Latin American Crisis of the 1980s“The Lost Decade”

Econ. 462Nov. 24, 2009Edward Kulow

John MagallanesYojasi Lomas

Conditions Prior to the Crisis

History of L.A. Debt Crisis

• Post WWII• Under Bretton Woods Agreement (1944)

- International Monetary Fund (IMF)• Economic Policy

- Import Substitution Industrialization Model

Continued . . . .

• Economic Growth- Eurodollar Market

- Early 1970s - Latin American exports increase• Western Banks Fund Expansion

Private Financing by Commercial Banks vs. IMF- 33% of all financing by 1973-~50% of all financing by 1976- 70% of all financing by 1980

Continued . . . .

• Oil Prices increase after 1973 (see graph)- Petro – Dollar

• US Dollar strengthened in late 1970s due to high interest rates (see graph)

Continued . . . .

• Oil Prices increase after 1973 (see graph)- Petro – Dollar

• US Dollar strengthened in late 1970s due to high interest rates (see graph)

Inflation and Interest Rates since 1970

- Inflation -U.S. Interest Rates

Contributing Factors

Between 1973-1983 external debt rose from $48 billion to about $350 billion (see graph)(about 58% of Gross Regional Product)

•Latin American Crisis – August 1982- Mexican Finance Minister Jesus Silva-

Herzog

L.A.C. Balance of Foreign Debt(In Millions)

Conditions During the Crisis

What happened?

• Global Economy slows into Recession• Debt Service

- $12 Billion in 1975- $66 Billion by 1983

• Banks react to Mexico’s announcement- Lending Freezes- All loans due immediately!

Continued . . .

• Situation Worsens- Domino Effect by Oct. 1983 (16 Nations)- Big 4 (Mexico, Brazil, Venezuela, Argentina) owe about $176 Billion (50% of debt)- $37/$176 Billion owed to 8 largest U.S. banks (representing 147% of capital reserves)

Conditions After the Crisis

Steps to Alleviate Debt Crisis

• Bridge Loans- Permitted countries to pay interests only!

• Debt-Equity Swap- Transfer of loan to another bank or 3rd party

• Restructuring- Extension of terms or payment schedules

• Securitization of Loans- Brady Plan

• IMF Restrictions

Brady Plan

• Securitization of sovereign debt- 1989 Nicholas Brady U.S. Sec. of Treasury- Converted loans into bonds backed by U.S. T-bonds (available to general public)

IMF Restrictions

• Conditional Lending– Increase in Interest Rates to Increase F.D.I.– Devalue Currency to Increase NX– Decrease Government Spending (no subsidies)– Privatization to relief financial burden– Stabilizes Index Prices & Wages to control inflation– Removal of Tariff Barriers

(from Import Substitution Industrialization Policy to Export Oriented Trade Policy)

L.A.C. Balance of Foreign Debt(In Millions)

Conditions Today

Where Does L.A. Stand Now?

Continued . . .

Recent trends in Latin America's Fiscal Performance (OECD)

• Since the end of the debt crisis of the 1980s, Latin American Countries have:– reduced deficits– lowered fiscal volatility – increased public expenditure and pioneered fiscal

innovations.

• However, important problems remain: – revenue generation relies on volatile non-tax sources

and regressive indirect taxes, while public spending and social transfers play a very limited distributive role

Any Questions?