Moscow REAL Secret Weapon
Whitmire, James M.
Moscow REAL Secret Weapon by James M. Whitmire In the wake of Afghanistan, the United States and the Soviet Union are back to strutting around each other like gunfighters at high noon, each...
...A very large debtor has substantiai influence over his creditor, for he can undermine or even destroy the bank by refusing to pay...
...It is a classic illustration of sending good money after bad...
...The magnitude of this debt is such that a Soviet default might spark a financial panic capable of collapsing the capitalist banking system...
...Ex-1m "credits" can be used only for the purchase of American goods, and are "tied" to a specific commodity or project...
...two types of loans are extended to COMECON nations...
...With the exception of Hungary, all COMECON nations are net importers of food...
...COMECON is a Common-Marketlike agency that coordinates economic policy for the Soviet Union and its East European client states...
...Untied loans can be used for anything: to cover balance-of-payment deficits, to buy hard currency for new purchases, or in some cases, to meet the payments on previous loans...
...A sheriffs deputy can't serve papers on a factory in Minsk...
...They do not have large, poterit armies and have not preoccupied themselves with devising new instruments of pressure and coercion, as have the Soviets...
...Though technically loans are made to individual COMECON members like Hungary, Russian planners wield almost total control over . the organization and its use of funds...
...If Iran's net default of $2 billion put a "severe strain" on Western banks, what would be the impact of a Sovietbloc default involving amounts 30 to 40 times greater...
...Thus, when economic difficulties forced them into the credit market in the early 1970s, Western bankers were impressed by their impeccable borrowing records...
...Since the new round of oil price increases, it has been estimated that OPEC will take in $300 billion in 1980, most of which will end up in Western banks...
...The Pentagon talks of fearsome new weapons: MX missiles, neutron bombs, particle...
...The rate of credit growth far exceeds the rate of real economic growth in the East...
...This prospect, one expert explains, lends overriding importance to "preventing nations from dropping out of the system altogether...
...Regular commercial loans are the same as those extended to companies...
...a Washingtonjirm...
...But poor nations are not a rigid ideological bloc acting cohesively...
...They must now be all the more impressed with that weapon's potential for an active, aggressive Soviet offensive designed to extract political concessions from a checkmated West...
...The Soviets are almost certain, at some point, to use the threat of default as a lever to gain political concessions from the West...
...Bankers belonged to the same fraternity then, and whatever tips they passed to their brothers didn't prevent the initial round of bad loans from being made...
...Many of their loans are not for specific purposes...
...Credit outstanding to "less-developed countries" has risen from $ 137 billion in 1974 to more than $300 billion today...
...As long as new loans continue, they probably would make the same gesture again...
...There is strategic argument about whether transferring advanced technology contributes to our adversary's military power...
...Can they obtain enough hard currency to repay COMECON debt to the West and cover this impending new expense...
...Wasowski believes word of a Soviet borrowing advance would spread quickly within this fraternity, causing bankers to react by moderating the eastward flow of funds...
...So were the full implications of the arrangement...
...The banks don't have to make them, and Washington doesn't stop them from making them...
...The specter of colossal default was raised last November when Iran announced that it would not repay the $10 billion it owes American banks...
...But there's never...
...Belatedly comparing notes, the bankers would find themselves accomplices to the runaway COMECON debt...
...To do so now would mean needless martyrdom for the goose that lays the golden egg-why refuse to accept this steady stream of gifts from the West...
...During the coming recession, when banks will once again be highly liquid and lack loan demand, the Soviets would blitz the credit markets, soaking up every loan available...
...The financial system is vulnerable to similar manipulation...
...Several days after the Afghanistan invasion, NATO ministers boldly declared they were considering retaliating by shutting off Soviet credits...
...It also means these arrangements enjoy the same secrecy that surrounds other private loans...
...Everyone assumes the Soviets are plotting ghastly new weapons as well...
...These loans increase inflation in the West, while gifting the Soviet bloc with priceless technology and machinery in return for the unenforceable promise that someday they will pay us back...
...Should U.S.-U.S.S.R...
...Bankers also contend that, even if the gold were used up, the vast Soviet oil reserves stand as collateral for COMECON borrowing...
...As is well known, banks are in the business of loaning their deposits (assets...
...The bankers declared COMECON countries to be good risks...
...Because they are entirely uninsured, they are called "sovereign risk" loans-loans against the creditworthiness of the country itself...
...Western bankers, caught in an "undertow syndrome" of sending good money after bad, seem determined to make our position even weaker...
...Banks often take the easy way out and reschedl.Jie loans because they seek to maintain what some disparagingly refer to debtor can't or won't repay, banks are unwilling to force him into default...
...It seems only a matter of time before other COMECON nations whose seven-year loans are coming due make the same "request...
...Treasury, administered by the Export-Import Bank...
...Most of the experts interviewed for this article believe that the Soviets would resort to default blackmail only after a radical deterioration of the political atmosphere...
...The Soviets are not so careless as to leave much money in our hands...
...Sources have told me that the ease with which COMECON obtained its loans was a revelation to Eastern governments...
...Allen Lenz of Commerce's Bureau of East-West Trade (whic;:h supports the above low-end estimates) predicts that by 1985 Sovietbloc borrowing CQuid hit $ 108 billion...
...A State Department source estimates that about one-third of COMECON's loans are credits from the Ex-1m Bank...
...At the same time, Eastern worker productivity is declining...
...The prospect of a Third World default, officials contend, is a greater cause for alarm than possible Soviet misbehavior...
...It would seem that, even ifhe were afraid to cut his losses and call in existing COMECON paper, a timid banker would refrain from making fresh loans...
...It recalls the adage, "Make a small loan and you have a debtor...
...In spite of such signs, bankers are willing to reschedule...
...You may think this has already been done because of the alleged "grain embargo" imposed after Afghanistan...
...simultaneously, because of the 1974-1975 recession, private-sector demand for loans was low...
...James M. Whitmire is a consultant with International Business Services...
...At the current price of $30 a barrel (certain to rise by 1982), that would cost the Soviets $7.6 billion a year...
...The West sends machines and 'grain, and receives nothing in return-except the illusion of prosperity for the farmers and THE WASHINGTON MONTHLY IJUNE 1980 firms being paid in funny-money originating on the Federal Reserve's press...
...Shipments of that grain continue...
...The relationship is propelled by an internal dynamic that makes Western banks feel obliged to maintain the flow of loans, even against their better judgment...
...Conventional wisdom holds that the prospect of a cutoff in grain, computers, and spare parts for vital machinery like oil drilling rigs is sufficient to deter the Soviets from any rash moves on the debt front...
...The first is government- supplied "credits"-direct loans from the u.S...
...concern within the international community that Soviet bloc countries will never be capable of generating enough hard currency to repay their debts-or, more chilling, have no intention of repaying in the first place...
...The West shows little inclination to call in Soviet-bloc paper now, thus forcing the inevitable default...
...Cold, Hard Kalashnikovs While Western governments feign ignorance of their predicament, the Soviet bloc is fully a'N~re of it...
...The most conservative estimate is that the debt has increased from less than $ 10 billion in the early 1970s, to $18 billion in 1974, to $48 billion in I 977-a pace many times greater than inflation...
...It's worse...
...We create the loans to "pay" ourselves for what we send...
...As a result of Soviet-bloc economic inefficiency, "East-West" trade in fact moves mostly in one direction-toward the East...
...Nowhere, they admit, is this guarantee written down...
...public response would play into Soviet hands, by increasing the West's sense of weakness and vulnerability...
...The new rate is Russia's "lowest growth since the war," a State Department economist says...
...The West's problem would be immediate: its banking system could well collapse into chaos...
...Noting that the English, West Germans, and Italians have loaned especially large sums to the Soviet bloc, Brzezinski is quoted as concluding, "If a COMECON country defaulted, it could create considerable problems...
...Georgetown University economist Stanislaw Wasowski, an East-West trade authority, considers the blitz analogy alarmist...
...The Third WQrld debt is, of course, troubling...
...Debt...
...It's never been forcibly exercised by a bank," says one informed official, "so it's impossible to tell if the implicit guarantee has any explicit value...
...Autarkic Child COMECON debt is a recent development because, until the early 1970s, the Soviets didn't want to borrcw money...
...It hovers between $60 billion and $80 billion today-an amount equal to the total assets of Exxon and General Motors combined...
...The Soviets are beginning to master the classic nuances of manipulating banks...
...It worked for the Soviet bloc during the 1974-75 recession...
...So far, the only public debate on EastWest trade involves the politics of the exchange...
...Nearly every major Western bank is involved in a syndicate that is on the hook: so the entire system, not just individual banks, is threatened...
...Perhaps the most chilling prospect is that the Soviets' debt card is likely to trump during a severe confrontation, when shooting has not yet started and probably can be avoided...
...Each individual bankerafraid to go public, cut his losses, and take the heat now-opts to postpone the crisis farther into the future with more doomed loans...
...COMECON centralized planning, which has met its initial goals of some crude capital formation,has proved incompetent at managing a sophisticated modern economy...
...The COMECON nation then uses the money as it sees fit while (in theory at least) repaying the lender in regular installments...
...When pressed, officials at the departments of Comrrierce and State admit that th~ growing COME...
...Back in 1976 Henry Kissinger described the debt as "sudden" and "striking...
...What's more, lending to the Soviet bloc continues at a furious pace, despite the loans' questionable merit from either a political or financial point of view...
...Incredibly, it is a weapon we are not only constructing for the Russians-but paying for as well...
...During times like these, that threat is certainly credible...
...A few losses could be avoided, for some of the COMECON debt involves goods not yet delivered...
...Bankers tend to see no alternative to being sucked under the tide of more COMECON loans...
...The truth is, one is already in place...
...But these would be long-term problems...
...COMECON nations have begun asking that their debts be "rescheduled," stretching out repayment timetables and effectively lowering interest rates...
...If Iran's net default of $2 billion put a severe strain on the system, what might be the impact of a Soviet-bloc default involving amounts 30 to 40 times greater...
...They've got us where they want us now...
...They are required by law to keep only about seven percent of the money they "have" on hand for demand-withdrawals...
...Moscow REAL Secret Weapon by James M. Whitmire In the wake of Afghanistan, the United States and the Soviet Union are back to strutting around each other like gunfighters at high noon, each ready to reach for the trigger...
...relations ever decline into desperate straits, the Soviets could simply defy their benefactors and cancel the debt outright...
...An Ex-1m loan to buy American computers, for instance, is essentially a payment from the Treasury to the computer firm, with money never coming to rest in COMECON accounts...
...As a result, Soviet-bloc GNP growth rates have fallen off recently-for instance, Russia's is growing at a rate of only 2.5 percent compared to 6 percent in 1970...
...In this case, the bank sends a lump sum directly to the central bank of the COMECON member nation...
...Poland couldn't even come up with the debt service...
...On OUf Assets In 1977 the Senate Foreign Relations Committee concluded that the entire international financial system could crumble beneath the weight of one or two major defaults, defaults that would send banks tumbling into each other like freeway traffic hitting a patch of ice...
...Poland, according to an IMF source, recently came perilously close to default...
...In that environment, bankers compete stridently for supposedly safe ways to unload their money...
...COMECON's early-I 970s arrival on the credit market couldn't have come at a better time from the East's perspective, because our commercial banks were inordinately liquid...
...Does this sound implausible...
...This combination would cause such frantic squabbling in the Wesi-distracting the attention of Western leaders-that clearly it would be at least a short-run tactical triumph for the Soviets...
...The only high-quality Russian exports seem to be vodka and weapons...
...As Richards Portes of the University of London points out, "If creditors force a country into default, they are in a fundamentally weak position, because the sanctions available to them are limited...
...Its transactions-especially knowledge of who is lending how much to whom-are shrouded in jealous secrecy...
...Experts disagree on the susceptibility of the banking community to such blitzkredit tactics...
...Quietly, assiduously, Western banks since the mid-1970s have allowed the Soviet bloc to pile up $60 billion to $80 billion in outstanding debt, according to The Washington Monthly's sources...
...Although it may be fine irony that we drown our sorrows in Soviet liquor, not even Armand Hammer would suggest we stock our armies with AK-47s...
...Central planners are finding it one thing to churn out carload after carload of steel, and quite another to fashion advanced computers...
...Repayments are made from COMECON to the Treasury...
...If the debtor does not pay, the U.S...
...Most of the banks granting COMECON loans are the same ones involved in other aspects of the intern~tional credit market...
...taxpayer takes the loss directly...
...While goods in this "trade" are moving East, money does not move in any meaningful way...
...Most of the industrial goods "sold" to the Soviet bloc in recent years have not been paid for in hard currency, but financed by loans from the U.S...
...But even if the Russians wanted to give us oil to cover their debts, it's questionable that they could extract it fast enough...
...They are learning to finesse and demur, allowing the bureaucratic momentum of good money after bad to work its magic unassisted...
...This means, first, that private loans are "not a matter of official government policy," the officer explained...
...They used our own commodities practices- which provide little government regulation of the markets and allow brokers to buy up grain without revealing the identity of their clients-against us...
...Obviously, it would not be possible to "repossess" the tractors, computers, grain, and other goods already shipped to the Soviet bloc...
...Trying to absorb the gigantic default would set in motion, many believe, a panic equal in magnitUde to the stockmarket crash in 1929...
...On the rare occasions Soviet-bloc countries borrowed, they were scrupulous about meeting interest and repayment timetables, an International Monetary Fund official s~ys...
...Failing foreclosure, our only retaliatory threat is to cut off grain and technology shipments to the East...
...But Eastern countries produce few goods of sufficient quality to compete on world markets...
...Banks usually form syndicates (risk-sharing pools) on sovereign risk loans, so that in case of trouble, the lead bank does not suffer all the loss...
...According to Central Intelligence Agency estimates, by 1982 Russia will be forced to begin importing 700,000 barrels of oil a day, just to meet its own needs...
...N A TO's fumbling response to the invasion of Afghanistan has given the Soviets an opportunity to observe how potent their default weapon is-even when employed in a tacit, passive manner, for strictly defensive purposes...
...The collapse of any large debtor like COMECON would . inevitably cause depositors to demand their money back, which would drain the federal deposit-insurance pools, activate other risk-sharing syndicates, and spread the chaos further...
...Right now the Soviet Union is wellstocked with gold, which could be used to cover some of the debt...
...Although insiders widely believe that COMECON has no intention of honoring its debts, it surely will not repudiate them as long as there is no crackdown on repayment...
...Bankers maintain that all COMECON loans are backed by an "implicit guarantee" from the Soviets...
...Unfortunately, the current recession descending on the U.S.-which is predicted to take on global proportions later in the yearpresents the Soviets with an ideal opportunity to throw a full-court press at Western banks...
...The current trends, Costick believes, point to a debt of at least $200 billion by 1990-$45 billion of which, he says, will be held by Russia itself...
...government or banks...
...Such a debtsay, pushed to about $150 billion-would be viewed, and rightly so, as a potential Dunkirk for Western banks...
...Our Partner, Leonid What began as a civilized courtship has degenerated into a shotgun marriage for Western banks...
...This analysis overlooks the possibility that the Soviets will shrewdly wait for a recession to saddle lenders with excess capital...
...The weapon...
...During a severe crisis (similar, say, to the Cuban missile crisis), which side would be injured more by a default/trade cutoff showdown...
...Make a large loan, and you have a partner...
...Indebtedness often increases the leverage of the debtor and decreases the leverage of the creditor," Brzezinski is quoted as saying...
...When the Soviet Union goes to Chase Manhattan," says another State Department officer, "they're treated just like Ford Motor Company, or any private customer...
...But they are testing COMECON's tactical leverage in subtle fashion, trying to "reschedule" rather than repay problem debts like Poland's...
...The Soviet regime traditionally has been highly autarkic, exhibiting an aversion to debt that one economist described as "positively Victorian...
...He has extensive personal experience with Soviet affairs...
...Even if, in spite of the evidence, you refuse to believe that the Soviets have been planning all along not to honor COMECON debts, you cannot help but worry that they will be incapable of repayment...
...I sure hope Citicorp knows what it's doing," he adds...
...beams...
...This episode had the salutary effect of stimulating some thought on the consequences of large defaults...
...CON debt is oininous, but they invariably change the subject by pointing to the much larger-and ·equally uninsured-debt . owed by Third World nations...
...Spe~ific loans are often tied to a project- say, the development of a coal field-whose completion will enhance the debtor nation's ability to repay...
...All Others Pay Cash Whatever happens in the future, the threat posed by the existing Soviet bloc debt is real and immediate...
...It could devastate the West without a shot being fired...
...While the banking community presents a closed front to the outside world," he says, "it is relatively smallperhaps a few thousand key bankers-and highly cohesive, with elaborate channels of communication...
...and has taught Russian at the University of Virginia...
...Following the 1973 quadrupling of OPEC oil prices, Arab petrodollars swelled Western banks...
...Besides their doctrinaire position that the presence of capitalist financiers would corrupt Marxist purity, Kremlin leaders believed that if Eastern economies were based on someone else's money,they could never be self-sufficient or secure...
...As far back as 1976, Financial Times reported that banks making uninsured loans to the Soviet bloc were "likely to make every effort to continue to lend in order to protect the loans they have already made...
...There are no such provisions in regular commercial loans, which make up the remaining two-thirds of the East's borrowing...
...One drawback of the credits is that Ex-1m contracts include human rights provisions, similar to those in the Helsinki Pact, that debtor countries are supposed to observe...
...Fortunately, the shock was absorbed with minimal funk, largely because the Iranians were so careless as to have left $8 billion in assets in American banks...
...Poland, the second-largest and most "over-extended" of COMECON borrowers (the Soviet Union holds the most loans, followed by Poland, East Germany, and Hungary), has been heavily rescheduled...
...A World Bank officer told The Washington Post that this action, "the largest default in financial history," put the banking system to "its most severe test in recent times...
...There is contention about whether our bulging grain exports serve to shore up the inefficient Soviet system and strengthen the Kremlin elite's grip on power...
...Yet it continued to climb, unopposed...
...It is, he says, the "symbolic effect of debt repudiation that is most feared...
...shortages, supply bottlenecks, and inflation are widespread throughout COMECON...
...like the credits Ex-1m extends, but "untied" loans...
...The committee had in mind defaults involving far less money than is now loaned through COMECON to the Soviet bloc...
...There would be a tremendous disruption of banks and business, but at least the losses would be cut and finished with...
...But you won't find this new secret weapon in the Red Army's arsenal, because it's not a bomb or a chemical...
...For all intents and purposes, these loans are made solely on faith, with no recourse if the Soviets refuse to pay," says a State Department analyst...
...This is why, some believe, the Soviets were willing to make good some of Poland's debt service...
...But, as we've already established, during "times like these" the Soviets have no interest in canceling COMECON debts, since they're receiving gifts as fast as they can unwrap them...
...been debate over the simple fact that the Soviet bloc, in effect, does not pay for what it gets...
...Blitzkredit The economic and political risks of the existing Soviet-bloc debt present immediate problems of frightening proportions...
...Even if it wanted to repay, it lacks the money to do so...
...Leave Me a Loan Government officials also worry that exposing such' a predicament to abrasive...
...the Soviet Union stepped in and covered $1 billion of the amount with gold...
...The West would also have to absorb the collateral damage of disrupted farms and businesses that base their production on the funny-money Eastern trade...
...The banks were eager to find Qutlets for idie capital...
...Obviously, they prefer not to speculate about the logistical specifics of foreclosing on that oil...
...In fact, the "embargo" applies only to additional tons beyond the eight million metric tons the U.S...
...Washington officially downplays the prospect of a COMECON default, but anxious Whispering can be heard...
...According to an informed source, Citicorp is the largest lender, followed (in rough order) by Morgan Guaranty Trust, Chase Manhattan, and Hanover Trust...
...What once seemed like a flirtation with capitalist corruption began to look like a fine means to drain strength from the crumbling bourgeois powers...
...Far more im'portant, they are not our avowed political and economic competitors...
...They would have an incentive to keep quiet about increased COMECON borrowing, if only to avoid public criticism...
...The West's tenuous grasp of the COMECON debt problem is indicated by the fact that no one can agree on how much credit actually has l?een extended...
...After finally tasting the forbidden fruit of Western credit, COMECON nations realized they could never be forced to repay...
...It would be the financial equivalent of the infamous 1972 grain deals, when the Soviets, taking advantage of the open access to commodities markets, nearly cornered the grain supply...
...he could simply plug into COMECON's free-flowing line of Western credit...
...It owes the West $18.5 billion...
...Most of the initial loans were five- to seven-year agreements on terms highly favorable to COMECON...
...But observers believe the banking community is caught in the "undertow syndrome," swirling ever deeper into trouble...
...He declined to be interviewed for this article...
...promised to export to Russia each year as part of the 1975 grain agreements...
...With the exception of the Soviet Union, all are net importers of energy...
...Debt service on that amount-or the interest needed to continue the loan, without retiring any principal-is $4.5 billion...
...It seems that if only Lee lacocc;:a could move Chrysler headquarters to Kiev, his money problems would be solved...
...The only way the Soviet bloc could raise enough hard currency to satisfy its debts would be to sell products to the West...
...The Soviets would lose access to further loans (gifts) from the West, and face eventual shortages in grain and technology...
...Considering the invasion of Afghanistan, the predicted defeat of SALT II, and the Soviets' perception of Carter's Olympic boycott as a hostile act, such a deterioration is not unimaginable...
...One source interviewed for this article referred to a conversation he had with National Security Advisor Zbigniew Brzezinski, in which Brzezinski admitted to worrying "quite a bit" about the political leverage the Soviets gain through their debt...
...But unless bankers cease making new and equally hopeless loans to the East, things could become far worse...
...We should have been a lot more cautious," says an informed State Department official...
...Miles Costick, director of the conservative Institute on Strategic Trade, says Commerce deliberately deflates the debt figure because of its desire to "generate trade at any price...
...There is growing...
...This makes· them the most precarious of all...
...Here's how it might work: The private international credit market, like the grain market, is largely unregulated...
...The idea was quietly dropped the day after it was announced...
Vol. 12 • June 1980 • No. 4
