In case you missed it, the American banking system has been giving out massive amounts of loans to foreign companies. This has good, and bad, consequences. Because the American banking system had a limitless amount of cash and credit (so it appeared), it was willing to loan out these quick and easy loans to businesses in China and India, amongst other emerging economies.
But now, with the American dollar going up, the exchange rates have become sharply assymetrical. Any emerging economy business trying to pay its loans is going to find that the amount they need to pay has sharply increased in local currency. With the Federal Reserve raising interest rates, these companies may find it difficult, or impossible, to pay the loans back. There’s always Chapter 11, leading to a massive wave of defaults across the world. Apparently around a trillion dollars may be at stake here.
The Federal Reserve cannot keep interest rates artificially low for ever. Then there’s also their massive 85 billion per month dollar printing program which has been steadily pumping dollars into the economy. At some point, all of these billions catch up and come to be known as “inflation.” But American economic head honchos were apparently supremely confident that the economy was so strong it could withstand an unlimited amount of money, especially for defense, being printed each year since 9/11.
Will the American economy be able to absorb the last 10 years of massive overprinting of dollars? Will the defaults in the emerging economies act like dominoes, bringing down the American financial system? Its hard to say for sure, but what is clear is that countries that have taken these easy loans from America are going to reconsider where they get their credit from, in the future. In fact, indebting people is nothing new in America-most people have massive amounts of credit card debts, and they also buy everything else, from college education to house to car to their monthly food items, on credit. For America, this is a normal way of operating. But for many other parts of the world, where debt is not considered an asset and a sign of normalcy, the sudden spike in interest rates and the resulting defaults could spell serious consequences.
In general, banking operates on trust, and the notion of stability. People plan their projections of future growth, and payment, based on a notion of stability of currency and exchange rates. When the rates start to fluctuate this wildly, businesses become more risk-averse, and the dollar becomes an unreliable currency. Of course, for the risk-takers who don’t have any other form of credit, the dollar will still remain a currency to bank on, since its more easily available to them in the form of credit than say, the Swiss franc. But in the long run, the losses incurred from the dollar’s easy credit (And easy indebtedness) may be harmful to emerging economies.
I’m also interested to know how many emerging economy countries are tied by debt to the World Bank, and what these loans are for. Also, how do they get repaid? And how is the dollar’s wild ascent going to affect these economies?
I was working as a consultant at the World Bank between 2008-2010. My job was to take part in the countrywide assistance strategy, and to note down the suggestions given by various groups of stakeholders in Pokhara, Nepalgunj and Biratnagar. In one of these sessions, teachers gave the feedback that the World Bank, in collaboration with the Nepal Government, had frozen the hiring of permanent teachers, but started a new program that allocated “block grants” to school—these grants were given in small chunks to schools to do what they wanted. Most schools built a spanking new concrete structure. In exchange, the World Bank put on hold the permanent hiring of teachers—that was the conditionality for the block grants (from what I could understand, the agreement was that the school could do whatever it wanted with the grants—including pay its teachers, which of course none of the schools actually did.) This left the government schools, in effect, with shiny new concrete buildings but poorly paid temporary “teachers” who may just have passed their SLCs. In other words, they took what was once a very efficient and well-functioning system from which many highly educated individuals graduated to go forth in the world and hold international positions, to a system which boasted “infrastructure” but whose commitment to teachers and teaching had been allowed to be greatly undermined. With the Maoist affiliated students threatening teachers, a teacher admitted to me that he hadn’t failed a single student for a few years, even if they were not sufficiently up to standard—meaning a lot of these Maoist gangsta boys then reached SLC but didn’t actually have the academic chops to pass the final examination.
My purpose in sharing this story is to show that loans that operate on this level of conditionalities can be dangerous. Who thought it would be a “neat” idea to stop hiring lazy permanent teachers? Perhaps there was some wild new radical theory of social change (no doubt started by anthropologists) which posited than handing $4000 to schools would automatically make them hire good teachers, or teachers more suitable to their ethnic and /or caste group. In fact, the program seems to have backfired, since the permanent teachers, many of whom are actually selfless and dedicated individuals who happen to spend a lifetime teaching in extraordinarily difficult circumstances for very little pay (and often facing mortal danger, as during the civil conflict when they were targeted by both sides), are now no longer present in these schools, leaving the schools in remote areas even more vulnerable than before.
These loans, therefore, can lead down the slippery path where governments, businesses and individuals end up taking actions that are bad for the collective good. The ironic part of this whole story is that the very student who fails from this educational system then has to go to Qatar and work in slave-like conditions to amass enough wealth, some of which will be extracted from the government as tax in order to service World Bank loans—the same loans that made him a less educated and less skilled man. I cite an example of a loan from the Word Bank, an “international” institution that just happens to be headquartered in Washington DC, but it could just as well apply to private businesses as well.
It would be a strange world in which only America’s monster currency swallows all others, in some PacMan like movement through the banking system. Clearly some intervention of international proportions would need to occur, especially if these fluctuations of interest and exchange rates also effect the debts of the Third World countries, via the World Bank, amongst other international banks that have been loaning money to poor countries for infrastructure, governance, et cetera.
How will the loans repayment work out? Lets hope the American lenders will think about a way out for themselves, as well as for their borrowers. There could be solutions, including allowing the businesses to repay the loans at the interest rates, and the dollar exchange rates, at which they initially made the contracts. Of course, this would bring on a big loss to American banks, but this might be better than not getting anything back in return.