Committee for the Abolition of Illegitimate Debt

1. Reducing purchases of toxic assets Toxic assets An asset that becomes illiquid when its secondary market disappears. Toxic assets cannot be sold, as they are often guaranteed to lose money. The term “toxic asset” was coined in the financial crisis of 2008/09, in regards to mortgage-backed securities, collateralized debt obligations and credit default swaps, all of which could not be sold after they exposed their holders to massive losses.  [1] from the US banks in order to relieve them of this burden.

2. Reducing the acquisitions of US Treasury Securities from these banks which the Fed FED
Federal Reserve Officially, Federal Reserve System, is the United States’ central bank created in 1913 by the ’Federal Reserve Act’, also called the ’Owen-Glass Act’, after a series of banking crises, particularly the ’Bank Panic’ of 1907.

FED – decentralized central bank : http://www.federalreserve.gov/ does in order to inject them with liquidity Liquidity The facility with which a financial instrument can be bought or sold without a significant change in price. . [2]

3. Raising interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation. (0.25% as of now).

This announcement itself was enough to lead major financial companies in the US and other countries (banks and their satellites in the shadow banking system, mutual funds, etc.) to pack-off some of their liquid investments from the emerging market economies (EMEs). This destabilized those economies: plunge in stock markets and currency depreciation (Indonesia, Turkey, Brazil, India, South Africa ...) [3]. In fact, the low interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rates prevailing in the US and Europe, combined with the central banks’ massive cash infusions in the economy, have always set financial companies on the trail of maximum profit Profit The positive gain yielded from a company’s activity. Net profit is profit after tax. Distributable profit is the part of the net profit which can be distributed to the shareholders. by investing in the EMEs which offer better returns than the North. The outflow of financial investment from the EMEs towards the most industrialized economies can be explained by the fact that the financial companies expected attractive returns in the North as soon as the Fed hiked interest rates [4]. These companies thought that other “investors” would withdraw their capital from these countries and it was better to act first. A herd mentality response resulted in a self-fulfilling prophecy.

Finally, the Fed did not raise interest rates and waited till end-2013 to reduce purchases of structured securities and treasury bills from banks. The dust almost settled.

The situation in June 2013 gives some idea of ​​what might happen if the Fed increases interest rates significantly. This is what the Bank for International Settlements Bank for International Settlements
BIS The BIS is an international organization founded in 1930 charged with fostering international monetary and financial cooperation. It also acts as a bank for central banks. At present, 60 national central banks and the ECB are members.

http://www.bis.org/about/ (BIS), the central banks’ central bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

ECB : http://www.bankofengland.co.uk/Pages/home.aspx , says “Capital flows could reverse quickly when interest rates in the advanced economies eventually go up or when perceived domestic conditions in the host economies deteriorate. In May and June 2013, the mere possibility that the Federal Reserve would begin tapering its asset Asset Something belonging to an individual or a business that has value or the power to earn money (FT). The opposite of assets are liabilities, that is the part of the balance sheet reflecting a company’s resources (the capital contributed by the partners, provisions for contingencies and charges, as well as the outstanding debts). purchases led to rapid outflows from funds investing in EME securities” (BIS, 84^th Annual Report, 2014, p. 76, http://www.bis.org/publ/arpdf/ar2014e.htm)

The BIS brings to light a worrying trend: financial companies that invest a part of their assets in EMEs do so in the short term. They can swiftly withdraw their funds if they discover other profitable avenues. Here is what the BIS says: “A higher proportion of investors with short-term horizons in EME debt could amplify shocks when global conditions deteriorate. Highly volatile fund flows to EMEs indicate that some investors view their investments in these markets as short-term positions rather than long-term holdings. This is in line with the gradual shift from traditional open or close-end funds to exchange- traded funds (ETFs), which now account for around a fifth of all net assets of dedicated EME bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock-exchange. and equity Equity The capital put into an enterprise by the shareholders. Not to be confused with ’hard capital’ or ’unsecured debt’. funds, up from around 2% 10 years ago… ETFs can be bought and sold on exchanges at low cost, at least in normal times, and have been used by investors to convert illiquid securities into liquid instruments”. (BIS, 84^th Annual Report, 2014, p. 77, http://www.bis.org/publ/arpdf/ar2014e.htm)

In short, the wellbeing of the EMEs depends a great deal on the policy followed by the most industrialized economies (especially the US, Europe and Japan). A hike in interest rates in the US may result in a significant outflow of volatile capital invested in EMEs with higher returns in mind.

“In addition, roughly 10% of the debt securities maturing from 2020 or later are callable, and an unknown proportion have covenants that allow investors to demand accelerated repayment if the borrower’s conditions deteriorate.” (BIS, 84^th Annual Report, 2014, p. 76. http://www.bis.org/publ/arpdf/ar2014e.htm ) This means that financial companies that purchased debt securities maturing in a relatively distant future (2020 or later) can demand accelerated and full repayment from a crisis-hit country. Obviously, this can only aggravate the situation of an indebted country: all inflows will stop simultaneously. This is another reason why the populations of developing nations need to be aware of the serious dangers posed by their country’s public debt. Payment of the illegitimate portion of the debt must be challenged immediately.

The decline in revenues from raw material exports is another factor that might lead to a fresh nd acute debt crisis in developing countries, since China – a major consumer of raw materials for her manufacturing industry – has reduced her huge imports. A drop in the price of raw materials can be fatal to the economic health of developing countries which depend mainly on exports. In this respect prices for raw materials might also drop if the Fed increases interest rates, as this reduces speculation responsible for high prices. The combined effect of a hike in interest rates and a decline in raw material prices could produce a situation similar to what happened in the early 1980s, when the debt crisis exploded in the developing countries. It is imperative to learn from that crisis and to act, so that the Southern people do not have to foot the bill once more.

Translated by Suchandra De Sarkar in collaboration with Christine Pagnoulle.