Introduction
Ferraro and Roser (para 4) define debt crises as external debt, which can be private or public, of developing countries which has been growing at an increasing rate and whose obligations these countries are unable to meet. The causes of debt crises can be external or internal and it is mostly a global phenomena. In this paper I will cover the causes and the situation of debt crises in the Latin American countries of Argentina, Mexico and Brazil. I will then define the relationship between the rising interest rates and the increase in commodity prices. I will also look at some attempts to solve this crisis. To do this I will concentrate on three literature Reviews that discuss the issue of debt crisis.
The debt crisis
According to the Federal Deposit Insurance Cooperation (1), debt crises in less developed countries were started by the declaration by Mexico in 1982 that it was unable to pay its debts. This was followed by the rescheduling of debts by other Less Developed Countries (LDCs). The situation was worsened by the foreclosure by several banks which required that debts be cleared immediately with no provision for refinancing. Financial panic was a major cause of most of the problems that followed the debt crises and this set in when countries rescheduled their debts increasing the prospects of major defaults and failure by some big banks.
To understand the debt crises it is necessary to have enough knowledge of the situations that preceded this. Ferraro and Rosser (para 8 & 15) see poverty and the economic conditions of the 1970s as a major motivation to borrow thus a major cause of debt crisis. Poverty in the Latin American Countries of Brazil, Mexico and Venezuela made these countries an easy target for foreign lending by the developed countries. At the same time the economic condition within this time was such that there was an increased rate of economic development in the global economy.
Sarkar and Singer (2) state that one of the most important scenarios that led to the debt crises began in the 1950s and 60s when the commodity prices for most exports that these countries depended on fell. This made these countries to start investing in the manufacturing sector and to do this they needed capital which could only be obtained by borrowing. In the 1970s there was the oil crisis that made the oil producing countries to have a lot of liquid dollars that they invested in banks in the developed countries like the United States of America (USA). These banks were able to lend a lot of money at low interest rates to developing countries such as Argentina, Brazil and Mexico to develop the infrastructure to support the move to manufacturing. The Federal Deposit Insurance Corporation (2) describes this as the multinationalism of the financial sector which enabled the United States of America and Europe to access funds from anywhere in the world and to use these in any part in the LCDs. Warnings given on the possibility of problems arising this increased lending were ignored and also the warnings given as to the impact of increase in oil prices on the ability of LCDs to repay on time were ignored. This is because an increase in oil prices should have been used as a reason to foresee the possibility of rescheduling and default of loans by the LCDs. According to the Federal Deposit Insurance Corporation (2), the rise in prices of crude oil also led to heighted inflation that led to increased cost of imports in developing countries. The fact that the money borrowed was also used for current consumption needs also contributed to the debt crisis
Connection with increased commodity prices
According to the Federal deposit Insurance Corporation (3) most of the Latin American countries had stopped production of primary resources in terms of food and minerals. They mostly depended on imports for these. The increase in oil prices also caused balance of payment problems for developing countries by increasing the prices of imports (2). The price increase in prices of imports implies that there will be a general increase in commodity prices.
Generally the increase in crude oil prices resulted in increase inflation and reduced purchasing power for the Latin Americans. Devaluation of currency was another step taken to reduce the effects of the debt crisis by these countries. This was another cause of increase in commodity prices.
An increase in oil prices is mostly accompanied by an increase in commodity prices. Considering the fact that these Latin American had moved to manufacturing as their primary activity the increase in oil prices meant an increase in cost of production since most machines were driven by oil.
The increase in commodity prices was also caused by a reduction in the prices of debt and the implementation of SAPs. The increase in commodity prices also meant a reduction in purchasing power for most people in these Latin American Countries.
Debt Crises and increased interest rates
The recession, which was caused by the inflationary pressures brought about by the increase in oil prices, in the United States of America and Europe caused interest rates to go up which meant that the countries that had borrowed now had to pay higher amounts. According to the Federal Deposit Insurance Corporation (6) currency rate fluctuations brought about by the increase in interest rate made the dollar exchange rate to increase and this lead to increased difficulty to repay their debts. This also caused capital flight from the LCDs since the overvalued exchange rates increased fears of devaluation and caused liquidity problems.
Increase in interest rates was also caused by the increased borrowing by the LCDs which were already facing hard economic conditions thus causing these banks to charge higher interests a condition that lead to increase of the debt crisis. According to Sakar and Singer (2) an increase in interest rates was a cause of the increase in the debt crisis. The fact that the developed countries especially the USA continued lending to these LCDs at higher interest rates further worsened the crisis. The crisis was also made worse by the fact that the debts were now capitalized at higher interest rates thus increasing the earlier debt.
Some solutions for the debt Crisis
Some of the ways that were used to solve the debt crises in These Latin American countries included turning to the IMF, Sakar and Singer (4) and regulatory reforms in the USA (Federal Deposit Insurance Corporation. The IMF imposed Structural Adjustment Programs (SAPs) which had the benefits of increasing exports and promoting enterprise. The programs were also aimed at commodity price stabilization and increasing exports was done through having an International Trade Organization that aimed to stabilize and maintain primary commodity prices. To reduce the debt burden the IMF had a system for automatic soft aid, liquidity for deficit countries and taxation on surpluses from the countries. Soft aid was meant to boost economic growth at lower lending rates and taxation on surpluses aimed at reducing exports and lowering commodity prices. Regulatory reforms in the USA included a statute that set a benchmark on the amounts that could be lent to any one borrower and enforcing of stringent monetary policies.
Conclusion
The debt crisis in the Latin American Countries of Brazil, Mexico and Venezuela was accompanied by increasing interest rates on debts and an increase in commodity prices brought about by inflation. Several reforms were brought about to solve this crisis but these reforms have not been able to solve all these issues.
Works Cited
Federal Deposit Insurance corporation, The LCD Debt Crises; An examination of the banking crises of the 1980s and early 1990s Vol 1; California. 1997, Web.
Ferraro, Vincent and Rosser, Melissa. Global Debt and Third World Development pp New York: St. Martin’s Press, 1994. Print.
Sakar, Prabirjit and Singer, Hans. Debt Crisis, Commodity Prices, Transfer Burden and Debt Relief. Cambridge: Cambridge University Press, 1982. Print.