A brief history of the debt crisis - SLUG

Text from "Unfinished business - Ten years of dropping the debt"

Strike One: The Cold War

After gaining independence, these leaders were approached by banks and governments in wealthy countries offering them loans at generously discounted interest rates. ‘Need to build a dam? Do it at five percent, even though the market rate is far higher.’ It all appeared too good to be true. And it was.

Unfortunately, most of the lenders didn’t have the interests of citizens in borrower countries in mind. This was the era of the Cold War. The United States and its allies were afraid that whichever countries weren’t made into friends would turn to the communists. The Soviets harboured reciprocal fears. Between the two competing empires, the US and the USSR, poor countries took on massive amounts of debt, usually for reasons that were not economically sound. As author Noreena Hertz reports, “More often than not, the lending process was so distorted by geopolitics that the logic that underpins sound borrowing ... was simply absent. As, too, was the criterion that underpins sound lending - that the borrower will likely be able to repay the loan.” (1)

Strike Two: The oil crisis

Trouble deepened with the oil crisis. In 1973, major oil-producing countries hiked their prices, made huge sums of money, and deposited those sums in dollars in western banks. Other economic changes, such as the end of the pegging of the US dollar to gold, flooded markets with cheap money. Interest rates plummeted, starting off a domino effect. To stop the slide and avoid an international crisis, banks decided to lend more money quickly and lavishly to poor countries. They did this without much thought about how the money would be used or if borrowers had the ability to repay. Poor countries took on even more debt: the value of poor country debt spiralled from around $70.2 billion in 1970 to $579.6 billion in 1980. (2)

Strike Three: Financial shift

From the late-1970s onwards, poor countries were delivered a triple blow from world markets: an unprecedented rise in interest rates, led by the US as a result of the fiscal conservatism of newly elected President Reagan; ensuing deflation that caused a dramatic slump in the price of commodities (like coffee and copper) on which poor countries’ incomes depended; and another huge increase in the price of oil.

The trap was sprung – poor countries were earning less than ever for their exports and paying more than ever on their loans and on what they needed to import. They had to borrow more money just to pay off the interest. That cycle has continued ever since.

The debt crisis emerges

Up to the early 1980s, banks had been recklessly lending to poor countries in the belief that they were a safe bet: whatever their problems, countries didn’t go bankrupt. In 1982, Mexico threatened to do just that by defaulting on its debts. The entire global financial system looked exposed, and rich countries and institutions had to do something about it. But their efforts – whether in bilateral discussions, ad hoc schemes such as the Brady Plans,(3) or the internationally agreed Heavily Indebted Poor Countries (HIPC) scheme launched in the mid-1990s (explained on page 16 below) – were all aimed at protecting both creditors and the financial system, rather than fundamentally resolving the debt crisis for poor countries.

The situation today

In the early 1980s, the interest rates on the loans tripled and even quadrupled, causing the debt crisis. While these interest rates have since come down, developing countries continue to be burdened with huge debts which many cannot afford to repay. The total external debt stock (that is, owed to creditors outside the country) of all developing countries in 2005 was $2.74 trillion, with some $514 billion paid back to the rich world that year alone. (4) This consists of: multilateral debt, owed to institutions like the World Bank and regional banks; bilateral debt owed to other countries; and commercial debt owed to banks and private companies.

To repay this debt, poor countries have to forego crucial spending to meet their people’s basic needs and to reduce poverty. Debt is one of the main barriers to development in poor countries today. (5) Moreover, successive generations are still paying off odious and illegitimate debts – incurred by loans made to oppressive regimes; to known corrupt officials; for obviously useless or overpriced projects; or granted on unacceptable terms, such as usurious interest rates. These should be cancelled on the basis of their illegitimacy.

Debt relief schemes impose conditions on countries that wish to benefit from them, often including a host of economic policy conditions, such as privatizations of state-run enterprises, opening of markets, and drastic public spending cuts. These reforms often harm the poorest people, for example cutting their wages and reducing their access to basic services. They also undermine democracy: if policies are determined in Washington, local parliaments become powerless, and political engagement becomes meaningless.

“Clear geopolitical interest dictated lending policy throughout the Cold War. This meant that both tyrannical regimes and regimes that didn’t even pay lip service to the lenders’ ideological beliefs were bankrolled by the West and the East to secure allegiance or to realise strategic goals. Zaire was lent money by the Americans although it never adopted a free market economy. Angola was lent money by the Soviets despite its insincere playacting at socialism. Saddam Hussein was lent money by the West and Arab states up until the 1991 Gulf War, despite the fact that his chemical gas bombing of the Kurdish city of Halabja in 1998, which killed 5,000 of his own people and wounded 10,000 others, was by then common knowledge. The Argentinian military junta of the 1970s was lent money by the United States, despite the fact that it was known to be ‘disappearing’ tens of thousands of people during its reign.” NOREENA HERTZ, FROM THE DEBT THREAT (6)


References:

1. Hertz, Noreena. The Debt Threat: How Debt Is Destroying the Developing World...and Threatening Us All. 2nd ed. Harper Collins, 2006. pp.31, 32.
2. Loser, Claudio. External Debt Sustainability: Guidelines for Low- and Middle-income Countries, G-24 Discussion Paper Series, United Nations, No. 26, March 2004
3. Named after U.S. Treasury Secretary Nicholas Brady, in the late 1980s the Brady Plan allowed highly indebted countries, mainly in Latin America, to convert commercial debts into new Brady Bonds, after many of those countries had defaulted on their debts.
4. Nominal figures for 2005, from Global Development Finance, World Bank, 2007.
5. Enough is enough: The debt repudiation option, Christian Aid, 2007, p.3.
6. Hertz, ibid.