An Umbrella for Rainy Days

Poland’s borrowing from Western banks began on a large scale as Christmas came to Warsaw in 1970. With the country facing severe food shortages, Communist Party leader Władysław Gomułka tried to alter national consumption patterns by raising prices on grain, meat, and clothing while lowering prices on tape recorders and televisions. It was a decision meant to address the problem of scarcity, but workers at Gdańsk’s Lenin Shipyard saw it as an attempt to solve the nation’s economic problems on their backs. Strikes paralyzed the nation’s coastal cities; clashes between police and workers left forty-four dead. ^{Footnote 6} The party replaced Gomułka with Edward Gierek, who repealed the price increases and travelled to the shipyards of Szczecin and Gdańsk to directly negotiate with the striking workers. Timothy Garton Ash has written, “In December 1970, the giant which the socialist regime had itself created, the new working class, first flexed its muscles, seized the men who claimed to rule in its interest by the scruff of their necks, and shook them.” ^{Footnote 7} Thereafter, Gierek announced a “new development strategy” that promised simultaneous wage and labor productivity increases. With more money in their pockets, so the theory went, Polish workers would both work harder and have the financial resources to meet their basic needs. Under pressure to match the capitalist “miracle” of Western Europe’s two and one-half decades of virtually continuous economic growth since the end of World War II, the new Polish leadership proposed to meet and eventually exceed the economic success of Western Europe through its new development strategy.

Gierek launched this ambitious program at a favorable political moment in the Cold War, as superpower détente between the United States and the Soviet Union, as well as West German chancellor Willy Brandt’s Ostpolitik, simultaneously removed the ideological taboo and myriad political barriers to Western banks and firms conducting business with the communist states of the Eastern Bloc. The key to Gierek’s new development strategy lay in gaining access to Western technology, which in turn required large amounts of hard currency. Therefore, Gierek turned to the unregulated financial markets of the West, known as the Euromarkets, to grease the wheels of this new development strategy.

The Euromarkets, composed of all currency deposited outside its country of origin (and thus subject to little regulation), were founded in London in 1955, when Midland Bank began attracting U.S. dollar deposits to meet its liquidity requirements during a period of tight monetary policy. They then greatly expanded during the 1957 sterling crisis after British banks began financing international trade with their dollar deposits instead of sterling because of the severe limits that the UK government had placed on the use of sterling in international transactions. ^{Footnote 8} Throughout the 1950s and 1960s, the United States heavily regulated the interest rates that banks could apply to their domestic deposits, so as Western European economies grew during this period, increasing numbers of companies, banks, and central banks decided to keep their U.S. dollar holdings abroad and receive a higher rate of return. Neither the U.S. government nor British government was eager to regulate this burgeoning foreign dollar market, so the Euromarkets continued to grow. ^{Footnote 9}

By 1970 the markets were valued at $110 billion, and constituted the Eastern Bloc’s point of entry into Western capital markets. ^{Footnote 10} In July 1973 Rothschild International Bank reported, “The granting of medium term loans to Communist countries at narrow interest margins seems to be virtually limitless.” ^{Footnote 11} The Polish Crisis would eventually provide such a limit, but through the end of the 1970s, the Eastern Bloc enjoyed easy access to the medium-term Eurodollar market, where the vast majority of sovereign lending occurred.

Just as the Polish government maintained ambassadors to governments throughout the world, so too did it maintain an unofficial ambassador to the Euromarkets in London. Jan Wołoszyn, the first deputy president of Bank Handlowy, Poland’s international trade and finance bank, was responsible for arranging syndicated loans from Western banks on the Euromarkets. In October 1980, Euromoney ran a profile of Wołoszyn as the Solidarity protests grew in Poland. “If Poland’s political leaders have a credibility problem with their own citizens,” the article reassured, “Wołoszyn … has none with the banks of the West.” Contrary to their views of his country’s economic system, bankers had nothing to fear with “Mr. Poland”: Wołoszyn was “credible, knowledgeable, and … impressive”; had never joined the Polish Communist Party; and had thought more than once about leaving banking for more leisurely bourgeois pursuits, gardening foremost among them. “This is a people business,” bankers reported to Euromoney, and Wołoszyn was “the one who, through his own charisma, standing, and personality, persuades many banks to lend to Poland.” ^{Footnote 12} And lend they did. In 1971 Poland had a net hard currency debt of $764 million. By 1975 that debt had ballooned to $7.4 billion, and by 1979 the nation’s foreign debt sat at an outsized $20 billion. ^{Footnote 13} With borrowed money billowing its sails, the Polish economy showed promise in the early 1970s and appeared to confirm Gierek’s economic growth theories, as real wages rose 7 percent and the economy grew 10 percent annually. ^{Footnote 14}

As the floodgates of Western capital opened in the early 1970s, commercial banks clung to assumptions about sovereign borrowers in general, and the Eastern Bloc in particular, that eased their minds as they channeled unprecedented amounts of money to foreign governments. “Countries don’t go bankrupt,” Walter Wriston notoriously proclaimed. ^{Footnote 15} After the 1973 oil crisis, Western commercial banks accepted billions of dollars in deposits from the oil states of the Middle East, and looked to loan these new reserves out to developing countries. ^{Footnote 16} In an attempt to bring rationality and stability to this process, the banks developed models for country risk analysis based on the frameworks used by the International Monetary Fund (IMF) and World Bank, and they created in-house risk management teams to monitor their exposure to particular countries and regions. ^{Footnote 17} Perhaps understandably, the socialist regimes of Eastern Europe were perceived as low-risk borrowers. Bloc countries had low debt levels at the beginning of the decade, and bankers believed that if these countries did run into payment troubles, they could easily reduce imports and boost exports to create the necessary hard currency earnings to repay loans. Gabriel Eichler, a commercial banker who specialized in sovereign loans to communist countries, later wrote about the banking mindset of the 1970s that “centrally planned economies … were thought to have a superior control of exports, imports, and especially finances.” ^{Footnote 18} What good was a command economy if not to control the cumulative consumption and production of its people?

Should that fail, however, bankers saw a strategic reserve behind the Eastern Bloc unparalleled throughout the rest of the global economy: the Soviet Union. Over the course of the decade, they came to believe in what was termed “the umbrella theory,” whereby they anticipated that the USSR would “come to the rescue” of its allies if they ran into financial trouble. A U.S. Congressional analysis from the period noted that the umbrella theory had “no known legal premise … as there is no signed agreement, bilateral or multilateral, within the context of Comecon [Council for Mutual Economic Assistance], that would make it incumbent upon the USSR to be the lender of last resort” for Eastern Europe; but, “it is presumed to be in the political interest of the USSR to provide that function … possibly in exchange for non-membership in the IMF.” ^{Footnote 19} With the umbrella theory in hand, financial institutions in the West came to view bloc countries as low-risk borrowers. ^{Footnote 20}

While Cold War détente reigned in the 1970s, banks enjoyed additional incentives to lend to Poland through well-endowed Western government programs that guaranteed bank loans to communist governments. For Western states, guaranteeing loans to the Eastern Bloc served the political purpose of normalizing interstate relations and the economic interest of exporters. ^{Footnote 21} In the United States government, the Commodity Credit Corporation (CCC) played the largest role in guaranteeing loans to Poland. The CCC was a legacy of the New Deal, and its founding mission was to stabilize the price of U.S. farm products by financing their export abroad. ^{Footnote 22} For Western banks, a government guaranteed loan was a loan without risk; if a debtor could not repay the loan, all a bank had to do was declare a default of the country in question and the government would pick up the tab. Nevertheless, Poland’s appetite for Western capital proved so great in the 1970s that government programs only covered a small share of the total debt. By decade’s end, government loan guarantees backed only a quarter of Poland’s total hard currency debt, leaving the banks with a larger liability than governments, and making the prospect of a Polish default a scary proposition for Western banks. ^{Footnote 23}

In the hope of staving off this prospect of default, the Gierek government spent the second half of the 1970s attempting to trim its borrowing exuberance. In June 1976 the government raised consumer prices, provoking one hundred thirty factory strikes throughout the country. Just as in 1970, the hikes were hastily repealed. The attempt at austerity, and the requisite repression that contained its effects, caused further condensation in the forces of political resistance. Over the next four years, a relatively strong counterculture of dissident publications developed with Gierek’s tacit acceptance. In the stead of suppression, he continued to import Western capital and wait for the long-promised change in his country’s economic performance. However, a succession of poor harvests in the late 1970s forced the government to dramatically increase its borrowing from Western government agencies to import agricultural products, even as it sought to cut back on its import of industrial machinery and technology. ^{Footnote 24}

Hints of looming financial catastrophe began to emerge in 1977 as it became clear that two-thirds of Poland’s medium- and long-term debt would need to be repaid in 1979 and 1980. ^{Footnote 25} Recognizing its dire financial straits, the Gierek government sought reprieve in long-term credit agreements and bilateral reschedulings of government debt with France, West Germany, and the United States. In response to Poland’s requests for aid, President Jimmy Carter’s administration formulated a policy response that would define U.S. government priorities throughout the coming crisis. Secretary of State Cyrus Vance laid out the administration’s stance on debt rescheduling, writing, “[I]it is our policy to participate in reschedulings only on a multilateral basis with comparable participation by private creditors and only in crisis situations.” Private creditors and other governments must be included, he wrote, in order to “share the burden on an equitable basis”; therefore, on a December 1977 trip to Poland, Carter boosted U.S. loan guarantees through the CCC to $500 million annually, even as he informed Gierek that no bilateral rescheduling would be forthcoming. ^{Footnote 26}

As Poland’s financial difficulties increasingly weighed on Gierek, the country’s troubles also burdened the minds of Western central bankers. By the late 1970s, the political and economic contexts that had supported Western lending to the Eastern Bloc—détente and petrodollar recycling—appeared to be unraveling. After the Soviet Union’s invasion of Afghanistan in December 1979, superpower tensions significantly deteriorated and many commentators declared the death of détente and the arrival of a “Second Cold War.” ^{Footnote 27} The Iranian Revolution of the same year and the Iran–Iraq War that followed precipitated a second oil price shock and put the system of petrodollar recycling under stress, as banks and central banks questioned whether the private banking system could recycle the oil producers’ profits back to the oil-consuming countries, as it had done in the first oil crisis of 1973–74. With the Cold War renewed and the system of sovereign lending teetering on the brink of instability, central banks feared that a sovereign debt default by a highly indebted nation could bring the global financial system to a grinding halt.

These fears came to light in an internal study the Bank of England (BoE) began in January 1980, telling titled “Apocalypse Now: Possible Consequences of a Default by a Major Borrowing Country.” ^{Footnote 28} As the title suggested, the study sought to determine whether and how a single sovereign default might lead to a general debt crisis. To examine the prospect, the BoE chose two countries, Brazil and Poland, to study in depth. The choice of countries was no accident. In 1980 Brazil was the largest sovereign debtor in the world, and Poland was a member of the Communist Bloc, which held $39.6 billion in net debt to Western banks. Amidst the worsening superpower tensions of the day, the BoE feared that “Eastern bloc countries [might] default on their debts to the West in retaliation for the economic measures taken by the US against the USSR.” Therefore, the true danger of a Polish default lay in its possible link to a broader default across the Eastern Bloc. In a preliminary analysis, a bank economist wrote, “international banks’ exposure to Eastern Bloc countries is substantial,” and thus “a general default” across the bloc would clearly be the most “serious.” Even if only Poland (“the country perhaps most likely to be allowed to slide into default and the most significant debtor”) defaulted, the BoE economist believed “the impact of any default would clearly be serious.” A default, the report noted, “would clearly heighten the banks’ perception of country risk and make banks reluctant to lend except on a higher spread. This would obviously have implications for the recycling of OPEC surpluses.” ^{Footnote 29}

Making matters all the more difficult was the BoE’s perception that Poland’s debt was not in fact controlled by the Polish leadership, but was instead under the discretion of the Soviet leadership in Moscow. Opinions within the BoE varied on how the Soviet Union would use Poland’s debt to harm the West. Upon reading the preliminary assessment, one policymaker wrote that the Eastern European countries would never “default of their own volition”; instead, he proposed, “surely where the satellites are concerned it is rather that economic/financial pressure (as well as political) from the USSR might force them to default.” ^{Footnote 30} P. J. Bull, another bank economist working on the project, envisioned a starkly different course of events. Short of a declaration of war between the Soviet Union and the United States, Bull wrote:

Default, Bull concluded, “would take Comecon decades to live down.” Presciently, he proposed that a different strategic calculus underlay Soviet policy. “A more likely scenario than default for Poland is for the Soviet Union to withhold any financial assistance until the Poles have done all they possible can to help themselves and have tapped every possible Western source for assistance.” ^{Footnote 32}

After further rounds of internal debate, the final Apocalypse Now report concluded that although the private banking system had withstood previous defaults from countries such as Zaire and Turkey in the 1970s, “in the event of a debt service failure by a major borrower, the consequences may be more far-reaching than recent examples would suggest … [in] its impact on the international markets.” It also noted, “The indebtedness of two particular country groupings—the non-oil ldcs [sic] and the Eastern bloc—is perhaps of particular concern at the present time.” ^{Footnote 33} Having reached its own internal consensus, the BoE circulated the report among other Western central banks and asked for comments on its analysis. The West German Bundesbank agreed with the BoE that a debt service failure by a major international borrower could threaten “the stability and functioning of the international banking and bond markets as a whole.” Echoing the U.S. government’s focus on burden sharing, the Bundesbank also stressed that “we should take care not to weaken the basic responsibility of commercial banks for their lending business.” ^{Footnote 34} U.S. Federal Reserve Board member Henry Wallich wrote that while he did not believe central banks needed to undertake “a formal, coordinate program of action” to prepare their banking systems for a sovereign default, he did believe “it would be useful for central banks to monitor developing troubled international lending situations and the positions of their banks.” ^{Footnote 35}

By the end of the 1970s, there could be no doubt that the banks were beginning to resist any increase in their financial exposure to Poland. In April 1979 Euromoney wrote, “Within two years, if not in one, Poland may have become the Euromarket’s problem borrower.” ^{Footnote 36} However, as Western banks began to spurn the prospect of more Polish lending, Western governments pressured them to continue lending because they feared that an economic collapse in Poland would invite Soviet intervention. In March 1980 the West German government announced a new round of DM500 million in loan guarantees and “made clear to the banks that it expected them to commit additional resources to Poland.” ^{Footnote 37} This led to a new syndicated loan from German banks to Poland totaling DM1.5 billion, 500 million of which was guaranteed by the government. ^{Footnote 38} Similarly, the United States made its own effort to get the private sector to continue lending to Poland. The National Security Council (NSC) concluded in the summer of 1980 that the U.S. government should “continue to make clear to US banks that it is in our political interest to maintain financial ties with Poland.” ^{Footnote 39} U.S. banks followed suit with another $325 million over the summer of 1980. ^{Footnote 40}

Even with the fresh infusion of capital, Gierek knew that market confidence would return only once he had shown the ability to impose austerity on the Polish population. On July 1, 1980, for the third time in a decade, the regime attempted to raise the price of food. Within three weeks, strikes had consumed the nation’s industrial centers. In mid-August, unrest returned to the Lenin Shipyard in Gdańsk where activists made both economic and political demands, including the reinstatement of two workers who had been fired for union organizing. One of these workers, Lech Wałęsa, went on to lead the local strike committee and eventually the Solidarity movement as a whole. The speed and size of the protests overwhelmed the normal state apparatuses of repression, so just as it had done in 1970, the regime sought to appease the protesters with a change in leadership and a recognition of some of their basic demands for wage increases. Most importantly, on August 31 the government and the fledgling opposition signed what became known as the Gdańsk Accords, which acknowledged the right of workers to form free labor unions. In September Stanisław Kania replaced Gierek as party secretary and conceded the workers’ right to form independent labor unions. By November, the disparate network of independent unions had coalesced around Solidarity, which eventually counted ten million members, and the crisis showed no signs of abatement. ^{Footnote 41} Clearly, the government did not have the domestic legitimacy to impose economic austerity on its own people. Indeed, the economic concessions granted to Solidarity only exacerbated the country’s hard currency problems. As the British Foreign Office noted in an analysis of the first months of Solidarity’s existence:

For the next fifteen months, Poland’s economic and political future hung in the balance, and banks, governments, and the Polish people competed to determine the country’s fate.

A Game of Chicken

Ronald Reagan and his senior advisors entered the White House believing that Poland would be the first test of their Cold War mettle. Recalling the transition period of December 1980, Secretary of Defense Casper Weinberger wrote that Reagan believed Poland would be his “first test” and “that a great deal would depend, for at least the next four years, on how he, and the nation, reacted to Soviet pressures in Poland.” ^{Footnote 43} Reagan’s first National Intelligence Estimate for Poland legitimately reported fears that “a swift and steep decline in living standards—capable of triggering civil disorder that could cause Soviet intervention” was a real possibility in the year ahead. The only way to prevent this precipitous decline, the report told the new president, was for Poland to receive a new round of financing from Western banks to stave off default and dramatic alterations in the price and availability of basic staples. Banks, however, were likely to make new loans “only if they received government guarantees.” Therefore, Poland would “require prompt financial assistance from either Western governments or the Soviet Union, and probably from both. Large-scale assistance may be required very soon.” ^{Footnote 44}

Very soon indeed. Two months into Reagan’s term, Jaruzelski issued a “cry for help” to the West and formally requested a rescheduling of the country’s debt. ^{Footnote 45} This request brought to a head the thorny issue of sharing the financial burden among governments and banks. Although Western governments were eager to sustain Poland’s nascent experiment with liberalization, they did not want the rescheduling to turn into an opportunity for the Soviet Union or Western banks to gain financially from governments’ politically motivated generosity. Western governments, which gathered in Paris to discuss the Polish situation, demanded that Poland seek “parallel action by the CMEA countries and by Western banks.” ^{Footnote 46} At the end of February 1981, the Soviet Union granted Poland a four-year moratorium on its debt, thus assuring Western officials that “the Soviets were playing their part.” ^{Footnote 47} Soon after, the banks indicated their willingness to follow the governments’ lead in rescheduling, and in April the governments rescheduled 90 percent of the $2.3 billion in principal and interest due in 1981. This was unusually generous (agreements with other debtor countries had rescheduled 75 percent); the governments chose such a high percentage on encouragement from the Reagan administration, which wanted to both support Solidarity and ensure that the U.S. government would not have to provide new credits in 1981. ^{Footnote 48} Only one condition was attached to the agreement: the exceptional circumstances clause. Under this clause, also known as the “Tank Clause” by the time it entered public discourse after the declaration of martial law, the creditor governments could suspend the rescheduling agreement if exceptional circumstances such as a political crackdown or Soviet intervention occurred in Poland. ^{Footnote 49} Only in the face of actual repression would it become clear whether Western governments could bring themselves to invoke the clause.

For at least a year after Solidarity’s formation, the Polish government and the Soviet Union navigated the competing pressures of the crisis with an eye toward pleasing Western creditors. In the fall of 1980, the Soviets reduced shipments of oil to all Comecon countries except Poland, so that it could be sold on the world market for hard currency. ^{Footnote 50} These earnings were in turn given to the Polish government in the form of $1.1 billion in hard currency loans. ^{Footnote 51} The scale of the Soviet aid, however, paled in comparison with the scale of Poland’s financing problem. Kania told the leaders of the Ministry of Internal Affairs in January 1981:

Soviet officials were helpless to discourage the regard their Polish colleagues showed for Western opinion because they could not meet most of Poland’s requests. ^{Footnote 53} The Soviets’ advice was therefore consistently rebuffed. At an August 1981 meeting between the Polish and Soviet leaderships in the Soviet province of Crimea, Kania and Jaruzelski told Soviet Premier Leonid Brezhnev that they could not take more stringent repressive measures because they needed Western financial aid. This prompted Brezhnev to respond:

Although the country needed further financial support, Poland also held leverage over the banks that made them far from slaves of Western masters. The Poles feared a loss of Western aid, but the banks dreaded a Polish bankruptcy. All international loans included what was known as a “cross-default clause,” which was supposed to provide creditors with the legal means to seize a debtor’s assets and recover a portion of their loss if a default were to occur. The problem was that Poland had virtually no assets in Western countries. A banker rhetorically asked in Euromoney: “What good would declaring default do? There aren’t any funds to seize.” ^{Footnote 55} Therefore, the banks did all they could to prevent a declaration of default. As long as default had not been called, they could continue pretending that Poland would one day pay them back, and thus could continue to count the loans as assets on their balance sheets. The actual prospects for repayment did not matter; as long as no one called a default, their accounting ruse could continue. In previous debt crises, the banks had also been able to turn to the IMF; but as they entered negotiations to reschedule Poland’s 1981 debt, no such recourse existed. To make matters worse, government officials in Paris had told the banks that they needed to sign a “comparable” rescheduling agreement to the one that the governments had signed in April so that the burden of Poland’s debt would be equitably shared between private and public institutions. As Poland entered negotiations with the banks, it maintained leverage born of a hint of mutually assured destruction: if Poland collapsed, the banks would suffer significant losses too.

With these dynamics in mind, bankers gathered throughout the spring to develop a unified policy through the formation of a lead negotiating committee. This proved difficult because American and European bankers had differing economic incentives and diplomatic approaches. With more loans outstanding and pressures to maintain the viability of the Polish export market, the European bankers took no issue with offering a “comparable” agreement that rescheduled the vast majority of the principal and attached few demands for economic reform. The U.S. bankers, who had much less of their balance sheets committed to Poland and were much more concerned about the precedent any Polish agreement would set for other countries’ debt reschedulings, demanded that structural economic reforms be attached and required that Poland still pay all of the interest on its 1981 debt. Euromoney reported on “weeks of arduous and often frustrating discussions” during which “committees were formed and re-formed, named and re-named, committee chairmen came and went.” The restructuring terms that emerged were a compromise between the two positions: 95 percent of the debt would be rescheduled over the next seven and one-half years with a interest rate margin of 1.75 percent, but Poland would have to retain “a technical advisor” with an “IMF-type role” who would have direct access to the Deputy Prime Minister for Economic Affairs. In what came to be known as “The Polish Memorandum,” the banks and the Polish government negotiated this package to reschedule Poland’s $2.1 billion debt to private creditors, provided that Poland pay the $500 million in interest on its 1981 debts by the end of the year. Euromoney concluded, “On paper, then, bankers have assigned themselves a political role in shaping Poland’s economy.” ^{Footnote 56} As with traditional diplomatic agreements, each side would have to return home and receive their leadership’s approval for such a deal. In the meantime, the Polish government would have to find $500 million.

Skepticism abounded that approval would be forthcoming from the communist side, particularly among Europeans. A French banker thought the entire exercise to be a flight of fantasy: “Can you imagine that the Soviets will allow an international expert to roam freely in Poland to look at the performance of the economy?” For some reason, this rather obvious point was lost on U.S. bankers. “The US banks in general see the Polish problem … as no different from International Harvester or Massey-Ferguson.” ^{Footnote 57} Even those who saw through the illusion of the bankers’ control over the Polish economy remained under the illusion of the Soviet Union’s ultimate saving grace. The financial community still wondered in July:

Only time would tell. As the multilateral financial brinksmanship progressed on the international level, Poland’s debt crisis took a toll on its domestic economy. Both foreign creditors from above and Solidarity from below squeezed the government’s financial position. As Poland lost access to global capital markets in 1980, the government was forced to dramatically curtail its imports of investment materials and industrial inputs. This cutback, combined with Solidarity’s strikes in the second half of 1980, led to a severe decline in economic output. In addition, the wage concessions won by Solidarity through strikes increased the monetary overhang in the economy. More money chasing fewer goods produced an economy of scarcity. Long lines for basic goods such as milk, cheese, and bread, along with rationing for meat, became the reality of daily life across the country. Through the spring of 1981, most segments of society blamed the government for this downward spiral, which only increased Solidarity’s social support. ^{Footnote 59}

As the domestic economy ground to a halt, the Polish Finance Ministry and Bank Handlowy struggled to keep the nation’s international finances afloat. Western banks had long since stopped providing new money to Poland without government guarantees, ^{Footnote 60} so Finance Minister Marian Karcz was forced to turn once again to Western governments for the $500 million in interest payments due to the banks. Throughout the fall, he met with government representatives in Paris to try and extract more concessions from the West. The same governments that had been so quick and generous with the rescheduling terms earlier in April now told their Polish counterparts that they could not approve any further financial aid.

Why the diplomatic change of heart? In the United States and Western Europe, there had been no loss of support for sustaining Solidarity’s experiment with liberalization. On the contrary, the longer Solidarity remained active in Poland and the longer the Soviets refrained from intervening, the more government officials allowed themselves to seriously consider the possibility that Poland might actually escape the Soviet orbit over the long term. In the United States, the National Security Council sought authorization from Reagan to begin negotiating a $2.5 billion multilateral aid package with Western European countries that would help Poland through 1983. ^{Footnote 61} Many officials doubted that such a program would provide a sustainable solution to the country’s economic problems, and others still anticipated that the Soviet Union would intervene. Robert Gates from the Central Intelligence Agency believed, as did most officials, that “the Polish experiment … is a crapshoot for enormous stakes,” and therefore “we should ‘wager on the muddle’ and provide the credits” for a long-term aid program. ^{Footnote 62}

In Paris, however, the same Western governments that professed to support “the Polish experiment” stonewalled Poland’s requests for aid. This, quite simply, was due to the banks. “No doubt the banks are hoping to be bailed out,” the NSC concluded. “Western assistance must be structured to prevent this.” ^{Footnote 63} With the banks’ debt rescheduling agreement contingent on Poland paying $500 million in interest by the end of the year, Western governments knew that any assistance they provided would go straight back into the banks’ coffers. In a series of meetings throughout the fall, the Polish delegation told the assembled diplomats that the banks were betting “that the governments would find the money.” The American delegate in Paris, Robert Meissner, retorted that the banks were “playing a game of chicken.” Western governments, he told Karcz, “could not find money to pay off the banks.” ^{Footnote 64} Because Meissner and his colleagues still wanted Poland “to receive the best deal possible,” they sought to tutor their novitiate communist counterparts on the tactics of Western financial negotiation. “The present terms should be seen as the opening bid from the banks, not their final offer,” he said. “Poland should not rush into a resettlement.” The French and British representatives reassured the Polish delegation that obstinacy in negotiation would not lead the banks to declare default. “Larger banks normally dissuaded smaller banks from taking legal action and legal action would only be taken if the debtor possessed substantial assets abroad, which Poland did not.” ^{Footnote 65} Having coached Poland’s diplomats on how best to deal with their own banks, the Western diplomats told them that “it was up to them” to strike a new deal with the banks or come up with the $500 million by December 10. ^{Footnote 66}

As his diplomats were stonewalled in Paris, General Jaruzelski began to sense that the course of domestic events was turning in his favor. At the start of the crisis, the population had initially blamed the government for the decline of the economy, but by the fall of 1981 many segments of society began to hold Solidarity at least partially responsible for the prolonged economic chaos and uncertainty. According to Andrzej Paczkowski:

Sensing his moment to discipline Solidarity had arrived, on October 18 Jaruzelski removed the final institutional roadblock to suppression by dislodging Kania as party chief, and adding that title to his own, including his previous roles as premier and defense minister.

When Jaruzelski declared martial law on December 13, Poland was bankrupt. The military action that came was swift and surprising. Claiming that his decision saved the nation from a political and economic “abyss,” Jaruzelski appeared on state television early in the morning to announce the decision. ^{Footnote 68} The implementation of the operation against Solidarity was so successful that few union activists perished. All foreign communication was cut, a curfew was imposed, and the nation’s borders were sealed. Soldiers patrolled the streets of all major cities, but there was little organized resistance.

The Polish Crisis had begun with Gierek’s attempt to impose economic austerity on Polish consumers through price hikes, and it ended with Jaruzelski’s attempt to impose discipline on the nation’s workforce. Over its fifteen-month existence, Solidarity had led many nationwide strikes and garnered wage increases that had severely hampered the government’s ability to earn the hard currency required to repay its debts. The strikes had become so commonplace that bankers crafted an oft-told joke out of the workplace strife:

Martial law was no miracle, but the government did portray it both domestically and internationally as a way to implement economic reforms. In his speech announcing martial law, Jaruzelski argued, “blows are continuously being dealt to the flagging economy … distressing lines of division run through every workplace. … Respect for man’s labor must be restored.” ^{Footnote 70} In the days following the martial law declaration, Polish Vice Premier Mieczyslaw Rakowski told the head of the German Chamber of Commerce that the government had taken action because “worker discipline” needed to be restored. ^{Footnote 71} Wiesław Gornicki, one of Jaruzelski’s advisors, told U.S. officials in Warsaw that Poland’s gross national product had fallen 35 percent in 1981 and that “a continued decline would ruin any chance of Poland’s repaying its debt … without swift action no plan for economic reform could be introduced.” ^{Footnote 72} Two months after the declaration of martial law, the Polish government introduced another round of severe price increases. Unlike 1970, 1976, and 1980, however, these price increases spawned only scattered resistance. Martial law had decisively, if only temporarily, broken the back of the resistance. ^{Footnote 73}

Bankers in the West agreed with the Polish government’s contention that martial law was the best way of implementing reform. “Most bankers think authoritarian governments are good because they impose discipline,” one financier anonymously told the Wall Street Journal. ^{Footnote 74} Thomas Theobold, the head of Wriston’s international division at Citibank, told the New York Times, “Who knows what political system works? The only test we care about is: Can they pay their bills?” ^{Footnote 75} A Frankfurt banker told the New Republic that he saw “the chance for Poland to return to a more normal working schedule” in the declaration of martial law, and “this could be a good thing for the banks.” ^{Footnote 76}

The banks, however, were sure not to let their approbation sully their firm stance in the negotiations over Poland’s 1981 interest payments. On the contrary, the game of chicken between East, West, and the banks over Poland’s private debts to banks continued unabated. December 10 had come and gone, yet Poland had only paid $150 million of the $500 in interest that they owed the banks. Betting that the banks would extend new loans before writing off their old loans as losses, Bank Handlowy requested a $350 million loan from Western banks just days after the declaration of martial law. To further increase the pressure on the banks, Jaruzelski wrote the head of the West German banking association that Poland would “not be able to pay interest on its loans this year.” ^{Footnote 77} The banks viewed the maneuver as an irritating “negotiating ploy” and quickly rejected the request. ^{Footnote 78} In turn, the banks increased the pressure on Western governments, informing them that they would only lend new money if they received a full government guarantee, which stood no chance of happening in the tense days following the imposition of martial law. ^{Footnote 79} Some bankers still expected the Soviet Union to step in and save its ally, as the umbrella theory predicted, but instead the Soviets took comfort in making the banks wait. U.S. embassy officials in Moscow reported an “oft-expressed private Soviet view” that “Western banks are so exposed in Poland that they will do anything to avoid the collapse of their position there.” ^{Footnote 80} Some Western diplomats even began to postulate that the Soviets were not paying Poland’s interest to Western banks because “it would set precedent for establishing [the] Soviet ‘umbrella’ theory for Eastern European debt.” ^{Footnote 81}

In reality, the lack of Soviet support for Poland was a product of a paucity of resources rather than diplomatic maneuvering. In the weeks following the crackdown, Jaruzelski made great hay out of reorienting the Polish economy away from the West and toward the other communist states of Comecon. On January 6, 1982, the Soviet and Polish governments announced a new Trade and Payments Protocol in Moscow, which promised to deliver increased Soviet natural gas, oil, iron ore, and agricultural machinery to Poland in its time of need. Beyond the diplomatic fanfare, however, the agreement did little to change the material realities of Soviet support. A week after signing the agreement, Leonid Brezhnev told his Politburo colleagues that the Polish economic reorientation posed “a difficult question” for the Soviet Union’s allocation of scarce resources. “We find ourselves at the limit of our abilities in terms of assistance to the Poles, yet they are submitting new requests. Perhaps we still have to do something, but we can no longer afford major advances.” ^{Footnote 82} Thus, major advances never came. In time, the U.S. Defense Intelligence Agency concluded that far from increasing their support, Comecon countries actually decreased their aid to Poland in the first months of 1982. ^{Footnote 83} The Polish Ministry of Foreign Trade similarly concluded: “The items Poland needs to replace [Western imports] are not available from other Comecon countries.” ^{Footnote 84}

Default: An Ace in the Hole, or a Joker in the Deck?

President Reagan viewed the declaration of martial law as nothing short of naked Cold War aggression. After hearing of the crackdown, he scratched in his diary, “Our intelligence is that it was engineered & ordered by the Soviet [sic]. If so, and I believe it is, the situation is really grave.” At a series of NSC meetings in the days following the crackdown, the administration groped for a response that befitted the gravity of events. After one such meeting, Reagan committed his conviction to his diary:

On December 23 he gave the nationally televised speech that prompted Wriston’s candle advertisement, telling the Polish government that its “crimes [would] cost them dearly.” ^{Footnote 86}

Conspicuously absent from Reagan’s speech was any mention of Poland’s outstanding debt to banks and rescheduled debt to Western countries. Early in the administration’s deliberations, Reagan ruled out invoking the Tank Clause. He told the NSC, the exception circumstances clause “seems more disruptive to our side” than to Poland. ^{Footnote 87} Because invoking the clause would send Poland into default, administration officials in the State and Treasury Departments agreed with Reagan and felt a Polish default would cause significant harm to the Western financial system.

Defense Secretary Casper Weinberger thought differently. As he watched events unfold in Poland, he became convinced that the martial law declaration presented the United States with a unique opportunity to inflict economic ruin on the Soviet Union and its allies. In the days after December 13, Weinberger gathered a team of economic and financial experts at the Pentagon for an all-day conference to weigh the prospects and implications of calling a default on Polish debt. Undersecretary of Defense Fred Iklé; Henry Rowen and Charles Wolf, economists from the RAND Corporation; and Roger Robinson, a vice president of Chase Manhattan Bank debated “a strategy for virtually killing off the Polish economy already in poor health.” Most of these individuals favored calling the default, although Robinson argued that “a politically driven default” could lead to “‘instant relays’ of sovereign default throughout the world.” ^{Footnote 88} In time, Robinson’s position would win the day. The threat of debt contagion—a concept more familiar to the post-Cold War world—had begun to impress upon the minds of government policymakers. And rightly so. Even without default, the financial implications of Poland’s declaration of martial law did indeed relay quickly throughout the world, as discussed below.

The private musings of Reagan’s diary, and even the public declarations of an Oval Office speech, were a long way from a coordinated response from the NATO alliance. Reagan and Secretary of State Alexander Haig found a reluctant cohort as they began to build a case for unified Western action. As the economic center of Europe, West Germany held the key to any movement. The victim of unfortunate circumstance, West German Chancellor Helmut Schmidt had been in the midst of a twelve-day visit to East Germany when Jaruzelski declared martial law. Either out of respect for his hosts or his business constituents, Schmidt had first told the East German press that Jaruzelski had done what was “necessary.” ^{Footnote 89} This caused few problems for him in Bonn, where the Bundestag decried the Polish transgressions of the Helsinki Final Act, but generally showed little interest in economic sanctions. Across the Atlantic, however, one would have thought that Schmidt had switched sides in the Cold War. The Wall Street Journal lampooned, “Mr. Schmidt’s stance toward Moscow speaks of a demoralized leadership whose best vision of West Germany’s future is as a Finlandized industrial vassal of a totalitarian empire.” ^{Footnote 90} Another commentator reprised an old favorite, “No more Munichs!” ^{Footnote 91}

It is no wonder, then, that Schmidt believed the Reagan administration’s response to Poland had been driven by the pathologies of “television” (read populist) democracy and the “emotionalism” of American domestic politics. Arriving in Washington on January 5, 1982 for talks with the administration, Schmidt sought to make two points to U.S. officials. First, he reminded his hosts that these things happen from time to time in the Cold War and there was not much that could be done to stop them. To partake in a hollow crusade, he later wrote, would be to raise the hopes of “freedom-loving Poles and tempt them to risk their lives,” only to find out that “the entire dramatic effort was in vain.” Second, he reminded his hosts that he was German, and history was not on his side. “Any West German attempt to drive a wedge between the Polish people and its government … would provide the Communist propagandists in Warsaw with arguments against alleged ‘German revanchism.’” ^{Footnote 92}

After another week of diplomatic negotiations, the core of the Western response coalesced at a NATO foreign ministers meeting in Brussels on January 11, 1982. At the strong encouragement of the Reagan administration, alliance members agreed to publicly hold the Soviet Union responsible for the crackdown on Solidarity. The allies also agreed to “not undermine” Reagan’s decision to deny Poland new credits and supported the American call to delay the rescheduling negotiations of Poland’s 1982 government debt indefinitely. All parties agreed that these sanctions would be removed once Jaruzelski had lifted martial law, released all political prisoners, and begun a meaningful dialogue with the opposition. ^{Footnote 93}

A thorn remained stuck in the side of the Western response: Poland still had not paid the interest on its 1981 debt to banks, and the risk of one of Poland’s five hundred creditor banks calling a default increased with each passing day. The largest banks did all they could, including buying out the Polish debt portfolios of smaller banks, to ensure that none of institutions holding Polish loans declared default. By the end of January, however, the situation had reached a breaking point.

One way for the banks to recoup a portion of their money was to call in the government guarantees on their loans. In the United States, however, standard CCC regulations required banks to declare default before the agency could reimburse their loans. In the heat of the crisis, it was now clear that a declaration of default could bring down the Western economy. If Reagan wanted to avoid financial catastrophe, he would have to wave the default declaration requirement and begin paying Poland’s debt with U.S. government funds. In this decision, he found the two foundational principles of his worldview—capitalism and anticommunism—in direct conflict. A default would bring the wrath of the global marketplace to bear on the Soviet empire, but it would also severely damage the global capitalist system. ^{Footnote 94} Frustrated by a choice with no good options, Reagan chose the preservation of capitalism, and authorized the CCC to make the first payment of $71 million to banks to cover maturing Polish debt without declaring default. ^{Footnote 95} In the long running game of chicken between the banks, Western governments, and the Eastern Bloc, it was thus Reagan who swerved off the collision course set by the prospect of a Polish default.

This was a decision best kept private, considering the disruption it would cause to Reagan’s domestic Cold Warrior image. William Safire of the New York Times ensured that no such luxury would be enjoyed. Based on documents leaked to Safire “by officials in defiance of lie-detector tests,” the newspaper reported the CCC payments on its front page, and Safire fumed over the developments in his weekly column. “In an eyeball-to-eyeball confrontation, the Reagan administration has just blinked. Poland’s rulers can afford to dismiss the Reagan rhetoric because they have seen that the U.S. is ready to do regulatory nip-ups to save them from default.” ^{Footnote 96}

Safire’s revelation added fuel to an already frenzied debate among political elites and the American labor movement over the merits of default and the proper course of U.S. foreign policy in the new era of financial interdependence. In the early months of 1982, U.S. Cold War politics began to catch up to the new financial dynamics that had been changing the East–West conflict over the previous ten years. George Ball declared in the Washington Post that “default would wreck the Western Alliance,” and that “no useful purpose could be served by a measure that would only further grind down the Poles,” not the Soviets. ^{Footnote 97} On the very same page, George Will demurred that real Cold War “tough[ness]” necessitated default. ^{Footnote 98} Lane Kirkland, the president of the AFL-CIO, labeled Western banks “the soft underbelly of freedom,” and pressured the Reagan administration to call the default. ^{Footnote 99} Establishment figures Zbigniew Brzezinski and Henry Kissinger were on the lookout for American credibility. Brzezinski concluded that the United States and its allies may “have to bite the bullet” on default, because “anything less than steps like these will not be credible.” ^{Footnote 100} Kissinger saw default as the West’s ace-in-the-hole. Like the nuclear-tipped aces of an earlier era, it was only useful if the other side believed the trigger could actually be pulled. ^{Footnote 101}

With such rhetoric in the air, it was only a matter of time before the debate found its way to the halls of Congress. A week after the New York Times broke the news of the CCC payments, Senators Robert Kastens Jr. (R-Wisconsin) and Daniel Patrick Moynihan (D-New York) convened hearings to investigate the administration’s policy toward Poland. Officials from the Departments of Defense, State, Treasury, and Agriculture, including Weinberger’s default advocate Fred Icklé, massaged their internal differences into a united public front that attempted to portray Reagan’s decision as tough and strategic. This led to a truly illogical series of statements. First, Icklé let slip that he (rightly) believed that “declaring default does not relieve the debtor of his obligations.” Undersecretary of State Robert Hormats turned this back to the official premise of administration action: that the Polish government might use default “as an excuse to relieve itself of its obligation to make any payments.” ^{Footnote 102} Under this revised premise, the administration believed that “best way of keeping pressure on the Polish government and indirectly on the Soviet Government” ^{Footnote 103} was to insist that they pay their debts by withholding the default get-out-of-jail-free card. Nevertheless, Iklé assured the committee that the administration wanted to “deliberately retain” default as “a live option” ^{Footnote 104} in case events in Poland took a turn for the worse. It seemed, implausibly, that the financial nuclear option—default—was at once a strategy of appeasement and the ultimate deterrent.

Needless to say, Kastens and Moynihan were not impressed. In their eyes, the decision not to call a default was motivated not by a desire to gain leverage over Poland but by a desire to save banks from writing down bad loans. Kastens took to the pages of the Wall Street Journal to make his case: “The crisis in Poland provides an unprecedented opportunity to hasten the breakdown of the Soviet Communist system. … Now is the time to declare Poland in default.” ^{Footnote 105} Around him, the neoconservative estrangement from Reagan came into full view. Norman Podhoretz confessed in the New York Times that he looked “with never failing amazement” on Reagan’s decision to pay the interest on Polish loans. “To say that neo-conservatives were disappointed by all this understates the case to an incalculable degree.” ^{Footnote 106}

Bankers paid no mind to the heated politics building in the United States. Their focus remained solely on maintaining their own profitability and financial credibility by finally signing a rescheduling of Poland’s 1981 debts. In early March Poland announced that it would pay all of the 1981 interest by the end of the month, and indeed it did. This cleared the way for the long awaited pageantry of formally signing the rescheduling agreement on April 6 at the Frankfurt headquarters of Dresdner Bank. While U.S. newspapers reported on the growing rebellion in Congress to the Reagan administration’s inaction, Euromoney covered the Frankfurt signing as though it were the Versailles Treaty. Across a two-page spread of Wołoszyn and Karcz signing the rescheduling agreement, the banner read, “Signed: The First Comecon Rescheduling … The camera catches a moment in Euromarket history.” ^{Footnote 107} Having signed the agreement for 1981, the banks and the Polish government were in the absurd position of having to turn around immediately and begin the negotiations to reschedule the loans for 1982, which were already months overdue. Polish officials did not let the absurdity deter them. “We will need up to $3 billion of fresh money this year,” Karcz told Euromoney soberly. If his country received the money, he believed “this year’s rescheduling will be easier.” ^{Footnote 108}

What Debt Hath Wrought

In the months that followed, fresh money never came. In fact, the months of crisis in Poland had precipitated profound changes in the international financial system that decisively influenced the last decade of the Cold War. “Fundamental change is sweeping the Euromarkets,” Euromoney reported in its May 1982 issue, “the era of the government borrower, the main prop of international bank lending in the ’seventies [sic], is dying.” ^{Footnote 109} The president of the Bank of Tokyo told the magazine that “the Eastern European economic situation” had generated “a change in attitude” among banks toward the sovereign loan market. ^{Footnote 110} At the June 1982 Annual Meeting of the Bank for International Settlements (BIS), its president, Fritz Leutwiler, told the board of directors: “I do see signs that the banks’ perception of the risks involved in their international lending may be changing. There have been indications that the banks are reassessing the creditworthiness of a number of sovereign borrowers.” ^{Footnote 111}

In turning away from their previous state clients, the banks were unwittingly sowing the seeds of their own potential destruction. A decline in sovereign loans did not mean a decline in sovereign debt. If capitalism was to avert a global crisis, sovereign borrowers were still going to have to find some way to repay their debt obligations. Otherwise, the accounting ruse that propped up the banks’ house of cards would collapse in a downward spiral of defaults, write-offs of losses, insolvencies, bank runs, and global depression. This spiral began with Poland’s financial crisis, accelerated after Mexico became insolvent in August 1982, and eventually grew into the global financial phenomenon that defined the decade: the so called Third World debt crisis. ^{Footnote 112}

The Polish crisis and its aftermath also exposed the “umbrella theory” for what it was: a theory with little basis in reality. As the illusion of a Soviet umbrella crumbled, banks stopped granting communist states new loans and global investors pulled their money out of the Eastern Bloc. The problems began in Hungary, which throughout the 1970s had been known as a model Comecon economy. In the first quarter of 1982, foreign institutions, particularly Arab investors, removed $1.1 billion of the $1.5 billion in convertible currency that they had deposited in the country. “Sometime during the winter,” Euromoney reported, “banks across the globe had not only decided that they did not wish to participate in syndicated loans to Comecon borrowers, but that they wished to cut all exposure to the area as much as possible.” ^{Footnote 113} Just as in Poland, the question became who would step up to bail out the country. The answer was the central banks of the economies with the most to lose from a Hungarian collapse: West Germany, France, and Great Britain, but not the Soviet Union or the United States. Through the Bank of International Settlements, these three central banks cobbled together a “lifeboat loan” of $510 million. ^{Footnote 114} The problems did not end with Hungary, however. Because of the fears of debt contagion caused by Poland, Romania lost all access to private Western credit and had more than $1 billion in overdue interest payments by the end of 1981. By April those outstanding interest payments had reached $3 billion. The question again was who would be Romania’s lender of last resort, and this time the IMF broke its own conditionality rules to provide a “token drawing” on its funds to pay creditors in July. ^{Footnote 115}

In each case, Western institutions stepped in to stem the tide, but they could not fix the underlying problem. The basic challenge of structural adjustment—to reduce national living standards and increase production of internationally competitive products—remained the responsibility of Eastern Bloc governments. Euromoney concluded that Eastern Europe “had entered a deflationary period” ^{Footnote 116} in which the ability to implement structural adjustment would decide the long-term fate of the bloc. In this matter, no one held out confidence for the future. Indeed, from the declaration of martial law until the fall of the Berlin Wall fall in 1989, Comecon nations struggled to regain their former position in Western capital markets.

For his part, General Jaruzelski attempted to freeze Polish society into submitting once again to the party’s power. On July 22, 1983, nineteen months after its declaration, martial law was lifted, but Solidarity remained officially outlawed. Due to the growing backlog of rescheduled debt, the nation’s total debt continued to grow, and by decade’s end it sat at $39.2 billion. ^{Footnote 117} Poland was finally admitted to the IMF in 1986, but the government proved continuously unable to impose austerity on its citizens. By 1988 government reports concluded that “the memory of martial law no longer holds people back” ^{Footnote 118} ; indeed, strikes broke out once more in the Gdańsk shipyards after a new attempt to raise food prices.

Thus, the roundtable process to bring Solidarity into the government began. Throughout the fall of 1988, the government and the union negotiated the terms of their engagement, and by the turn of the new year, the two sides were working together in a limited fashion. From the government’s standpoint, the logic of the roundtable was simple. As the finance minister told the IMF, “the main purpose of the round table talks is to offer a political concession so as to facilitate the implementation of the authorities’ economic plans.” ^{Footnote 119} The government had concluded that it was “evident that at Wałęsa’s beckoning, Western economic assistance could be forthcoming.” ^{Footnote 120} Indeed, far from the West making aid conditional on continued reform, the Polish government began to argue that reform would be conditioned on further aid and debt relief. A government spokesman told the New York Times in March 1989, “that delayed aid to Poland would have the effect of ‘a mine planted under the political agreement the West has been urging so ardently.’” ^{Footnote 121} In the end, neither side had to wait long for the reform or relief they desired. After the legalization of Solidarity on April 17, 1989, newly elected U.S. President George H. W. Bush offered limited debt relief and increased investment loans. ^{Footnote 122} By the end of the summer, political events were moving too fast for the Communist Party to control, and on August 24, the Polish parliament elected Tadeusz Mazowiecki, a member of Solidarity, to be prime minister. During his inaugural address to the parliament, Mazowiecki fainted and left the building momentarily to receive medical attention after he regained consciousness. Upon his return, he joked with the chamber, “Excuse me, but I have reached the same state as the Polish economy. But I have recovered, and I hope the economy will recover too.” ^{Footnote 123} In the months and years to come, Western governments and banks would attempt to play doctor, relieving over half of what was then the country’s $45 billion in debt. ^{Footnote 124}

The financial history of the Polish Crisis demonstrates that the reemergence of financial globalization after the breakdown of the Bretton Woods system deeply affected the last years of the Cold War. The founding of Solidarity in the shipyards of Gdańsk contributed to the end of the Cold War not only because it stoked the confidence of millions of Poles and other Eastern Europeans living under the yoke of communism, but also because it shook the confidence of the Western financial community in the economic viability of communism. After the crisis broke out in the summer of 1980, commercial banks rethought the profitability of lending to sovereign countries in general, and to communist states in particular, and the Eastern Bloc lost the easy access to global capital markets it had enjoyed throughout the 1970s. With limited access to the ever-deepening pools of global capital that took shape during the 1980s, communist states struggled to impose the structural adjustment on their populations that their Western creditors demanded. Thus, when the end of the Cold War came in the fall of 1989, it was the result not only of communism’s loss of legitimacy among the peoples of Eastern Europe, but also its loss of creditworthiness on global financial markets.