| 1. Introduction | | | | buy time to strengthen their capital base. Banks began |
| The debt crisis and loan defaults have been a | | | | to accept the rolling over of debts , the re-scheduling |
| constant feature of the global economy, the present | | | | of debt repayments, and the supplying of new money. |
| size of the world debt problem overwhelms the | | | | While agreeing to delay in the repayments of the loans, |
| imagination. It is clear that the countries in the Third | | | | the banks opposed any reduction in the interest of the |
| World are in an inherently disadvantageous position. As | | | | loans. |
| primary exporters, they are at the mercy of price and | | | | This was the structural weakness of the financial |
| demand fluctuations in international markets. These | | | | system. Once committed, it was practically impossible |
| fluctuations are beyond the sellers' control as they | | | | for banks to withdraw from the market. |
| reflect the economic health of client industries in the | | | | 3. (C) Interest Rates and Recession |
| West. | | | | If higher oil prices set the stage for a heavy debt |
| The total world debt soared from approximately $100 | | | | burden for many countries in the 1970s, the global |
| billion in the early 1970s to nearly $900 billion dollars by | | | | recession and high interest rates of 1980-82 added |
| the mid-1980s. Time Magazine stated, "Never in history | | | | sufficiently to the burden indiscreetly. |
| have so many nations owed so much money with so | | | | Borrowers became accustomed to low real interest |
| little promise of repayment" . | | | | rates in the 1970s, it made sense to borrow in such |
| This paper will explain the "origins" of the debt crisis | | | | conditions. In 1979-80, nominal interest rates were high, |
| problem and re-assess in detail the causes of the debt | | | | (LIBOR - London Interbank Offered rate - averaged |
| problem, and question whether the Third World Debt | | | | 13.2%). Approximately two-thirds of developing country |
| Crisis was a crisis of debt (i.e. the fault of the | | | | debt is indexed to LIBOR . |
| developing countries) or of credit (i.e. irresponsible | | | | However, by 1981-82, inflation fell sharply, but nominal |
| lending by banks). | | | | interest rates remained high. This meant very high real |
| 2. The "origins" of the Debt Crisis problem | | | | interest rates of 7.5% in 1981 and 11% in 1982. It did not |
| There are so many books and articles that provide | | | | make sense to borrow in such conditions, but by then |
| detailed descriptions to the origins of the debt problem . | | | | most non-oil developing countries had no choice in the |
| However in my opinion, the global debt problem stems | | | | matter. They had to borrow more in order to pay-off |
| from two periods: | | | | old debts, and the interest rates had an immediate |
| • In particular, the forces dating to the | | | | effect on debt growth. |
| mid-1970s, and the first oil price shock (1973-74) | | | | Instead in an effort to reduce inflation, some Western |
| • The beginning of the Reagan Administration | | | | Governments increased interest rates and adopted |
| 2. (A). The mid-1970s and the first oil price shock | | | | tight fiscal policies. The non-oil developing countries paid |
| The period 1974-80, played a huge part to the debt | | | | the price of that interest rise in 1981-82. For debtors, |
| crisis, which can summarised as follows: | | | | inflation is a good thing, as it erodes the debt they have |
| Firstly the most important oil-exporting countries, (not | | | | to pay off. For creditors, who wanted to reduce |
| being able to utilise domestically the vast financial | | | | inflation, increased interest rates were a worth-while |
| surpluses generated by oil price increases), made huge | | | | price to pay for lower inflation. |
| deposits in various financial institutions. | | | | The problem of this policy, was that higher interest |
| Secondly, at the same time, a good number of middle | | | | rates tended to aggravate the world recession, that |
| and high income oil exporting nations (especially those | | | | began in the 1979-80period. Growth rates in the OECD |
| with a higher degree of industrialisation) decided to | | | | countries fell from an average of 3.2% during the |
| accelerate their rates of economic growth, not | | | | 1973-9 period, to an average of 1.2% during 1980-81 |
| withstanding the increase in oil prices. That policy | | | | periods. Falling demand in the OECD countries, |
| contrasted sharply with the "stagflation" situation | | | | especially for primary commodities, was responsible |
| prevailing in the OECD countries. | | | | for a fall in export values. Demand for primary |
| Thirdly, in order to carry out their economic expansion | | | | commodities is generally inelastic, and one reason being |
| policies, many developing countries requested huge | | | | that there was already a surplus capacity in the |
| loans from OECD commercial banks, (in the form of | | | | OECD. |
| Euro-dollars ), so they are able to make massive | | | | 3. (D) The Domestic Policies of the Third World |
| imports of all kinds of goods, (apart from oil: in particular | | | | Countries |
| chemical products, foodstuffs and capital goods). | | | | I must admit that, not all of the blame of the debt crisis |
| Following upon this point, the OECD banks, with great | | | | should fall on the burden of the Western financial |
| liquidity and a weak domestic demand for funds | | | | banks. Some blame has to go to the developing |
| started a wild competition to export capital to the more | | | | countries themselves. Domestic policy errors |
| dynamic of the less-developed countries (LDC). This is | | | | contributed to the deterioration of the debt situation. |
| a very critical moment, as for that very moment, the | | | | In Mexico, for example, the government allowed the |
| LDCs decided to apply to the international private | | | | "Peso" to become seriously overvalued, and allowed |
| banking system to obtain the money required to | | | | budget deficits to surge to 16.5% of GNP in 1982, when |
| implement their expansive economic policies. | | | | the presidential election made authorities reluctant to |
| Finally, in order to decrease the risks of those | | | | carry out effective budget-cutting measures. The |
| operations, the international private banks, decided to | | | | government stuck to a strategy of high growth (8.2% |
| "change the terms and conditions of the loans" shifting | | | | annual growth in 1978-81). The strategy was based on |
| from the fixed of interest that had prevailed until then, | | | | the assumption that oil prices will always keep rising. |
| to variable rates. The borrowing nations accepted | | | | That probably exceeded capacity growth and failed to |
| such changes under the influence of the aggressive | | | | take adequate account of the substantial weakening |
| marketing techniques employed by the banks. This | | | | of the oil market in 1981 . |
| included attractive offers that appeared to be to the | | | | In Brazil, domestic adjustment policies were stronger |
| borrowing nation's benefit, without realising the grave | | | | and indeed contributed to a severe recession that |
| harm that they would suffer in the future. What | | | | began in 1981 and continued into 1983. Even so, Brazil's |
| appeared in the beginning appeared as a mere | | | | domestic policies bear substantial responsibility for the |
| technical innovation that came to be a real trap, since | | | | eventual crisis in 1982. Throughout the 1970s, after the |
| any increase in the interest rate would apply to the | | | | oil shock, Brazil consciously followed a high-risk |
| total outstanding debt. | | | | strategy of pursuing high growth rate based on rapid |
| 2. (B). The Reagan Administration | | | | accumulation of external debt. The resulting legacy of |
| The second period started shortly after the Reagan | | | | large debt proved to be an oppressive burden when |
| Administration in the USA (January 1981). During this | | | | the international economy weakened and exports |
| period, the situation of the mid-1970s changed | | | | declined instead of continuing their earlier rapid growth . |
| completely. Alongside a world economic recession, | | | | Matters were made worse by overvaluation the |
| inflation became increasingly intense in the US and | | | | "Cruzeiro" after an ill-fated attempt to bring down |
| other industrial nations, and rates of interest escalated. | | | | domestic inflation by placing a 40% ceiling of |
| The economic recession in the central nations caused | | | | devaluation in 1980. nevertheless, in 1981, the |
| a sharp drop in prices of raw materials exported by | | | | government was taking adjustment measures and |
| Third World countries. This was precisely the moment, | | | | was considered by the international financial |
| when the financial charges, due to interest payments | | | | community to be managing the economy well. |
| became heavier, and when the flow of fresh capital to | | | | In Venezuela and Mexico, policies led to large capital |
| the Third World began to decrease. | | | | flight abroad. The basic defect was maintenance of an |
| Such was the case in Autumn 1982: Mexico was an oil | | | | overvalued exchange rate on a fully convertible basis, |
| exporter, (or was at least self-sufficient), declared that | | | | combined with domestic interest rate policy that failed |
| it could not repay its debts, and the crisis in Mexico | | | | to provide sufficient attraction to retail capital |
| caused the full attention of the entire industrial nations. | | | | domestically. As a consequence, in 1982, the decline in |
| The crisis became universal, and was followed by 30 | | | | Venezuela's official external assets reached over $8 |
| other Latin American countries in 1983, (including Brazil | | | | billion, although on current account its deficit was only |
| and Argentina ). Latin American countries had to | | | | $2.2 billion . |
| compress their imports in order to be able to continue | | | | Similarly, in Mexico, errors and omissions showed |
| paying their debt services, and for the first time, Latin | | | | outflows of $8.4 billion in 1981 and $6.6 billion in 1982, |
| America became an important "net capital exporter". | | | | and short term capital outflows added $2.1 billion in |
| The extreme problem in 1982 derived primarily from | | | | 1982, for total capital flight of $17 billion . This is almost |
| the effects of global recession from 1980 to 1982, | | | | as much as Mexico had borrowed in the same period. |
| combined with hostile mental shocks to credit markets | | | | In Argentina, in 1980 and 1981, errors and omissions and |
| caused by events in individual countries. To a traditional | | | | short-term capital outflows registered total capital flight |
| economist: "the problem is a consequence of the | | | | of $11.2 billion. To make things worse, Argentina had a |
| development from inflation to dis-inflation in the world | | | | very ineffective stabilisation policy with the collapse of |
| economy. Funds that were borrowed when inflation | | | | the "Peso", and extremely high inflation in 1981. |
| was high, and real interest rates were low or negative, | | | | The hostile shock of the credit markets from the |
| are no longer cheap in an environment of lower | | | | Falklands did not help! As this was associated with the |
| inflation and high interest rates". | | | | mutual freeze of assets, between the United Kingdom |
| 3. The causes of the Debt Crisis problem | | | | and Argentina . Thus, the capital flight has contributed |
| Having examined the growth of debt during the 1970s, | | | | to nearly one-third of total debt in Argentina. |
| and having looked at the circumstances which led to | | | | Another problem, with the Third World countries was |
| crises for Latin Countries (Mexico in particular) during | | | | their long-term development strategies. Such strategies |
| the early 1980s, the next question to be answered is | | | | included : |
| "why did the debt grow so fast in the 1970s?" | | | | (i). Excessive protection in programs of industrialisation |
| 3. (A) The rise in oil prices | | | | based on import substitution. |
| One of the most important causes of debt growth | | | | (ii). Inadequate pricing of capital |
| was the rise in oil prices in 1973-4 and 1979-80. only a | | | | (iii) Over pricing of labour |
| few debtor countries, such as Mexico, Indonesia, | | | | (iv). Overly ambitious and ineffective development in |
| Venezuela and Ecuador, benefited from the rise in oil | | | | many developing countries. |
| prices. The table below, shows the difference | | | | The damaging pressures from the global economy |
| between what was paid for oil and what would have | | | | have made it more essential that distortions in basic |
| been paid for oil, had its price not increased more than | | | | development strategies be corrected. Such long-term |
| the US inflation rate. | | | | developments strategies consequently made their |
| Impact of oil prices on the debt of non-oil developing | | | | goods less competitive on world markets. |
| countries | | | | A further problem was the growing reliance on |
| 1973-1982 (billions of US dollars) | | | | short-term debts. This was very prevalent in Brazil, |
| YEAR A B A-B | | | | Mexico, Argentina and Venezuela. In 1982 : |
| 1973 4.8 4.8 0.0 | | | | • Brazil's short-term debt stood at $21.3 billion, |
| 1974 16.1 5.3 10.8 | | | | (total debt to banks $62.7 billion) |
| 1975 17.3 5.7 11.6 | | | | • Mexico's short-term debt stood at $31.2 |
| 1976 21.3 6.8 14.5 | | | | billion, (total debt to banks $62.7 billion) |
| 1977 23.8 7.5 16.3 | | | | • Argentina's short-term debt stood at $13.5 |
| 1978 26.0 8.6 17.4 | | | | billion, (total debt to banks 25.5 billion) |
| 1979 39.0 10.9 28.1 | | | | • Venezuela's short-term debt stood at $15.3 |
| 1980 63.2 11.9 51.3 | | | | billion, (total debt to banks $26.7 billion) |
| 1981 66.7 12.1 54.6 | | | | Over 50% of Mexican and Venezuelan debts to |
| 1982 66.7 11.9 54.8 | | | | Western banks had maturities of one year or less. |
| TOTAL 344.9 85.5 259.5 | | | | The assumption was that such short-term debt |
| A= Actual cost of oil | | | | facilities would be always available: ye another |
| B= Cost of oil if its price has not increased beyond US | | | | incorrect assumption. |
| inflation rate | | | | 4. Conclusion |
| C= Additional cost of oil | | | | The global debt problem that has emerged in many |
| The additional increasing cost of oil over the decade | | | | developing countries in 1982, can be traced to higher oil |
| was therefore $260 billion. This massive transfer of | | | | prices in 1973-74 and 1979-80, high interest rates in |
| resources between Third World countries could not | | | | 1980-82, declining export prices and volumes |
| have taken place without equally massive borrowing | | | | associated with global recession 1981-2, and with |
| from Western banks. | | | | problems of domestic economic management. |
| 3. (B) The Western Banks | | | | The global debt problem has grown to large |
| The Western commercial banks would also have to | | | | dimensions, and in 1981-82 that growth outpaced the |
| take some of the blame and were only too happy to | | | | growth of exports that sustain the debt. Due to the |
| lend to sovereign states whose export performance | | | | magnitude of this debt, and the widespread evidence |
| looked promising. Such lending was more profitable | | | | of debt-servicing difficulties, the debt problem currently |
| than lending in the developed First World markets. The | | | | poses a considerable risk to the security of the |
| Third World was regarded as a growth area for new | | | | international financial system. As, the debt crisis is likely |
| lending by Western banks. | | | | to continue, and be an obstacle on the growth of |
| The almost unlimited availability of bank loans very | | | | international trade through lower exports, investment |
| often persuaded a process of de-industrialisation. | | | | and employment. |
| Increased debt led to increased interest payments, | | | | ENDNOTES |
| which (if the loans were not properly invested), led to | | | | Time Magazine, 10 January 1984, p42 |
| further loans. Through these changes, many Third | | | | Robert Gilpin, The Political Economy of International |
| World countries became more vulnerable to | | | | Relations, Prince town University Press, 1987, p317-185 |
| developments in the world economy. | | | | The Economist, Is Anybody Paying, 14 March 1987. |
| If this argument is taken into account, then the | | | | Hitesh Patel has written many articles on the |
| Western commercial banks themselves are | | | | Euro-Dollar market. Further details can be obtained at: |
| responsible, for five reasons: | | | | Mario Marcel and Gabriel Palma, The Debt Crisis: the |
| (i). The banks believed that countries could not go | | | | Third World and the British Banks, Fabian Society, |
| bankrupt, and that no real insolvency crisis could occur. | | | | Series number 350, May 1987, p1 |
| (ii). Many of the loans were organised through a | | | | IMF, World Economic Outlook and International Finance |
| syndicates of banks, and many of the participating | | | | Statistics (Various issues) at the British Library |
| banks felt no need for their own "risk assessments". | | | | Mario Marcel and Gabriel Palma, The Debt Crises: The |
| (iii). Competition for a share of the market transformed | | | | Third World and the British Banks, Fabian Society, |
| many banks into virtual "loan-pushers". The two main | | | | Series number 350. May 1987 |
| players being City Bank (US) and Natwest Bank (UK). | | | | IMF International Financial Statistics Yearbook, 1982 |
| (iv). Lending at variable interest rates allowed the | | | | William R Cline, "Mexico's Crisis, The World's Peril", |
| banks to transfer the risk associated with inflation to | | | | Foreign Policy, No 49 (Winter 1982-83), p 107-18 |
| the borrowers. | | | | William R Cline, "Brazil's Aggressive Response to |
| (v). The absence of effective regulatory bodies in the | | | | External Shock", World Inflation and the Developing |
| international financial market made it easier for banks | | | | Countries, William R Cline and Associates, (Washington: |
| to follow their own short-term interests and instincts in | | | | Brookings Institution, 1981), p102-35 |
| their lending policy, and to ignore the medium and long | | | | UN Economic Commission for Latin America, |
| term effects of their actions. | | | | Preliminary Balance of the Latin American Economy in |
| It must be remembered that in the financial business of | | | | 1982, Santiago, January 1983, p13 |
| lending money, loans are an element of a huge | | | | M.S. Mendelson, Commercial banks and the |
| commercial market, where banks struggle for a share | | | | Restructuring of Cross-Border Debt, New york: Group |
| of the market. This is socially constructed capitalism in | | | | of Thirty, 1983, p23 |
| practice. | | | | Banco De Mexico, Informe Annual, Mexico City, 1982, |
| The intention of lending money to the Third World was | | | | p230 |
| a "new concept", where banks relied on a "handful of | | | | IMF, International Financial Statistics, May 1983, p68 |
| simple credit-worthiness indicators", that were not | | | | Word bank, World Development Report 1983, Part II, |
| helpful in forecasting the likelihood of the crisis. Some | | | | Washington, 1983 |
| banks even began to push their customers to accept | | | | (Short-term debt data, by country): American Express |
| higher loans, by offering customers more money than | | | | International banking Corporation, International debt: |
| they had asked for, and by easing their credit | | | | Banks and the LDCs, AMEX Bank review Special |
| conditions. | | | | Paper No 10, London (American Express International |
| Another point to note, is that, the banks also needed to | | | | Banking Corporation), 1984. |