U.S. Doesn’t Learn From Its Prior Debt Mistakes

George Bush, people often remarked in the weeks after the election, is the first sitting vice president elected to the presidency since Martin Van Buren succeeded Andrew Jackson. President Bush probably hopes the parallel stops there. The immensely popular Jackson presided over an orgy of financial deregulation and good times funded by debt. Van Buren had the unglamorous, unpopular job of cleaning up after Old Hickory, to end up a one-term President.

The financial mess left over from the Reagan years is already dogging the Bush Administration and Treasury Secretary Nicholas F. Brady. Its agenda is being determined by messy problems that can no longer be ignored. Mounting losses in the thrift industry and imminent signs of political upheaval in Latin America forced the Bush team to launch major initiatives in its first 100 days.

But the Third World debt problem is the worst. Politically and diplomatically it is the most complex and--with the exception of the course of events in Eastern Europe--the most dangerous issue the Bush team must face.

The Brady plan--such as it is--was unveiled while the streets of Caracas, Venezuela, were still wet with the blood of rioters protesting the policies of the International Monetary Fund, and when other industrialized countries were growing increasingly restive over Washington’s reluctance to move on this issue. This plan is an admission that the Baker plan--espoused by James A. Baker III when he was Ronald Reagan’s Treasury secretary--will not work, and that the Third World cannot borrow its way out of debt. It also offers some concrete proposals to help debtor countries make modest but real reductions in both their debt service payments and in the total amount of their outstanding debt. But Washington has yet to face the real issues that make the debt problem so dangerous, and it has not yet figured the real costs of solution.

One troublesome issue is the contradiction between our trade and debt policies. The U.S. trade policy embodied in the current trade law, and supported by a bipartisan coalition in Congress and the White House, calls for aggressive measures to reduce U.S. trade deficits with the rest of the world and, if possible, to move from a trade deficit of $120 billion to a trade surplus of $50 billion.

But U.S. debt policy continues to call for debtor countries to step up their exports to earn the foreign exchange to service their debts. With one hand, we are trying to hold back the South Koreas and the Taiwans; with the other, we are trying to turn the Mexicos and Brazils into Asian-style newly industrialized countries.

The last time anybody tried such an unbalanced trade policy was in the 1920s. Then it was the Allies of World War I who had a contradictory policy toward German war debts. Germany was to pay its debts in gold and on time, and was expected to earn a trade surplus to accomplish this. But the Allies were not prepared to sacrifice their domestic industries to competition from the Hun.

In some respects, U.S. policy today is less sophisticated and less generous than it was in the ‘20s. The Dawes plan of 1924--almost a Baker plan in its time-- substantially reduced Germany’s annual debt-service obligations. It also included a generous loan to help Germany restructure its economy; and while the Baker plan was unable to generate substantial new loans for debtor countries, the Dawes plan led to a wave of private lending to Germany.

In 1929, the Young plan went even further. It put an end to Allied interference in the German economy, reduced Germany’s reparations obligation and spread payments over 59 years. Yet even this plan, however generous it seemed to Americans, was deeply resented in Germany and gave Adolf Hitler a needed political issue. With the coming of the Depression, the Young plan became irrelevant. A conference in Lausanne canceled 95% of Germany’s debts and further sweetened the deal by providing that Germany would no longer make payments to the Allies, but to a European conservation fund. Too little, too late. The Lausanne plan, which would almost certainly have satisfied Germany in 1924 or even 1929, was scornfully rejected by Hitler in 1933.

Unfortunately, as in the ‘20s, the international financial system has been allowed to degenerate into a collection agency. This is not what founders of the IMF and the World Bank intended. Americans of both parties agreed after World War II that the politics of debt had poisoned international relations in the ‘20s for no good reason. “Forgive us our debts as we forgive those who are indebted to us,” was the prayer on the lips of statesmen at Bretton Woods who established the modern financial system.

The spirit of that prayer--particularly important when the United States has become the world’s largest debtor--seems conspicuously absent from the current climate in Washington, and resentment of the world system is growing in the Third World.

Too little, too late has so far been the theme of Washington’s approach to the debt problem. Progress is measured in inches, the journey in miles. It is tempting for Washington to avoid bold moves on debt. Bold moves make waves; waves rock boats. But, just as inaction in the face of the thrift crisis proved to be the worst of all options, the approaches of Charles G. Dawes, Owen D. Young, Baker and Brady magnify the risks and costs of an explosive situation. What the young John Maynard Keynes wrote of the German debts in 1919 still makes sense today: “We shall never be able to move again, unless we can free our limbs from these paper shackles. A general bonfire is so great a necessity that unless we make of it an orderly and good-tempered affair in which no serious injustice is done to anyone, it will, when it comes at last, grow into a conflagration that may destroy much else as well.”

We must hope Bush, Baker and Brady overcome the temptation to procrastinate and temporize on debt. Had Van Buren acted with the decision and flair of Old Hickory, he might be remembered as something more than a historical curiosity.