War loans, swap lines and Chinese highways: a history of official lending

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John Maynard Keynes attends the United Nations International Monetary and Financial Conference at the Mount Washington Hotel in New Hampshire, which led to the establishment of the Bretton Woods institutions for multilateral lending. © Getty Images

The World Bank’s new chief economist Carmen Reinhart and academics Christoph Trebesch and Sebastian Horn, both based in Germany, have a fascinating paper out looking at how governments and other public lenders have come to the rescue of their foreign counterparts over the course of modern history.

The paper, available here for $5, goes back to the French revolution, analysing 230,000 loans over 225 years to pinpoint the trends that have shaped foreign lending by officialdom. Here, for your reading pleasure, are three of them.

In crises, foreign officials plug the gap

In 2010 former Bank of England governor Lord King mused that while most large complex financial institutions were global “in life”, in death it was a different matter.

This home bias holds not only when banks fail. It’s also there in the tendency for foreign lenders to take flight during bouts of market turmoil. Economist Hélène Rey has written a lot about what drove this bias in 2008. The fallout from the coronavirus pandemic has been no different. Via the FT’s Frankfurt financial correspondent Olaf Storbeck:

US banks are pulling back from lending to European companies during the coronavirus pandemic, fuelling concerns that Wall Street may be quietly withdrawing to its home market in a repeat of the last financial crisis.

Bankers, advisers and company executives said American lenders had become more cautious in underwriting bilateral and syndicated loans to large corporate clients across the region in recent weeks.

The response to the retrenchment of the private sector has — on this and other occasions — been for domestic governments to step in and provide support. In the case of the German government, this has involved covering salaries, loan guarantees and a massive fiscal stimulus.

That domestic governments step in when demand crashes is well known. What we were not so aware of was the degree to which (since the end of the first World War, at least) foreign governments or other official sector organisations, such as the IMF or World Bank, helped plug gaps left by private lenders. Here’s a chart from the research:

Steadfast central banks

Up until 1945, almost all international official lending was linked to war financing:

Via the paper:

Notable lending surges occurred during the French Revolutionary Wars, the Napoleonic Wars and the First Crimean War. In each case the Great European Powers provided substantial financial support to their allies by means of loans, guarantees and grants. Similarly, during the Latin American Wars of Independence the newly founded republics co-operated financially through the extension of loans and grants in an effort to win against Spain . . . 

A big part of the reason for this change over the past 75 years was a desire to prevent future conflicts:

During the first half of the 20th century, the two World Wars stand out, leading to historically unprecedented levels of international assistance. Interestingly, however, the aftermaths of the two wars look very different. After World War I, official flows quickly dried up, with only modest lending for relief and reconstruction. In contrast, after 1945, official lending remained strong over the course of the entire Bretton Woods era. US bilateral loans, in particular, played a crucial role in the closing of the Dollar Gap and the reconstruction of Europe (mostly connected with the Marshall Plan).

This period – from the breakdown of the interwar gold exchange standard in 1931 to the late 1960s – can be considered the heyday of official finance. With widespread capital controls on private flows and financial repression, official loans constituted the only feasible means of international capital transfers.

But an enduring feature of both the pre- and post-WW2 period has been the consistency with which central banks have provided support beyond their borders in time of financial crisis:

Via the paper:

During the 19th century, there were repeated episodes with sizeable central bank lending, including the Panic of 1861, the Baring Crisis in 1890 and the Panic of 1907. In the 20th century, international central bank lending intensified during the interwar years. In the 1920s, for example, consortiums of central banks agreed to extend reciprocal credits so as to help each other return to gold (Meyer 1970). In 1931, central bank lending reached a historic peak, with total credits exceeding 3% of US GDP. Yet, these rescue credits, mainly extended to Austria, Hungary, Germany and Britain, did not suffice to prevent the interwar gold standard from collapsing (Accominotti and Eichengreen, 2015).

Beyond these rescue operations, the US Federal Reserve granted a series of short-term credits to Latin American countries facing balance-of-payments difficulties during the 1930s. In the decades following World War II, central bank lending across borders played a crucial role in the defence of the Bretton Woods System of fixed exchange rates during the 1960s and involved sizeable drawings on the Federal Reserve’s swap line network, with support flowing to the US, the UK and France (see also Bordo, Humpage and Schwartz, 2015).

China’s underestimated influence

With the creation of the Bretton Woods Institutions, the role of bilateral creditors in foreign official lending dwindled during the post-WW2 period:

However, that masks some interesting developments — notably the arrival on the scene of China (more on which here) and other emerging market powers. This, the authors argue, has driven a “comeback” in official lending:

It is not widely appreciated that we witnessed a comeback of official lending in the past two decades. China’s rise as an international creditor has been underestimated due to a lack of data and transparency. We document how China has become one of the most important official creditors worldwide, as almost all of its foreign lending is extended by the government and its state-owned banks (see also Horn, Reinhart and Trebesch 2019). China’s official lending boom is part of a more general rise of new creditor powers, especially emerging markets such as Russia, India, Brazil or the Arab oil states, who have all become active official lenders in varying degrees.

In addition, dozens of new official lending institutions were founded since WW2, including a range of regional development banks and regional financial arrangements in Asia, Africa and South America. The result has been a notable increase in “South-South” official sovereign lending. More generally, we find a much higher incidence of official loans in the current era. Today, most financial crises, natural catastrophes and wars are accompanied by official lending of some form. This was not the case historically.

The rise of China and of other emerging donor countries such as India or resource-rich Arab countries is, the authors claim, a big driver of bilateral lending becoming a “prime source” of borrowing for dozens of low-income and emerging countries.

Lending that, like the loans that came before it from Western institutions, will echo the geopolitics and ideologies of its time.


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