Debt and Debt Crisis

History

In the 1970s, oil-producing countries increased the price of oil significantly, generating massive profits. These profits, referred to as petrodollars, were deposited in a number of Western banks, especially in the United Kingdom and the United States, and they were recycled by bankers in the form of loans to developing countries. Many of the loans were channeled to Latin American countries as well as to several countries in Asia and sub-Saharan Africa. In some cases, money was lent to military dictatorships that had never been democratically elected. They used the loans in wasteful and unproductive ways, including the creation of large steel plants that never produced steel, and environmentally damaging dams, and to purchase weapons. At the time, however, interest rates were low and commodity prices were rising. External debts, while large, could be serviced with export revenues.

This situation changed in the 1980s, when conservative world leaders such as Ronald Reagan and Margaret Thatcher began to put restrictive monetarist policies in place, which led to increases in interest rates. Commodity prices began to fall, while the prices of manufactured goods began to rise, which resulted in deteriorating terms of trade for commodity-producing developing countries. As a result, many borrowing countries found it increasingly difficult to meet their debt service obligations.

The worsening situation came to a head in August, 1982, when the Mexican government announced that it had run out of foreign exchange reserves and would be unable to service its debt. The bankers reacted promptly to the Mexican default, fearing its repeat across the continent.

The 1982 debt crisis created a new role for the International Monetary Fund (IMF), which was charged with managing the crisis. The banks were forced by the IMF to contribute to the Mexican bailout and that of other countries that were running into difficulties. Lengthy negotiations were held with countries on a bilateral basis to prevent the formation of a debtors’ cartel and to save the banks that had lent the money.

The response to the question of default was to provide fresh loans so that debtor countries could continue to service old loans and to keep the dollars flowing from the developing countries to the northern banks. Effectively, the debt crisis was “resolved” by further increasing the already unpayable debts of Third World countries. These actions converted the poorer countries of the South into net exporters of capital to the wealthier countries of the North. By 2000, many countries of the South had much higher total debt burdens compared with two decades earlier.

Although the debt crisis sent the banking world into turmoil, for some economists it was seen as a blessing in disguise. At this historical moment, neoliberal thought, a belief in the economic efficiency of the market and the need to reduce the role of the state in economic affairs, was once again in ascendancy and was being promoted by influential economists such as those of the Chicago School of Economics. The debt crisis was seized on as a means to reorient Third World economies toward more promarket economic policies and dismantle protectionisms and state subsidies. Bailout packages were thus accompanied by strict conditionalities in the form of structural adjustment policies, and Third World countries were discursively constructed as sites of economic inefficiency and malaise that required harsh economic medicine.

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