Newfoundland and the Global Debt Crisis

There is often a contradiction between democracy and debt. Voters elect governments who pursue populist policies which, before long, may lead to debt crises.

The countries then turn to the IMF for help. The IMF attempts to impose conditions which set the stage for economic slumps.

The governments became highly unpopular and sometimes suffer counter-revolutions. And soon enough, the IMF is blamed for "interfering" with a sovereign country.

What has been missing from contemporary debates about the IMF's role is any memory of what the world was like before the Washington-based institution's creation.

On several occasions, the United States deployed military forces to collect debts from troubled countries.

But the most extraordinary debt restructuring of the pre-1945 era did not occur in Latin America. It was in a dominion of the British Empire, the country of Newfoundland.

During the early 1930s, Newfoundland experienced a form of political punishment and national humiliation for its debt problems which has never been surpassed by any other country with financial problems.

The British established settlements to exploit Newfoundland's fishing resources after John Cabot explored it 1497. Newfoundland then became Britain's oldest colony.

The King authorized the governor to establish the island's first parliament in 1832.

That made it the second-oldest parliament (after Westminster) in the Empire.

In the late 19th century, Newfoundland was sovereign enough to negotiate trade agreements with the United States — and enjoyed all the other traditional trappings of sovereignty.

However, the Newfoundland government went on a slippery path when it chose to borrow heavily.

First, it did so to finance military expenditures during the First World War, then to finance the construction of a railway — and to cover operating deficits throughout the 1920's. By 1933, there was a public debt of over $100 million — and Newfoundland's national income was just $30 million.

The Great Depression put Newfoundland over the edge. How so? Newfoundland's major export was fish.

The depression in the Catholic countries of Latin America caused a sharp decline in the price of fish. That made it impossible for the government to continue borrowing.

How much did the government need? In 1933, the budget deficit was $3.5 million — or over 10% of the island's GDP.

The Newfoundland government turned to the British government for help. London obliged — by appointing a royal commission to investigate the country's economic situation. The commission produced a report which condemned Newfoundland's fiscal policies in the 1920s for creating an unsustainable debt burden.

Critics of the IMF, take note: The commission's proposed solution to the crisis has no parallels in any other sovereign debt restructuring. The royal commission proposed that Newfoundland should give up both independence and democratic self-government.

The British government would instead establish a special six-man commission and royal governor to head the country.

The commission would not be responsible to the people of Newfoundland but to London — and the British House of Commons.

The notion that a self-governing community of 280,000 English-speaking people should give up both democracy and independence in order to avoid debt default was unprecedented. Yet, the commission proposals were accepted by both the people and the government of Newfoundland

One important reason for this was that public confidence in Newfoundland's own government had been eroded by scandals during the late 1920s and early 1930s. In 1932, a group of demonstrators had actually occupied the parliament house and chased the prime minister through the streets in order to lynch him.

As a result of the lack of confidence in the local politicians, many Newfoundlanders concluded that a British-appointed commission might provide a better public administration.

In truth, The Royal Commission's description of Newfoundland's democracy would not be out of place in today's Argentina. Here is a telling excerpt:

"Rival politicians … in the desire to secure election, were accustomed to make the wildest promises involving increased public expenditure in the constituency and the satisfaction of all the cherished desires of the inhabitants. The latter, as was natural, chose the candidate who promised them the most.

"…the electors in many cases preferred to vote for a candidate who was known to possess an aptitude for promoting his own interest at the public expense rather than for a man who disdained to adopt such a course.

"They argued that, if a man had proved himself capable of using his political opportunities to his personal advantage, he would be the better equipped to promote the advantage of his constituents; an honest man would only preach to them."

If that same British commission were to be dispatched to Buenos Aires today, it would be fascinating to read its commentaries on Argentina's political institutions and capacity for responsible self-government.

The Argentine record has been so abysmal it would not be difficult to imagine the commission proposing either the restoration of Spanish imperial rule — or the establishment of an Argentine protectorate under the nominal rule of the IMF.

Amazingly, the debate in the House of Commons mirrored today's debates over IMF aid. The government argued for British adoption of Newfoundland's debts — under the extreme "conditionality" of rule from London.

Meanwhile, the opposition Labour Party strongly opposed the Newfoundland proposals on grounds that they were undemocratic — and that that it was morally indefensible to rescue bondholders who had made a bad investment.

The British government passed the bill. The Commission of Government took over responsibility for Newfoundland's affairs in early 1934. There was an immediate recovery in business confidence and the city of St. Johns was able to complete a debt offering which had stalled before the commission reported.

But despite its best efforts, the commission could not fundamentally transform the country's economic situation. That was the result of the continuing low price of fish — and the fact that all other resources were controlled by foreign business interests.

The way out was offered by Newfoundland's neighbor, Canada. The Canadians offered to take on 90% of the island's debt if it joined the Confederation. On April 1, 1949, Newfoundland became a province of Canada.

Curiously, Newfoundland's Parliament never ratified the confederation treaty. The treaty itself was an act of Britain and Canada, not Newfoundland. But that was because the British — who were essentially Newfoundland's creditors — wanted it that way. Even if Newfoundland's own representatives did not.

If the IMF had existed in 1933, it would have granted emergency debt relief to Newfoundland. The country would have never given up democracy or independence. Indeed, democracy is now a pre-condition for IMF aid.

But as no institution such as the IMF existed in 1933, Newfoundland was compelled to choose between democracy and default.

The story of Newfoundland during the 1930s continues to be a unique tale of how the British Empire coped with a debt crisis in a small country.

But it is also a reminder of why in the aftermath of World War II the nations of the world created the International Monetary Fund. They did not want nations to ever again confront a choice between debt and democracy.

It is a legacy worth pondering as we contemplate the future of policies for helping troubled countries cope with the demands of the global financial marketplace.