Debt, More Debt, and Yes, Even More Debt

Mariano Torras Finance, Future, General, Health/Disease, History, International/Development, Macroeconomics, Public policy/Wellbeing Leave a Comment

November 22, 2020

In August of this year, Nobel laureate Joseph Stiglitz and Hamid Rashid warned that a global debt crisis was looming. And just last week, Zambia became the sixth country this year – after Argentina, Belize, Ecuador, Lebanon, and Suriname – to default on its sovereign debt when President Edgar Lungu’s government failed to make a $42.5 million interest payment that was due. Under normal circumstances one sovereign default is newsworthy; the latest announcement merely underscores what a strange year it has been. Yet, as harmful as the pandemic has been to poor countries, naturally increasing their dependence on foreign assistance, we must be careful not to lay the defaults at Covid’s door. At least not entirely.

How, then, did the six countries – with possibly another three to follow shortly – find themselves in such an adverse situation? Was it mere recklessness and irresponsibility? Or worse? Part of it may indeed be what some call “odious debt,” the debt taken on by despotic or otherwise corrupt regimes mostly to enrich their families and cronies, debt that should not be enforceable because it was illegitimate to begin with. But it would be only a small part of the story.

The fact is that defaults aside, several dozen poor countries today often find themselves in a highly indebted position, either to international lending agencies like the IMF or to commercial creditors – or usually both. Why? Consider that poor countries need strong currencies like the dollar (we call such currencies “foreign exchange” or forex for short) in order to buy many products from abroad. They need the dollars or euros because no exporter would accept their domestic currency – Mexican pesos, Thai baht, Ethiopian birr, or whichever other – for their merchandise. You might ask why, instead of borrowing, they don’t simply earn forex from exporting their own goods. Is it not what international trade is about anyway?

To be brutally frank about it, one would need to sell many tons of coffee or bananas, for example, to earn enough forex to import needed machinery or even Mercedes-Benzes. Not to oversimplify things, but the fact is that, with few exceptions, developing countries mostly do not have a sufficiently diversified economy to be able to offer higher value products in global markets. If they are not exporting coffee or bananas it is cacao, copper (Zambia’s specialty), sugar, or some other primary product. Poor countries therefore almost invariably find themselves on the short end, with what we call a current account deficit (similar to a trade deficit, except that it also counts income inflows and outflows).

What it means is that in order to pay for their imports they must find another way to attract forex. One way to do it would be to persuade investors from other countries to invest. Unfortunately, the lion’s share of such investment goes from one rich country to another – which should make sense, because investors are trying to make a buck, not engage in charity. So, the principal way that such countries obtain sufficient forex is by borrowing.

Ideally, the borrowing country imports mostly productive capital or inputs, and slowly builds up its economy, diversifies it, and gradually becomes more self-sufficient. But it seldom happens this way. The odious debt I mentioned earlier has indeed thwarted such objectives time and again. But there is more to it. People in poor countries want to be well fed, and their country often produces insufficient food. They even desire some of the middle-class trappings they learn about from Western TV shows. So, even non-corrupt national governments often see fit to sacrifice the country’s long-term development objectives for satisfaction of the short-term needs and desires of the people.

As a result, poor countries have almost never succeeded at fully industrializing and developing. South Korea is arguably the only exception. Failing to modernize and diversify their economies, most poor countries end up in a situation of “international debt peonage.” They continue to rely on a steady stream of loans to help not only pay for imports but pay interest on their debt – precisely what Zambia just declared itself unable to do. Creditors as well as exporters want to be paid in forex, not Zambian kwacha.

So, the next time you read about a country suffering a debt or “balance or payments” crisis, know that what is occurring is always related to some sort of forex shortage. The G20 countries are presently trying to negotiate relief funds from the IMF for poor countries affected by Covid. When the IMF bails countries out, what it does is provide an emergency forex supply; but what it extracts are promises to cut social spending, increase taxes, and often devalue the domestic currency (in theory to promote exports). They are measures aimed at ensuring the country’s creditworthiness, not at improving (or even maintaining) the modest living standards of the people.

Which brings us back to Covid-19. World Bank chief economist Carmen Reinhart recently warned that the pandemic could fuel a global financial disaster. But it would be a disaster far removed from the one faced by the nations presently in default. Reinhart recognizes that the enormous stimulus and liquidity provided by rich countries to stabilize their economies after the pandemic collapse was necessary; but as strategies she deems them unsustainable. Here we are talking about borrowing trillions of dollars – i.e., throwing caution to the wind – precisely to preserve short-term living standards in rich countries. The contrast with the situation faced by the poor indebted countries could not be starker. It is indeed one of the privileges of having forex for domestic currency.

Yet Reinhart is quite correct that the mounting government debts make financial systems increasingly tenuous, a subject on which I also recently posted. And it is also true that the longer the pandemic goes on, the greater the threat. The recent defaults by Zambia and the other countries only happened because they are the weakest links in a weakening global economic chain.

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