Debt and Debt Crisis

The debt crisis is related to the emergence of an integrated global financial market and shifting capital flows to and from the “developing” world from the late 1960s to the 1980s. The shakeup of these capital markets during the early 1980s revealed the vulnerability of the global banking system. For the large commercial banks, the “crisis” diminished by the late 1980s as these banks wrote off their liabilities, sold their debts, or rescheduled debt payments. But for debtor nations, the debt crisis spurred deep cuts in public services throughout the 1980s and 1990s as part of broad economic and social restructuring programs.

Three underlying causes of the debt crisis were a ballooning of the global money supply during the 1970s, the changing structure of international debt, and a global economic recession that hit developing economies hard during the early 1980s. Beginning in the 1960s, the global money supply was influenced by the efforts of U.S. companies to finance overseas operations from U.S. and non-U.S. banks operating beyond the confines of U.S. banking regulation. U.S. deficits with the Vietnam War also increased the international supply of dollars. The looming crisis of competitiveness of the U.S. economy was temporarily resolved in 1971 when President Richard Nixon took the United States off the gold standard, suspending the rights of dollar holders to exchange dollars for gold and devaluing the dollar to encourage exports. This staved off an immediate crisis in the United States, but it destroyed the system of stable exchange rates. Speculators moved into international financial markets, leading to what some analysts have called the era of “casino capitalism,” marked by floating exchange rates and increasingly footloose capital flows.

Another part of the debt crisis was associated with the oil price hikes of the mid-1970s. As oil revenue rolled in, Oil Producing and Exporting Countries (OPEC) could not spend it all within their own economies. Because OPEC countries were not using the money to pay for goods and services, the threat was that this would withdraw money from the world economy and precipitate a global recession. Commercial banks began to recycle these “petrodollars” to developing countries, in some cases offering more money than the countries were seeking. For the nonindustrialized countries, especially Latin America, the heavy borrowing seemed to make possible the kind of development that was expected of them during this period.

Two factors combined to precipitate a financial crisis. First, the structure of the developing countries' debt started to change. In the case of Latin America, from the period following World War II through the early 1960s, nearly two thirds of the capital flowing into the region came in the form of official development assistance or public money from government aid and multilateral agencies. These funds were either direct transfers or favorable long-term, low-interest loans. By the end of the 1970s, however, more than 90% of the foreign capital coming into Latin America was private money in the form of direct foreign investment or private bank loans. Moreover, the character of private lending also changed. During the early 1970s, longer-term low-interest loans were the norm. Yet by the late 1970s, many banks began to shift to short-term lending at variable interest rates. Much of the developing world, especially Latin America, saw an explosion of short-term debt between 1978 and 1982. This changing debt[Page 88] structure would have dramatic consequences. When the United States, under President Ronald Reagan, began to tighten the money supply through higher interest rates during the early 1980s, many countries saw their debt multiply almost overnight.

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