PROBABLE CONSEQUENCES OF DEFAULT

Economic outlook

Probably the single biggest threat to our national economy-and to our own individual abilities to make ends meet-is the likelihood that the billions of dollars loaned by U.S. banks to various Third World countries will never be repaid. And, with that likelihood inexorably moving toward certainty, we think that the following essay by Vern Myers, whose wisdom has graced this column often in the past, can provide a worthwhile description of what the overall effects of that default might be. Now, we're not saying that Vern's predictions are 100% sure, mind you, but we are saying that he's been too danged right too many times in the past to be safely ignored! (Excerpted courtesy of Myers Finance & Energy, Suite 310 Peyton Building, Spokane, WA 99201.)

"There is no chance of any principal being repaid for a decade or more."—Henry Kissinger.

Let's you and me take it as a fair statement that the debts [of the Third World countries] are not going to be paid for at least ten years—if ever.

How is this to come about, and what is the likely effect on us? Here are the possibilities:

[1] The debtor countries will declare a default—and the banks will go broke.

[2] The banks will declare the debtor countries in default, and the banks will go broke.

[3] Neither the banks nor the debtor countries will cry default, but the debtor countries will just stop paying—de facto moratorium.

[4] The debtor countries will pay a little bit of interest once in a while.

The scenarios in [1] and [2] above will not happen. The debtor countries would have nothing to gain and would only be cutting their throats to declare a moratorium or a default. The banks would bring the ax down on their heads right away rather than suffer gradual severance. In the process of gradual destruction, there is always a chance they might get away.

The third and fourth are the most likely probabilities, and the fourth is a little more likely than the third, because the debtor countries mostly don't have even the money to pay full interest. This will produce a gradual public deterioration of bank credibility, and in confidence that banks can survive. What we are looking at, then, is the total demobilization of $300 billion or $400 billion that, up to now, we included in the liquidity of our Western monetary system.

Let's face it, as long as the situation can go on this way, the U.S. government is not going to pay the banks, and it is not going to pay the debtor countries. So there will be no extra dollars floating around on that account. Indeed, the net result of this will be a great tightening of the existing liquidity. Banks will become very tightfisted, will take few chances. It's a period of contraction in lending.