First as tragedy, now as farce: lessons from 12 August 1982

11 September 2017 by Mark Perera

As the saying goes, history repeats itself because no one was listening the first time. This month marks the 35th anniversary of an event that sparked a debt crisis across the developing world. It was a crisis triggered by low interest rates in the Global North, a reckless boom in lending and borrowing to Southern countries over-reliant on commodity exports, and a fall in the price of those same commodities. Sound familiar? The parallels with today’s developing world debt crisis are stark, and looking back at how the 1980s crisis arose and how it was dealt with, there are worrying signs that very little has been learned despite repeated calls by Eurodad and other civil society organisations for a comprehensive, UN-backed debt workout mechanism.

A crisis begins

On 12 August 1982, Mexican Finance Minister Jésus Silva Herzog made a series of phone calls to the US authorities and the International Monetary Fund IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.
(IMF) to inform them that his country would no longer be servicing its outstanding debts. This unilateral halt on debt payments was unexpected - mainly because the warning signs had been largely ignored that Mexico, like many other developing countries, was in debt distress. In a short space of time, many countries followed in Mexico’s wake, with defaults occurring across the Global South: within four years, more than 40 countries had agreed some form of debt restructuring with creditors, 16 of them in Latin America alone. But the crisis, and the solutions designed to deal with it, deeply damaged the region’s economic and social development, leading to rising poverty levels and widening inequality between 1980 and 1990. This period was subsequently dubbed the “lost decade for development” by the UN Economic Commission for Latin America and the Caribbean.

Turning a blind eye

In the run-up to its default, the Mexican economy was heavily dependent upon oil exports, boosted by new reserves discovered in the mid-1970s. High oil prices had fuelled confidence in the country’s prospects, and it borrowed heavily from willing lenders, mainly to fund physical capital investment. In 1979, interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
rose sharply on the back of moves by the US Federal Reserve FED
Federal Reserve
Officially, Federal Reserve System, is the United States’ central bank created in 1913 by the ’Federal Reserve Act’, also called the ’Owen-Glass Act’, after a series of banking crises, particularly the ’Bank Panic’ of 1907.

FED – decentralized central bank :
to counter inflation Inflation The cumulated rise of prices as a whole (e.g. a rise in the price of petroleum, eventually leading to a rise in salaries, then to the rise of other prices, etc.). Inflation implies a fall in the value of money since, as time goes by, larger sums are required to purchase particular items. This is the reason why corporate-driven policies seek to keep inflation down. caused by a hike in oil prices, and remained high as President Reagan took office, cutting taxes and financing increased defence spending with external and domestic credit. The high rates meant Mexico found servicing its debts increasingly difficult. As global oil demand waned, export revenues fell, and international reserves depleted rapidly. Domestic currency devaluations caused the debt burden to increase, and the August 1982 default became inevitable. At the time of its default, Mexican sovereign debt Sovereign debt Government debts or debts guaranteed by the government. amounted to around US$80bn, largely held by private banks in the US, Europe, and Japan.

Like other commodity-rich developing states, Mexico had capitalised on a credit boom from commercial lenders. This was fuelled by an overabundance of liquidity Liquidity The facility with which a financial instrument can be bought or sold without a significant change in price. in global capital markets and a hunger for returns in the face of low interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rates in the US and other industrialised countries. High commodity prices during the 1970s meant many countries in the Global South had seen steady growth - but many like Mexico were over-dependent on one or two key commodities Commodities The goods exchanged on the commodities market, traditionally raw materials such as metals and fuels, and cereals. , and inherently vulnerable to shocks in market prices. Overconfident lenders recklessly ignored warnings – including from the then Chair of the US Federal Reserve – and kept on lending.

It ain’t over till it’s over

While the debt crisis signalled that decisive policy action was needed, it took years for a sustainable solution to be agreed. The immediate response from an unprepared international community was to organise hasty bail-outs, in order to keep the debt service Debt service The sum of the interests and the amortization of the capital borrowed. to the banks flowing artificially. But focusing on the solvency of overexposed Northern banks meant they also avoided facing the consequences of irresponsible lending decisions. As a result, debt stocks actually rose as countries took on more bridging loans while imposing harsh structural adjustment Structural Adjustment Economic policies imposed by the IMF in exchange of new loans or the rescheduling of old loans.

Structural Adjustments policies were enforced in the early 1980 to qualify countries for new loans or for debt rescheduling by the IMF and the World Bank. The requested kind of adjustment aims at ensuring that the country can again service its external debt. Structural adjustment usually combines the following elements : devaluation of the national currency (in order to bring down the prices of exported goods and attract strong currencies), rise in interest rates (in order to attract international capital), reduction of public expenditure (’streamlining’ of public services staff, reduction of budgets devoted to education and the health sector, etc.), massive privatisations, reduction of public subsidies to some companies or products, freezing of salaries (to avoid inflation as a consequence of deflation). These SAPs have not only substantially contributed to higher and higher levels of indebtedness in the affected countries ; they have simultaneously led to higher prices (because of a high VAT rate and of the free market prices) and to a dramatic fall in the income of local populations (as a consequence of rising unemployment and of the dismantling of public services, among other factors).

, ultimately shrinking their economies.

After repeated attempts at rescheduling debts, and years of negotiations, it was not until the 1989 ‘Brady Plan’ that real debt relief by the private banks was agreed, and it took eight years for the Paris Club Paris Club This group of lender States was founded in 1956 and specializes in dealing with non-payment by developing countries.

of official bilateral creditors to allow for minimal reductions in debt stocks for the poorest countries involved in the crisis. They had to wait until 1996 for the door to be opened to comprehensive debt reduction via the HIPC Initiative of the World Bank World Bank
The World Bank was founded as part of the new international monetary system set up at Bretton Woods in 1944. Its capital is provided by member states’ contributions and loans on the international money markets. It financed public and private projects in Third World and East European countries.

It consists of several closely associated institutions, among which :

1. The International Bank for Reconstruction and Development (IBRD, 189 members in 2017), which provides loans in productive sectors such as farming or energy ;

2. The International Development Association (IDA, 159 members in 1997), which provides less advanced countries with long-term loans (35-40 years) at very low interest (1%) ;

3. The International Finance Corporation (IFC), which provides both loan and equity finance for business ventures in developing countries.

As Third World Debt gets worse, the World Bank (along with the IMF) tends to adopt a macro-economic perspective. For instance, it enforces adjustment policies that are intended to balance heavily indebted countries’ payments. The World Bank advises those countries that have to undergo the IMF’s therapy on such matters as how to reduce budget deficits, round up savings, enduce foreign investors to settle within their borders, or free prices and exchange rates.

and the IMF. Nevertheless, it was not until the Multilateral Debt Relief Initiative in 2005 that debt levels in most low income countries could genuinely be reduced to sustainable levels, allowing for a fresh start. This came a full 23 years after the outbreak of the crisis, during which the populations of the countries affected paid a heavy social cost.

The only real mistake is the one from which we learn nothing

Could such a crisis be resolved more swiftly and decisively today? For a start, none of the debt relief schemes mentioned above could benefit a developing country running into payment problems now. The continued lack of a regime for debt crisis resolution means countries would probably face the same chaotic and protracted process as Mexico did in the 1980s. The need for a sovereign debt workout mechanism has long been championed by Eurodad, other civil society organisations, and the UN: political will, particularly amongst leaders in the Global North, is vital to establish such a mechanism to ensure fair, speedy and sustainable solutions to debt crises. When devising these solutions, obligations to creditors need to be weighed against a country’s non-financial obligations, such as those under international human rights law, to minimise the detrimental social costs for citizens. Of course, prevention is better than cure, and truly responsible lending and borrowing is critical to averting the emergence of unsustainable debt burdens in the first place.

If nothing else, the 1982 Mexico crisis shows that we cannot afford to ignore red flags when they are waving in front of us. A new developing world debt crisis is already upon us - now is the time to act.




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