In1981–1983, theworldeconomysufferedasteeprecession.JustastheGreatDepressionmadeithardfordeveloping countries to make pa
Posted: Thu May 05, 2022 6:47 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. • 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. • 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?