Debt and default in the 1930s: Causes and consequences

Abstract

This paper studies interwar experience with external debt and default. It begins with a description of the contours of international borrowing and lending in the 1920s. We then use some empirical models from recent literature on the 1970s to describe the interwar data. Macroeconomic variables for over 20 countries are related to cross-section variations in borrowing and debt during the period from the end of the 1920s to 1938. The paper then considers the incidence and correlates of sovereign default for 1934–1938, using regression to determine the association between standard measures of economic structure and performance and subsequent interruptions to debt service. Such variables as the magnitude of the debt burden, the deterioration of the terms of trade during the Great Depression, and the stance of monetary and fiscal policies provide a remarkably accurate explanation of the incidence of default. We go on to provide a long-run perspective on default and on the remedies available to creditors. The provisions of loan contracts are reviewed with an eye toward analyzing the scope for renegotiation. The discussion emphasizes the contrast between the regime of bond finance that prevalied in the interwar years and the current regime of bank lending. We analyze the roles of governments, banks and bondholders' protective committees in the negotiation process. We then present new estimates of the ex post realized rates of return on British and American foreign lending in the 1920s. This empirical analysis uncovers a striking contrast in the returns realized on loans floated in the two countries: while the (nominal) internal rate of return on dollar loans was less than 1% per annum, the comparable return on sterling loans was in excess of 5%. The paper concludes with a discussion of factors which help to account for this dramatic difference.