The LDC debt problem has been a persistent feature of international economic discussions in the 1980s. The most recent period of large-scale sovereign default and debt readjustment, the 1920s and the 1930s, offers the best available evidence on the organization of international lending and the readjustment of existing debts. In Discussion Paper No. 300, Research Fellow Barry Eichengreen and CEPR Director Richard Portes examine the interwar experience in order to shed light on the as yet unresolved debt problems of the 1980s.
Eichengreen and Portes explore the factors affecting the extent and incidence of interwar default. Econometric analysis suggests that capital markets have not grown more sophisticated over time: the past repayment record of a country, its current political circumstances and its economic policies all helped determine the risk premia on foreign bonds floated in the 1920s. The incidence and extent of interwar default depended on the size of external shocks, the burden of the debt and the domestic policy response, as well as non-economic variables, such as proximity to a major military power and international political links.
The authors investigate the implications of different debt management strategies for debtors' subsequent macroeconomic performance. In the 1930s as in the 1980s, efforts to maintain debt service tended to be associated with fiscal austerity, import compression and export subsidies, while default was often accompanied by fiscal expansion, monetary reflation and encouragement of import-substituting industries. Countries which interrupted debt service appear to have recovered more quickly from the Great Depression than those which did not default. Countries that defaulted in the 1930s did not incur a differential cost in terms of inferior capital market access in the 1940s and 1950s, once they reached settlements with their creditors: neither defaulting nor non-defaulting debtors had significant access to portfolio capital after 1945.
What evidence does the interwar period provide on the likely performance of schemes to resolve the current debt crisis? The `clean-break' analogy with Chapter 11 corporate bankruptcy proceedings is no more applicable to the 1930s than to the 1980s, Eichengreen and Portes note: interruptions to debt service were sporadic, and uncertainty over the magnitude of transfers sometimes lasted several decades. In contrast to the 1980s, interwar default in some cases led to a substantial reduction of transfers from debtor to creditor. But `selective debt relief' schemes nonetheless allowed creditors a reasonable overall rate of return, exceeding the yields on UK and US Treasury bonds.
The essentials of every global plan for debt relief proposed in the 1980s were all first suggested in the 1930s a special international lending facility, matched injections of private and public funds, and conversion of existing assets into new ones featuring different contingencies. Such global schemes foundered, then as now, on the issues of who should fund and control them. Market-based debt reduction (`buybacks'), however, did make a useful contribution to resolving the debt crisis of the 1930s, Eichengreen and Portes argue, by reducing the debt over- hang and eliminating marginal creditors

Dealing with Debt: The 1930s and the 1980s
Barry Eichengreen and Richard Portes

Discussion Paper No. 300, February 1989 (IM)