Friday, June 03, 2005

BBC NEWS | Business | Bush opposes UK Africa debt plan

Let's see if I can do justice to this gods...liquidity and near money *bleah*

Debt in the context of Africa, particularly the Heavily Indebted Poor Countries (HIPC) is bad. On the moral level (never thought you would hear me say that did you? =P), this is literally a case of the child paying for the sins of the father. The debt was accrued mostly by the previous government, often dictatorships, who spent this money on unproductive things like defence (too much), invasion of neighbouring countries and self-aggrandisation projects with little benefit to the people they claim to serve. As a result, the money having been frittered away literary, all they are is paying for things that were of no benefit to them. It's one thing for future generations to pay for infrastructure like highways (which they will benefit from but was paid for by their earlier generations), but not for the useless projects mentioned above.

In turn, because of the Cold War, the developed nations found it both expident and necessary to not simply turn a blind eye but to continue these loans for fear of destabilising the regime or opening it to the influence of the Communist. This was particular true for the so-called 3rd World countries, for their original (political) definition meant that they were not originally affiliated with either the Western Democracies of the Communists.

But times have changed and particularly so for the governments where the dictators have stepped down or been forcibly removed and more democratic regimes (relatively of course) have come in to take their place. If you refer to an earlier post where I argued that nascent democracies faced massive perils on almost all fronts i.e. politically, economically and socially. And one of the biggest problems impeding their progress is debt (well more accurately it's a lack of capital and the ability to spend it well but the root cause is arguably debt). Debt interests repayment alone can take up to 40% of that year's budget, money that could be more fruitfully spent elsewhere say in education and health to build up the social infrastructure for the long-term future of the nation.

The oddity of this entire situation is that it is the tendancies of the successful nations (particular those on the path of growth and progress) who make the repayments while those who are languishing tend to get moratoriums on those debt or not pay at all. Or arguably this creates a perverse disincentive not to growth or have the capacity to pay, because once you do so, most of your nation's growth and budget goes towards debt repayment.

The other oddity also is that this repayment in turn flows back to these nations whether in terms of aid or further loans essentially to pay back the original loan (or sometimes simply debt interest repayment). Actually it is not as insane as it sounds. Very often, a lack of capital means that you're never going to break out of the poverty trap and achieve what is known as capital take-off, the prequisite for a prosperous (at least in terms of growth) nation.

Here comes the really complicated part i.e. why debt relief may be bad economically for the World Bank, IMF and the liquidity of the capital markets. First, an explaination about money and liquidity. As we all know, anything can be used as money i.e. a method of transaction where something represents value which can be exchanged for goods and services. So cigarettes are a form of money in prison, as was various metals and bits of shell. Liquidity then refers to what some textbook call the moniness of money. In other words, how readily can it be used to be exchanged for goods and services. So money has the highest liquidity and real estate (land) is right at the other end. Things like bonds, equity (stocks and shares) occupy an intermediate position. Some (negotiable/promissory notes i.e. a promise to repay a debt) are so liquid that one can call them near money. Companies will accept them instead of money (with a slight discount to reflect their lesser liquidity)

So because these 3rd world debts are backed by the G8 and the US dollar, they are so secure that essentially these organisations use them as much as they do money. So if you look at the foreign reserves of a nation, you will find such debt (see point about negotiable notes above) alongside your more traditional notion of money/currency. And these actually make up a not inconsiderable amount in the total capital flows globally (more than a trillion a day).

Now, liquidity in capital markets is good, because it allows for capital flows from places which are capital rich but have lesser investment opportunities in terms of rate of return (say China, or any developed nation particularly current USA and western EU) to flow to capital poor areas (rest of the world). And at the same time, allows for a smoothening of interest rates e.g. when there is a sudden surge in demand or fall in domestic savings. Furthermore, the more money that flows, the greater the investment opportunities that arises because of lower interest rates (pure demand and supply, assuming demand stays the same, the higher the supply, the lower the interest rate) which in turn generates more growth and incomes globally.

So if you actually grant 100% debt relief, a lot of countries are going to see their foreign reserves take a hit. Also note that the US is not opposed to debt relief. In fact, because of the absurdities pointed out above, they are quite willing to go ahead. But they do have pretty stringent criterias for aid and debt relief i.e. countries must come up with their own plan and show that they are capable of pushing through with the plan. It is so stringent that only two countries thus far have qualified, Houndaras and Madagascar.

Anyway, this is why the UK plan comes in. Why not use the capital gains on the gold to fund the debt relief, thereby maintaining global liquidity and making it 'fair' to all. And it won't 'cost' a thing. The IMF is a little unhappy because this takes a chunk out of their personal coffers, something that grants them a modicum of independence from the G8 (especially the USA) and every other G8 nation is worried that this would cause a fall in the prices of gold which would make everyone else unhappy with them (and possibly have negative economic repecussions gloablly). I think The Economist argues that the French have been offloading gold for sometime to no ill effects so this plan could work.

My guess is that the US is being a little pissy over the entire issue because of the black hole that is developmental aid and the UK plan smacks too much of do-goodism without a proper consideration of whether it will actually be good for the nations involved. But even so, I think there is no real dicotomy between the two plans. Debt relief can still only be granted to the nations that show a willingness and capability to change. It's definately not a total substitute for aid, which is where America could come in with their checks and criterias.

Anyway, I think it's a good start (just hope it doesn't affect our foreign reserves which includes gold in its calculation) and I seriously hope that the relevant African nations finally get out of the rut they're stuck in.



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