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More on Third World Debt

Monetary Digest, August 1984

Since Mexico’s near default two years ago, articles about the banks’ plight with Third World debt have appeared in all establishment financial publications, with one of the best series appearing in “The Wall Street Journal on June 22, 1984.

The banks’ problem is two fold. First, there are strong indications that they will not get their money back. This has been admitted by some of the more realistic bankers involved. However, strangely enough, this is not their primary concern.

Their main fear is that the borrowing nations may simply state that they’re not going to pay, thereby forcing the banks to write off the loans against capital. In many cases, it would mean outright bankruptcy; in other cases, it would reduce capital below levels required by regulatory agencies.

Therefore, if the banks and their friends at the Federal Reserve and FDIC can continue the facade that the problem is being worked out and that the debtor nations aren’t going to walk away from the loans, they have solved their major problem.

If the Third World borrowers repudiate, an alternative to letting the banks fail would be for the government (taxpayers) to bail them out. This could be done through cash infusions directly by the Treasury or indirectly by the FED and FDIC.

Few people think that the government will let the largest banks in the country fail, and the government bailout of Continental Illinois National Bank is strong evidence that this position is correct.

One way of handling the problem would be for the regulatory authorities to allow the banks to write off the loans against future profits. However, this idea is not acceptable to the big banks and has received virtually no attention from the news media.

Few people working on the “solutions” are concerned about the countries involved. Consider the draconian measures imposed by the International Monetary Fund on the borrowing nations in order for them to obtain IMF loans and guarantees.

For example, industrial production has fallen 8%, and more than one million workers have been laid off in the two years since Mexico’s inability to pay became known. Wage-price controls lave lowered real wages 40-50% over the last year, despite two salary increases granted this year.

In the Dominican Republic where the IMF insisted on cessation of food subsidies, the prices of some staples doubled, causing riots in which more than 50 people were killed. Riots also occurred Sao Paulo, Brazil when the government instituted IMF programs. General unrest is prevalent even in countries where the citizens have remained calm.

Something has to give. If the governments continue IMF programs, the unrest will fester into revolutions, which are not uncommon south of the border.

The leaders of the debtor nations are cognizant of this, and being politicians, they are trying to avoid responsibility for the problem. In fact, the presidents of Argentina, Brazil, Columbia, and Mexico have said as much.

While these countries are not publicly saying that they will refuse to pay, some of their neighbors have moved in that direction. On June 4, Ecuador announced that it was suspending payments on $247.5 million it owes to governments, while continuing to service its $7 billion bank debt.

On the same day, Bolivia formally told commercial banks that it would “postpone” payments on the $720 million it owes them. The next day, Peru announced its “full moral support for Bolivia in it’s decision.” Peru also announced that it had “rescheduled” $1 billion in loans to western nations.

Meanwhile, Argentina’s Economy Minister praised Bolivia’s move as an “act of national sovereignty,” and warned that other Latin American countries might follow Bolivia’s lead. Argentina’s pugnaciousness worries the bankers since its $43 billion in foreign debt dwarfs those of Bolivia and Ecuador.

An outright co-ordinated repudiation by the larger debtors would collapse many banks. Because of the fear of widespread bank failures or even the collapse of the entire banking system, there most certainly will be participation on the part of the U.S. government. It could come two ways.

First, the U.S. government could openly participate in the bailout through more contributions to the IMF as it did with the last year’s controversial $8.4 billion donation. Or, the Federal Reserve could buy the bad loans from the banks. Direct purchases of new Third World debt by the Fed is another possibility.

This would require massive increases in the money supply for, as everyone you know, the federal government is operating in the red.

The other possible course would be for the banks to extend the loans for 15-20 years with a secret agreement that the dollar will be debased, making it of less value vis-a-vis the currencies of the debtor nations. This solution would reverse the problems that have arisen because of the strength that the dollar has gained since Regan took office.

Having borrowed dollars, they must pay back dollars. If the dollar is made cheaper, as was the case during the Carter years, the loans will be easier to repay. If it is a drastic debasement, it would virtually make gifts of the loans. Recent developments regarding Mexico’s loans suggest that the first phase of such a bailout is under way.

According to a recent article in the “Arizona Republic,” which has a Mexico City Bureau, the bankers are “convinced Mexico eventually will have to follow Bolivia’s example and stop payments on its giant $85 billion debt.” Therefore, the banks have entered into negotiations to stretch out the repayment of some $58 billion over the next 12 to 15 years.

Additionally, the bankers have publicly said that they will give Mexico the best deal yet on rescheduling, including interest rates independent of the volatile U.S. prime. A rate of 1% to 1-1/2% over LIBOR (London Interbank Offered Rate) is considered generous.

However, some reports from Mexico say that the hardliners want a rate very close to the banks’ cost of money. Such a rate would would virtually eliminate bank profits on Mexican loans. And, Brazil and Chile, now at the negotiating table with their $100 billion and $18 billion debts respectively, would expect comparable deals.

To the bankers, as well as the debtor nations, this may be much preferred to the austerity programs which will lead to revolution. Revolution will mean repudiation of all external debt as was the case in 1917 in the Soviet Union and in 1949 in Red China. Repudiation means writing the loans to zero; it means bankruptcy for many big banks in the United States and western Europe.

Any government bailout, and only government is capable of engineering one, will result in massive inflation. It’s only a matter of time before this is recognized by world investors, at which time we can expect a massive dumping of the dollar for other currencies and precious metals.

More On Scams

The February, 1984 issue of “Monetary Digest” carried warnings for various types of scams and frauds being perpetrated on unsuspecting people wishing to invest in precious metals. Invariably, these deals appeal to greed or fear and are aimed at unsophisticated investors. Recently we learned of an experienced investor who got stuck.

The approach was standard; he received a phone call from a salesman who offered him the opportunity to “control thousands of ounces of silver” for just one third down. So, he sent $10,000 as a “downpayment” on 4500 ounces valued at $7.34 an ounce including a 5% commission. (A comparable investment at Certified Mint would carry a commission of 1.5%.).

When he received his paperwork, he learned that in addition to the 5% commission of $1,575, he paid an “administration fee” of $6,664. He learned also that he had made a deposit of only $3332 on a $33,323 investment and that $29,991 was due on or before July 26, 1986. If at that time he wishes to “extend the date” for a period of one year, he will be able to do so only by paying an additional administration fee of $2,665.00.

By reading the fine print, he has also learned that the transaction cannot be liquidated through an offset, and that he is liable for the full purchase price. He cannot sell to avoid delivery and handling charges.

The paperwork doesn’t indicate whether or not the seller has physical possession of the silver. This tends to indicate that there is no physical silver, and at best the contract is hedged in the futures market. It smells like another scam, and coming out of Florida, it may be the work of former I.G.B.E. people.

Unfortunately, all the bad deals aren’t offered by the “fly-by-night” firms. Some of the old, highly respected firms rip their customers regularly with over-priced numismatic and quasi-numismatic gold and silver coins.

For example, in March one of the country’s largest precious metals dealers was offering uncirculated Mexican silver dollars in quantity at $10.95 each when they could have been bought at $8.50 most anywhere else. Also promoted were Canadian $100 proof gold coins for $285 when they were selling at $230. In addition, he offered what he called “hand selected rolls of beautiful choice Franklin proof half dollars for only $395 per roll.” The market price: $250 per roll.

The last two to three years haven’t been all that great for bullion dealers. Because of the competitiveness of the business, commission were cut to bare bone during the active markets of 1978-1980.

As a result, with today’s slow markets, many firms have gone out of business. However, some firms have “diversified” into numismatic and quai-numismatic coins, enabling them to increase their margins of profit on the fewer sales that they are seeing.

Not all the firms, though, were satisfied with the normal profit margins that came with numismatic coins, so they over-priced them. However, this is not the worst case. Some firms over-graded the coins that they sold, defrauding their customers.

As we’ve stated before in this newsletter, numismatic coins are for the collector who know what he’s doing. Numismatic coins are not for the average investor who simply wants a hedge against inflation. There are too many things that can go wrong.

The Modern Little Red Hen

Once upon a time, there was a little red hen who scratched about the barnyard until she uncovered some grains of wheat. She called her neighbors and said, “If we plant this wheat, we shall have bread to eat. Who will help me plant it?”

“Not I,” said the cow.

“Not I,” said the duck

“Not I,” said the pig

“Not I,” said the goose

“Then I will,” said the little red hen. And she did. The wheat grew tall and ripened into golden grain. “Who will help me reap my wheat?” asked the little red hen.

“Not I,” said the duck. “Out of my classification,” said the pig. “I’d lose my seniority,” said the cow. “I’d lose my unemployment compensation,” said the goose.

“Then I will,” said the little red hen, and she did.

At last it came time to bake the bread. “Who will help me bake the bread?” asked the little red hen.

“That would be overtime for me,” said the cow.

“I’d lose my wellfare benefits,” said the duck.

“I’m a dropout and never learned how,” said the pig.

“If I’m to be the only helper, that’s discrimination,” said the goose.

“Then I will,” said the little red hen.

She baked five loaves and held them up for her neighbors to see. They wanted some and, in fact, demanded a share. But the little red hen said, “No, I can eat it.”

“Excess profits!” cried the cow.

“Capitalist leech!” screamed the duck.

“I demand equal rights,” yelled the goose, and the pig just grunted. They painted “unfair” picket signs and marched around the little red hen, shouting obscenities.

When the government agent came, he said to the little red hen, “You must not be greedy.”

“But I made the bread,” said the little red hen.

“Exactly,” said the government agent. “That is the wonderful free enterprise system. Anyone can enter whatever business he wants and profit from his efforts.”

“However, under our modern government regulations, the productive members of society must share the fruits of their labors with the idle. Be grateful for what you have left,” said the agent as he confiscated the bread.

The indolent neighbors planned to grow fat on the little red hen’s bread, but she never baked any more, or so they thought. You see, the little red hen thereafter operated in the underground economy.