In1981–1983, theworldeconomysufferedasteeprecession.JustastheGreatDepressionmadeithardfordeveloping countries to make pa
Posted: Thu May 05, 2022 6:34 am
In1981–1983,
theworldeconomysufferedasteeprecession.JustastheGreatDepressionmadeithardfordeveloping
countries to make payments on their foreign loans—quickly causing
an almost universal default—the great recession of the early 1980s
also sparked a crisis over developing-country debt.
The U.S. Federal Reserve in 1979 adopted a tough anti-inflation
policy that raised dollar interest rates and helped push the world
economy into recession by 1981. The fall in industrial
countries’ aggregate demand had a direct negative impact on
the developing countries, of course, but three other mechanisms
were also important. Because the
developingworldhadextensiveadjustable-ratedollar-denominateddebts(originalsinin
action),therewasan immediate and spectacular rise in the interest
burden that debtor countries had to carry. The problem was
magnified by the dollar’s sharp appreciation in the foreign
exchange market, which raised the real value of the
dollar debt burden substantially. Finally, primary commodity
prices collapsed, depressing the terms of trade of many poor
economies.
The crisis began in August 1982 when Mexico announced that its
central bank had run out of foreign reserves and that it could no
longer meet payments on its foreign debt. Seeing potential
similarities between Mexico and other large Latin American debtors
such as Argentina, Brazil, and Chile, banks in the industrial
countries —the largest private lenders to Latin America at the
time—scrambled to reduce their risks by cutting off new credits and
demanding repayment on earlier loans. The results were a widespread
inability of developing countries to meet prior debt obligations
and a rapid move to the edge of a generalized default. Latin
America was perhaps hardest hit, but also hit were Soviet bloc
countries like Poland that had borrowed from European banks.
African countries, most of whose debts were to official agencies
such as the IMF and World Bank, also fell behind on their debts. Mo
st countries in East Asia were able to maintain economic growth and
avoid rescheduling their debt (that is, stretching out repayments
by promising to pay additional interest in the future).
Nonetheless, by the end of 1986 more than 40 countries had encount
ered severe external financing problems.
Growth had slowed sharply (or gone into reverse) in much of the
developing world, and developing -country borrowing slowed
dramatically. Initially, industrial countries, with heavy
involvement by the International Mo netary Fund, attempted to
persuade the large banks to continue lending, arguing that a
coordinated lending response was the best assurance that earlier
debts would be repaid. Policy makers in the industrialized
countries feared that banking giants like Citicorp and Bank of
America, which had significant loans in Latin America, would fail
in the event of a generalized default, thus dragging down the world
financial system with them. (As you can see, there was more than
one near miss on the road to the 2007–2009 financial meltdown!) But
the crisis didn’t end until 1989 when the United States,
fearing political instability to its south, insisted that American
banks give some form of debt relief to indebted developing
countries. In 1990, banks agreed to reduce Mexico’s debt by 12
percent, and within a year, debt-reduction agreements had also been
negotiated by the Philippines, Costa Rica, Venezuela, Uruguay, and
Niger. When Argentina and Brazil reached preliminary agreements
with their creditors in 1992, it looke d as if the debt crisis of
the 1980s had finally been resolved.
1. Draw your own parallels to the current situation with a U.S.
FED increasing interest rates dramatically to keep inflation in
check. How would in your opinion this time around the situation end
with developing economies with large debt amount denominated in US
dollar? Or why would the situation 40 years later be different?
theworldeconomysufferedasteeprecession.JustastheGreatDepressionmadeithardfordeveloping
countries to make payments on their foreign loans—quickly causing
an almost universal default—the great recession of the early 1980s
also sparked a crisis over developing-country debt.
The U.S. Federal Reserve in 1979 adopted a tough anti-inflation
policy that raised dollar interest rates and helped push the world
economy into recession by 1981. The fall in industrial
countries’ aggregate demand had a direct negative impact on
the developing countries, of course, but three other mechanisms
were also important. Because the
developingworldhadextensiveadjustable-ratedollar-denominateddebts(originalsinin
action),therewasan immediate and spectacular rise in the interest
burden that debtor countries had to carry. The problem was
magnified by the dollar’s sharp appreciation in the foreign
exchange market, which raised the real value of the
dollar debt burden substantially. Finally, primary commodity
prices collapsed, depressing the terms of trade of many poor
economies.
The crisis began in August 1982 when Mexico announced that its
central bank had run out of foreign reserves and that it could no
longer meet payments on its foreign debt. Seeing potential
similarities between Mexico and other large Latin American debtors
such as Argentina, Brazil, and Chile, banks in the industrial
countries —the largest private lenders to Latin America at the
time—scrambled to reduce their risks by cutting off new credits and
demanding repayment on earlier loans. The results were a widespread
inability of developing countries to meet prior debt obligations
and a rapid move to the edge of a generalized default. Latin
America was perhaps hardest hit, but also hit were Soviet bloc
countries like Poland that had borrowed from European banks.
African countries, most of whose debts were to official agencies
such as the IMF and World Bank, also fell behind on their debts. Mo
st countries in East Asia were able to maintain economic growth and
avoid rescheduling their debt (that is, stretching out repayments
by promising to pay additional interest in the future).
Nonetheless, by the end of 1986 more than 40 countries had encount
ered severe external financing problems.
Growth had slowed sharply (or gone into reverse) in much of the
developing world, and developing -country borrowing slowed
dramatically. Initially, industrial countries, with heavy
involvement by the International Mo netary Fund, attempted to
persuade the large banks to continue lending, arguing that a
coordinated lending response was the best assurance that earlier
debts would be repaid. Policy makers in the industrialized
countries feared that banking giants like Citicorp and Bank of
America, which had significant loans in Latin America, would fail
in the event of a generalized default, thus dragging down the world
financial system with them. (As you can see, there was more than
one near miss on the road to the 2007–2009 financial meltdown!) But
the crisis didn’t end until 1989 when the United States,
fearing political instability to its south, insisted that American
banks give some form of debt relief to indebted developing
countries. In 1990, banks agreed to reduce Mexico’s debt by 12
percent, and within a year, debt-reduction agreements had also been
negotiated by the Philippines, Costa Rica, Venezuela, Uruguay, and
Niger. When Argentina and Brazil reached preliminary agreements
with their creditors in 1992, it looke d as if the debt crisis of
the 1980s had finally been resolved.
1. Draw your own parallels to the current situation with a U.S.
FED increasing interest rates dramatically to keep inflation in
check. How would in your opinion this time around the situation end
with developing economies with large debt amount denominated in US
dollar? Or why would the situation 40 years later be different?