The arms for Iraq scandal: Oil price collapse and Iran war prompted credit crisis: Patrick Cockburn in Washington looks at why Iraq defaulted on payments to the West

'IRAQ has an attitude problem regarding foreign debt,' wrote a US official in July 1988. 'Iraq only fully repays creditors who offer large new loans.' By then the ability or willingness of Iraq to pay was absorbing more and more government time in London and Washington.

The difficulties for Iraq had started in 1986 during the war with Iran. At the beginning of the year a surprise offensive by the enemy had captured the Fao peninsula south of Basra. In Baghdad the Iraqi government reconsidered its defensive strategy. It decided to plan for a counter-offensive, requiring more weapons and the money to buy them.

But 1986 was also the year in which oil prices collapsed. Iraqi oil revenues to pay for military and civil imports were only dollars 7bn. Saudi Arabia and Kuwait, so generous in the early years of the war, were alarmed by the squeeze on their own oil revenues.

'The inadequacy and unreliability of oil revenues has forced Iraq to rely on massive external financial assistance, in the form of grants, loans and reschedulings,' concluded a study by Eximbank, the US government agency responsible for extending credits and the equivalent of the Export Credits Guarantee Department in Britain.

Documents declassified in Washington because of 'Iraqgate' and in London because of the Matrix Churchill trial show escalating bureaucratic conflicts on both sides of the Atlantic about how to deal with the Iraqi demands. In the US, in particular, with strong memories of the overthrow of the Shah and the US diplomats held hostage in Tehran in 1979-80, there was sympathy for Iraq mixed with wariness towards Saddam Hussein.

On the commercial front there were prizes to be gained. In the early 1980s West Germany, France, Italy and Japan had plunged into the Iraqi market where President Saddam was financing a construction boom with dollars 30bn to dollars 40bn in loans from Saudi Arabia and Kuwait. But by 1983-84, Western export credit agencies found they were not being repaid. The Iraqis rescheduled but by 1986 were not even replying to urgent telexes from lenders.

By 1988 only the US, UK and Australian credit agencies were offering medium-term cover for trade with Iraq and they were doing so because Iraq had decided that they alone would be paid on time. 'You heard it right, they are getting paid on time,' concluded Eximbank in astonishment, noting that formerly favoured suppliers like France, Germany, Japan and Italy were out in the cold.

With great skill, in 1986-90 the Iraqis played for support from the US and British. National security and commercial interests were appealed to in turn. High technology projects were dangled in front of US firms.

Clement Miller, a US credit specialist, was told by Iraqi officials that the US should not worry about getting repaid 'because Saddam Hussein himself had sent around a circular which said, very simply, pay the Americans] I have to admit, this seemed reassuring to me, but only for a while. I then realised that, in Iraq, what Saddam giveth, Saddam can taketh away.'

Matrix Churchill, bought by the Iraqis in 1987, acted as a conduit for Iraqi purchases of military equipment. A 1983 advertising handout in Cleveland, Ohio boasts that Matrix Churchill 'is the major supplier of machines for munition production in the UK and one of the leading suppliers world-wide'.

The bureaucratic debate in the Matrix Churchill papers tends to mask the absurdity of allowing the sale of such a company to the Iraqis while seeking to limit military equipment available for export to Iraq.