https://geopoliticaleconomy.substack.com/p/debt-political-wealth-flows-poor-rich

Aug 05, 2024

How does the structure of the international financial system cause a drain of wealth from the poor to the rich? Political economists Radhika Desai and Michael Hudson discuss the politics of debt.

MICHAEL HUDSON: The current Ukrainian debt tangle shows what a double standard there is for the IMF, and in fact, the whole international bond community, when it comes to treating countries that can't pay their debt and are in similar debt straits.

Two years ago, when the fighting with Russia began, when Russia had to intervene because the Russian-speaking areas of Ukraine were under civilian attack, it was obvious that Ukraine wouldn't pay the debt. So the international bondholders that had debt falling due then said, okay, you don't have to pay us now. We know that you're at war. Let's put it off for two years, and let's wait until August 1, 2024.

That's exactly where we are now. Two years ago, they said the war will certainly be over by then. The IMF and the United States said Ukraine is going to beat Russia, and for all we know, we'll march into Russia, but there won't be a war. Ukraine can pay back then. So everybody said, okay, wait, you'll just keep accruing interest to us.

You can imagine what happened a month ago as the payment time came due. What was Ukraine going to do? And obviously, Ukraine didn't have the money, and the bondholders had a choice. Either they could insist on being paid and say, you're in default, we're going to list you in default, and if you can't pay us, that means that the IMF, according to its rules, which it doesn't follow, but according to the rules, if people did follow them, that it's not permitted to lend to countries that are in default against private creditors.

That's because the IMF is a policeman acting as a lobbyist for the private creditors, forcing bonds to be paid.

And so the leading bondholders, we're talking about people, the biggest bond funds, PIMCO bond fund, Blackstone got together, and they had a choice. What they did was something very remarkable. They actually said, okay, Ukraine, not only do you not have to pay the debt that's falling due now, but you can write down the debt by about 39% because we know that you can't pay. Just promise to pay us beginning in a few years more from now when we know that you will have defeated Russia and can afford to pay. And they actually took a very large loss on what had become Ukrainian junk bonds.

What surprised me is this is not what normal international bankers did. It was open to them to say, no, we're going to foreclose, and they would have understood that the US government and the IMF would have done everything they could to prevent a default by Ukraine, and they would have bailed out Ukraine. But somehow, the US government arm-twisted the bondholders.

We have no idea why, but the bondholders did something that is very uncharacteristic in taking the loss on the $50 billion loan that was falling due. The IMF explained that since the West no longer lives by the rule of law, but by the rule based order, everything can go ahead.

We already know that one of the other articles of agreement of the IMF says that it's not allowed to make a loan to a country in war. The IMF said, and I'm paraphrasing, well, if the country is going to war for a purpose that the United States and NATO support, of course, since we're the arms of NATO, basically, and the US Defense Department and State Department, of course, we can waive the rules. The rules are meant only for when we want to apply them against recalcitrant countries that have difficulty paying the debt.

So they just made new loans to Ukraine to enable it to keep fighting the war. And the bondholders all pretended that somehow Ukraine isn't going to lose, that somehow they're going to come out solvent and pay the bondholders.

Nobody has any idea of what actually convinced them. But of course, since Blackstone and PIMCO are very close to the US State Department, there must have been a discussion, arm twisting and some kind of off-the-books promise that don't worry, we'll take care of you.

And apparently there are two plans that are set up for how Ukraine can pay the debts. Blackstone and JP Morgan are working together to organize what they say will be a bonanza of selling off Ukrainian resources once the war is over. And they think that this is going to be a huge market for American companies, European companies to buy Ukrainian land, Ukrainian public utilities and any assets they have.

So if Ukraine wins the military war, we know that won't happen. But if they did, then they'll cease to be a country that owns its own resources. Anyway, it'll end up looking sort of like Argentina or other countries that are told, pay your debts by selling off your land, selling off your mineral rights. And Ukraine has minerals, all in the Russian speaking areas, lithium and others. And the illusion is that somehow that all this money that will be paid to the Ukrainian government for buying out its assets will be used by the government to pay the bondholders and remain solvent.

That's basically the IMF strategy for the last 50 years. If Latin American countries or African countries can't pay their debts and have to borrow from the IMF, they have to sell off their mineral rights, their lands and the others.

There must be a plan B. And I've been trying to figure it out. And my suspicion is that the bondholders were told, well, if somehow a miracle happens and Ukraine loses the war, then the Eurozone will take the $300 billion that they've taken, seized from Russia, and they will give this to Ukraine as reparations for the war. And Ukraine will use the money they seized from Russia to pay the bondholders. That's only my guess, but I can't imagine the bondholders would have taken the loss right now unless they had these two, plan A and plan B, in their minds. Well, as Radhika said, this is not a market relationship. It's a political relationship.

MICHAEL HUDSON: I'd actually like to begin earlier. You made an important point that the debts of the industrialized nations, Europe and the United States, have all been war debts.

It started in the 13th century. The Roman church declared war on other Christian countries, mainly Germany, that didn't accept the Roman Catholic direction for control. And they fought against the orthodox Christian countries. And so they basically hired warlords like William the Conqueror to turn England into a fiefdom.

The problem is how they have armies that work for the Vatican, the warlords were sort of serfs. But how do you get the money to pay for the war?

It was the Roman church that in the 13th century that organized merchant bankers from Italy, the North Italian bankers, the Lombards, they were called to make loans to England and other countries going to war.

In order to do this, the Roman Christian church reversed the whole spirit of Christianity, saying charging interest is okay if you do it for a good Christian purpose that we approve, like going to war. From the 13th and 14th century right down through the 20th century almost all of the foreign debts, the domestic debts, the public debts of European countries were all war debts. And that's continued.

The important thing about war debts is they're not self-amortizing. Going to war doesn't give you the money to repay the creditors. And that's a problem.

Global south debts largely are not a result of international war. That makes the global south debts different from the European debts. You could call it a class war or what we do, a geopolitical war of the industrial nations against the industrial suppliers.

MICHAEL HUDSON: And it's a financial colonialism, you can say. To me, the problem began to loom already in the mid-1960s. In 1965, I was Chase Manhattan's balance of payments economist. And most banks had their own economists to judge how much money can third-world customers afford to pay. They had me looking at Chile, Argentina, and Brazil, and they said, see what their export potential is. See how their balance of payments is. How much surplus are they gaining that somehow we can get them to pledge the surplus for us to make loans? Because the international department of the bank made money by lending out to these countries.

I did a quick analysis and I could say, well, if you look at the balance of payments, they're already living by borrowing. They're already not generating a surplus. And you had banks already in the mid-60s begin to cut back on the loans because it was still— lending to these countries was still largely a market phenomenon back then.

They said, well, we're the creditors. We don't want to make a loan that goes bad. And the only way that we can secure our loans is to know that there is a [trade surplus] and a balance of payment surplus. That ceased to be the problem.

So at some point, and I think this must have been in the 1970s, I was a consultant for a number of brokerage firms and underwriters. And I was known as one of the three Dr. Dooms at that time. I said, I don't see how Latin America can pay to take on any more debt. They're already loaned up.

We had a meeting at the Federal Reserve and its officialturned to me and said, Mr. Hudson, you say that these Latin American countries can't afford to pay the debts. But suppose you did your analysis to England. England is in the same boat. There's no way of saying how it can pay its debts, is there?

This is when England was devaluing sterling. I said, yeah, that's absolutely right. And the Federal Reserve man said, well, but it does pay its debt. And how does it repay? We lend them the money because they're our ally. And if we tell the banks, you can afford to lend money to these countries with no visible means of support, but we'll stand back of them, then you don't need to do an economic analysis. It's a political analysis. And if they're friends, just like for England, we'll back them up.

Ws you know, England did end up devaluing. By the late 1970s, I was working for UNITAR. And in 1978, 1979, I wrote a series of, published a series of articles for UNITAR saying the global South cannot afford to pay. I went on record at a UNITAR conference in Mexico City saying this.

So it became already that they couldn't pay unless the U.S. would lend them the money. Well, by 1982, as we've discussed before, Mexico started the whole Latin American debt bomb by not being able to make the payments on its short-term debt called tessobonos that were yielding maybe 20% at that time because the market-based investors saw that they couldn't pay. It was apparent for a long time.

That led to a domino effect. Argentina, Brazil, and the remainder of the 1980s saw the Brady Plan come in and the international bondholders got together and said, we know that the third world countries, as they were called then, can't pay. You've got to write down the debts to something that is payable and at least will give the creditors an idea that yes, at this written down level, they can afford the service of the debts.

This agreement wasn't believed by American or European investors. In 1989 and 1990, I was hired by Scudder, Stevens, which was a money manager, to start what became the world's first sovereign debt fund, mainly for third world debt.

When they hired me, they said, Michael, you're known as Dr. Doom. You've been saying that the countries couldn't pay. Suppose we start a third world bond fund and it'll only be a five-year fund. Do you think that Argentina, Brazil can afford to make the payments on this debt for the next five years?

This was at a time in 1989 when Brazil and Argentina were paying 45% interest on their dollar bonds. Just imagine, you know, in two years, you get all of your money back in interest and you still have all of the bonds.

Scudder went all around the United States meeting to banks, not a single bank, not a single investment fund or pension fund was willing to invest. They said, no, we've got burned with the Latin American debt bonds. We don't want any part of it.

They went to Europe, England, Germany, France, nobody would buy anything. So finally, they went to Merrill Lynch and said, can you underwrite these bonds? Let's find some country that might buy these bonds at 45%.

Merrill Lynch told its Latin American office in Argentina to issue shares in this sovereign debt fund. Scudder wanted to call it the Sovereign High Interest Trust, SHIT, but I think they had a name that didn't quite get that.

The only people who would buy Argentinian and Brazilian debts bought them in the Argentinian market where the shares were sold and the company was organized in the Dutch West Indies. Americans were not allowed to buy these shares. When you have an offshore fund, that usually is only for foreigners.

The countries that were buying Argentinian and Brazilian sovereign dollar debts were members of these countries themselves. And obviously, they must be the oligarchy that was doing this. No doubt, the central bankers and the president's family bought them because, well, we're in charge of paying the debt, so of course we'll buy the fund. And if we're going to default, then we'll sell the debts to some sucker. But as long as we're in charge of deciding to pay the dollar debts, we can afford to buy them.

You had this client oligarchies throughout the third world were basically buying this third world debt. And the fund took off. It was the second best performing fund in the entire world in 1990. I think an Australian real estate fund came first.

All of a sudden, this led to a new flood of lending to the third world countries, largely because the IMF said, well, these countries are in the U.S. orbit. We're supporting their governments. After all, this is after the Chilean overthrow when the U.S. government had assassination teams all over Latin America putting in place client oligarchies that, of course, were going to pay the dollar debt.

At that point it ceased to be a market relation. It became completely political and all of the U.S. and European investors began to jump in.

MICHAEL HUDSON: It wasn't only the banks. By the 1990s, you had private bond funds come in.

MICHAEL HUDSON: I want to just summarize what you said. When the oil prices were quadrupled, the deal that was made with Saudi Arabia is, you can charge whatever you want, but keep your earnings in the United States. That flooded the US market with money. The money was put in the US banks. And you're right. The bank said, what are we going to do with all this money? They had to find customers. And the paying customers were the third world debtors.

What brought this to an end? When Paul Volcker raised the interest rates, as you said, all of a sudden the international investors sold their foreign holdings and said, we're going to buy US treasury bonds yielding 20% in 1980. I remember that very well. So you're right. That led to the whole crisis. All of a sudden, no more of this gusher of Saudi dollars in US banks was available. And when the credit stopped, all of a sudden, Mexico and Latin American countries couldn't borrow the interest to pay.

Throughout the 1970s, as you pointed out, basically, countries would borrow and they didn't have any problem paying the debt because they borrowed the interest. That's a Ponzi scheme.

MICHAEL HUDSON: Yes, I agree. Yeah.

MICHAEL HUDSON: It's hard to begin in 1990 because if you had it in 1990, you'd have the 1998 Asian debt crisis. And this was the whole collapse of the Asian currency and the result of the debt crisis for almost everywhere except Malaysia. There was a huge sell-off of third world, especially Asian—

MICHAEL HUDSON: The situation is much worse than what your charts show. Debt to GDP is meaningless for the third world countries and for almost any country outside of the United States. Debt is not paid out of GDP. In America, you could say it is, but the debt of the Global South countries, Asian countries, is not in their own currency, it's in dollars.

The question is, how do you turn their GDP into dollars? These countries do not have, unlike the United States, these countries do not have debt in their own currency. So what you really need to compare and to look at is what is the trade surplus and the balance of payment surplus of these countries?

We're talking like 1,000%. And now just look at this chart that you just put up. Take Africa from 2010 to 2023. Up to 9%. 9% means you're having a doubling time in about eight years. Now, it's been much more than eight years since 2010. You've had the debt of Africa double and quadruple simply by interest payments.

So most of the debt of these countries, the Global South countries, is not money that's been borrowed. It's interest that have accrued on their existing debt. And they can borrow to pay the interest, but all of that is an accrual of interest, not loans. The actual flow of new credit to these countries has already dried up years ago. It's just their accruing interest on the past debts that they took on being assured that somehow with the IMF coordinating things, it was looking after them and the pretense that they would be able to pay these debts when there was no way in which most Global South countries could repay these debts, especially dollarized debts without some means of earning dollars, which they really don't have.

So what did they do? That little decades that you're showing when they were essentially privatizing, only making the debts by borrowing the interest and to some extent selling off their patrimony.

MICHAEL HUDSON: I don't like the euphemism resource transfers. Not a single penny of resources was transferred to these countries. A financial loan is not a resource. A resource is tangible means of production that help you grow. A resource is a factory. A resource is some means of production.

Giving countries the money, especially the money to pay their debts, isn't a resource. It's a financial claim. It's the opposite of a resource. It's a debt that they owe, a financial handcuff and a straitjacket on them, not a resource transfer. This is IMF creditor talk.

MICHAEL HUDSON: How can the IMF make loans to these countries to enable them to pay the debt and keep rolling it over, lending them the interest rates, not to default, if they have the problems that you describe? This is not a market relationship. If we define a market relationship as creditors act responsibly, they won't make loans to countries that can't pay their debt because the market relationship is supposed to balance risks with the interest rate. That hasn't happened at all. The risks are so high that the interest rates would have to be much, much higher.

So there has to be another explanation. The explanation is the IMF and the American policymakers know that the debts can't be repaid. What we're saying is that the debts can't be repaid is not a secret known only to us. The reason that loans are made to countries that can't be paid is precisely because if a country can't pay it out of its export earnings, out of its other balance of payments and flows, it has to do what an individual would do. If you borrow money to the bank for a mortgage and can't pay, the bank gets your house. That's what happened to the global south countries.

The IMF will go and say, oh, you can't pay? Well, we'll make you the loan in order so that your currency won't devalue again and raise your consumer prices as foreign exchange import prices go up. We'll make you the loan, but you have to sell off your utilities, your oil and resources. Let's bring in our friends from the World Bank. The World Bank is supposed to help you, remember?

The World Bank has all of this advisory group to say, we will help you privatize your resources. We will do for the global south just what BlackRock is doing for Ukraine. We'll help you sell all of your means of self-support to the foreigners. We can help you stop being a sovereign country and become a good, what America calls democracy, letting foreigners buy all of your assets that you're privatizing, Margaret Thatcher style.

This calls into question, what is a sovereign debt? Are these countries sovereign if they have to sell off their basic means of support to foreigners? They're not sovereign at all. The IMF and the World Bank work together as a one-two punch to prevent other countries from taking control of their own fate, to prevent the global south countries from using their tax revenues to actually invest in social spending and capital formation and subsidizing their own agricultural industrial self-sufficiency instead of being able to do this.

The function of having to load down countries with debt is all of their domestic fiscal surplus is paid to foreign creditors, not for use in their own countries. This means that debtor countries have ceased to be sovereign in any meaningful way of the world.

I think that that is the logic, is this consciousness is spreading among the global south countries. They realize that paying foreign debts is a kind of financial neocolonialism, except it's colonialism without the gunboats, unless you're like Chile and America has to come in and do a regime change operation. So this has transformed the whole issue.

MICHAEL HUDSON: Here's the problem. You can't borrow your way out of debt. All that does is add yet more interest payments, and it's a pomzi scheme. The fact is that global south countries and other countries can't pay the debt out of their existing output, because they can't print the dollars. They can only print their own currency, and if they throw that on the market to buy dollars, the currency is going to go way down, their import prices go up, and they have inflation.

A country can say, okay, I realize, like Argentina or Brazil, we realize this, but if we don't pay the debt, then the credit of the bondholders can do what they did to Argentina under Judge Grisa. Grisa can say, well, grab all of their assets abroad that you can do.

You mentioned that China changed the picture. There's only one way that third world countries can repudiate the debt, and that is banding together and saying, well, we're going to repudiate the debt, and if the bondholders in America and Europe try to grab our resources there, then we'll retaliate by nationalizing the foreign ownership of our own land and mineral rights and public utilities that we've had to sell off under the IMF promises that this will make us more competitive.

The problem goes way back to 1955 at the Bandung Conference when the non-aligned nations already saw there was a problem, and you mentioned before how this was recognized in the 70s, recognized in the 1980s and 90s, but at that point, there was no way that countries could band together.

The only way that I see in practice for the Global South countries not to pay their debts and say, I'm sorry, you've made bad loans. If you make a loan that we can't pay, then you've failed in doing what creditors are supposed to do, a market analysis saying we'll only make loans that can afford to be paid. Otherwise, you're making us a loan that can't be repaid, and we're not going to sacrifice our growth and sell off our natural resources just because you've made a bad loan. That's your problem, not our problem.

The problem for debtors is to make the bad loan problem a problem of the creditors, not their own problem, and that requires a restructuring of the whole international financial system and actually the kind of break between the global majority and US-NATO that we've been talking about. So far, even though there's talk of a BRICS bank, there's nothing of the scale that we've spoken about that is done. There still needs to be a change in consciousness that the debts can't be paid and shouldn't be paid and are in fact odious debts.

This is the consciousness that I think it may take another year or two, and the reason we're having these geopolitical shows is to try to spread this consciousness of saying this is not a problem that can be solved. It can't be solved. It's a quandary, and the way to avoid the quandary is to change the whole system. Say, okay, it's been a bad system for the last 80 years of Bretton Woods and US domination. It's time now for us to be a sovereign country and say our own growth comes before paying the debts to foreign creditors.