Foreign Relations of the United States, 1981–1988, Volume XXXVIII, International Economic Development; International Debt; Foreign Assistance

216. Information Memorandum From the Director of the Policy Planning Staff (Solomon) to Secretary of State Shultz¹

Washington, April 3, 1987

SUBJECT

• Approach to the Debt Problem

Attached are talking points on the debt situation plus the framework for an international institution that would purchase debt from commercial banks wishing to get rid of paper.² As elaborated, this proposal would be similar but somewhat broader than ARA’s proposal which we discussed with you on March 16,³ and with HR 1423—introduced recently by Representative John LaFalce (D–NY).⁴

We discussed the talking points with John Whitehead on April 2. While agreeing with the analysis, John does not favor an international institution to trade debt. He has three basic objections:

— The proposal would give some incentive to countries with a serious debt problem to follow bad economic policies in order to increase the discount on outstanding debt.

— The debt problem is so great that it would be impossible to raise enough money to cover outstanding debt. As an example, he notes that if the U.S. were able to get Congressional approval for a $1 billion capital share, the most we could probably hope to raise from other governments would be on the order of $3 billion. If we were then able to borrow $4 billion from private capital markets and use the resulting $8 billion to purchase outstanding loans at 50¢ on the dollar, we would only be able to acquire $16 billion in debt—a drop in the bucket.

— This scheme would be seen on the Hill as a bank bailout, which would be politically impossible to get through the Congress.

John agrees that something has to be done to add to the Baker Plan, but whatever we do should still center on the case-by-case approach. He stresses the importance of eliminating capital outflows from the LDCs and finding a way to target additional lending to those countries which are able to repatriate capital—say a dollar of new lending for each dollar of capital inflow. He sees a bright future for debt-equity swaps, and believes that direct investment rather than debt offers the best hope for restoring growth in debtor countries.

John, and we, agree that a new banking institution (or any other single proposal) will not in itself solve the debt problem. Certainly the idea is not to establish an institution that will purchase all outstanding debt. Indeed, one possibility would be to exclude Mexico, Brazil, Venezuela and Argentina (who account for about $300 billion or over one-third of total LDC debt) from this approach because they are so large and resource-rich that the existing pattern of creditor-debtor relations should be followed. (Excluding these countries, however, could complicate the task of raising capital for the facility.) Because most of the debt is government-to-government, we would exclude the poorest (mainly African) countries from the facility as well. Essentially, therefore, the institution would exist for a middle tier of countries such as Ecuador, Colombia, Philippines, Ivory Coast, Chile and Morocco.

Further, we would see the institution as one element in a policy package that might also include:

— measures to encourage capital reflows;

— reforms in U.S. banking regulations to eliminate problems associated with alternative bank approaches to debt;

— debt-equity swaps; and

— a strengthened IBRD cofinancing effort aimed at encouraging direct investment.

We suspect that there are others as well. EB, ARA and S/P are examining alternatives and are working on an evaluation for you.

1. Source: Reagan Library, George Shultz Papers, Secretary’s Meetings with the President (04/01/1987); NLR–775–19–22–1–6. Confidential. Drafted by Kauzlarich (S/P). A stamped notation at the top of the memorandum reads: “Super Sensitive.” Quinn initialed the memorandum and wrote “4/3.” The memorandum was included in a briefing package for Shultz for an April 3 meeting with Reagan. According to the President’s Daily Diary, Shultz, Baker, and Carlucci met with Reagan on April 3 from 1:30 to 2:01 p.m. (Reagan Library)
2. The talking points are attached but not printed.
3. See Document 211 and footnote 2 thereto.
4. See footnote 5, Document 213.