The Nether Borrowers

“NOTHING HAS SO MUCH cowardice as money,” Argentina’s Juan Perón once observed. Perón spoke with authority. In the 1950s he and his second wife, Evita, fearing for their money’s security, sent an estimated $700 million out of the country they governed into the refuge of numbered Swiss bank accounts. The Peróns’ successors perpetuated the practice. In the last decade, Argentineans, from the wealthiest in the land to their chambermaids, sent 65 per cent of the country’s incoming loans right back out again. Such flights of capital became a prime cause and a prime effect of the debt crisis. Some consider capital flight the single largest obstacle to resolving the Third World debt crisis.

The flight of valuables, generally foreign exchange, to countries safe from revolution, confiscation and economic disarray, or to countries that provide a better return on investment or escape from high taxes, has always occurred.

In sound economies, people routinely transfer their money across borders to finance trade deals, to earn higher interest rates in foreign bank accounts, to buy foreign securities, or to invest in real estate and other business endeavors. Money leaves a country in millions of transactions, large and small, in debt and in equity, but money comes in too, with the net effects generally being unalarming.

The routine transfers which were occurring in the Third World, however, were different: mainly cash was going out, and — in large part to replace that cash — mainly loans were coming in.

According to Morgan Guaranty Trust Company, the flight of capital has been so large that without it Argentina, Venezuela, Malaysia, and Mexico would have been almost debt-free, and Nigeria and the Philippines would have had their external debt halved. By the end of 1987 the foreign wealth held by the citizens of the 15 largest Third World debtors amounted to $300 billion — more than half of the foreign debts owed by their countries.

In Mexico, the revolving door’s rotations reached a peak under President Lopez Portillo — a former law professor whose administration became synonymous with profligate spending, corruption, and capital flight. During his presidency, the country’s foreign debt more than doubled to $85 billion, as Mexicans sent roughly $90 billion abroad. The more foreign exchange became available, the more left the country.

A Mexico City newspaper published a list of 575 names of Mexican nationals, each of whom had at least $1 million deposited with foreign banks. The exposure of these sacadolares — people who take out dollars — caused an uproar as it coincided with Mexico’s pleading for $10 billion in new foreign loans to avert bankruptcy. “The problem is not that Latin Americans don’t have assets,” commented one U.S. Federal Reserve Board member. “They do. The problem is, they’re all in Miami.”

The simultaneous accumulation of foreign debt and flight capital is no coincidence: foreign loans provided foreign currency to ship abroad. As explained by James Henry, an expert on capital flight: “More than half of the money borrowed by Mexico, Venezuela, and Argentina during the last decade has effectively flowed right back out the door, often the same year or even month it flowed in.” Oil-rich Venezuelans sent back some $27 billion between 1979 and 1984, $4 billion more than the country borrowed.

Ironically, while foreign borrowing fueled capital flight, capital flight caused foreign exchange shortages that drove several debtor countries back to the banks.

A year after borrowing a billion dollars in 1978, the Nigerian government went back for a second billion dollars — naked looting and capital flight had swallowed the first billion as fast as it came in. (Later, the billion was traced to Swiss bank accounts, but by then the military government of the day had retired with political immunity.)

While easily available foreign loans made capital flight possible, economic mismanagement made it inevitable.

To foster local investments, Third World governments put caps on interest rates often below the inflation rate, but caps instead chased money to countries providing higher rates of return. High fixed exchange rates for national currencies, designed to make imports look cheap and keep inflation down, also made foreign investments look like bargains. People converted their local cash and businesses into dollars as fast as they could and sent them abroad. The artificial exchange rates encouraged imported luxury goods, all of which were available for pesos on the dollar. In countries like Mexico and Argentina, where the citizenry was free to purchase foreign currency until 1982, these policies combined to drain national treasuries of their foreign currencies in a matter of years, sometimes months.

Inflation rates, meanwhile, skyrocketed out of this world. Governments across Latin America, in particular, were printing more and more money to help cover the costs of extravagant investment schemes, subsidies to industries, and the salaries of teachers and health care workers. But the more money they printed the less it was worth. Their citizens watched with horror as their savings dwindled overnight. Inflation became so bad in Bolivia, for example, that the Banco Boliviano Americano didn’t bother to check the number of notes deposited with it, but merely weighed them by the sackful to assess their value. According to the Wall Street Journal, “To buy an average-sized television set with 1,000 peso bills takes more than 68 pounds of money.” One commentator called the spiraling inflation and capital flight the “fever blisters of sick economies in conflict.”

The public could see the writing on the wall: the high inflation, persistent trade deficits, and uncontrollable foreign borrowing would inevitably force steep devaluations, wiping out their savings. Millions of Latin Americans — even cab drivers and waitresses — cashed in their pesos for dollars, often banking the proceeds offshore. The Asian public responded similarly. The first finance minister in the new Philippines government of Corazon Aquino remarked that “every successful businessman, lawyer, accountant, doctor, and dentist I know has some form of cash or assets which he began to squirrel abroad after Marcos declared martial law in 1972 and, in the process, frightened every Filipino who had anything to lose.”

When they weren’t sending their assets abroad, Third World citizens were safeguarding their assets by hoarding “Yanqui” dollars in their own countries. By the mid-1980s, U.S. monetary officials noted that three $100 bills were in circulation for each man, woman, and child in the United States. The U.S. Treasury estimated that as many as $20 billion in $100 bills (or 200 million $100 bills) were offshore.

Eventual devaluations and foreign exchange controls didn’t stop the hemorrhage. In 1986 Morgan Guaranty Trust Company appraised capital flight from the big ten Latin American debtors (Brazil, Mexico, Venezuela, Peru, Colombia, Ecuador, Bolivia, Uruguay, Argentina, and Chile) at fully 70 per cent of all their new loans from 1983 to 1985, with Mexico sending out almost twice the amount being received in new loans.

Brazil, whose realistic exchange rates had always kept its citizens’ cash at home, joined the ranks of the capital flight countries as the public voted non-confidence in the worsening economy of the late 1980s: almost $20 billion left the country in just 1988 and 1989. Brazil’s flown assets are now estimated at over one-third of its external debt.

Monies spirited out of the Third World were parked in everything from real estate to time deposits to car dealerships and bank accounts abroad. “Many parts of California don’t realize how much of their prosperity they owe to Mexico’s crisis,” said David Todd, a partner in the accounting firm of Price Waterhouse in Newport Beach.

Mexicans sank as much as two-thirds of their flight capital into bank time deposits. Along with U.S. government treasury bills, these deposits were safe, highly liquid, untaxed, and simple. When some large Mexican depositors began to worry about the health of the U.S. banks that loaned too much to places like Mexico, they shifted their holdings into U.S. government securities. “What’s indisputable,” said Henry, “is that when wealthy Mexicans invest their own capital abroad, they are much more cautious than the foreign bankers who financed all their country’s debt.”

The wiser the big commercial banks became, the more aggressive became their efforts to attract deposits from wealthy Third World citizens. With their Third World sovereign loan business on the wane, the big commercial banks moved on to “IPB” or international private banking, a fiercely competitive, but necessarily low profile, growth field for the world’s largest banks.

Mexican depositors were especially wooed. Citibank, Morgan Guaranty, Bank of America, and Chase Manhattan, plus several large regional banks in Texas and California, all served a key client list of at least several hundred wealthy Mexican customers. According to Henry:

They all have very active calling programs designed to recruit new clients. They all play an active role in helping wealthy Mexicans get their money out of the country. They all help such customers design sophisticated offshore trusts and investment companies to shelter income from taxes and political exposure. They all try very hard to keep the identity of their customers a secret. They are all more or less actively involved in lobbying U.S. authorities to preserve policies toward taxation, bank regulation, and bank secrecy that are favorable to their clients.

One IPB agent, a Mexican graduate of the University of California, was hired by Merrill Lynch, Pierce, Fenner & Smith to recruit Mexican clients. According to the Wall Street Journal, “His technique was simple: Open the Mexico City Yellow Pages and call up the presidents of the companies that had the biggest ads. `If you didn’t come back from Mexico with $1 million in investments, the trip was considered a failure,’ the Mexican graduate explained. `But the competition was very rough.'”

In 1986 Citibank, the most aggressive American bank in international private banking, had over 1,500 people dedicated to IPB worldwide (although to maintain discretion, they were usually connected with other parts of the bank). About half of its $26 billion in IPB assets probably belonged to Latin Americans. The “Big Four” — Brazil, Mexico, Argentina, and Venezuela — owed Citibank only about $10 billion. All told, Citibank may owe more money to Latin Americans than Latin American countries owe it.

As U.S. tax laws exempt non-residents from paying taxes on portfolio interest, and disclosure laws do not require U.S. banks to report the countries of origin of private banking assets, the U.S. became one of the world’s more attractive tax havens for flight capital. U.S. banks came to manage international private banking assets of roughly $100 to $120 billion, 60 to 70 per cent of which came from Latin American private banking assets, while U.S. banks had outstanding Latin America loans of about $83 billion. Not only was the U.S economy as a whole probably a net debtor of Latin America: U.S. commercial banks were close to being net debtors of Latin America.

The banks’ real role, said Henry, “has been to take funds that Third World elites have stolen from their governments and to loan them back, earning a nice spread each way.” The banks had to realize they were playing the role of the go-between: just as surely as they lent the money to governments, deposits from individuals in those same countries would come right back to them. “Sometimes the money never even leaves the United States. The entire cycle is completed with a few bookkeeping entries in New York.”

The result, according to the late economist Carlos Diaz-Alejandro, was the accumulation of “private assets and public debt.”

Economist George B.N. Ayittey, a native of Ghana, blames both parties to the transaction. “It takes very little common sense to realize that pouring water into a bucket full of holes is pointless. Similarly, without genuine efforts by the [poor countries] to address the domestic side of the debt crisis, an international rescue package of loans will flow right back out of the debtor nations in the form of capital flight and booty.”

After years of propelling the revolving door with billion-dollar loans to Third World governments and billion-dollar deposits from Third World private citizens, Walter Wriston, then chairman of Citicorp, spoke to the nub of the issue in early 1986, after $3 billion had left Mexico in one month alone: “If your own people don’t trust you, why should anybody else?”

Sources and Further Commentary

Details of the Perón’s flight capital come from “Will we see a cartel of Third World debtor countries?” by Gwynne Dyer, in The Toronto Star, July 30, 1984, and Eva Perón, The Myths of a Woman by Julie M. Taylor, Basil Blackwell, Oxford, 1979. The extent of flight capital from Argentina comes from “How to Resolve Latin America’s Debt Crisis” by David Felix, in Challenge, November-December 1985.

For Morgan Guaranty Trust Company’s analysis see “LDC Capital Flight” in World Financial Markets, Morgan Guaranty Trust Company, March 1986.

For other good descriptions of the extent of capital flight, and the forces that created it, see “Has Capital Flight Made the U.S. a Debtor of Latin America?” in Business Week, U.S., April 21, 1986; “How Hot Money Has Beggared The Third World” by Lenny Glynn, in Report on Business Magazine, from The Globe and Mail, Toronto, September 1985; “Capital Flight from Developing Countries” by Mohsin S. Khan and Nadeem Ul Haque, in Finance & Development, Washington, D.C., March 1987; Hot Money and the Politics of Debt by R.T. Naylor, McClelland and Stewart, 1987

One of best sources of information on capital flight is “Where The Money Went” by James S. Henry, in The New Republic, April 14, 1986. See Henry for details of Mexico’s capital flight. Also see A Fate Worse Than Debt by Susan George, Penguin Books, 1988, especially for details on Mexico’s capital flight. According to George, Antonio Ortiz Mena, a Mexican and past president of the Inter-American Development Bank, estimated that Mexicans had sent roughly $90 billion abroad during President Portillo’s administration — more than the $85 billion debt at the time.

Officials from the World Bank and the IMF concur with Henry’s assessment of the coincidence between foreign loans and capital flight: “The ease with which residents engage in capital flight is obviously directly related to the availability of foreign exchange, which in itself is a function of foreign borrowing. Exchange controls may increase the implicit costs of moving funds abroad, but experience shows that such controls can be circumvented. Common ways of doing this are underinvoicing of exports, overinvoicing of imports, and even outright smuggling of currencies or foreign exchange-earning commodities.” See “Capital Flight from Developing Countries” (as above).

See Debt Trap by Richard W. Lombardi, Praeger, New York, 1985 for details of Nigeria’s missing $1 billion.

For descriptions of how economic mismanagement fuelled capital flight see Debt Trap by Lombardi (as above); The Debt Threat by Tim Congdon, Basil Blackwell, 1988; “Capital Flight from Developing Countries” (as above); “When inflation rate is 116,000 per cent, prices change by the hour,” by R. Nazario in The Wall Street Journal, European Edition, February 8, 1985; “How to Resolve Latin America’s Debt Crisis” by David Felix, in Challenge, November-December 1985.

For details of how President Marcos of the Philippines frightened capital away from the country he governed see The Revolving Door? External Debt and Capital Flight: A Philippine Case Study, by James K. Boyce, Department of Economics, University of Massachusetts, June 1990.

See “Where the Money Went” by Henry (as above) for a description of the extent to which non-Americans hold “Yanqui” dollars.

For details on Brazil’s capital flight see “Inflation Reaches the Boiling Point in Brazil” in Swaps, The Newsletter of New Financial Instruments, Washington, D.C., vol. 3, no. 8, August 1989.

The details of Mexican capital flight came from “Mexico’s capital flight still wracks economy, despite the Brady Plan” by Matt Moffett, from The Wall Street Journal, September 25, 1989; “Mexicans fall into step on bank moves” by Matt Moffett, in The Wall Street Journal, May 25, 1990; and from Henry’s article in The New Republic, as above.

For George Ayittey’s and Walter Wriston’s quotations see “The real foreign debt problem” by George B.N. Ayittey, in The Wall Street Journal, April 8, 1986.