CLARK GROUP PARTICIPANTS (Cont'd)

MAILING ADDRESS

Mr. Larry Brainard
V.P. and Sr. International Economist
Bankers Trust Company
Economics Department, P.O. Box 318
Church Street Station
New York, New York 10015
212-696-7601

IF USING FEDERAL EXPRESS,
ECT.

529 Fifth Avenue

Mr. David Rockefeller
30 Rockefeller Plaza
Room 5600
New York, New York 10112
212-247-3700

Mr. Walt Wriston
Chairman
Citicorp
39 Park Avenue
New York, New York 10041
212-559-4883

Mr. Mark Leland
Assistant Treasurer
for International Affairs
Room 3430
Depart. of Treasury
Washington, D.C. 20220
202-566-5363

The Honorable
Peter G. Peterson
Lehman Brothers, Kuhn, Loeb
One William Street
New York, New York 10004
212-558-1854

ARNOLD & PORTER

March 29, 1982

MEMORANDUM

TO: Henry A. Kissinger

FROM: William D. Rogers

RE: Clark Group

1. Contemporary Western practice with respect to sanctions against Soviet behavior is highly unsatisfactory.

-- Stop-start does not work. To sanction every irritant in the relationship is too episodic. Trade and financial relations are built over the long term. They cannot be turned off and on overnight.

-- Conventional sanctions are less effective every day. We have virtually exhausted the list of those measures which hurt the Soviets more than they hurt us.

-- In the past, sanctions have been announced and there has been no follow-through. Proclamations of truth, but no consequences, as some have called this practice. Our reputation for firmness and

ARNOLD & PORTER

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reliability suffers.

-- Finally, but not least, the present sanction practice is splitting the Alliance.

2. Yet it is unthinkable that the West, with the overwhelming share of the world's economic power, should continue to deal with the Soviet Union in the disorganized, disoriented way it has in the past.

-- The West must not repeat in the decade of the 1980's the mistake it made in the 1970's -- permitting the Soviet Union to alter the geopolitical balance where and how it wished at the moment it and its allies were gearing their economies to depend on Western resources.

-- Our banks are already hostage to the economic policy decisions of Moscow. For Western governments to tolerate the further mushrooming of credits to the East would expose the West to even more serious pressure from the East.

ARNOLD & PORTER

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3. The Soviet bloc is increasingly dependent upon credits and technology from the industrial democracies. Poland has made clear that the Communist economic system is rotting. This rot represents an historic opportunity for the West. Poland alone will require more than $2.5 billion of new Western credits this year just to keep its economy afloat.

-- The issue, in short, is not whether Poland should formally be declared in default. (Indeed, the Group is opposed to such a formal declaration. Default would only precipitate a competitive struggle between Western creditors over the meagre Polish assets still available in the West, and would decrease, not enhance, the prospects that Western banks and governments will be repaid.) The issue is whether Poland -- and all the other nations of the Soviet system -- will have access to future Western credits which they vitally require. That issue is of the highest political concern to nations of the Western alliance.

ARNOLD & PORTER

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4. The Group therefore conceives it to be a matter of the highest priority that the United States and its allies develop a coherent, long-term strategy to govern the economic relationship between the East and the West in the years ahead. It is the view of this group that political constraints must govern that relationship. The West should do this to preserve what is left of its own alliance, to avoid enhancing the vulnerability of its financial and trading institutions to political manipulation by the Soviets and over the long term to take advantage of what may be the most significant lever on Soviet behavior around the world.

-- The policy must be a coordinated Western policy. The United States can do little by itself. Even as to grain, a U.S.-only embargo would hurt us more than the Soviets unless Argentina, Canada and Australia went along.

-- Our policy must offer inducements and incentives as well as penalties. Carrots as well as sticks.

ARNOLD & PORTER

- 5 -

-- We are fully aware of the magnitude of this task. It will not be easy to persuade the Allies to go along. Earlier attempts have failed. It will be even more difficult to design a global bargain which will be at the same time adequately specific and comprehensive enough to take account of the contingencies of the future.

5. In the process we shall also have to determine the balance to strike in those negotiations between demands for concessions in Poland, in the nuclear arena, in conventional armaments, or as to Soviet and proxy behavior in the Third World.

6. But the Group is persauded that the time has come to try to design just such a comprehensive strategy. The problems of the West are serious problems of policy, but the problems of the Soviet system are structural and basic. To the West belong the vast bulk of the world's resources and its heritage of human values. It cannot be beyond the wit of the West's leadership to put

March 23, 1982

MINERALS AS STRATEGIC COMMODITIES

Out of the some 2000 minerals in the earth's crust about 100 are used industrially. Many of these are widely dispersed geographically and in abundant supply. Only a handful would be considered strategic and these would vary by country. Strategic minerals are those essential to the national economy, imported in large measure, and potentially in short supply if normal trade flows are interrupted. If supply is interrupted, substitutes can often be used but usually at a greater cost and after some passage of time.

The Eastern Bloc is relatively well off in reserves and in production of strategic materials except possibly for cobalt, for which they are importing 68% of their requirements.

The Western World is also largely self-sufficient in strategic minerals or metals without the necessity of significant imports from the Eastern Bloc countries. However, the major industrial nations in this group are dependent upon imports from developing countries for a substantial proportion of their needs. The United States and its allies are more vulnerable to interruption of supplies from these sources than is the Eastern Bloc. South Africa, Zaire, Zambia, and Zimbabwe are critical suppliers of strategic minerals.

Of 14 strategic minerals or metals, there are 7 for which the United States is importing more than 85% of its requirements: bauxite; chrome; cobalt; columbium, manganese; the platinum group; and tantalum. These are available outside the Eastern Bloc but supply sources are heavily concentrated. Of the world's reserves:

99% of chrome is in South Africa and Zimbabwe
50% of cobalt is in Zaire and Zambia
90% of columbium is in Brazil
81% of platinum group is in South Africa

The U. S. currently imports 3 metals of major importance from the U.S.S.R.: chromium; the platinum group; and titanium as sponge metal.

The United Kingdom is 100% dependent on imports for 7 of its 8 critical materials (chromium; cobalt; tungsten; manganese; vanadium; molybdenum; columbium; and the platinum group).

Japan and our other Western allies are similarly dependent on imports for the minerals critical to their economies.

The U.S.S.R. has historically imported only 5 of the 40 strategic and critical minerals it needed - tin, bauxite and alumina, fluorine, antimony, and tungsten. It has been a leading producer of manganese and asbestos and exported these to OECD countries. Although it releases no figures, the U.S.S.R. has earned large amounts of foreign exchange

[L.C.]

2.

by exporting gold and platinum group metals. However, the U.S.S.R. mineral trading patterns have shifted in the last year away from the country's long-standing obsession with self-sufficiency. The U.S.S.R. has begun to import strategic materials for itself and its allies from countries whose output has traditionally gone mainly to the U. S. and its allies. The Soviets have moved from being net exporters to net importers of such strategic minerals as manganese, cobalt, chromium, platinum group, vanadium, tantalum, and titanium. Also on their buying list are beryllium, lithium, copper, lead, and zinc.

What has prompted this change is not clear. However it has brought the Soviets into competition with the West for the mineral resources of Africa and the rest of the Third World.

**South Africa** is the world's fourth largest nonfuel minerals producer. It has large and varied mineral wealth.

**China** is emerging as a larger exporter of strategic materials of importance for such high technology industries as defense, aerospace, and advanced electronics. Much of its mineral reserves are as yet undeveloped but the potential is huge.

**Table I** lists import dependence for critical minerals by countries or groups of countries.

**Exhibit II** comments in more detail on the more important strategic minerals, what they are used for, and what substitutes, if any, are available.

## Conclusion

The U.S.S.R. and the Comecon countries are not particularly vulnerable to a disruption of mineral supply sources. Indeed, these countries are, if anything, less vulnerable than the U. S. and its allies. The countries of Southern Africa occupy a critical position in assuring supplies of critical minerals to the West.

E. W. Littlefield

Strategic Minerals

Although government stockpiles and lists of "strategic minerals" can be quite extensive, a number of the materials are included because of current import volumes, without regard to stability and political alliance of sources, to substitutability of other materials for the import, or to the extent to which its consumption is discretionary.

For the 18 minerals often cited as critical and vulnerable imports, a brief explanation of their importance follows (Table 1 of this report compares import dependence for these minerals of the U.S., EEC, Japan and COMECON).

Vulnerable and possibly critical:

chromium - 
* U.S.S.R. and South Africa dominate chromite production
* South Africa has 68% of world reserves
* indispensable to stainless steel production
* no long term alternative to reliance on South Africa and Zimbabwe

cobalt - 
* concentrated in developing countries (especially in Africa)
* vital to aerospace and electrical products
* nickel may be substituted in several uses, but less effectively
* sufficiently high prices could bring on some U.S. production after some time lag

manganese and ferromanganese -

* no satisfactory substitutes

* approximately 90% of world production is from Eastern bloc, South Africa or developing countries

* seabed resources may eventually provide alternative sources

* the U.S. has no manganese deposits

platinum - 
* used for catalytic and corrosion-resistant properties

* primary sources as COMECON and South Africa

* scrap recycling and substitution by more readily available gold, silver and tungsten could reduce vulnerability

* much usage in Japan is for luxury, not critical, items

Less vulnerable minerals:

titanium (rutile) and titanium metal sponge -

* important aircraft and defense use

* no known substitutes for titanium metal in aircraft and space use

* rutile ore is available from allies (mostly Australia)

* U.S. imports are an economic choice - low grade local reserves could be utilized and sponge metal (currently produced in Japan and the U.S.S.R.) could be produced here.

vanadium - 
* alloy used in high-strength steel for aircraft, etc.

* U.S. reserves would, with time, replace South African and Chinese supplies

* substitutes are available

* reserves currently held would mitigate the impact of disruptions

And in practical terms it may prove almost as effective.

First announced on April 3, details of the freeze were spelled out on Tuesday by the Bank of England.

The essential difference is that the British government is not attempting to impose its order on banks outside its

the continued functioning of the international banking system. The 10-day delay between publication of the original British government order and the details of the order published Tuesday is explained by the fact that the British authorities took extensive advice

→ Argentina: Page 20

# Reagan, Bankers Meet on Soviet Bloc

By JAY ROSENSTEIN

WASHINGTON — President Reagan met with banking industry officials and others Tuesday to discuss United States economic policies toward Soviet bloc countries.

The group, organized by former Secretary of State Henry A. Kissinger, had been requested by the White House to present views on East-West economic relations and credits, accord-

## INSIDE

### New NAMSB Chairman Nominated

Herbert W. Gray, chairman of Mutual Bank for Savings, Boston, has been nominated chairman of NAMSB................................2

### A New Approach for Thrifts

Anthony M. Frank, the California S&L executive behind the first interstate takeover of failing thrifts, has suggested a new approach to deal with the troubled Fidelity Savings and Loan Association, San Francisco................3

### Before the Courts

Significant lawsuits before federal and state courts that affect the financial services industry and its regulators are listed........3

### Fed Rebuffs CRA Protest

The Federal Reserve Board, over protests of a community group, allowed NBD Bancorp, Detroit, to acquire a Michigan bank........3

### 'The New Television'

New television technologies can provide businesses with a megapunch medium: MARKETING MANAGEMENT................................................................4

### Getting Going on Deregulation

A Presidential committee on deregulation might help the wheels in Washington turn, wheels slowed partially by those being regulated: REQUIRED READING................................4

### EFT Priorities on the West Coast

West Coast community banks in a survey ranked automated teller machines as a major electronic project over the next few years: OPERATIONS & TECHNOLOGY................................14

Bank Stocks................................................................6

ing to an Administration aide here.

The Administration and those attending the meeting declined to comment.

The White House said bankers scheduled to attend the afternoon meeting with the President were David Rockefeller, former chairman of Chase Manhattan Corp.; Lawrence J. Brainard, vice president and senior international economist at Bankers Trust Co. of New York; Willard C. Butcher, chairman of Chase Manhattan Corp.; Elvis L. Mason, chairman of InterFirst Corp. of Dallas; and Walter B. Wriston, chairman of Citicorp.

Also scheduled to attend were Mr. Kissinger; William D. Rogers of the Washington law firm of Arnold & Porter; George P. Shultz, former Treasury Secretary and now president of Bechtel Group Inc.; Edmund W. Littlefield, chairman of the executive committee of Utah International Inc.; and Peter G. Peterson, chairman and president of Lehman Brothers Kuhn Loeb Inc. ■

equity to fit the market in a week.

Similar in some respects to a recently proposed offering of "equity notes" by Manufacturers Hanover Corp. — but quite different in others — Chase plans to sell $150 million in 10-year notes with contracts attached obligating the holder to purchase a specified number of common shares at a future date. In the same prospectus, an offering is included for $175 million in zero-coupon notes.

Although not directly related to the

# Does Mammoth We

By LAURA GROSS

NEW YORK — The group of six western bank holding companies which just announced a decision to explore joint service offerings could someday — laws permitting — become one gigantic bank holding company, chief executives of two of the institutions said Tuesday.

"Big trees do grow from little acorns judiciously planted," said Berne Hart, president and chairman of United Banks of Colorado, Denver. "Of course, such a possibility is at this point purely speculative."

His colleague at Valley National Corp., Roger A. Lyon, president, agreed that "anything is possible; at this stage we could do anything." He added, "Who knows where this is going to go. I do hope it is a little acorn which grows into something big, but more than that I hope our customer bases are

## BARCLAYS VISA SERVICE WILL
KEEP YOU SMILING.

Barclays Visa account representatives have only one job: keeping you happy with Barclays service. Find out how good—good service can be. Contact John C. Hayes, Vice President, Barclays Bank, Travelers Cheques Division. Call collect: (212) 233-1511.

GO PLACES WITH THE LEADER

AUGERSOJ

April 12, 1982

VSN: 4 Pack= 4

I. The Issues

We are entering an era of deep and dangerous change in
our relations with the Soviet Union. Its leadership is in
transition. Its ability to transfer power smoothly is no
greater now than it has been for the past sixty years. Its
economy is in difficulty, its relations with its neighbors
troubled in every quarter from Poland around to China, and it
seems unable for domestic reasons and unwilling for ideological
ones to relax its headlong pursuit of military power.

For our part, the changing nature of East-west relations
has introduced new strains into the Alliance. Western
financial banks are exposed in the East. Official Western
trade practices are undisciplined and unsettled. Western views
on nuclear policy and the meaning of Third world ferment in
~~El Salvador~~ and elsewhere for the superpowers are sharply
divided.

The manifest consequences of these new conditions of
East-west relations have been two:

-- an increase in Soviet adventurism, and

-- an erratic response by the industrial democracies
to that adventurism.

April 12, 1982

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A. Even in "crisis-free" conditions, the economic relationship between East and West has been permitted to tilt toward the Soviets.

-- From the theoretical economic standpoint, trade takes place only when it is to the mutual advantage of both parties: trade is a plus not a zero sum game. But the gains from trade are not always evenly distributed. The division of the gain between two parties is the subject of the bargaining process (including the use of non-economic trade-offs).

-- Both buyers and sellers can be severely squeezed by over-dependence on one buyer or seller. This factor has always led prudent buyers and sellers to diversify sources and markets.

-- The USSR sums buyers or sellers together when it approaches a western market, typically buying through a purchasing commission. The Western side, by contrast, is characterized by many participants and collaboration among U.S. sellers is often banned by our anti-trust laws. The result is that the USSR is a coordinated market participant, while the Western side lacks coordination.

ROGERSTV

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-- Another special and increasingly unfavorable feature of recent East-West trade involves the non-material (technological) aspects of our export transactions. The principal items from the East of interest in the West are raw materials: oil, timber, minerals. They contain no ideas as articles for sale. Western manufactured goods sold to the East, by contrast, are typically loaded with scientific and engineering ideas.

-- Thus, broadly speaking, the balance of relative advantage seems somehow to have been turned upside down. One would think that the primitive Soviet economy would have more to gain from East-West trade. A kind of dependency on advanced products, let alone grains, should have developed by now. But reality appears to be otherwise. Producer pressures and concern about rippling effects of a financial squeeze have put more apparent pressure on the West than on the East.

-- In the financial arena, furthermore, the record shows that western governments bear a major share of the responsibility for the uncontrolled expansion of East block, and particularly Polish, debt in the

April 12, 1982
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period after 1975. Loans were offered in the name
of Ostpolitik or export promotion with little or
no consideration of ability to use or repay the
funds. There has been no clearly defined policy
toward Eastern Europe. In 1976, the Ford
Administration initiated an effort within the OECD
to examine the implications of East-west trade and
credits and to develop a framework for managing
these relations. The Carter Administration
abandoned the effort. The result was a leadership
vacuum. Europe saw little reason not to pursue
narrow economic interests without reference to the
broader security concerns of the Western Alliance.
The consequence was a massive rise in Western credit
to the East.

B. Even more significantly, perhaps the West has been singularly unable to turn its trade and financial power to advantage during times of East-West crisis. Poland and Afghanistan taught stern lessons. They made it embarrassingly clear that we have no effective Alliance sanctions policy against Soviet adventurism.

-- We have learned that stop-start sanctions do not work. To respond with new pin pricks to every irritant in the relationship is too episodic. Trade

April 12, 1982
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-- Conventional sanctions are increasingly ineffective.
We are close to the bottom of the list of trade
measures which hurt the Soviets more than they hurt
us. Witness the difficulty over grain and the gas
pipeline.

-- In the past, sanctions have been announced but there
has been no follow-through. "Ringing proclamations
of truth, but no consequences," as George Shultz
puts it. Our reputation for firmness and
reliability suffers.

The West possesses the overwhelming share of the world's
economic power. Given the stakes -- and the opportunities --
is unthinkable that we should continue to deal with the Soviet
Union in the disorganized way we have in the recent past. The
West must not permit the Soviets to assult the geopolitical
balance without penalty or to solve its economic problems by
means of Western aid without paying the political price -- if
that is the right word -- of restraint and stability in
international conduct.

April 12, 1982
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-- To act otherwise is to license Soviet adventurism.

-- It also risks exposing the Western trade and financial system to greater Soviet pressure. Our banks become hostage to economic policy decisions made in Moscow.

-- But most important, it would forego the most effective means available for arranging a comprehensive understanding between the two superpower systems, including both political and economic components.

Poland made clear that the Communist economic system is rotting. Poland alone will be asking for billions of fresh western credits this year just to keep its economy afloat. This rot represents an historic opportunity for the west.

The issue which deserves priority attention is not what to do about the past -- not whether Poland should formally be declared in default, for a particular example. (Indeed, the majority of the Group is opposed to a formal declaration of default. It holds that default on the Polish debt might precipitate a race between Western creditors for the meager Polish assets left in the west.) The issue is an issue of the long-term future: whether and on what terms the nations of the Soviet system will enjoy access to Western trade and financial resources in the years to come.

April 12, 1982
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II. The Options

The Group conceives it to be a matter of the highest
priority that the United States and its allies design a
coherent strategy to govern the future economic relationship
between the East and the West in the years ahead. We see the
issue as yielding three broad options to official policymakers:

-- the first option is the option of economic warfare

-- a policy of attempting to force the Soviet system
to its knees, based upon the premise that the stern
and unrelenting pressure of trade and financial
denial will over time lead to fundamental change
within the Soviet system.

-- the second option would be a period of disciplined
    economic pressure designed to open the door to
    comprehensive negotiations between the East and the
    West. These negotiations would look, on the one
    hand, to the articulation of canons of restraint
    in matters of concern to the respective sides, and,
    on the other, would explore principles of enhanced
    cooperation and mutual economic accommodation.

-- the third option would be to continue the practices
  of the past, permitting trade and financial

April 12, 1982
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-8-

relations to turn largely on market considerations,
with an occasional uncoordinated governmental
intervention, in the hope that expanding trade and
a thickening network of economic ties will somehow
in the natural course of things lead to an
amelioration of the Soviet system.

The Group leans to the second course. It is the view
of the majority that considerations of overall political
strategy must govern the economic relations between East and
west in the future. The market test must be a necessary, but
it is not a sufficient, condition to regulate future trade and
financial transactions. Bankers and traders can be relied on
to apply that market test. But Western governments must design
a political framework for the economic links: -- to preserve
their own alliance, diminish the prospects that their financial
and trading institutions will be vulnerable to manipulation
by the Soviets and over the long term to take advantage of the
most significant lever available on Soviet behavior.

We believe that a period of coordinated restraint by
the West may achieve these objectives. It could lead
to a period of years ultimately to a wide expansion of economic contacts and trade
and credit in return for real restraint in Soviet conduct --
a comprehensive economic deal for a comprehensive political
deal, in other words. But such an effort will require careful
analysis of at least four related issues:

April 12, 1962
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1. First, we must decide exactly what it is we want.

We must strike a balance beforehand between demands for political liberty in Poland and the other East bloc countries, for agreement in the nuclear arena, for conventional armament reductions and for restraint in Soviet and proxy behavior in the Third world.

2. Second, we must determine what the West is prepared to do. This includes both the question of what trade restraints the United States will impose on its exports and imports from the Soviet bloc, and what trade measures we can and may expect to arrange with Europe. To take an important illustration, it may well be that with respect to the gas pipeline it would be more effective not to attempt any further cut off of the first line but to bring pressure to bear with respect to the second, and to that end rely primarily on the development of alternative sources of supply.

3. The third issue is to develop in the West a new understanding of the real purpose of sanctions. The problem has been particularly difficult in the past for the Europeans because they have conceived that we were reaching for the first option -- economic warfare -- rather than the second -- disciplined economic pressure designed to lead to positive understanding. But the United States cannot act effectively

April 12, 1982
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by itself. Even as to grain, an embargo would hurt us more
than the Soviets unless Argentina, Canada and Australia
cooperate. The Group believes that the chances that our Allies
will go along in the future will be markedly increased if there
is clear agreement about the framework and the ultimate purpose
of our policy.

4. The fourth problem is to define <u>what we are prepared</u>
<u>to offer the Soviets economically</u>, supposing that a
comprehensive arrangement is possible.

The Group is persuaded that in designing such a strategy
we hold a far stronger hand than the Communists. The problems
of the West are serious problems of policy. The problems of
the Soviet system are structural and basic. To the West belong
the vast bulk of the world's resources and its heritage of
human values. It cannot be beyond the wit of leadership to
put together a strategy which takes full advantage of the
historic opportunity before us.

III. The Next Step

The effort should be initiated at the Versailles summit
conference. The proposal should include but go beyond the
Buckley Mission's call for harmonization of official credit
policies and exchange of financial information.

April 12, 1982
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-- We should prepare a comprehensive declaration which would establish the principles of common policy within the Alliance (excluding nuclear issues) for dealing with the Soviet Union. We would make clear that the West sees its relations with the East in terms far broader than military -- economic, cultural, social and ideological.

-- within this framework, the Versailles initiative would emphasize that the strength of the west turns on its ability to speak to the East with one voice. It would suggest that the West consider a number of specific and concrete measures to improve coordination and discipline. These might include:

(1) A commitment to update regularly the common list of prohibited exports.

(2) A mechanism for exchanging information among all OECD governments about new credits to the East, public and private.

(3) An Alliance institution to conduct an intensive ongoing country risk review of the East bloc economies, drawing on the facilities of the IMF and the private banks, but under the mandate of the Alliance governments.

POGERSO!

April 12, 1982

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(4) An agreement to review regularly and actively the respective policies on export credits and financial guaranties, with a commitment to establish a common and non-competitive policy in this area among all the OECD members.

(5) Concomitantly, an agreement to harmonize or eliminate all government subsidies in such credits.

(6) An informal clearing house for information and communication among all western banks active in Eastern Europe, with which the Allied governmental mechanisms referred to above may coordinate policy.

(7) Above all a definition of the ultimate goal of what economic incentives we can offer as governments and what we desire in return. We must, in short, define both the tools at hand and our ultimate objectives.

The deterioration of the Soviet system is a danger and an opportunity for the West. An effective Western response along the lines proposed here should be seen in the same ambiguous way by the Soviet Union -- as a threat that the West will respond in a more disciplined fashion to future Soviet assults on the international system, and as a promise that there are real benefits at hand in the form of Western economic cooperation if the Soviet Union is prepared to conduct itself with the restraint that our dangerous age demands.

EIR

Executive Intelligence Review

304 West 58th Street, New York, N.Y. 10019, (212) 247-8820

December 10, 1984

Dear Talk Show Hosts and Producers:

Would you like to have as guests on your show intelligence specialists and foreign and domestic correspondents who have the inside scoop on news events weeks before the networks and the national press?

Executive Intelligence Review, the exclusive news magazine founded 10 years ago by economist Lyndon H. LaRouche, Jr., is expanding its press services to include a radio and television division that can provide you with regular talk show guests on political and economic issues of importance.

EIR's record speaks for itself in every major area:

* Who runs world terrorism? Three weeks before Egyptian President Mubarak documented the links of Libya's Qaddafi to the murder of Indian Prime Minister Gandhi, EIR had exposed the Qaddafi terrorist connection to this and other crimes. And EIR exposed the Bulgarian connection to the assassination attempt against the Pope more than a year before it broke in the rest of the U.S. press.

* Where is the economy headed? Since their initiation four years ago, EIR's quarterly economic reports have been more accurate in their predictions than Chase Econometrics, the Wharton School, and _all_ the other major economic think tanks. EIR's economic analysts don't have to guess; they know how the world economy actually works.

* What are the Soviets up to? EIR's Soviet watchers don't just read the news that the Soviets print for export; they read and listen to _all_ the Soviet media. For example, EIR has been documenting the Soviet's crash program for beam weapon defense in detail since 1977--while most of the other major press is still parroting Soviet propaganda about a "ban on weapons in space."

* Is there really "overproduction" in our farm sector? The answer is no, and EIR agriculture experts have caught the U.S. Department of Agriculture lying with statistics. As EIR has documented, the U.S. family farmer--the most productive agricultural sector in the world--is being forced out of business by a few Swiss-linked cartels who want to produce less food in order to feed fewer people.

MORE

-2-

* What are our allies thinking? EIR's correspondents based around the world provide an inside picture of what is really going on, not just what the Eastern Establishment media want Americans to hear. From the debtors cartel in Latin America, to defense policy in Europe, to separatist movements in the Mideast and Asia, EIR has provided the kind of news analysis that governments listen to.

EIR is also well known for its controversial articles on the moral crisis facing the nation. Specifically, our correspondents have documented how euthanasia is a Nazi policy and who is backing it today; the drug epidemic, who's financing it and why; the decline in education and the role of the National Education Association in destroying America; who's pushing homosexuality--and population control; the role of rock music in destroying the ability of youth to think.

Correspondents on these topics and many others are available for scheduling on talk shows by phone and in person. Sample copies of EIR are also available upon request. If you are interested, please give me a call at (212) 247-8820.

Yours sincerely,

Robyn L. Hyman
EIR Press Services,
Radio and Television Division

P.S. For your convenience, I have attached a partial list of correspondents available this month.

RH:mc

FIRST DRAFT

2-11-82

GOVERNMENTAL ACTION vs. INTERNATIONAL LENDING

THE POLISH CRISIS HAS GIVEN RISE TO A BLIZZARD OF ARTICLES AND
EDITORIALS AS TO HOW TO DEAL WITH THAT NATION'S APPROXIMATELY
$16 BILLION OF EXTERNAL DEBT THAT IS OWED TO SOME 500 WESTERN BANKS.
IT WASN'T SO LONG AGO THAT AN EARLIER MEDIA BLIZZARD DEALT WITH THE
BILLIONS OF EXTERNAL DEBT OWED BY IRAN TO A NUMBER OF THE SAME BANKS.
IN THE MEANTIME, LIGHTER FLURRIES OF MEDIA COMMENT HAVE DEALT WITH
THE EXTERNAL DEBT OF ZAIRE, NICARAGUA, COSTA RICA AND TURKEY.

THE VAST PREPONDERANCE OF THESE ARTICLES AND EDITORIALS - IRRESPECTIVE
OF THE MERIT OF THE ACTIONS THEY ESPOUSE OR THE CONCLUSIONS THEY
REACH - REFLECT, TO VARYING DEGREE, A MISUNDERSTANDING OF THE ECONOMIC
RATIONALE, LEGAL BASIS AND ACCOUNTING TREATMENT OF INTERNATIONAL
LENDING TRANSACTIONS.

ACCORDINGLY, HOPING TO AVOID INVOLVEMENT IN CONTROVERSIAL POLITICAL
POSITIONS, THIS ARTICLE IS DIRECTED TOWARD EXPLAINING, IN AS FACTUAL
A MANNER AS PRACTICABLE, THE BUSINESS OF INTERNATIONAL LENDING BY
PRIVATE BANKS.

PERHAPS THE FIRST POINT TO DEAL WITH IS WHY BANKS ENGAGE IN INTER-
NATIONAL LENDING AT ALL. THE ANSWER, NOT SURPRISINCLY, IS BECAUSE IT
IS PROFITABLE - EVEN TAKING INTO ACCOUNT THE ATTENDANT CREDIT AND
POLITICAL RISKS. AND WHAT MAKES IT PROFITABLE IS THE ACCELERATING
TREND TO A SINGLE, INTERDEPENDENT GLOBAL ECONOMY.

- 2 -

AS PEOPLE, EVEN IN THE MOST REMOTE PARTS OF THE WORLD, BECOME MORE AND
MORE AWARE OF THE DIVERSITY AND ABUNDANCE OF PRODUCTS AND SERVICES CREATED
IN VARIOUS PARTS OF THE GLOBE, DEMAND FOR THESE PRODUCTS AND SERVICES
HAS RISEN. IT HAS ALSC BEEN RECOGNIZED THAT FOR PEOPLE OR INSTITUTIONS
IN ONE PART OF THE GLOBE TO ACQUIRE PRODUCTS AND SERVICES PRODUCED IN
ANOTHER PART OF THE WORLD, PAYMENTS MUST BE MADE IN AN INTERNATIONALLY
ACCEPTABLE CURRENCY GENERATED, FOR THE MOST PART, BY THE PRODUCTION OF
OTHER GOODS AND SERVICES.

AN ILLUSTRATION: NATURAL GAS OWNED BY INDONESIA'S OIL AGENCY, PERTAMINA,
FLOWS OUT OF A WELL DISCOVERED BY ROYAL DUTCH SHELL INTO A LIQUIFICATION
PLANT DESIGNED BY FRENCH ENGINEERS AND BUILT BY A KOREAN CONSTRUCTION
COMPANY. THE LIQUIFIED GAS IS LOADED ONTO U.S. BUILT AND REGISTERED
TANKERS, USING A NORWEGIAN DESIGN. THE SHIPS SHUTTLE TO JAPAN AND
DELIVER THE LIQUID GAS TO A LOCAL PUBLIC UTILITY WHICH USES IT TO PRO-
DUCE ELECTRICITY THAT, AMONG OTHER USES, POWERS AN ELECTRONIC FACTORY
THAT MAKES TELEVISION SETS THAT ARE SHIPPED ABOARD A HONG KONG
CONTAINERSHIP TO THE WEST COAST FOR DELIVERY TO AMERICAN FARMERS IN
LOUISIANA THAT GROW RICE WHICH IS SHIPPED, AMONG OTHER PLACES, TO
INDONESIA ABOARD CREEK BULK CARRIERS. ALL OF THE VARIOUS FACILITIES,
SHIPS, PRODUCTS AND SERVICES INVOLVED IN THIS COMPLEX SERIES OF EVENTS
ARE FINANCED BY U.S., EUROPEAN AND JAPANESE COMMERCIAL BANKS WORKING
IN SOME CASES WITH INTERNATIONAL AND LOCAL GOVERNMENTAL AGENCIES. THE
FACILITIES, SHIPS, PRODUCTS AND SERVICES ARE INSURED AND RE-INSURED BY
U.S., EUROPEAN AND JAPANESE INSURANCE AND RE-INSURANCE COMPANIES.
INVESTORS IN THE VARIOUS FACILITIES, SHIPS, PRODUCTS AND SERVICES ARE
LOCATED THROUGHOUT THE WORLD.

- 3 -

THE ILLUSTRATION IS FACTUAL. IT IS MENTIONED HERE NOT BECAUSE IT REPRESENTS A UNIQUE SET OF INTERNATIONAL COMMERCIAL RELATIONSHIPS. RATHER IT IS REPLICATED BY SIMILAR TRANSACTIONS OVER AND OVER AGAIN THROUGHOUT THE GLOBE. THE MAGNITUDE AND PACE AT WHICH THE INCREASINGLY INTERDEPENDENT GLOBAL CEREMONY IS MOVING IS REFLECTED IN TABLE I.

THE LARGE INTERNATIONAL COMMERCIAL BANKS HAVE FACILITATED THE PROCESS BY EXTENDING CREDIT ACROSS NATIONAL BORDERS TO PRIVATE, QUASI-PRIVATE AND GOVERNMENTAL BORROWERS. THIS CREDIT TAKES THE FORM OF SHORT, MEDIUM AND LONG-TERM FINANCING IN THE FORM OF LOANS, LETTERS-OF-CREDIT, GUARANTIES AND SECURITIES UNDERWRITING AND DISTRIBUTION. THE MAGNITUDE AND PACE OF THESE INTERNATIONAL CREDIT TRANSACTIONS HAS MATCHED THE PACE OF INTERNATIONAL TRADE. SEE TABLE II.

BECAUSE THE NUMBER OF INTERNATIONAL BANKS WHO HAVE THE SIZE, EXPERTISE AND CAPITAL TO ENGAGE IN THESE INTERNATIONAL FINANCIAL TRANSACTIONS IS RELATIVELY LIMITED AND THE CREDIT, POLITICAL, CURRENCY AND RATE RISKS INVOLVED ARE RELATIVELY COMPLEX TO EVALUATE AND ASSUME, THE RESULTING PROFITS ARE RELATIVELY GENEROUS.

THERE IS, OF COURSE, NO REASON WHY THE GOVERNMENTS OF THE COUNTRIES IN WHICH THE INTERNATIONAL BANKS HAVE THEIR LEGAL COMICILE COULD NOT, IF THEY CHOSE, PRE-EMPT THE ROLE OF THE BANKS IN AN EFFORT TO REAP THE PROFITS THAT RESULT FROM INTERNATIONAL FINANCING. WERE THIS TO HAPPEN, I FEAR, HOWEVER, THAT OVER TIME, THE INEFFICIENCIES OF NON-PROFIT MOTIVATED BUREAUCRACIES AND THEIR SUSCEPTIBILITY TO SHORT-TERM POLITICAL INFLUENCES WOULD BRING THE INTERNATIONAL CREDIT SYSTEM TO A GRINDING HALT. NEVERTHELESS, GOVERNMENT PRE-EMPTION IS POSSIBLE.

HAVING DETERMINED THAT INTERNATIONAL LENDING IS AN IMPORTANT AND,
FOR THE BANKS, PROFITABLE PART OF THE GLOBAL ECONOMY, IT MIGHT BE WORTH
DEALING WITH SOME OF THE TECHNICAL ASPECTS OF PCW INTERNATIONAL LENDING
IS CONDUCTED.

USUALLY THE TRANSACTION STARTS WITH AN INSTITUTIONAL BORROWER IN
ONE COUNTRY APPROACHING ONE OR MORE PRIVATE COMMERCIAL BANKS DOMICILED
IN ANOTHER COUNTRY FOR A LOAN. IT MAY WELL OCCUPY THAT BANKS WILL
ORGANIZE SYNDICATES AND OFFER PROSPECTIVE BORROWERS COMPLETING FINANCING
PROPOSALS; HOWEVER, THE POPULAR VISION OF BANKERS BEGGING TO THROW
MONEY AWAY IS REALLY INACCURATE. THE BORROWER MAY BE A PRIVATE
CORPORATION, AN AGENCY OF A GOVERNMENT, OR A GOVERNMENT ITSELF. THE
TERMS OF THE LOAN PROPOSALS ARE REVIEWED, NEGOTIATED, AGREED UPON AND
REDUCED TO WRITING. NORMALLY THEY INVOLVE THE PURPOSE, CURRENCY AND
PRINCIPAL AMOUNT OF THE LOAN; THE INTEREST PAYABLE; THE REPAYMENT TERMS
AND MATURITY OF THE LOAN; THE NATURE AND EXTENT OF ANY GUARANTIES OR
COLLATERAL TO SECURE THE LOAN; AND THE RESPECTIVE ADDITIONAL PROMISES
OR CONVENANTS TO BE OBSERVED BY THE BORROWER.

THE LOAN AGREEMENT, DEPENDING ON THE COMPLEXITY OF, AND THE LAWS
GOVERNING, THE TRANSACTION CAN RUN FROM ONE TO HUNDREDS OF PAGES.
UNIVERSALLY, HOWEVER, THE DOCUMENTS PROVIDE THAT IF THE BORROWER
(WHETHER PRIVATE CORPORATION, GOVERNMENTAL AGENCY, OR GOVERNMENT) FAILS
TO COMPLY WITH ONE OR MORE OF ITS OBLIGATIONS, THEN A "DEFAULT" (AS
DEFINED IN THE LOAN AGREEMENT) OCCURS. IF DEFAULT HAS NO SIGNIFICANCE
IN AND OF ITSELF - IT HAS EITHER OCCURRED OR IT HAS NOT OCCURRED.

- 5 -

IF THE EVENT OF DEFAULT (SAY, A FAILURE TO PAY PRINCIPAL OR INTEREST WHEN DUE, A FAILURE TO OBSERVE A COVENANT, OR A DEFAULT IN PAYMENT OF INDEBTEDNESS OWED TO OTHER LENDERS) HAS OCCURRED, THEN THE LENDING BANK OR BANKS HAVE THE OPTION (1) TO DO NOTHING, BUT WITHOUT PREVICICING RIGHTS TO TAKE LATER ACTION; (2) TO EXPRESSLY WAIVE THE DEFAULT AND PERHAPS REVISE THE LOAN AGREEMENT BY RESCHEDULING THE DATES FOR PRINCIPAL AND/OR INTEREST PAYMENTS OR REDRAFTING ONE OR MORE OF THE APPLICABLE COVENANTS; OR (3) TO DECLARE THE ENTIER DEBT TO BE IMMEDIATELY DUE (THIS LAST ALTERNATIVE BEING COMMONLY CALLED AN "ACCELERATION" OF THE DEBT). WHICHEVER COURSE THE LENDERS FOLLOW, THE DEBT REMAINS OUTSTANDING.

IF THE LENDING BANK OR BANKS ELECT TO ACCELERATE THE DEBT AND THE DEBTOR DOES NOT PAY IN FULL, THEY HAVE AVAILABLE A NUMBER OF REMEDIES. IF THEY HAPPEN TO HOLD DEPOSITS OF THE DEBTOR, THEY CAN "SET-OFF" THESE DEPOSITS AGAINST, AND UP TO THE AMOUNT OF, THE DEBT (THIS WAS THE CASE IN THE IRANIAL DEBT ACCELERATION). IF THEY HAPPEN TO HOLD GUARANTIES OR COLLATERAL FOR THE DEBT, THEY CAN PROCEED AGAINST THE GUARANTOR(S) OR FCRECLOSE ON THE COLLATERAL. IF THEY HAVE NEITHER DEPOSITS, GUARANTIES OR COLLATERAL, THEY CAN PROCEED TO LOCATE AND ATTEMPT TO SEIZE AND SELL, BY APPROPRIATE LEGAL PROCESS, PROPERTY BELONG TO THE DEBTOR.

WHETHER THE DEBTOR IS A PRIVATE CORPORATION, GOVERNMENT AGENCY OR GOVERNMENT, THE LENDING BANKS CAN PROCEED TO EXERCISE THEIR AVAILABLE REMEDIES BOTH WITHIN AND OUTSIDE THE COUNTRY OF THE DEBTOR'S DOMICILE USING AVAILABLE LEGAL PROCEDURES. SINCE, HOWEVER, LEGAL PROCEEDINGS BROUGHT IN LOCAL COURTS OF THE COUNTRY IN WHICH THE BORROWER HAS ITS DOMICILE MAY, FOR REASONS OF NATIONAL SELF INTEREST, BE INEFFECTIVE OR, AT BEST, SLOW, THE LENDERS USUALLY INCLUDE IN THE LOAN AGREEMENT PROVISIONS BY WHICH THE BORROWER ALSO SUBMITS TO THE INITIATION OF

- 6 -

LEGAL ACTION IN COURTS LOCATED OUTSIDE THE COUNTRY OF ITS DOMICILE.
THESE PROVISIONS OFTEN INCLUDE WAIVERS OF THE DEFENSE OF SOVEREIGN
IMMUNITY, CONSENTS TO ATTACHMENT AND AGREEMENTS THAT A "NEUTRAL" BODY
OF LAW WILL APPLY TO THESE EXTERNAL LEGAL ACTIONS. INCORPORATING, AS
DISCIPLINES IN THE INTERNATIONAL LENDING ARENA TIGHTEN, GOVERNMENT
AGENCY AND GOVERNMENT BORROWERS ARE WILLING TO ACCEPT, AND LENDERS
ARE INSISTING ON, PROVISIONS OF THIS TYPE.

PRIVATE CORPORATE BORROWERS AND SOME INCORPORATED GOVERNMENT AGENCY
BORROWERS WHICH FIND THEMSELVES UNABLE TO PAY THEIR DEBTS OR TO
PERSUADE THEIR LENDERS TO RESCHEDULE THEM MAY, ON THEIR OWN INITIATIVE
OR THAT OF THE LENDERS, BECOME SUBJECT TO BANKRUPTCY PROCEEDINGS.
THESE PROCEEDINGS, USUALLY CONDUCTED IN THE COURTS OF THE BORROWER'S
LEGAL DOMICILE (AND THEREFORE ALSO SUBJECT TO MOTIVES OF NATIONAL
SELF-INTEREST), MAY RESULT IN EITHER A MANDATORY RESCHEDULING OF THE
DEBT OR A LIQUIDATION OF THE BORROWER AND A DISTRIBUTION IF ITS ASSETS
TO ITS CREDITORS.

HOWEVER, THERE SIMPLY IS NO MECHANISM FOR A NATIONAL GOVERNMENT TO BE
THROWN INTO, OR TO INITIATE, BANKRUPTCY PROCEEDINGS. THE CLOSEST THING
TO IT IS WHEN THE GOVERNMENT BORROWER AND ITS LENDERS AGREE TO ACCEPT
THE INTERNATIONAL MONETARY FUND AS THE CATALYST FOR, ON THE ONE HAND,
SUGGESTING CORRECTIVE FISCAL AND MONETARY POLICIES FOR THE GOVERNMENT
BORROWER AND SUGGESTING A DEBT RESCHEDULING AS PART OF THOSE POLICIES.
THE WHOLE PROCESS IS, HOWEVER, VOLUNTARY.

INTO THIS RATHER ORDERLY WORLD OF THE LEGALITIES OF INTERNATIONAL
LENDING THERE ENTER, ON OCCASION, UNANTICIPATED EVENTS WHICH
DRAMATICALLY CHANGE THE NATURE OF THE RELATIONSHIPS BETWEEN THE

LENDER BANKS AND THE BORROWERS. FOR EXAMPLE, GOVERNMENTS, USUALLY AS PART OF A REVOLUTION, ENACT DOMESTIC LAWS DISAPPEARING, OR MAKING IT ILLEGAL TO PAY, EXTERNAL DEBTS OF THE FORMER GOVERNMENT (RUSSIA DID THIS IN 1917, GERMANY IN 1934, UBA IN 1960). OR GOVERNMENTS HAVING JURISDICTION OVER SOME LENDER BANKS USE THE CREDIT AND DEPOSIT RELATIONSHIP WITH A FOREIGN GOVERNMENT AND ITS CORPORATIONS TO EXERT ECONOMIC PRESSURE (ENGLAND DID THIS WITH RHODESIA IN 1962, THE UNITED STATES WITH IRAN IN 1979).

WHEN THESE EVENTS OCCUR, THE LENDER BANKS, BEING PRIVATE ENTERPRISES, HAVE NO ALTERNATIVE BUT TO ADJUST TO THESE GOVERNMENT INTERVENTIONS AS BEST THEY CAN. UNLESS SPECIFICALLY PROHIBITED BY APPLICABLE LAW, THE BANKS CAN STILL SEEK TO EXERCISE THEIR AVAILABLE REMEDIES OF SETTING-OFF, EXERCISING RIGHTS AGAINST GUARANTORS OR COLLATERAL, AND ATTACHING AND EXECUTING ON DEBTORS' EXTERNAL ASSETS WHERE THEY CAN BE FOUND.

USUALLY, HOWEVER, AFTER A PERIOD OF TIME WHICH MAY BE AS SHORT AS A FEW YEARS (IN THE CASE OF IRAN) OR AS LONG AS SEVERAL DECADES (IN THE CASE OF GERMANY) INTER-GOVERNMENTAL OR PRIVATE AGREEMENTS ARE REACHED UNDER WHICH DEBT SERVICE IS RESUMED ON AN ADJUSTED BASIS. TABLE III INDICATES THOSE SITUATIONS WHICH HAVE OCCURRED WITHIN THE LAST 20 YEARS WHERE A GOVERNMENTAL ACT PRECLUDED REPAYMENT OF INTERNATIONAL DEBTS OWED TO PRIVATE COMMERCIAL BANKS AND, WHERE APPLICABLE, THE APPROPRIATE DATE RESCHEDULED REPAYMENTS WERE RESUMED. IT IS TO BE NOTED THAT ONLY CUBA'S DEBTS REMAIN UNRESOLVED.

FINALLY, IT WOULD SEEM TO BE WORTHWHILE TO SEE HOW THE COMMERCIAL BANKS AND THEIR REGULATORS DEAL WITH THE FINANCIAL REPORTING OF THEIR

- 8 -

INTERNATIONAL LOANS, BOTH THOSE IN GOOD STANDING AND THOSE NOT SO.

INTERNATIONAL COMMERCIAL LOANS (AS WELL AS ALL OTHER LOANS) ARE, SO LONG AS THEY ARE NOT IN DEFAULT AS TO PAYMENT OF PRINCIPAL OR INTEREST, CARRIED ON THE ASSET SIDE OF A BANK'S BALANCE SHEET AT 100% OF THEIR PRINCIPAL AMOUNT AND INTEREST THEREON IS ACCRUED PERIODICALLY ON THE BANK'S INCOME STATEMENT, IRRESPECTIVE OF THE DATES OF ACTUAL INTEREST PAYMENT.

IF AN INTERNATIONAL COMMERCIAL (OR OTHER) LOAN GOES INTO DEFAULT AS TO INTEREST, IT IS PUT ON A SO-CALLED "NON-ACCRUAL" OR "NON-PERFORMING" BASIS FOR _INCOME_ REPORTING PURPOSES. UNLESS THERE IS SPECIFIC REASON TO BELIEVE THAT THE PRINCIPAL OF THE LOAN WILL NOT ULTIMATELY BE PAID IN FULL, THE LOAN (EVEN IF ON A NON-ACCRUED BASIS) WILL CONTINUE TO BE CARRIED AT 100% OF PRINCIPAL AMOUNT FOR _ASSETS_ (OR BALANCE SHEET) REPORTING PURPOSES.

IF AN INTERNATIONAL COMMERCIAL (OR OTHER) LOAN IS IN DEFAULT IN INTEREST (AND THUS ON A NON-ACCRUED BASIS) AND ALSO IN DEFAULT AS TO PRINCIPAL INSTALLMENTS, THE LENDER BANK, ITS REGULATORS AND AUDITORS FACE A JUDGMENT CALL AS TO WHETHER THE LOAN SHOULD PROPERLY BE REFLECTED AS AN ASSET AT 100% OF ITS PRINCIPAL AMOUNT. IF THEY FEEL THE FULL AMOUNT OF THE LOAN IS UNLIKELY TO BE PAID IN FULL, THEY WILL "RESERVE AGAINST" THE LOAN BEING FAIRLY REFLECTED ON THE BALANCE SHEET. THE PROCESS BY WHICH THIS IS DONE IS TO CHARGE (REDUCE) THE BANK'S BAD DEBT RESERVE IN AN AMOUNT EQUAL TO THE DOUBTFUL PORTION OF THE LOAN AND, AT THE SAME TIME, CHARGE (REDUCE) THE LOAN BY THE AMOUNT OF ITS DOUBTFUL PORTION. AS RAPIDLY AS PRACTICABLE, THE BAD DEBT RESERVE IS REPLENISHED BY MAKING CHARGES TO THE BANK'S EARNINGS.

- 9 -

IF REPAYMENT OF THE ENTIRE AMOUNT OF THE LOAN IS IN DOUBT, THE PROCESS IS THE SAME EXCEPT THAT THE LOAN IS TOTALLY REMOVED FROM THE ASSET SIDE BY AN EQUAL OFFSETTING CHARGE TO THE BAD DEBT RESERVE. THIS REMOVAL OF A LOAN FROM THE ASSET SIDE OF THE BALANCE SHEET IS FREQUENTLY REFERRED TO AS "WRITING OFF" THE LOAN.

HOWEVER, THE ACCOUNTING AND LEGAL TREATMENT OF A LOAN WHICH HAS BEEN "RESERVED AGAINST" OR "WRITTEN OFF" ARE FUNDAMENTALLY DIFFERENT.

FOR ACCOUNTING PURPOSES, THE LOAN'S "NON-ACCRUAL", "RESERVED AGAINST" OR "WRITTEN OFF" STATUS IS TO REFLECT TO REGULATORS, DEPOSITORS AND INVESTORS OF THE BANK, A CONSERVATIVE BUT FAIR EVALUATION OF THE TROUBLED STATUS OF THE LOAN.

FOR LEGAL PURPOSES, HOWEVER, THE LOAN CONTINUES TO EXIST AS A DEBT OF THE BORROWER - WITHOUT REGARD AS TO HOW THE BANK CHOOSES TO TREAT IT AS AN ACCOUNTING MATTER. THE BANK IS FREE TO CONTINUE EFFORTS TO RESCHEDULE OR COLLECT THE LOAN IN SUCH MANNER AS IT DEEMS APPROPRIATE. ONLY WHEN THE EXPENSES INVOLVED IN SEEKING TO COLLECT A LOAN EXCEED, IN THE BANK'S JUDGMENT, THE POTENTIAL RECOVERY IS A LOAN TRULY ABANDONED. AND EVEN THEN, IF THE ABANDONED LOAN IS TO A GOVERNMENT, THE MEMORY OF THE DEFAULTING BORROWER'S BEHAVIOR AND COSTS TO THE BANK REMAIN.

AND, CURIOUSLY ENOUGH, IT IS THIS LAST INTANGIBLE FACTOR, THE MEMORY OF PAST POOR CREDIT BEHAVIOR, WHICH IS THE BEST DETERRENT AGAINST THE TEMPTATION OF GOVERNMENTS (WHICH CANNOT GO BANKRUPT) TO DEFAULT OR REPUDIATE THEIR DEBTS. ACCESS TO INTERNATIONAL CREDIT MARKETS IS

-10-

INCREASINGLY ESSENTIAL TO COUNTRIES SO THAT THEIR CITIZENS CAN
ACCESS THE WEALTH OF GOODS, MATERIALS, SERVICES AND TECHNOLOGY
THAT IS AVAILABLE IN THE WORLD. IT IS IMPOSSIBLE, AS A RESULT OF
THE TELECOMMUNICATIONS REVOLUTION, TO KEEP PEOPLE FROM KNOWING
WHAT IS PRODUCED AND AVAILABLE IN OTHER PARTS OF THE WORLD. IF
GOVERNMENTS, THROUGH THEIR OWN MISMANAGEMENT, RUIN THEIR INTERNATIONAL
CREDITWORTHINESS AND THUS THEIR ACCESS TO WORLD MARKETS, IT IS NOT
UNLIKELY THAT THEIR CITIZENS MAY CHOOSE TO SELECT GOVERNMENTS OF
BETTER MANAGEMENT CAPABILITY.

March 22, 1982

POLISH DEFAULT: BANKERS' PERSPECTIVES ON THE ISSUES

Current Situation

Poland's default on its external obligations last March
has caused major changes in the flows of private capital between
western banks and Eastern Europe. Total bank credit remained
unchanged at about $60 billion in 1980; borrowings by the Soviet
Union and the G.D.R. rose about $4 billion, but lending to other
Eastern European countries declined over $3 billion. More recently,
bank lending for the Soviet Union and the G.D.R. has dried up for
medium and long-term loans and has been sharply restricted in the
short-term area as well. U.S. bank claims on Eastern Europe declined
from a peak of $7.0 billion in December 1978 to about $5 billion
at the end of last year.

During 1980 Eastern European countries paid an estimated
$7 billion in interest to western banks. This figure includes
$350 million in past-due interest payments from Poland paid in
early 1982. Given recent economic and political developments
in Eastern Europe, there is unlikely to be any net expansion of
bank credit to the area; a further decline in lending is possible.
Making allowances for the modest interest earnings of the Eastern
European countries, the net flow of financial resources from the
East to the banks may be estimated currently at $500 million per
month or $6 billion a year.

2

The $6 billion annual net financial transfer is the price the Eastern European countries must now pay in order to maintain bank credit at current levels. The reaction of private financial markets last year left them with little doubt that a substantially higher price would have to be paid if Poland did not make interest payments to the banks. Banks have no better an idea than anyone else how Poland will be able to come up with some $1 billion in interest the country owes them in 1982. It is clear, however, that if the payments are stopped the financial cost to the area will greatly exceed the $1 billion that is owed.

In short, Eastern Europe's desire to maintain access to bank credit in the West is the main lever the market has to assure the continued servicing of the debt. The past few months demonstrate that pressures exerted by the private market were successful - $350 million in past-due Polish interest was received by the banks in January through March. Given this success, the banks will continue to push for all interest to be paid when due.

## Default Scenarios

Two issues must clearly be recognized in any discussion about default. One is that the implications of default depend crucially on how formal default comes about. A second point is that government decisions concerning default and granting new money are separate issues.

3

From the banks' point of view, the issue is not whether Poland is in default - this is evident. The issue is which actions the banks should take to maximize their chances of receiving timely interest payments and eventual repayment of principal. The options range on one side from lending the debtor the money needed to pay the interest to pursuing the debtor with attachments on his assets in order to force a debt settlement.

In Poland's case, the banks have chosen to press for full payment of interest. They have refrained from exercising their legal rights to attach Polish exports or assets in the West, and they have allowed Poland several extra months to make good on its promise to pay interest. Were Poland to declare a moratorium on interest payments or fall seriously behind in making these payments (e.g. arrears running over one year), there is every reason to believe that the banks would act to attach Polish assets. The goal in seeking attachments is not to possess the assets themselves, but to shut down Poland's ability to trade and conduct its business affairs with the West, thus forcing a settlement.

The implications of formal default called by Poland or by the banks as a group (for the reasons noted) are straightforward. Poland's ability to trade with the West would be severely curtailed (since intermediaries would have to be used to avoid new attachments) and Poland's access to bank credit would be shut off for decades. Such a default would have severe repercussions throughout Eastern Europe by virtue of sharp cutbacks in credit availability from western banks.

4

The implications of formal default triggered by U.S. political
actions are very different from these. If the default declaration
is seen to be merely a technical declaration (e.g. to satisfy CCC
regulations), nothing at all may happen. The banks would not be
forced to seek attachments and they probably would not do so. Yet,
one cannot be totally sure, given all the legal uncertainties.
However, if the U.S. government forced the banks to blanket the Poles
with attachments (e.g. by bringing attachments itself), the implications
would be far-reaching. Such an action would give the Poles an
excuse to shut off the modest flow of payments now being made.
More importantly, however, it would give them an incentive to seek
a separate settlement with the Europeans, in effect leading to a
selective repudiation of debt held by U.S. banks and the U.S. govern-
ment.

There is every reason to believe that European banks and
governments would cooperate with the Poles to prevent attachments
in their countries and to aid Polish evasion of such sanctions.
Europe's exposure is considerably larger than the United States' -
75% of Poland's debt is owed W. European banks and governments -
and the damage elsewhere in Eastern Europe would seriously harm
their vested interests in those areas.

There is not only a significant probability that such a
default action would fail, but it would also impose massive costs
on the alliance.

5

These costs would be felt both in the strategic and economic areas, e.g. refusal to cooperate on defense policy, refusal to assist the United States in reschedulings elsewhere (Turkey, Zaire, India, Costa Rica). An additional concern is that such a default would hurt "friendly" countries (Yugoslavia).

Of greatest concern to the banks is the precedent that such a default action would create in international financial markets. U.S. banks are aware that they operate in a political environment wherever they do business. Such a default action, however, represents a very different type of direct political interference in private capital markets; it would have serious effects on the longer-term stability of these markets.

Banks can handle a default caused by reason of non-payment. They are not equipped to handle a default caused by the political action of one country without the support of other major lending countries. Such a development would undermine the trust among international banks, which is essential for the sound functioning of world financial markets.

As regards bank debt, therefore, the West retains leverage on the East only so long as these private markets are allowed to operate free of government interference. Poland's debt problems, in fact, have their source in such interference as reflected in the massive lending after 1976 by western governments (including

6

the U.S. government whose loans rose from $300 million to $1.8 billion; loans from U.S. banks are the same today as they were in 1976).

The fundamental problem in East-West financial flows is the lack of discipline in the granting of official export credit to the East. A U.S. declaration of Polish default does not improve the chances that an agreement on official credits can be reached with the allies. On the contrary, the current U.S. policy of not forcing formal default leaves the United States the necessary flexibility to forge a new policy with the allies regarding new official credits, not only for Poland but also for the Soviet Union and other Eastern European countries. The challenge facing our policy makers is to find ways to create a common allied policy on official credits to the East.

POLAND'S FOREIGN DEBT CRISIS
---
BACKGROUND AND PERSPECTIVES

Lawrence J. Brainard

Bankers Trust Co.

Submitted as testimony to the European Subcommittee of the Senate Foreign Relations Committee, January 27, 1982

During the seventies Poland and many other countries faced serious balance of payments problems. Despite sharp hikes in oil prices and slow economic growth in industrial countries, most countries were able to make needed economic adjustments; these countries continue to meet their external obligations. Poland was an exception. In March 1981 Polish authorities acknowledged their inability to meet principal and interest payments and requested creditors to reschedule the country's debts.

In seeking to assess the reasons for Poland's debt problems, two issues are of foremost concern. The first is to identify the factors which explain the inability of Polish authorities to make necessary economic policy changes so as to contain the crisis. The second is to explain the apparent breakdown of disciplines in international lending which allowed Poland to amass over $25 billion in debts.

## Failures of Economic Management 1970-75

The roots of Poland's debt crisis go back to the 1970 riots which led to the appointment of Edward Gierek as first secretary of the Polish United Workers Party. Workers' discontent brought Gierek to power; his new policies reflected an attempt to placate

2

[w]

them and other important social groups in Polish society. This
was populism pure and simple, a strategy to gain political support
by giving everyone what he wanted: higher wages for workers, higher
prices for farmers, western technology for industry, and economic
reform to top it off.

Foreign trade was given a critical role to play in Gierek's
new economic strategies. In the traditional centrally planned
economy, policy makers act to balance imports and exports by
virtue of their wide-ranging control over resource allocation. Imports,
thus, are effectively restricted by the country's ability to export.
The new strategy turned this approach to balance of payments manage-
ment on its head. It was argued that traditional central planning
was responsible for the stagnation in which the economy found itself
in the late sixties. Further, what was needed was an infusion of
western technology to be financed by western credits. Such credits
could be repaid out of the exports to be generated by the new invest-
ments.

In view of Poland's resource endowment (coal, sulfur, copper),
such a strategy seemed feasible in the abstract. In reality, the
strategy's implementation contributed to the rapid escalation of
serious economic disequilibria. Imports were now limited only by
the possibilities of obtaining credits in the West. The traditional
discipline that imports should balance exports was removed, but an
effective system to set import priorities and to ensure that such
imports generated exports was not implemented. The new approach
actually weakened the central control of the planning commission by
decentralizing decision making to the industrial ministries and large
industrial conglomerates. But the rest of the centrally planned
model remained intact, replete with irrational prices and other

3

familiar inefficiencies. In a word, the new model retained all the irrationalities of the old system, but without the benefits of its controls on foreign trade and investment.

Given an unrestrained demand for credit, the only effective limitation on borrowing came from the lenders. Such restraints were not binding, either from the banks or western governments. Most banks were inclined toward an optimistic assessment of Poland's economic prospects. After all, Poland's level of debt was very low, the economy was endowed with many natural resources, it was a net energy exporter and credits went for purchases of investment goods. There was also a general assumption in the market that planned economies could easily control imports if necessary and that the Soviet Union would stand behind borrowings by any Eastern European country.

One American bank, however, took a different approach. In 1975 the Chase Manhattan Bank persuaded the Polish government to organize a credit for the development of a copper mine and smelter. The agreement provided extensive data and annual on-site reviews of the project to the lenders. Although loans to Poland and other Eastern European countries conformed to Eurocurrency market practice as regards term, rate and legal agreements, none of these countries provided basic information on balance of payments, reserves and foreign debt as did most developing country borrowers. Chase was concerned that the rapid expansion of credits could prove unsound, because the banks had no way to ensure that the funds were used effectively. Although the Chase credit was a success, particularly with other American banks, it did not set a pattern in the market. In retrospect, of course, Chase was right, but the market did not fully support this initiative.

4

Western governments were just as eager to provide credit at this time as the banks. In the eyes of most western governments, Gierek represented the best that detente could offer, a "flexible" communist leader with big orders for exporting firms. He was without question the most popular Eastern European leader in the West during the seventies. Western government attitudes toward Poland, in turn, were a significant factor that encouraged banks in their lending. Summing up, the root causes of Poland's economic crisis may be identified as the politically popular but economically irrational policies of the Gierek leadership. The implementation of these policies removed critical internal economic disciplines. The lack of effective constraints on Polish economic performance from the side of most bank and western government creditors permitted economic disequilibria to worsen. By 1975 the current account deficit exceeded $3 billion, up from near balance in 1972.

## The Worsening Economic Crisis 1976-80

In June 1976, the Polish government introduced substantial increases in meat prices, seeking to reduce the growing burden of subsidies on the budget resulting from the fixed price policy in place since 1971. After a series of riots broke out in several industrial cities, the government rescinded the measures. Industrial workers were the major beneficiaries of Gierek's populist policies. Because of the failure of the attempt to increase meat prices, the government feared imposing the costs of adjustment on the workers. This fear reflected the fact that Gierek's political support rested on his ability to keep workers happy with continuing rises in real incomes. The policy imperatives, therefore, were to tinker with economic reform in the hopes that productivity could be increased, to squeeze a little

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out of agriculture and to placate Poland's creditors in the West.

The government's attempts to come to grips with the economy's problems encouraged all kinds of _ad hoc_ administrative measures and direct controls, particularly on imports. Cuts in imports, however, interfered with the completion of many half-finished projects and prevented the growth in exports which were needed to reduce the current account deficits. Sustained large current account deficits, in turn, forced the government to find new loans in the West.

Between 1976 and 1980, Poland's foreign debt more than doubled, rising from $11.5 billion to $24.0 billion. In order to understand how such an increase was possible, we must first look at the current composition of debt. Polish authorities announced on January 9 that the total debt was $28.5 billion at the end of 1981. Of this sum, $7.5 billion, or about 25%, is owed to 501 commercial banks in western Europe, Japan, Canada and the United States; another $11 billion (39%) is owed to these governments. Approximately 70% of these sums are due to west European banks and governments. The remaining $10 billion is owed to governments and banks outside the western industrial countries and to non-bank corporate creditors. A breakdown of these sums is not available.

These data on commercial bank exposure are substantially lower than the $16.2 billion figure published by the Bank for International Settlements. The BIS data pick up an unknown portion of bank loans which have western government guarantees and substantial amounts of claims registered by banks located in western Europe but owned by governments elsewhere, e.g., Arab countries, Eastern Europe, and developing countries.

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Bank reactions to the worsening economic situation varied. U.S. banks, for example, restricted their lending to Poland. Between December 1976 and June 1978, claims of U.S. banks rose only $35 million, while total bank claims were rising over $5 billion. By restricting new loans, U.S. banks hoped to bring indirect pressure on the Polish government to change policy. And since there was a hope that such change was possible, the U.S. banks were willing to take a wait and see attitude rather than "pull out" loans which would have made economic adjustment much more difficult.

Although the attitude of U.S. banks was a source of concern in Warsaw, governments and banks in Japan and western Europe were pursued to increase loans to fill the void created by the withdrawal of U.S. banks. The full story of Poland's borrowing strategies during this period are not fully known. Two factors probably account for much of the increased lending by banks. One was the aggressive move beginning in 1977 by many European and Japanese banks into all types of international lending. These banks were less insistent than American banks on economic disclosure and they were more inclined to look for comfort at non-economic factors such as an assumed Soviet commitment to support borrowings by Eastern European countries (the umbrella theory).

These banks were also more susceptible to efforts by Poland's Bank Handlowy to "piggy back" its credit requirements on imports other than capital goods. Imports of raw materials, spare parts and the like, which had been settled in cash or short-term credit were now being financed by two and three year credits. The Polish importer would tell the exporter that he must arrange credit in order to get the contract. The company would then turn to its house bank for

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financing. The data appear to indicate that many of these banks were reluctant to refuse such questionable financing requests. These practices substantially shortened Poland's debt maturity profile, causing a rapid escalation in the country's debt service requirements and aggravating the country's economic difficulties.

The Gierek government, meanwhile, was largely successful in leveraging its political ties with the United States and western Europe to secure additional credits. The Carter administration, for example, substantially increased financing for Polish grain purchases under CCC arrangements; this resulted in a sharp jump in official U.S. claims on Poland. Some western European governments at this time were bending the informal rules on official credits. Although these credits are supposed to be tied to capital goods or spare parts, they were increasingly used for medium-term financing of raw materials and semi-fabricated goods. Substantial amounts of credit were also raised by Poland from new government sources in the Middle East and Latin America.

With all of this financing going on, it is not surprising that the restraint shown by U.S. banks had little effect on Polish economic policies. I believe the evidence shows that U.S. banks acted responsibly at this time. They continued to maintain their level of exposure and led an effort which succeeded in obtaining economic data on Poland's balance of payments and debt. Given the lack of unity among lenders, the U.S. banks were not in a position to influence economic policy in a direct fashion and no effort of this nature was made.

Events in 1979-80 followed a predictable course. As financing requirements mounted, the government belatedly began to move in earnest to shore up the economy. The 1979 austerity plan tightened