The cornerstone for many international relations is economic investment. Often, economics can either make or break relationships between two nations. An example of this could be the rapid boom of Latin American countries in the twentieth century, where it was a result of industrialization, newfound resources, and economic growth. This was enough to spark the interest of foreign countries, and the rapid growth of Latin American countries led to foreign countries seeking to have a stake in their affairs, particularly the United States. Having Latin America as their next door neighbors, it was unsurprising that the United States began to view Latin America as a worthy investment. Latin America only began to progress more as time went by, leading to a progress in both civil as well as economic infrastructure. This positive net of balances resulted in the government attempting to guide their nation’s economics towards state-owned enterprises. However, in Latin American countries, there was an issue of concentrated wealth. This was due to a government composed primarily of the elite class. This imbalance in Latin American economies along with failure to audit expenditures created a perfect formula for the Latin American Debt Crisis. The Latin American Debt Crisis can easily be compared to the East Asian Financial Crisis. This paper will gauge the global reactions of both debt crises and will explain why one debt crisis was taken much more seriously than the other. With information provided, this paper will show why the Latin American Debt Crisis is a key factor in Unites States-Latin American relations, even to this day.
A debt crisis can be defined as a case in which “a situation in which the large debts owed by a number of individuals, organizations or countries threaten to overwhelm them, so that they become unable to service their debts, which in turn, may threaten the stability of larger structures.” (Collins 1) This means that a country is announcing that it is unwilling to return any interest on investments made to them.
Before the debt crisis, Latin America lacked a stable economy. Their economy would often work in rapid booms and bursts, meaning that the economy would expand and then contract itself both often and rapidly. This expansion and contraction helped to set the basis for the development of the Latin American economy. Following the First World War, Latin American countries were no longer allowed to trade with Europe. This caused a decrease in the prices of Latin American exports. An especially detrimental blow for Latin America as they are primarily export reliant. This lack of purchase of exports led to the Global Economic Crisis of 1930, which was a lack of exports while the demand for imports began to increase. Furthermore, Latin America has struggled with war deficits since the wars for independence. This balance-of-payments crisis, which has been occurring since the first world war, was one of the main elements behind the crisis. Before the 1960s, Latin America accumulated more debt than their currencies. This led to a balance-of-payments crisis, resulting in Latin America to invest in the development of Latin American industries rather than remain dependent on other countries, also known as import-substitution industrialization. In order to make this shift, Latin America must first find the funds to lead this shift into progress. Because of the partnership throughout history between Latin America and the United States, the latter was willing to supply the loans to Latin America. However, these loans were given under the assumption that Latin America would be able to repay the loans, which the United States later found out as not the case.
Beginning in the 1970s, all Latin American countries were borrowing money from foreign investors. This was in an effort to fund their development, particularly Argentina, Brazil and Mexico. Those that invested in these expansions did so under the assumption that their investment would be paid times two. While this was happening in Latin America, new developments were being made in Middle East. The newly found abundance of oil caused the price of oil to increase by 300%. Latin America at the time, like much of the world, was very reliant of oil, thus importing oil quite frequently. This increase in cost caused the world economy to slow down. The influence of the United States caused Middle-Eastern countries to invest their earnings into the United States’ banks. By doing so, the Middle East hoped to increase their returns as the United States was a global power at the time. This money that the Middle East put into American banks was then used to be loaned to Latin America. However, this was all under the assumption that Latin America would be able to pay back these loans, plus the increased profit on interest. By 1983, Latin America had borrowed more than 50% of its GDP or $315 billion dollars. This amount was over half of all private debt flows at the time.
On top of everything at the time, there was an increase in interest rates in Western countries during the 1980s as a result of high inflation rates. Because of this, the amount that Latin American countries had to pay back increased. When Middle-Eastern countries then requested to withdraw their funds, the United States contacted the Latin American countries hoping to reobtain their funds the debt was unable to be paid. This was a result of inability of Latin American countries to manage their funds and malpractice of odious debt. Latin American countries then experienced a credit crunch as a result. A credit crunch is “a money market situation in which loans are hard to get. Credit crunch occurs usually when a government tries to control inflation by imposing restrictions on lending to consumers and small business.” (Business 1) The credit crunch that Latin America was in resulted in a halt of development in Latin America. Once foreign investors realized that Latin America would be unable to payback its debt, these investors halted their investments in fear of debt-default. When it became clear that the investments made by the United States and the Middle East would not be recovered, the IMF introduced Brady bonds to help with the problem. In order for the IMF to become involved, there were several rules which had to be followed. These rules were primarily targeted in hopes of privatizing Latin American industries hoping to create a market that was more in favor of laissez-faire as well as removing tariff barriers. All in hopes of creating a more equal distribution of wealth to stabilize economic inequalities.
In order to understand what the IMF proposed, it is important to understand what a Brady bond was. Brady bonds were “debt relief for developing countries on the part of their creditor banks.” (Lee 1) Basically, the United States would replace the Latin American bonds which held no value with eons backed by the US Treasury, thus helping to secure the principal sum. Furthermore, these bonds were made tradeable, meaning that bonds could be traded with other instruments. By trading their bonds, the debt could be eliminated. Investors would be given the opportunity to repurchase into the market allowing investors to potentially exit transactions. However, even with the help of the IMF, the public was still concerned with what would result from the Latin American Debt Crisis.
With an understanding of the Latin American Debt Crisis, an analysis can be made as to whether similar instances has happened between the United States and other nations. The closest reoccurrence to this crisis was the East Asian Financial Crisis. During this crisis, Asian economies began generating high values as well as began to increase in exports before the crisis occurred. When Thailand decided to remove the Thai Baht’s peg, rather than continue to allow their currency to devaluate, causing other Asian currencies to depreciate similarly. This caused an estimated 38% devaluation all across Asia. This led to international stocks to lose about 60% of their value affecting any investments other nations had made. This reflected what happened in the Latin American Debt crisis because nations began to stop investing in Asia in an effort to save their own economies.
It can be seen in both the Latin American Debt Crisis as well as in the East Asian Financial Crisis that there seems to be a commonality; developing nations. All regions experiencing financial debt are developing areas that relied on stronger economic powers to help finance their development. When agreeing to accept investments from other nations, they also made their markets more open to inflow from other nations. This caused them to expose their already delicate economies to the constantly changing exchange and interest rates. Though both crises were similar in nature, the United States was much more relaxed about the East Asian Financial Crisis than the Latin American Debt Crisis. One reason why the United States may have been so much more relaxed about the East Asian Debt Crisis is because unlike the Latin American nations, East Asian nations were not requesting loans from the government, but rather from privatized firms. This as well as the fact that during the East Asian Financial Crisis, East Asian countries had an exponentially large amount of domestic savings while during the Latin American Debt Crisis, Latin American countries had massive budget deficits. Though both nations suffered financial crisis Latin America was affected much more than East Asian countries. This shows that:
“The Latin American financial crisis of the 1980s and the East Asian financial crisis of the following decade have a primary contrasting consequence determined by bankruptcies. Many governments in Latin America went bankrupt following the crisis due to their inability to repay loans to foreign lenders. The contagion effect among lenders stemming from the acknowledgement of the credit crisis led to large withdrawals of credit from the Southeast Asian countries, causing bankruptcies of businesses and financial institutions. A common practice in Asian economies is government protection and intervention of major business enterprises when about to fail to avoid bankruptcy (Hayami 2003). However during the crisis major Asian companies went bankrupt. Many businesses collapsed, and as a consequence, millions of people fell below the poverty line in 1997-1998 (Summers 2000). The private bankruptcies in East Asia and the public bankruptcies in Latin America is a contrasting consequence however the people in the two regions were economically devastated and experienced the same fate.” (Kulkarni 20-21)
The main causes of the East Asian Financial Crisis was a failure to execute financial supervision. This led to East Asian countries to borrow more than they should have, however rather than causing long-term lasting effects, there were only short term effects. In comparison, the Latin American Debt Crisis was a combination of economic transparency failure as well as bad macroeconomic policies which reflected many years of corruption in the states. It is these mentalities that will eventually be seen again during the Global Economic Crisis of 2008.
The Global Economic Crisis shocked many nations as a result of the real estate bubble. When the Global Economic Crisis occurred many economies all over the world became victims of the credit crunch, a reflection of what Latin America experienced only this time on a significantly larger scale. This disrupted economic growth and trade between all nations. Following what had happened previously in the Latin American Debt Crisis, the United States was now hesitant to invest in order to help trade once again prosper. This is a reflection of Latin America’s previous inability to pay back loans. The United States did not have this problem with East Asian countries, however, as a result of the rapidly increasing success of East Asian economies, despite the Global Financial Crisis.
With an understanding of the Latin American Debt Crisis as well as the East Asian Financial Crisis, it is now possible to compare the progress that has been made regarding trade between Latin America and the United States. Between 1998 and 2009, United States merchandise trade saw an increase of 82%. Though the United States once again continued trade between the nations, only a select few nations were allowed to participate in agreements such as NAFTA. This was done in an effort eliminate trade efforts between Canada. Latin America and the United States to strive towards open economies and free trade between the nations. Due to lack of faith in Latin American economies, many other nations refused to sign the agreement with the United States. Instead these countries proposed FTAA attracting the cooperation of Latin American countries that are still developing.
The reason for non-cooperation between Latin American countries and the United States is due to different primary objectives. Amongst the most priorities of Latin America is reducing barriers for agricultural trade with the United States. In order for a successful agreement to be signed, this must be fulfilled. Most of Latin America’s products are from the agricultural sector. With the United States enacting strict policies on these products, it has proved to be detrimental for Latin American economies. However, the United States instead has chosen to focus on negotiating services trade (tourism, technology, and financial trades, etc.), investment, and intellectual property rights. One issue between these deals however is that in order to support those industries, there is a need for foreign investment; a method that has been previously shown to be problematic. The issues of corruption makes foreign investment in Latin America a difficult topic to master as previously seen in the Latin American Debt Crisis. In regards to the United States and Latin America, neither nation is willing to compromise in fear of damaging their own economies. Seeing that both nations are reluctant to actively participate in trade with one another, the expectation for U.S. – Latin American trade relations in the future is highly unlikely.
During the Latin American Debt Crisis, Mexico was the first of many of default on its debt. During February of 1982, a sharp decline in reserves resulted in the Mexican government to devalue the peso. This meant that the debt burden to the United States would increase. Even with the devaluing of the peso, Mexico was still unable to halt the loss of reserves, thus running out of cash. On top of that, Mexico does not have enough reserves saved up, the reserves at the time are only enough to cover Mexico for three weeks’ time. By August of 1982, Mexico was forced to informed the both the IMF as well as the United States that Mexico would be unable to pay back its debt. The following month, Mexico was forced to nationalize their banking system. This was done in an effort to prevent bankruptcy of the private banking sector. Following this, payments to the private sector began to cease leading Mexico to face a Debt Crisis.
After receiving almost a 3.8 billion USD load from the United States, the peso was devalued 50% to the United States dollar, only months after receiving the loan. This caused inflation rates to skyrocket to 100%, thus leading Mexico into a recession. During the next few years, unemployment levels increase dramatically, particularly in rural areas. Following the devaluation of the peso, net exports began to increase. During this crisis, the increase of net exports was the only positive contributor of Mexican economic growth. Resulting from the crisis, Mexico’s international trade declined nearly 43% while still having a large foreign debt which needed to be paid off. While Mexico was already struggling financially, the prices of oil collapsed on the world market. This caused economies all over the world to slow down. This slow down resulted in Mexico’s GDP to grow only at 0.1% a year. Because of this, the 80s in Mexico is considered to be the “lost decade”.
Before the debt crisis, Mexico experienced a period of economic stability and growth. This all changed in the 1970s with the election of Luis Echeverria as president. As fiscal expansion began to increase, so did public debt. Budget deficits followed soaring up to 10%. As a result, inflation in Mexico rose up to 20% in 1973. The rising inflation led to many other downfalls in Mexico’s economy. The balance of payments began to deteriorate as well as the real exchange rate began to be largely overvalued. Almost all of the debt that Mexico had obtained at this time was held by the private sector even though the money was lent by the commercial banks. Mexico’s largest financial deficit was towards the United States. Their super power neighbor and Mexico were tied with about three-fourths of Mexico’s interest rates. Furthermore, the LIBOR was being repriced every six months. Credit at this time was especially vulnerable because repricing would be driven by economic changes in the creditor nations. After the balance of payments pressure and the devaluation of the peso by 50%, Lopez Portillo was then installed as the Mexican president. In an attempt to stabilize the economy, Lopez agreed with the IMF on a stabilization program. However, following the first of the stabilization program; inflation, budget deficit and account deficit all began to fall.
After the discovery of new oil reserves in 1979, the IMF program was discarded. Instead, an expansionary fiscal policy was implemented in Mexico. With this implementation the real GDP growth was between 8% and 9% and the inflation rate continued to accelerate, however never passing 30%. After 1979, many factors continued to worsen the debt. During the second oil shock of 1979, oil prices skyrocketed. As an oil exporter, this skyrocket was beneficial to Mexico, increasing their oil revenues. Though the oil shock was in Mexico’s favor, the worldwide recession which followed this shock was not. This caused Mexican exports to be decreased, thus further depreciating the Mexican economy. This affected not only Mexico but the rest of the world as well. Worldwide interest rates began to reach record levels. This increase in United States interest rates was a result of the Federal Reserve’s attempt to curb oil-based inflation. This decision by the Federal Reserve caused United States dollar exchange rates to rise even more than before. Making it more difficult for Mexico to pay back their debt to the United States. The overvalued exchange rate of the peso led to fears of devaluation. Though the annual exchange rate was held constant, there was still a fear of capital flight. Even with Mexico’s lack finances to pay back their debts, they continued to borrow money from other superpowers. When the real interest rate began to turn negative, the debt began to continue to accumulate. The depreciation of the peso was not enough to end overvaluation. The increased financial instability continued devaluations of capital flight. By 1980, government expenditures began to escalate. This resulted in large fiscal deficits which could not be matched by a rise in revenues. Even non-oil revenues at this time began to decrease. Much of this was due to the Mexican government’s reluctance to raise prices. As the budget deficit continued to grow, so did the public debt. Following the devaluation of the peso as well as the rise of global interest rates, Mexico’s debt jumped to 49% of GDP. As a result, Mexico was unable to service its external debt.
In 1982, the Mexican government began large scale debt repayments. This two-year respite was granted by the United States commercial banks. An agreement was reached in December to reschedule much of the capital payments on the public sector debt. At the same time, Mexico and the IMF had agreed on a stabilization program. This program also included assistance with Mexico’s structural reforms. Due to Mexico’s debt increasing the capital base many international banks provide, many nations feared that the banking system would collapse. In order to counter this the Baker plan was introduced. This plan allowed high-debt countries to access medium-term loans, loans given by commercial creditors. In June of 1983, the “Paris Club” rescheduled Mexico’s sovereign debt. The Paris Club was an informal group of financial officials that provides various financial services. This includes debt restructuring as well as debt relief. The restoration of the capital markets brought hope that debtors would now be able to grow out of their debt. However, rather than the decrease of capital outflows the opposite effect happened and inflation skyrocketed. Investment in Mexico fell and Mexico had no economic growth during this period. Therefore, the Baker plan was determined a failure.
Following the Baker plan was the introduction of the Brady plan. At this point, the United States banks were able to cope with potential losses due to Latin American Debt. The idea of the Brady plan was that debt relief would become acceptable by offering a smaller and safer payment stream. This was in exchange for original claim which could not be fully serviced. Between 1989 and 1992, the Mexican government was able to reach an agreement on a finance package. This package would help with 49.8 billions of Mexico’s debt. The Brady plan was proven to be a success and helped Mexico to pay back their debt with the reduction of both interest as well as principal payments.
A result of the Latin American Debt Crisis was the United States’ ability to develop a more cautious mindset in regards to trade with Latin America. Latin America’s balance-of-payment discrepancies are due to inability to finance export reforms. This along with implementations of strong institutions ensures that investments do not disappear during transactions shows that the United States has a harsher stance towards Latin American counties than East Asian countries. Based on the arguments stated above, the long term effects of the Latin American Debt Crisis is made clear. The first is that countries with investments in developing nations have a positive pressure to exert a structural soundness if they wish to continue investments. Furthermore, commercial banks residing in developing nations must increase their reserve in order to combat losses on loans in order to ensure another economic crisis will not occur. Due to the Latin American debt crisis, it can be seen that the United States now holds a negative perception of Latin America. The aftershocks of this negativity is still shown today, therefore I argue that the likelihood of a reparation of U.S.-Latin American relations is far from likely.