Discuss the internal and external causes of the debt crisis, with specific reference to latin America and Africa

To show the major problems that were at the start of the debt crisis it is fundamentally important to discuss OPEC and the rise in oil prices in 1973-74.  The LDC’s needed more foreign currency to buy oil, so this increased import bills which meant debt would increase because their current accounts would go into deficits.  Most of the cause to this was totally external, as when OPEC countries placed surplus cash into western banks, therefore at the disposal of international financial markets. The Euro Dollar markets became easier to borrow from due to bank lending rules being relaxed.

The Petro Dollars from OPEC made international lending even more relaxed as they had large surpluses to and this allowed to give loans to high risk LDC’s, which they would use to finance long term loans which were becoming insecure this was known as recycling of oil surpluses This can be linked to the internal problem within the country, for example this showed an increase in private loans which meant that it was open to miss use and increased interest rates which private banks can control.  There was a major shift from the IMF to the use of private loans, from the 1960’s to the 1980’s. The LDC’s were really in no position to bargain on these terms as they needed oil, as it has no substitutes.

The dynamics of the debt build came together to show high interest rates, low export prices and a low demand for their exports. This was emphasized in the 1979 oil crisis as the industrialised countries tried to combat inflation, this affected the LDC’s in a number of ways. This deflation led to a fall in demand for goods from LDC’s so the prices of these goods fell. This deflation also incurred interest rates rising. This culminated in an extra $41billion dollars being placed on the debt through interest rates rising. 

Within the financial markets a problem appeared that is linked to the above external causes. This was called a recycling problem for example taking money from countries with cash surpluses and giving it to countries with account deficits. After the Second World War the IMF was set up under the Bretton Woods system to resolve the recycling problem. Its main aims were to reduce surpluses and account deficits and create symmetric adjustment. This broke down in the 70’s and many arguments for this have been put forward. Its total inability to create symmetric adjustment was a fundamental in the floor in the IMF. It created resentment due to the fact that deficit countries had to reduce their income and no such pressure was placed surplus countries to do the same. The US was a major influence in the IMF mainly because of its large surplus and because of this the LDC’s found it had to as it did not have any say in the international monetary institutions. The collapse of the IMF resulted in the more Market orientated solutions, which still let countries like the US would have a major say.

These more Market orientated options as mentioned before are western banks and they tried to take the place of the IMF and resolve the recycling process. There was though a more collective problem with this and it had a large external effect on the LDC’s. The Credit rationing system employed by most banks lacked proper co-ordination. So at first (1970’s) they could decide which countries would be lent more or les via their importing or exporting oil. By the 1980’s they were lending the same amounts to a number of countries but mainly due to the fact that competition between international banks hit a high in this period. This meant again that banks lending rules were relaxed and LDC’s could borrow more money as the banks saw the risks of lending as being less of a factor than losing market share in the international markets.  

This created a major problem when the debt crisis occurred when in places like Mexico defaulted on payments. Banks then opted out of lending, meaning the LDC’s found it hard to raise capital this had knock on effects. The banks felt no effect as their governments bailed them out fearing repercussions on their own economies. There was lack of access to international capital markets for trade credit and less export meaning less access to foreign currency. Economists Eaton and Gerositz argued that banks should had lent to a point where costs of defaulting equaled the benefits, but they over lent and defaulting was the easier option. 

Looking at the external effects on the countries shows that there must have been some factors that increased borrowing within the LDC’s. There are many different internal reasons for many different countries. Generally there are two major problems that helped the build up. Investment and borrowing in a certain country must involve a good return on any investments and not just social returns but an improvement in the amount of cash raised. This is related to the fact that although some projects may not have been misdirected, some investments took a long time to start showing a profit. Meanwhile the banks wanted repayment quickly, and with the rise in interest rates the LDC’s budget plans came into problems. Also projects that generate foreign currency may not have suited that certain country because of geographical aspects.

Misuse of the loans also occurred via a concept called capital flight where money was transferred to other bank accounts offshore for private investment; this is what was wrong with bank loans as mentioned before. This took place more when the IMF collapsed and there was no control on where the loans went. The affects on this result in lack of investment so there is lower output in the economy meaning it’s harder to pay back loans and a subsequent belt tightening on the nation as a whole. This also meant an increase in borrowing and more capital flight resulting in more repayments and higher interest rates.  This is caused by a few individuals in that country which showed the International Monetary system to be open to serious corruption, which caused vicious circles in certain countries in Africa and Latin America.

Looking at Certain countries like Brazil they are plagued by inflation a huge foreign debt declining real wages and inability to compete effectively on international market. It has a bad distribution of wealth. Rural and urban poverty have increased with industrialisation. All of these related to the debt crisis, but also the country has had 20 years of dictatorship, which has not helped the corruption of foreign aid. Industrialisation could not continue for Brazil as it had done since the 1960’s and consolidating economic growth from these years became a major problem.

The Crisis of the 1980’s came about from external reasons but the entrenched vested interests in the country from the military, Landowners and multinationals, meant that in a period of high inflation and spiraling debt the country had no solid industrial policy that could cope with this and keep the industrial machine going. Adding to this was the fact that countries like the US were major players in the international market, and with such large amounts of aid going to Brazil it controlled most of its exports. For Example they were able to put a stop barrier on cheap imports from developing countries, which may compete. They stopped letting countries like these develop their primary products before exporting them, which again relates to the foreign currency problem. A very good example of this was when Brazil in the 1980’s tried to export coffee, the USA government acting on behalf of the instant coffee companies threatened to cut off aid, which left Brazil with no option. The underlying fact though is that if LDC’s processed 10 commodities such as coffee or copper it could add up to 27billion on the countries earnings.    

In Sub-Saharan African states such as Zambia Gambia and Uganda similar things have happened since the 1960’s. The international economy has been affected in the 80’s by lack of trade and increasing interest rates, which caused massive capital outflows. Sub Saharan Africa has also been dominated by political coups, civil disorders, and political conflicts with neighboring states, which has meant that aid has not always been used for the right purposes. Population explosion have also put pressure on the economy with deteriorating natural environment, droughts and famine. These factors plus the external influences meant that African economies declined a quarter in GDP per capita.

The Debt Crisis was ultimately the combined influences of internal and external influences that built up from the 70‘s and culminated in the crisis being a world problem in the early 80‘s. The LDC’s were in an open position in which the rich oil dominating countries could take advantage and increase their world Market share. Internal causes were of great significance as if it was not for countries needing to develop then they would have not needed to borrow so much money. The final point is the break down of organisation in the world monetary systems would have not allowed the money to be given to places like Brazil and Sub-Saharan Africa that were vulnerable at that present time. These factors are still trying to be resolved to this day.    

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