Two International Debt Crises – A Lesson from History
February 3rd 2008 11:00
Sometimes history repeats itself and then it’s for the ones who study its meanders to take advantage of it and come up with better solutions for current problems. Such is certainly the case of the German war reparations in the aftermach of the Great War and is certainly also the case of the loans to Third World countries culminating in 1982.
These two situations contain something common, which in the second case was much better addressed than in the first. Just follow me and we will go through it.
World War I (1914-18) was a very cataclysmic event: dead soldiers were 10 million and 20 million injured; dead civilians 10 million plus another 20 million dead from famine and diseases caused by the war. Costs of the war in 1914 dollars amounted to $230 billion for military expenses and damages to property of $150 billion.
I sourced the information for the first part of this article from the book A Concise Economic History of the World by Rondo Cameron.
Not surprisingly, the Allied Nations, Britain, France, Belgium and the United States of America demanded reparations from Germany after the war. Having lost the war Germany had to accept this imposition. The reparations were substantiated in a series of treaties, the most important of them was the Treaty of Versailles which stated in its Article 231, the so called the war guilt clause, that Germany accepted “the responsibility of Germany and her allies for causing all the loss and damage…as a consequence of the war…”.
The demanded reparations were enormous including large amounts of armament, a greater part of its merchant marine, 5000 locomotives and 150,000 train carriages, many trucks and a large amount of commodities. Part of it was also a 15 year Allied occupation of the Rhineland.
On top of all this, monetary reparations were also demanded. The monetary reparations sought were, in1921, twice the German national income. You would wonder how Germany would pay for it.
Someone involved in the negotiations was John Maynard Keynes for Britain, who resigned from his position in protest and wrote the book The Economic Consequences of the Peace which made correct predictions for the outcome for this situation.
Meanwhile, most Allied countries repudiated the gold standard and imposed heavy tariffs on international trade. Not surprisingly, Germany, not being allowed to trade internationally, was also not being able to make the gold and currency necessary to pay for the reparations.
Inflation ensued in Germany, mostly as a result of the move out of the gold standard, in incredible ways: the exchange value the Mark in 1914 was 4.2 to the US dollar; by the time of the last transaction in 1923 it was 4.2 trillion to the dollar!
In 1923 Germany defaulted on the payment of reparations. France and Belgium send troops to occupy the Ruhr but German workers offered passive resistance, frustrating the occupiers.
On the other hand, Britain, France and other Allied countries took loans from the US but, without the reparations payment from Germany, were not able to repay the US. The US, though, refused to accept this linkage and kept on demanding repayment for its money.
Germany also took loans from the US which it could not repay. This situation threatened the entirety of the banking system of all the Allied countries and also Germany, a risk too great to run.
In the end, the Americans accepted that Germany, in order to pay for its war reparations, had to keep receiving credit from the US, and various amounts, both from the US government and private, followed.
This situation encapsulates a lesson which in my view is that you cannot irresponsibly financially overburden a country and still expect it to serve its debt – but if you do so, you have to give them a way out of the situation by manner of continued financial transfers. This way, the country in question can mange its economy and still serve its debt which, hopefully, in due time will be fully paid.
This situation would find parallel later in history.
In 1974 the OPEC (Organisation of Petroleum Exporting Countries) increased the price of petrol exported to the West from $3 per barrel in 1973 to $30 in 1980. The resulting situation was one of very high inflation together with economic stagnation in the West, which was called stagflation. And with it, large sums of money as petrol payments where transferred to the bank accounts of mostly developing countries. But whose banks would receive this inflow of cash?
After decades of growth most American banks and some European as well, being large at home, had opened branches in many developing countries. They were the ones to receive such petrol shock dollars as deposits. What any bank manager would think in such circumstances, and understandably, would be: “how can I lend this money for an interest?”. This simple thought started a roller-coaster of action and effects.
I found the information for the second part of this article in the book The Alchemy of Finance by George Soros.
Coincidentally or not, many developing countries started applying for loans to improve their economies and these banks were presto to satisfy them. Their criteria was very loose and sometimes they just found out the national income of a country and calculated whether it would be enough for the country in question to serve the debt. This way a huge amount of money was lent to developing countries.
What happened next was that these debtor countries actually found it impossible to serve their loans and the danger of default or repudiation of debt loomed in the horizon. This cast a dark shadow on the entire banking system of the West, but mostly on the United States.
The abundance of capital to be loaned and the pressures of competition, or maybe just too much greed, drove the US banking system to a brink. If the loan repayments were defaulted the losses to be carried by most large US banks would be so large that they would be wound up carrying this collapsing effect through to the smaller banks. An entire castle of cards would crumble. This was the year of 1982.
What Americans then found as a way out for this dangerous situation was to realise that, for debtor countries to service their loans, they would have to develop their economic capabilities as well as manage current affairs and that required the issuance of further loans by the US.
This way, debtor countries would continue growing their economies and also servicing their loans successfully. The practical effect would be a net resource transfer to the US that would equal the servicing of the debt.
This situation parallels the German war reparations situation around 1923 above but, by this time promptly having the problem fixed, closes a circle.
These two situations contain something common, which in the second case was much better addressed than in the first. Just follow me and we will go through it.
World War I (1914-18) was a very cataclysmic event: dead soldiers were 10 million and 20 million injured; dead civilians 10 million plus another 20 million dead from famine and diseases caused by the war. Costs of the war in 1914 dollars amounted to $230 billion for military expenses and damages to property of $150 billion.
I sourced the information for the first part of this article from the book A Concise Economic History of the World by Rondo Cameron.
Not surprisingly, the Allied Nations, Britain, France, Belgium and the United States of America demanded reparations from Germany after the war. Having lost the war Germany had to accept this imposition. The reparations were substantiated in a series of treaties, the most important of them was the Treaty of Versailles which stated in its Article 231, the so called the war guilt clause, that Germany accepted “the responsibility of Germany and her allies for causing all the loss and damage…as a consequence of the war…”.
The demanded reparations were enormous including large amounts of armament, a greater part of its merchant marine, 5000 locomotives and 150,000 train carriages, many trucks and a large amount of commodities. Part of it was also a 15 year Allied occupation of the Rhineland.
On top of all this, monetary reparations were also demanded. The monetary reparations sought were, in1921, twice the German national income. You would wonder how Germany would pay for it.
Someone involved in the negotiations was John Maynard Keynes for Britain, who resigned from his position in protest and wrote the book The Economic Consequences of the Peace which made correct predictions for the outcome for this situation.
Meanwhile, most Allied countries repudiated the gold standard and imposed heavy tariffs on international trade. Not surprisingly, Germany, not being allowed to trade internationally, was also not being able to make the gold and currency necessary to pay for the reparations.
Inflation ensued in Germany, mostly as a result of the move out of the gold standard, in incredible ways: the exchange value the Mark in 1914 was 4.2 to the US dollar; by the time of the last transaction in 1923 it was 4.2 trillion to the dollar!
In 1923 Germany defaulted on the payment of reparations. France and Belgium send troops to occupy the Ruhr but German workers offered passive resistance, frustrating the occupiers.
On the other hand, Britain, France and other Allied countries took loans from the US but, without the reparations payment from Germany, were not able to repay the US. The US, though, refused to accept this linkage and kept on demanding repayment for its money.
Germany also took loans from the US which it could not repay. This situation threatened the entirety of the banking system of all the Allied countries and also Germany, a risk too great to run.
In the end, the Americans accepted that Germany, in order to pay for its war reparations, had to keep receiving credit from the US, and various amounts, both from the US government and private, followed.
This situation encapsulates a lesson which in my view is that you cannot irresponsibly financially overburden a country and still expect it to serve its debt – but if you do so, you have to give them a way out of the situation by manner of continued financial transfers. This way, the country in question can mange its economy and still serve its debt which, hopefully, in due time will be fully paid.
This situation would find parallel later in history.
In 1974 the OPEC (Organisation of Petroleum Exporting Countries) increased the price of petrol exported to the West from $3 per barrel in 1973 to $30 in 1980. The resulting situation was one of very high inflation together with economic stagnation in the West, which was called stagflation. And with it, large sums of money as petrol payments where transferred to the bank accounts of mostly developing countries. But whose banks would receive this inflow of cash?
After decades of growth most American banks and some European as well, being large at home, had opened branches in many developing countries. They were the ones to receive such petrol shock dollars as deposits. What any bank manager would think in such circumstances, and understandably, would be: “how can I lend this money for an interest?”. This simple thought started a roller-coaster of action and effects.
I found the information for the second part of this article in the book The Alchemy of Finance by George Soros.
Coincidentally or not, many developing countries started applying for loans to improve their economies and these banks were presto to satisfy them. Their criteria was very loose and sometimes they just found out the national income of a country and calculated whether it would be enough for the country in question to serve the debt. This way a huge amount of money was lent to developing countries.
What happened next was that these debtor countries actually found it impossible to serve their loans and the danger of default or repudiation of debt loomed in the horizon. This cast a dark shadow on the entire banking system of the West, but mostly on the United States.
The abundance of capital to be loaned and the pressures of competition, or maybe just too much greed, drove the US banking system to a brink. If the loan repayments were defaulted the losses to be carried by most large US banks would be so large that they would be wound up carrying this collapsing effect through to the smaller banks. An entire castle of cards would crumble. This was the year of 1982.
What Americans then found as a way out for this dangerous situation was to realise that, for debtor countries to service their loans, they would have to develop their economic capabilities as well as manage current affairs and that required the issuance of further loans by the US.
This way, debtor countries would continue growing their economies and also servicing their loans successfully. The practical effect would be a net resource transfer to the US that would equal the servicing of the debt.
This situation parallels the German war reparations situation around 1923 above but, by this time promptly having the problem fixed, closes a circle.
| 60 |
| Vote |
Shared on
Subscribe to this blog
