2. Liars And Hucksters
issue 168 - February 1987
2. Liars and
Third World debts are nothing new. Bankers have been tempted by Latin America since the earliest days of independence. And promised profits have regularly overcome financial prudence.
AWAKE and raring to go, eh? This is where the real excitement starts: we're going to talk about banks.
I can hardly wait.
The Third World is also going to figure largely in this magazine. So Latin America would be as good a place as any to begin: somewhere like Poyais.
Central America. You may never have heard of it; now's the time to broaden your horizons. One of the country's most dynamic early developers in the 1820s was Gregor MacGregor.
I think so. But with Latin American sympathies; he had fought with Simón Bolívar helping liberate Latin America from the Spanish yoke. So you would expect him to be pretty committed. His idea was to sell bonds to help develop Poyais.
Wait a minute. I know what a bond is, of course, but maybe other readers don't.
Very thoughtful. A bond is just a piece of paper you get which certifies that you have lent someone money - like an IOU. It specifies when the money is to be repaid and what interest you will get in the meantime. Governments nowadays issue, or 'sell', bonds when they want to raise money.
Anyway, Macgregor was extremely successful in selling his Poyais bonds. They had a high rate of interest. Investors thought they were on to a good thing. they bought £200,000 worth.
Did they hit the jackpot?
Not really. You hadn't heard of Poyais because it didn't exist. MacGregor just sold his bonds (very pretty they looked too) and made off with the proceeds, never to be heard of again.
Look at the map before you part with your money, I say.
Not a bad idea, but not entirely foolproof. By 1827 there were some £20 million worth of Latin American bonds - all of them issued from real countries - on which the borrowers had stopped paying the interest. They were, in other words, in 'default'. Some of the loans were eventually returned, but a lot of investors lost a lot of money. Not too different from what is happening today.
I thought it was the banks who lent the money?
Money can be lent and borrowed in all sorts of ways. Banks are just one source - but they have always been an important part of the picture.
The first bankers seem to have got into the business almost by accident. These were goldsmiths back in the seventeenth century. They had gold deposited with them for safe-keeping and they issued receipts in return. At first such receipts carried the name of the owner of the gold. But later they were written in the form: 'I promise to pay the bearer ten ounces of gold'. Other people were then prepared to accept receipts alone in exchange for goods - since this would give them a claim on the gold. Such receipts were an early form of banknote.
The goldsmiths realized too that many people left their gold undisturbed for long periods. That meant that they could write more receipts than they had gold for and lend them (for a suitable charge) to people who wanted to borrow this 'money' temporarily.
Sounds a bit risky. What if all the 'bearers' turned up demanding gold?
Simple. The 'bank', in this case the goldsmith, would crash, owing a lot of gold: there would have been a 'run on the bank'. But this would only happen if depositors got nervous that their gold was at risk. If people think that a bank will crash it almost certainly will. And that's as true today as it was then.
You mean if I started a rumour that the National Australia Bank was about to go under it would bring them crashing down?
It would if everyone believed you. Would you really do such a thing?
I don't mind, I'm with Citibank.
Don't be in too much of a hurry. Nowadays money moves around so fast the banks often choose to have huge loans between each other. So if you brought one bank down many of the others could collapse too - yours included.
The end of capitalism as we know it?
Quite possibly. Though at some point governments might well step in to bale out the banks. How did we get into this subversive mode? We were talking about investing in Latin America Banks were involved in these loans too. But they weren't names you'd be very familiar with; these were 'merchant' banks.
There are roughly two kinds of bank. The first includes the likes of Citibank and Barclays with a large number of local branches at which they offer to take care of the money of millions of individuals and companies.
Very helpful of them.
Yes, but not entirely altruistic. They also make tidy profits by lending that money out again and charging interest to the people who borrow it. Such banks are often called commercial or 'clearing' banks. They're the retailers of the banking world.
Then there are the wholesalers, called the investment or merchant banks. These do not usually open their doors to the public. Large sums of money pass through their hands. They can operate in all sorts of ways. They might, for example, buy bonds from companies or governments and sell them to investors. Or they might just put large investors (like pension funds) in contact with potential borrowers and then charge a fee for the service.
I don't think I need the services of a merchant bank.
I only mention them because it was a London merchant bank, Barings, which was one of the first to get into trouble in Latin America. By the early eighteenth century it had become a financial giant - capable of raising and investing much greater sums of money even than governments. When President Thomas Jefferson wanted to buy Louisiana from Napoleon it was Barings who financed it.
But investing in the New World was a risky business. The new American states like Maryland and Pennsylvania often defaulted on their loans. And in 1875 the State of Mississippi declared in a constitutional amendment that it was not going to pay up at all - and it has not done so to this day.
Calls for a stiff reminder - threats of legal action, etc.
That's been tried, but to no great effect. Strange, isn't it, that the US has this kind of murky financial history but still makes such outraged noises about the Third World?
Less of the outraged commentary please. Back to the nineteenth century.
OK. Even in those days Latin America could chalk up some pretty respectable debts. And it was Argentina which eventually brought Barings to its knees. In the 1880s this seemed like a country with a golden future. The capital, Buenos Aires, was a boom town, attracting migrants and money from all over the world. And bankers felt that the vast and fertile agricultural land around it offered all the security they needed.
But they reckoned without the greed and incompetence of corrupt governments. A lot of the loans were siphoned away and it soon became clear that investors wouldn't get their money back. Barings, which had been buying Argentinian bonds for resale (as well as making investments with the bank's own money) was in such deep trouble that only a If banks do acquire bad debts they can - as a last resort - sell such bonds. But they might try other measures first.
Like sending in consultants with bulges under their jackets?
Something like that. Banks in the nineteenth century would think nothing of taking over a finance ministry or two - in Egypt, say, or the Ottoman Empire - to redirect income into their own pockets. And the US regularly used to dispatch gunboats to places like Haiti and Nicaragua to organize the collection of customs dues in an effort to recoup the money. Not the kind of thing you can get away with nowadays.
So what do they do?
They send in the IMF. Not in this case an Intervening Military Force, but the International Monetary Fund.
Very clever. Is this the level of dialogue we can expect from now on?
It doesn't get much better. But I promise you it doesn't too much worse either. And my word is my ...
Illustration: Camera Press
Money to the Third World
INVESTORS, whether corporations or individuals, usually want security as well as profitability. So mostly they choose to invest in their own country. When they do took overseas the majority of Western investors will choose to place their money in other industrialized countries
But, as the chart below indicates, a substantial proportion of private investment nowadays also goes to developing countries
Private flows to the Third World are supplemented by official ones from Western governments. Some of this is in the form of aid - indicated as official development assistance in the chart below. The rest will be loans made at commercial interest rates. The chart indicates the dramatic expansion of aid flows in the 1970s and shows how this was supplemented by additional bank lending in the early 1980s.
Source: World Development Report, World Bank, 1985