign and domestic loans at some approximation of market value...
...But ingenious financiers worked out a saving solution...
...Capitalism is a tough system...
...OPEC's price coup in 1973-74 transferred vast resources from oil importers to oil exporters, notably Saudi Arabia, a desert land blessed with few inhabitants and virtually limitless oil reserves...
...The New Deal partly revived the American economy, and that most wasteful of public works projects, World War II, completed recovery and during the 1950s and 1960s assured American economic and political hegemony over a devastated Europe and Japan...
...In the third quarter of that year, Americans saved just 2.5 percent of their after-tax income, a record low...
...However, he quickly added, Paul Volcker and other establishment types would never allow a major New York bank, or, as later events confirmed, even an important Chicago bank to go belly-up...
...Of course, the domestic accompaniment to such a policy will be a revival of the inflation that plagued the economy in the late 1970s, expelled Jimmy Carter from the White House, and bestowed upon America the dubious blessings of the Reagan administration...
Vol. 33 • April 1986 • No. 2
