Economic Report of the President

of lenders that some debtors will not be able to achieve the requiredadjustment is precisely what makes them reluctant to lend.Fortunately, a serious financial disruption is unlikely. The debtorcountries and the banks which are their major creditors share astrong interest in an orderly resolution of the debt problem. For thedebtor countries, maintaining good financial standing is essential ifthey are to maintain access both to world capital markets and to theirexport markets. At the same time, banks realize that demanding toorapid a repayment from debtor countries could prove counterproductive,and they are probably willing to provide enough financing sothat debtor countries can more easily handle the financial squeeze. Althoughbanks find themselves in somewhat of a "prisoner's dilemma"situation, in which no one bank will want to lend if it believes thatthe loans will only go to repay other banks, this problem should notprove insoluble. The banking community should be able to work withthe International Monetary Fund (IMF) in negotiating agreementswhich balance an adequate degree of new lending to the debtorcountries with realistic economic adjustment plans. To aid in thisprocess, the Administration and representatives of other industrialnations recently agreed in principle to an enlargement of the IMF'sresources.Perhaps the most important safeguard against a financial crisis isthe ability of the governments and central banks of the majorindustrial countries to provide a safety net for the international financialsystem. Central banks act as lenders of last resort for commercialbanks, providing effective protection against banking panics. At thesame time, industrial country governments have demonstrated theirwillingness to help provide temporary financing for developing countriesin order to bridge the interval until agreements can be reachedwith the IMF. (The IMF recently concluded agreements with Mexico,Argentina, and Brazil.)Effects on World TradeAlthough a serious disruption of the international financial systemis unlikely, for all of the reasons cited, serious problems still exist.Even under optimistic assumptions, those developing countries withhigh ratios of debt to exports will be forced to improve their tradebalances substantially in order to pay the interest on their debt.Much of this trade balance improvement will probably come throughreductions in imports, involving painful reductions in output and realwages in the debtor countries. This will also depress demand for theproducts of industrial countries—particularly the United States,which has especially close trading relations with some of the majorLatin American debtors. The debt problem of the developing countriesmay worsen the U.S. trade balance by $10 to $20 billion and75