Debt Crises Do Not Have to Develop Into Catastrophes
Jürgen Kaiser, debt expert, reminds us of the agreement that helped Germany after WWII to avert a debt trap and calls for a bankruptcy code for sovereign nations on the back of the COVID-19 crisis.
May 10, 2020 Produced by Lynn Fries / GPEnewsdocs
LYNN FRIES: Hello and welcome to Global Political Economy newsdocs. I’m Lynn Fries. In this newsdoc we are going to be looking how a world lacking a bankruptcy code for sovereign nations is massively ill-equipped to deal with the sovereign debt crises unfolding with the COVID-19 pandemic. In most all countries there is a bankruptcy code for individuals, corporations, municipalities but there is no such equivalent bankruptcy code for sovereign nations. This is a gap in the post-war international financial architecture, one that’s persisted since 1944 when the Bretton Woods Agreement was established between Allied Powers. The dire consequences have been escaped by one country – Germany. As a defeated heavily indebted nation, Germany’s debt sustainability was restored due to a comprehensive debt restructuring agreement given to them by their Western creditors, the Allied Nations, as victors of World War II. That agreement was the 1953 London Debt Accord.
In One Made it Out of the Debt Trap published in 2013 on the topic of the then current debt crises, including that of Greece, Jürgen Kaiser wrote that principles from the London Debt Accord would have delivered faster and more sustainable results had they been applied.
Here to talk to us about lessons into the present from the London Debt Accord is Jürgen Kaiser. Based in Dusseldorf, Jürgen Kaiser has been coordinator of the German Debt Crisis Network, the German Jubilee 2000 Campaign (Erlassjahr2000) and the Germany Jubilee Debt Network (erlassjahr.de) from 1995 into the present. The Germany Jubilee Debt Network is an NGO with around 700 member organizations throughout Germany. Welcome, Jürgen.
JÜRGEN KAISER: Hello. Welcome, Lynn.
FRIES: Jürgen, in your writing you’ve made it clear that the whole agreement has to be understood in the context of the Cold War. And that this strong confrontation between East and West played a role in why the West German government was able to win such large concessions from its Western creditors. But Germany has gone from being on its knees in economic terms to running the world’s largest current account surplus for the 4th consecutive year as we’ve seen on the back of results in from the IFO research institute in Munich. So a real exporting power house. What was it that the German delegation fought so hard for in negotiating terms of this agreement? Start by telling us something about Germany’s lead negotiator, Herman Josef Abs.
KAISER: Yeah. To start with Herman Josef Abs was a somewhat controversial personality in German history. He was a leading figure of the Deutsche Bank. In that capacity, he also played a somewhat controversial role during the Nazi era. He played this down in his memoirs – saying that he simply was no hero like most other Germans weren’t heroes either. And there’s still some controversy around how actively he was involved in what they call Arisierung of Jewish property, for instance. So in that sense, he was certainly a controversial person. He was a great banker. I mean he knew what he was talking about in terms of state finance and banking systems. So he was very, very apt for this role like for a few others that he later played in context of other debt crises. He led a delegation, it was to negotiate. And his aim was to actually negotiate a substantial relief and to provide balance of payment and fiscal space for a reactivation of the German economy. And he knew that Germany needed more fiscal space, that there was a huge demand for infrastructure investment after the destructions of the war, and that the more Germany could finance out of its own resources of this, the less dependent the country would be. So that’s what drove him actually. And so he was really a tough negotiator on behalf of Germany in confrontation to those who have just less than 10 years ago been at war and had actually defeated Germany in order to win this kind of relief that he wanted to have.
FRIES: Jürgen talk more about these negotiations for debt relief and the connection made between debt management and trade. A principle pointed to in various Germany Jubilee reports on the London Debt Accord is that in response to pressure from Herman Joseph Abs, Germany’s transfer capacity, in other words, its ability to earn the necessary foreign currency to cover ongoing debt service from export earnings became the principle criteria for estimating the debt relief that was given to German.
KAISER: The principal that you mentioned, that was really certainly one of the most interesting aspects of the London Debt Accord. But it was only one principle and there were a few other key aspects that make the Agreement so valuable. Like the overall amount of debt relief that Germany got; the way how this was calculated; the possibility to have arbitration courts in terms of different interpretations of the Accord. And one of them was that Germany managed to get a clause into the Agreement that would allow it to actually cease payments if it did not have a trade surplus with the respective individual creditor country. Yeah. That meant that creditors found themselves in a situation to either buy German goods or to forgo, at least temporarily, the payments on the Accord.
We do not know of any case where this clause has ever been invoked but still it took its effect because the incentive was for trading partners to actually buy German goods – which were still relatively cheap because in its earliest times the mark was not as overvalued as it later became. So all this taken together led to a situation where West Germany practically from the beginning started its career towards becoming world champion of exporters.
FRIES: Germany’s foreign creditors took a haircut by forgiving half of the debt they were owed by Germany; Germany a lot of room to maneuver from its foreign creditors when it came to having to meet payment obligations for the remaining debt. Talk more about this point that debt servicing was to be financed from export earnings. So Germany didn’t have to resort to using up currency reserves or to taking out new loans in order to make payments on the existing loans.
KAISER: Yeah, Germany at least didn’t have to touch reserves on a net basis. I mean, they may have used – on making the daily payments they may have taken resources from the reserves but on a net basis, it’s the way that you described it. They only needed to use trade surpluses. And the effect of this was to avoid what we today call a debt trap. Germany could not be caught in a situation where it actually had to use up its reserves, then replenish them by taking out new loans and out of such resources make regular payments.
FRIES: Jürgen explain the situation where if West Germany wasn’t able to meet payments on its debt obligations, there were arrangements for consultations between debtors and creditors and arrangements to seek the advice of an appropriate international organization. And in contrast, what goes on today where creditor governments like Germany and creditor institutions like the Paris Club, the IMF and the European Central Bank dictate terms to debtor nations.
KAISER: Yeah, indeed. What we are having right now and what still is regularly confronting countries that find themselves in insolvency situations is that they have to negotiate with a cartel of their creditors, which is called the Paris club or the London club if we talk about private creditors, which as I said only covers a part of all the external payment commitments of that particular individual sovereign. And the principle of the Paris Club is actually a pre-democratic one. Yeah, because the Paris Club is a group of creditors that listens to what the debtor has to say and then make a decision in the absence of the debtor countries’ delegations.
FRIES: As well documented by Jubilee Germany and others, the implementation of this process has a long history. Briefly, what does that history tell us?
KAISER: We have seen in a lot of countries in the developing world that actually insolvency situations – including by the international financial institutions – were not taken as insolvency situations but as illiquidity situations where providing new loans would be logically the right instrument in order to help cover a temporary illiquidity. And by doing so, we had in the developing world in the 1990s the effect that debt crises in Latin American and African countries that have started as a problem between private investors and private exporters and the importing States then turned – through the continuous refinancing out of development budgets of richer countries and particularly out of the multilateral financing institutions (World Bank, regional development bank, IMF) – into a crisis between official creditors and official debtors and that could not be resolved anymore. Because countries were literally in a trap by taking always out new loans in order to pay off the old ones with the debt indicators rising. And so you had extreme cases, like Senegal which renegotiated more or less the same debt 14 times before it was finally cancelled under the HIPC (Highly Indebted Poor Country) Initiative. And only from 1994 onwards, they started providing also cuts into the debt stock, into what really the problem was but also then to a certain amount. And that was a long, long and very, very painful story for quite a lot of countries.
And it had to do with the fact that indeed nobody was in any position to challenge and to enforce something more ambitious that would have been far more intelligent for everybody. Because if you keep refinancing the debt over a long time frame and then ultimately have to make the debt cancellation, that’s even more expensive for the creditors. And Germany and Germany’s creditors were spared from that process. On the one hand because from the outset, Germany got not only a slower scheduling but a cancellation of around 50% of what was actually due. The rest was rescheduled over a long time frame and under relatively favorable conditions. So Germany never had a problem. And should there be any problems, for that case there was not only one but actually four arbitration fora established for various kinds of problems that there may have been. And arbitration meant that it was neither Germany nor its creditors that would ultimately make the decision. But an arbitral body that would be independent of both sides and would be in a position to make an informed statement on the basis of an independent assessment of the situation and the need for (inaud). And that’s practically, practically the opposite of what debtor countries of today are facing.
FRIES: What seminal work recognized that with no formal bankruptcy code for sovereign nations devastating sovereign debt crises throughout the developing world was a systemic problem and with this laid out a detailed proposal to establish a sovereign debt restructuring mechanism to close that gap in the international financial architecture.
KAISER: That started with quite some academic work that was done at that time. There was the UNCTAD Trade and Development Report in 1986.
FRIES: Fifteen years later at the IMF this kind of analysis resurfaced in a formal proposal for an in-house debt restructuring mechanism at the IMF. What happened to that?
KAISER: The drive towards the sovereign debt restructuring mechanism in 2001 was first endorsed by a large group of countries from North and South and then it was basically one quite important member of the IMF who actually halted the whole process.
FRIES: A resolution to establish a Sovereign Debt Restructuring Mechanism for a fair and orderly insolvency procedure for sovereign states had been brought to UN General Assembly with the support of the G77+China and UNCTAD as a technical adviser. When it came to vote in 2015 only 6 UN Member States cast a NO vote. Along with the US, UK, Japan, Canada and Israel, Germany was 1 of the 6 NO votes.
KAISER: Yeah, that was a very, very sad story. It was just the latest of the major attempts to establish something like such an insolvency framework. The Greek crisis, for instance, that was still in full swing at that time, it was pretty clear that had such a mechanism being established at a place as remote as New York – to which all parties could have turned – even that crisis could have been solved more easily and in a more efficient way. Our hope to turn the crisis that we are now all facing with the COVID into something that actually changes structures and development hurdles that have been there for a long time is that this crisis could be taken as a good reason to actually implement such a mechanism.
FRIES: And a concluding thought as we wrap up?
KAISER: Debt is destiny, I mean, countries are going to take out loans for a very long time or forever. As long as the global economy works in a way like it does today, people will take out loans and it will make sense. It’s right to do so. But over-indebtedness and debt traps, they are not destiny. Yeah. Crises will come but crises do not have to develop into catastrophes. And in order to make that sure that’s what we need – a mechanism that we long since had in our domestic context. Yeah, I mean the domestic insolvency frameworks were developed when capitalism in Europe developed. And it was clear that you could not have a stable social situation when you had more and more groups of deprived desperadoes that were over-indebted did not have any chance to reintegrate into ordinary citizen’s life. And therefore had no other options than taking to weapons, to robbery, to everything. And in order to prevent this, the principle of individual insolvency was developed within practically all our jurisdictions. And it makes a lot of sense. And this is what we are lacking. I mean, people still think too much that you can leave half the world in a desperate situation and live on an island of prosperity. And I think this is something that where COVID is also different from what we used to have. I think it was António Guterres who said: We either beat the pandemic worldwide or we don’t beat it. Yeah, if we allow pockets of infection hotspots to persist, they will reach us sooner or later. And therefore, I think this crisis can only be resolved if everybody has the means to combat the pandemic.
FRIES: Jürgen Kaiser, thank you.
KAISER: You’re most welcome.
FRIES: And from Geneva, Switzerland thank you for joining us for this episode of Global Political Economy or GPEnewsdocs.
Jürgen Kaiser has coordinated the German Debt Crisis Network, the German Jubilee 2000 Campaign (Erlassjahr2000) and the Jubilee Germany Debt Network (erlassjahr.de) from 1995 into the present. Erlassjahr.de is an NGO of about 700 organisations that strive for a fair and transparent international insolvency framework.
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