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I. History/Background
In the 1960s and 1970s many Latin American countries, notably Brazil,
Argentina, and Mexico, borrowed huge sums of money from international creditors for
industrialization; especially infrastructure programs. These countries had soaring
economies at the time so the creditors were happy to continue to provide loans. Initially,
developing countries typically garnered loans through public routes like the World
Bank. After 1973, private banks had an influx of funds from oil-rich countries and
believed that sovereign debt was a safe investment.
Between 1975 and 1982, Latin American debt to commercial banks increased at
a cumulative annual rate of 20.4 percent. This heightened borrowing led Latin America
to quadruple its external debt from $75 billion in 1975 to more than $315 billion in
1983, or 50 percent of the region's gross domestic product (GDP). Debt service (interest
payments and the repayment of principal) grew even faster, reaching $66 billion in
1982, up from $12 billion in 1975.
Massive amounts of debt issued by dictatorships only worsened the situation
When the world economy went into recession in the 1970s and 80s, and oil
prices skyrocketed, it created a breaking point for most countries in the region.
Developing countries also found themselves in a desperate liquidity crunch. Petroleum
exporting countries flush with cash after the oil price increases of 1973-74 invested
their money with international banks, which 'recycled' a major portion of the capital as
loans to Latin American governments. The sharp increase in oil prices caused many
countries to search out more loans to cover the high prices, and even oil producing
countries wanted to use the opportunity to develop further. These oil producers
believed that the high prices would remain and would allow them to pay off their
additional debt.
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As interest rates increased in the United States of America and in Europe in 1979,
debt payments also increased, making it harder for borrowing countries to pay back
their debts.
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Deterioration in the exchange rate with the US dollar meant that Latin
American governments ended up owing tremendous quantities of their national
currencies, as well as losing purchasing power.
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The contraction of world trade in 1981
caused the prices of primary resources (Latin America's largest export) to fall.
While the dangerous accumulation of foreign debt occurred over a number of
years, the debt crisis began when the international capital markets became aware that
Latin America would not be able to pay back its loans. This occurred in August 1982
when Mexico's Finance Minister, Jesus Silva-Herzog declared that Mexico would no
longer be able to service its debt. Mexico declared that it couldn't meet its payment due-
dates, and announced unilaterally, a moratorium of 90 days; it also requested a
renegotiation of payment periods and new loans in order to fulfil its prior obligations.
In the wake of Mexico's default, most commercial banks reduced significantly or
halted new lending to Latin America. As much of Latin America's loans were short-term,
a crisis ensued when their refinancing was refused. Billions of dollars of loans that
previously would have been refinanced were now due immediately.
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The banks had to somehow restructure the debts to avoid financial panic; these
usually involved new loans with very strict conditions, as well as the requirement that
the debtor countries accept the intervention of the International Monetary Fund (IMF).
There were several stages of strategies to slow and end the crisis. The IMF moved to
restructure the payments and reduce consumption in debtor countries. Later it and the
World Bank encouraged opened markets. Finally, the US and the IMF pushed for debt
relief, recognizing that countries would not be able to pay back in full the large sums
they owed.
However, some unorthodox economists like Stephen Kanitz attribute the debt
crisis not to the high level of indebtedness nor to the disorganization of the continent's
economy. They say that the cause of the crisis was leverage limits such as U.S.
government banking regulations which forbid its banks from lending over ten times the
amount of their capital, a regulation that, when the inflation eroded their lending limits,
forced them to cut the access of underdeveloped countries to international savings.
In the 1980s, the world experienced a debt crisis in which highly indebted Latin
America and other developing regions were unable to repay the debt, asking for help.
The problem exploded in August 1982 as Mexico declared inability to service its
international debt, and the similar problem quickly spread to the rest of the world. To
counter this, macroeconomic tightening and "structural adjustment" (liberalization and
privatization) were administered, often through the conditionality of the IMF and the
World Bank. This crisis involved long-term commercial bank debt which was
accumulated in the public sector (including debt owed by SOEs and guaranteed by the
government). The governments of developing countries were unable to repay the debt,
so financial rescue operations became necessary.
(1) Official grants and loans (often concessional--i.e., at low interest rates and with
grace periods and long maturities)
(2a) Long-term commercial bank loans
(2b) Short-term commercial bank loans
(3) Securities markets (bonds, equity)
This list is in the ascending order of instability. ODA flows are more stable and
predictable (unless you have a problem with big donors or international organizations)
while securities markets can be very volatile. In the latter case, it is almost impossible
even to identify who are the investors.
The 1980s crisis was caused by (1) and (2a), especially the latter. The 1990s
crises were more often caused by (2b) and (3). The Asian crisis of 1997-98 was mainly
caused by (2b). This however does not mean that all financial crises in the 1990s and
2000s are of the latter type. The old type crises (caused by fiscal deficits) still occur
today.




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II. The Causes of the crisis

There are many complex reasons for international debt crisis in 1980s. The paper
would focus on Latin American countries who mostly suffered from the crisis.

Increasing Government Consumption
First, as Latin American countries
were going through economic growth
and Cold War period in 1970s and
1980s, they increased government
consumptions on food subsidies,
medical subsidies and military goods.
In addition to increased consumption,
in 1973 and 1979, there were two
major oil shocks which made oil prices
much higher. As their growing
economies required more energy
inputs, they had to pay much more
costs for acquiring oil.

Large Amount of Debt
With growing consumption levels and economies, Latin American countries had to
increase their debt amounts to meet financial needs. Basically, the 1970s was a so called
inflationary decade. Global economy went through high economic growth. Especially,
through two major oil shocks in 1970s, OPEC (Organization of Petroleum Exporting
Countries) could get great inflow of large cash flows because importing countries had to
pay higher prices and their quantities demanded did not decrease by large. OPEC did
not have large consuming abilities at those periods. Most of earnings were not used for
investing in domestic projects. Rather, they invested their money in large international
banks. These earnings were mostly in US Dollar and were deposited as euro-dollar
deposits.

Those international banks such as World
Bank had a lot of cash flows and decided to
reinvest in developing countries with high
growth potential. These banks formed
syndicate loans and lent their money to
those countries (Mexico, Brazil and
Argentina) for their national projects. As
shown in the graph, their debt amounts had
largely increased from 1970s to 1980s. By
1983 the region had borrowed from other
countries up to 50% of its GDP or $315
billion.

Unfavorable Global Economic Situations

Major economies such as the United States of America, Japan and European countries
were experiencing stagflation from late 1970s. The situation got worse and worse. With
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high inflation rates and stagnant outputs, interest rates highly increased in these
periods.

As shown in the graph, US Treasury rates,
one of the benchmark interest rates, had
reached historical maximum points around
15%. This situation implies that Latin
American countries had to pay much more
debt amounts. Most of loans and bonds
were issued at floating rates based on
LIBOR or US Treasury rates. Thus, for their
coupon and interest payments, Latin
American countries had to pay much more
funds than their expected amounts.

Depreciating Currencies

In 1970s, Latin American countries enjoyed
large appreciation for their currencies. In other
words, they could borrow US Dollars at much
lower costs. However, as economic situations
became unfavorable, their currencies were
depreciated against major currencies. For
example, Mexican Pesos got much cheaper and
cheaper as the outlook for Mexicos economies
got more and more negative. This also led to
much higher debt payments as their loans were
mostly borrowed in US Dollars.



III. The measures taken to deal with the aftermath

1. The Baker Plan Growth, the Key to Breaking the Debt Crisis.

US Treasury Secretary James Baker initiated the baker plan in 1985. In his
plan, he firmly believed that growth would be key in reducing and putting a halt
to the debt crisis. In his plan, adjustment was combined with debt rescheduling
and new money. He assumed that the issue was the lack of liquidity, so the
solution would be delaying the repayment. Unfortunately, even after delaying
repayment, many indebted countries could not pay back and that led to the
balance-of-payment being worse than it was before.

The issue was not illiquidity but rather insolvency. As his plan failed, it
was recognized that the real solution would come from cutting the debt stock
and not delaying payment itself.

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2. The Brady Plan. The Key to The Crisis is Debt Reduction

Since the Baker plan failed, another plan had to be implemented.
Therefore, in 1989 another US Treasury Secretary Nicholas Brady initiated his
own Brady plan. In his plan, market-based reduction would be implemented.
What this meant was that the indebted nations would buy their own debt at a
discount in the secondary market using various techniques. What this amounted
to was exchanging a large amount of your own bad debt for a smaller amount of
good debt, which must be repaid in full. The IMF and World Bank facilitated
these loans.

3. The Highly Indebted Poor Country Initiative (HIPC) Debt Forgiveness is The Key

The IMF and World Bank launched the HIPC Initiative in 1996, with the aim
of ensuring that no poor country faces a debt burden it cannot manage. Since
then, the international financial community, including multilateral
organizations and governments have worked together to reduce to
sustainable levels the external debt burdens of the most heavily indebted
poor countries.

In 1999, a comprehensive review of the Initiative allowed the Fund to
provide faster, deeper, and broader debt relief and strengthened the links
between debt relief, poverty reduction, and social policies.

In 2005, to help accelerate progress toward the United Nations Millennium
Development Goals (MDGs), the HIPC Initiative was supplemented by the
Multilateral Debt Relief Initiative (MDRI). The MDRI allows for 100 percent relief
on eligible debts by three multilateral institutionsthe IMF, the World Bank, and
the African Development Fund (AfDF)for countries completing the HIPC
Initiative process. In 2007, the Inter-American Development Bank (IaDB) also
decided to provide additional (beyond HIPC) debt relief to the five HIPCs in the
Western Hemisphere.

IV. The Impact of the International Crisis

When we consider the international debt crisis in the 1980s, the two regions
Latin America and East Asia were both affected by the crisis, however Latin America
was more severely impacted by the crisis. As the Latin America borrowing from US
commercial banks and other creditors increase too dramatically during the 1970s. At
the end of 1970, total outstanding depths from all sources concluded only $29 billion,
but by the end of 1978 that number had increased to $159 billion. By 1982 the depth
level reaches $327 billion. Between 1975 and 1980, the debt owed by Latin America
countries to private commercial banks increase at an average annual rate of 20%. Latin
America quadrupled its external debt from $75 billion in 1975 and $315 billion in 1983
which is 50% off the regions GDP. Debt service in the form of interest rates and
repayment of principal went from $12 billion in 1972 two $66 billion in 1982. Entitling
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1980s as a Lost Decade.

By October 1983, 27 countries owing $239 billion has rescheduled their depth
to bank or were in the process others would follow, 16 of the nations were from Latin
America and the four largest Mexico, Brazil ,Venezuela, and Argentina owes various
commercial banks $176 billion or approximately 74% of the total LDC debts
outstanding. Of that amount roughly $37 billion was owed to the eight largest US banks
and constituted approximately 147% of their capital and reserves at that time. As a
consequence, several of the world's largest banks face risk of major loan defaults and
failures it is only because the US government allowed these bank not to write off their
loses that they did not go bankrupt.

The debt crisis interrupted after the shock generated by the sudden increase of
interest rates. External debts has been climbing steadily but slowly since the 1970s and
on average which is still moderate in 1980 below 30% of GDP on average and slightly
more than two times the value of exports. Once the debt crisis broke out the foreign
commercial bank stop sending money to them and begin to think only of getting the
money back the oil dollar recycling and syndicated loans will completely terminate then
the financial risk youth room extended to them through the IMF or international
monetary fund and World Bank in close coordination with the US government. They
wanted to extend the loans to fill the financial gap.

That is why in conclusion these official loans were financed by developed
countries through capital contributions and loans. Sometimes the financial help which
was needed was so huge that the international monetary fund and World Bank loans
were not enough. The international community provided larger loans so Paris club
group of official lenders to a particular developing countries.

The impact of the crisis cost of per capita income to drop and increases the
poverty of the gap between the wealthy and the poor. Due to a sudden drop in
employment late shootings and young adults will force to do illegal drugs trading and
even some sort out in prostitution.

Since the employment rate was so low it causes also some problems such as
homicides, and increasing crime rate which affected these countries making it strongly
undesirable to live. As a result turns out the countries while trying to solve this problem
felt pressured to constantly pay back the money which they owed, but would delay the
process even further in re-building the economy which was already in ruins.

Among the Latin America financial crisis, that prices of the 1980s has been the
worst of all. It involves all 18 countries for example including Columbia which did not
experience debt crises but did face a strong balance of payment disturbances as well as
moderate banking crisis. Furthermore, this has been the worst crisis in terms of
diversity of dimensions and duration measured as the number of months country
during which a particular dimension of the crisis was evidenced. Countries in Latin
America were lost and unable to repay their debts which then they turned to the
international monetary fund that provided money for loans and those unpaid debts. As
a result international monetary fund forced Latin America to reform itself to become a
favor free market capitalism.
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International monetary fund assist Latin America to operate its austerity plans
and programs that can lower the spending in an effort to recover from the debt crisis.
Through this plan brought through by the international monetary fund, Latin America's
economy began a step to becoming a capitalist free-trade economy which is a type of
economy that is preferred by those developed countries.

The impact of international debt crisis also costs Latin America's growth rate
to see it fell dramatically due to governments austerity plans which prevented them
from any more spending. The government spending tended to increase from an average
of 12% of GDP in 1950 to 22% in 1982 in case of central government spending however
this expansion was financed by the increased taxes, thus creating Central government
deficit in the range of 1 to 2% of GDP up to the mid-1970s. The real effective interest
rate on the Latin America's region stepped fluctuated between -1% and 2% between
1975 and 1980. It average to know more than 4% during those years reaching a peak of
6% in 1981 to 82.

A massive process of capital outflow served to depreciate Latin America
countries exchange rate and raise interest rate tightening credit expansion and slowing
investments. Latin America was shutoff entirely from FTI during the 1980s which
resulted in deep recession and massive migration to USA.

The near zero real rates of interest on short-term loans along with the world
economy expansion make this situation bearable in the early part of 1970s. By late in
the decade however the priority of the industrialized world was directed to lowering
inflation, which then led to a tightening of monetary policy in United States and Europe.
Nominal interest rate rose globally and in 1981 the world economy entered recession at
the same time commercial banks began to shorten repayment. In charge higher interest
rates for loans for Latin America countries were in the position that their debts burdens
were unsustainable.

The beginning of the crisis started in June 1982, when the Mexican finance
Minister Jesus Silva Herzog informed the Federal Reserve Chairman, the US treasury
secretary and the international monetary fund managing director that Mexico would no
longer be able to pay service to its depth, which at that point totals to $80 billion. Which
other countries later on followed. Ultimately, 16 Latin America countries rescheduled
their depth as well as 11 LDCs in other parts of the world.

V. Suggestion on how to prevent such a devastating situation
in the future
When providing a balance-of-payments rescue package, the IMF and the World
Bank always require that appropriate corrective policies be undertaken (called
conditionality). They provided the carrot and the stick.
In order to cope with the 1980s debt crisis, these international organizations
created new lending facilities such as:
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- World Bank's structural adjustment lending including "structural adjustment loan
(SAL)," at commercial interest rate, and "structural adjustment credit (SAC)," at
concessional interest rate
- IMF's structural adjustment facility (SAF) and enhanced structural adjustment facility
(ESAF)
Conditionality typically consisted of macroeconomic tightening (budget cuts and
low credit growth to reduce domestic expenditure, i.e., "absorption") and "structural
adjustment" (deregulation, privatization, trade liberalization, etc. to stimulate private
supply response). The theoretical background of this strategy was called neoclassical
development economics. Simply put, it assumes that the private sector will grow strongly,
once macroeconomic instability and government intervention are removed.
In 1985, US Treasury Secretary James Baker initiated the Baker Plan in which
adjustment was combined with debt rescheduling and new money. Fifteen highly
indebted countries were designated as candidates. This plan was based on the
assumption that the problem was illiquidity so delaying the repayment will solve the
problem. The debt stock was not reduced but the repayment schedule was simply
pushed back into the future.
But when the delayed repayment approached, it was clear that the indebted
countries could not pay back and the balance-of-payments situation was even worse
than before. The problem was not illiquidity but insolvency. It was gradually recognized
that the real solution must come from cutting the debt stock itself, not just from
delaying the repayment.
Therefore, in 1989 another US Treasury Secretary Nicholas Brady launched
the Brady Plan, in which market-based debt reduction was implemented. This meant
that the indebted countries engaged in buying up their own debt at discount in the
secondary market using various techniques (debt buyback, debt-equity swap, etc).
These amounted to exchanging a large amount of your own bad debt for a smaller
amount of good debt. IMF and World Bank loans could be used for these operations.
Mexico was again the first country to take advantage of this scheme.
In addition, some countries of geopolitical importance (particularly for the US)
were accorded with very generous treatment. Poland (in transition from socialism to
market) and Egypt (US ally in the Gulf War against Iraq) were given debt forgiveness in
which loans amounting to tens of billions of dollars were written off. They did not have
to repay later or buy back their own debt. Their debt was simply canceled.




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REFERENCES/BIBLIOGRAPHY

Debt Crisis of the 1980s. grips.ac.jp. Economic Research Institute.
http://www.grips.ac.jp/teacher/oono/hp/lecture_F/lec10.htm

The LDC Debt Crisis. http://www.fdic.gov/. Federal Deposit Insurance Corporation.
http://www.fdic.gov/bank/historical/history/191_210.pdf

The Mexican 1982 debt crisis. http://www.rabobank.com. Rabobank Economic
Research Department.
https://economics.rabobank.com/publications/2013/september/the-mexican-1982-
debt-crisis/

Gregory Ruggiero. 1999-03-15. http://www.angelfire.com. Personal Blog.
http://www.angelfire.com/nj/GregoryRuggiero/latinamericancrisis.html


http://www.worldhunger.org/articles/global/debt/caritas2.htm

https://www.mtholyoke.edu/acad/intrel/globdebt.htm

Arrau. P., How Does the Debt Crisis Affect Investment and Growth? A Model
Applied to Mexico, International Economics Department, The World Bank, WPS
378, Washington. D.C. 1990.
The Debt Crisis and Latin Americas Lost Decade (1980s) Presentation by
Professor Victor Menaldo on Political Economy of Latin America.
https://www.imf.org/external/np/exr/facts/hipc.htm

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