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Needed: A New Deal On Global Debt



Central bankers flocking to Jackson Hole, Wyo., for their annual late-August retreat this year might want to take time to learn the DIP. It's not a dance but rather something called debtor-in-possession financing. DIP involves segregating the defaulted loans of a bankrupt company, wiping the slate clean, and starting the borrowing process all over. A restructured company gets new credit, the bank get a small percentage of its old unwise loans back over time, and everyone starts to play the all-important growth game again. DIP lending is a desperation strategy used only when corporations face ruin and banks stand to lose everything. This is increasingly the plight of Russia, Asia, and parts of Latin America, where de facto default may be the best choice among evils.

Debt overhang is crushing economic growth. It is time to consider a global write-down. The best way may be to swap emerging-market debt for long-term bonds backed by hard collateral ranging from U.S., German, and Japanese government bonds to Russian oil reserves. That was the idea behind the Brady bonds, named after Nicholas Brady, Treasury Secretary under George Bush, that helped revive economic growth in Latin America and Central Europe in the '80s. Then, government debt was swapped for the Brady bonds. Today, most of the debt is private, making the swap more complicated but not impossible. Brady-style bonds can work in the '90s, too.

The Russian crisis highlights the global liquidity squeeze that is strangling economic growth on a scale not seen for decades. In what were just a year ago some of the fastest-growing regions of the world, banks are not lending, governments are devaluing, and investors are racing to sell currencies and assets in one country to cover losses in another. An International Monetary Fund-sponsored policy of higher interest rates, higher taxes, and competitive devaluations is sending much of the global economy into a disastrous deflationary spiral. Ask any Kansas farmer or CEO of a multinational in Chicago. World demand for their products is plummeting, along with prices paid and profits made.


A backlash against globalization has already begun. Without a dramatic policy change by international creditors, leadership in the current crisis will slip away from the dominant industrial countries and international lending agencies. Already, devastated Asians, angry at the damage done to them by high-octane global capital and inappropriate IMF policies, appear to be losing faith in the open-market system and the institutions that support it. Hong Kong, the paragon of laissez-faire capitalism, is openly intervening in the stock market. Thailand and Indonesia are nationalizing banks. Now, Russia is taking a giant step backward by contemplating capital and price controls while printing rubles.

The epicenter of pain is East Asia, where the spreading crisis began a year ago. Output is collapsing, unemployment is soaring, and a nascent middle class--hitherto one of history's champion consumers of goods and services--is being pushed back into poverty. This region alone constituted half of all output growth from 1991 to 1997. Without this Asian demand, commodity prices are falling around the world, putting tremendous pressure on any nation that exports oil, grain, livestock, or gold. The Canadian dollar is down to a 140-year low against the U.S. dollar, the South African rand is crumbling, the Venezuelan bolivar is set to tumble, and the ruble is in free fall.

The downward spiral won't end until demand is restored and deflation is stopped. To do this, banks must begin lending. American banks hold about $40 billion of Asian debt. European banks hold the lion's share, about $350 billion. In addition, Germany has up to $30 billion of loans to Russia. The Japanese have $245 billion in East and Southeast Asian debt on their books. All these banks already face significant write-offs on these loans ranging from 30% in Hong Kong to up to 80% in Indonesia and 90% in Russia. If the emerging world recession gets worse, the banks could wind up with nothing. Better to save something by taking a hit, exchanging bad debt for new long-term paper. Japan, in particular, can benefit from this plan. Only a dramatic write-down can get the country moving again and pull Asia with it.


An increase in global liquidity must accompany the new deal on debt. That demands a dramatic change in IMF policy. Devaluation, high interest rates, and high taxes have not led to a restoration of investor confidence in Asia. They will not do so in Russia, either. Indeed, there is a revolt against IMF policies under way. Russia, Thailand, South Korea, and Indonesia are turning away from austerity and daring the IMF to stop them. Huge public-works programs are being launched in Asia to generate jobs, build needed infrastructure, and stimulate demand. Six months ago, the IMF demanded that Jakarta run a balanced budget. Now, Indonesia has decided to run a deficit of 8% of gross domestic product. Thailand agreed to run a 3% budget surplus in exchange for IMF loans. Bangkok reversed course, and now it will run a deficit of 3%. Along with nearly all the other Asian countries in crisis, Thailand is lowering interest rates significantly as well. Indeed, rates in Korea and Thailand are now half what they were six months ago.

It is time for a clean financial slate. New lending and new easing are needed to get everyone back in the growth game. A swap of old debt for new bonds not only forces reckless lenders to take a needed haircut, it also sets the stage for getting liquidity pumping again in the global economy. That is the message the Jackson Hole central bankers should take away from their sojourn.

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