55. Foreign Debt: Don't Let False Analogy Fool You.

Foreign Debt: Don't Let False Analogy Fool You.
Bob Komives
::

I did not enjoy the story,
One opines;
it is much too artificial.

So it is,
Two reminds;
but such is the real world.

I suppose it is,
One resigns;
I suppose it is.

A Dialogue

I think most of us consider borrowing money to be serious business; we do not do it if we have in hand the money or resources to undertake our project; we borrow when we need money for good projects. A developing country would seemingly pay for its projects itself if it has the money to do so, borrow if it does not. As any individual, does not a country borrow because it needs the money? If it cannot collect the money at home it needs foreign money, right? No, wrong.

Clearly, the Guatemalan government borrows from foreign lenders because it believes it needs the foreign money, just as I believe I need a bank's money when I ask for a loan. But herein lies the great mistake --the false analogy behind loans to national governments. It is falsely assumed that the principles of private borrowing can be applied to borrowing by governments of sovereign nations that caretake their own currencies. This error built the international debt crisis.

When I borrow from a bank --in an unsecured loan-- paper passes in two directions. I hand the bank a signed paper that is my loan agreement. In return, I get paper money. I try to prosper. By prospering I can pay off the loan, maintain a good credit rating, and borrow more if needed. By managing well my financial affairs, I also manage the value of the paper that I issued to the bank, my loan agreement.

I control the value to the bank of my loan by the skill with which I manage my financial affairs, however the bank has almost no control over the value of the money that it gives to me. While the bank tries to prosper and manage well its financial affairs, it does not manage the value of the paper dollars that it passes out in loans. The effect on the value of money that comes from the actions of one bank is insignificant. Money fluctuates in value due to forces that neither bank nor borrower can manage. Our roles are not symmetrical. While we borrowers manage the value of the paper we issue, moneylenders cannot.

An international, intergovernmental loan is different: both borrower and lender manage the value of the paper they issue. When Guatemala borrows one million dollars from the USA its representative signs a piece of paper called a loan agreement and, in return, receives other paper called dollars. Each paper dollar gives Guatemala a claim to some resources in U.S. America. Although dollars may be used for transactions outside of the USA, their fundamental value lies in a guarantee by the government of the United States of America that this money can buy a million dollars worth of goods and services in the USA. The amount that each dollar can buy is not guaranteed; the right to participate in the USA marketplace is. During the period in which Guatemala uses the borrowed dollars, the government of the United States of America protects the value of the dollars as best it can. It manages the total number of dollars in circulation as well as the general flow of the USA economy. It tries to maintain a healthy dollar.

The loan agreement signed by Guatemala gives the USA claim to some of the resources of Guatemala. The fundamental value of the loan agreement lies in a guarantee by the government of Guatemala that it will forgo use of somewhat more than one million dollars worth of its future resources to repay the loan plus interest. The government of Guatemala protects the value of the loan agreement as best it can. It controls the number of loans that the country has outstanding as well as the general flow of the Guatemalan economy. It tries to maintain a healthy loan agreement.

This international loan is symmetrical. Paper dollars buy a paper loan. A paper loan buys paper dollars. U.S. America hands Guatemala paper dollars signed by its treasurer and continues to manage the dollar's value. Guatemala hands U.S. America a paper loan agreement signed by a comparable government official and continues to manage the loan's value. In economic terms, the roles of the USA as lender and Guatemala as the borrower are essentially the same.

Timing is one incidental difference, but not as significant as it might seem. Presumably the outflow of dollars would be an immediate drain on the USA, whereas the drain on Guatemalan resources gets delayed until project benefits flow. The timing of benefits should accordingly be just the opposite --early in Guatemala, delayed in the USA. However, both economies are likely to make short and long-term adjustments that dampen the effects of timing. Dollars that leave as a foreign loan do not necessarily come home quickly to the USA to be cashed in. Some will circulate for years internationally before returning to extract goods and services from the national economy. The loan agreement itself is a long-term national asset that will tend to uphold the short-term value of the dollar. A rapid drain on the economy of the USA is unlikely. In Guatemala, a loan agreement may affect domestic resource allocation long before the payments are due. Guatemala should gain in the short-term as it takes in money from the lender. However, the short-term drain felt by Guatemalans may be as great or greater than that experienced by citizens of the USA. Anticipating the debt payments, their government will tend to favor investments in export production, thereby altering local consumption. The citizenry of Guatemala may experience this extraction of customary goods and services from their economy almost immediately.

Don't let a false analogy fool you. Borrowing by national governments is not like borrowing by you and me.

:: Bob Komives, Fort Collins © 2006-2008 :: Plum Local IV :: 55. Foreign Debt: Don't Let False Analogy Fool You. ::
With attribution these words may be freely shared, but permission
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