International Debt Crisis

International Debt Crisis
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International Debt Crisis
To begin with international debit occur when countries borrow funds from other governments, international financial institutions private capital markets the same way as individuals, friends or families borrow money from each other for various purposes. Usually countries borrow money for the purpose of development. This includes infrastructure development like roads, hospitals, and public amenities. At times countries also borrow in other to furnish its army with proper weapons. The borrowed funds are a debt owed and the country needs to return it together with some interest after a period of time elapses. This is the same case scenario as with individuals borrowing money from each other. The only difference is that an individual borrows money for their own benefit whereas a country can borrow money without the knowledge or approval of its citizen. On the con side at times such funds are misused and end up benefiting only a few individuals. At times the funds may be engaged on constructive activities but owing to the financial conditions such as the economic crisis it is unable to repay its debt. This sets another difference between and individual and country in terms of debt (Calvo 2002). An individual who fails to repay their debt is declared bankrupt through a judiciary process. Countries on the other hand cannot file for bankruptcy. It is the obligation of the creditors and not court to determine whether or not a certain financial condition will deter the country from paying its debt.
Economists over time have come up with probable reasons for the emergence of the international debt crisis. These include; macroeconomic policies that are unreasonable, hitches in the contacts involving creditors and debtors transactions across the borders, poor creditor and debtor relationships involving the borrower countries, unreasonable interactions with the creditors across the borders and flawed global structures that hinder cross border financial interactions. Out of these proposed reasons the main dilemma is what needs to be fixed first. Taking an example of Latin American debt crisis, the first two probabilities and solutions were considered by economists who sympathize with the market structures. The fifth remained as the option to those economists who were skeptical of the market structure. In developing nations, the international debt crisis is progressive and not intermittent (Cline 1996).
However, the root course of the international debt lies in complexity. It is based on the economic policies and development choices that can be traced back to the 1970s and 1980s. It started with the quadrupling of the oil price by the Organization of Petroleum Exporting countries (OPEC) back in 1973. This saw OPEC nations depositing much of its acquired wealth in commercial banks. The banks in a quest to invest the deposited money issued out loans to developing nations without scrutinizing whether the funds are used for worthwhile purposes. The borrowed funds were of no benefit to the poor with projects such as armament. Most of these projects which cost billions of dollars failed and the only beneficiaries included top ranking government officials and a privileged minority. On the other hand, the inflation rate in the US soared. This forced the US to adapt tough monetary policies. This contributed to an increase in interest rate followed by a worldwide recession. It can be inferred that in the 1980s the cause of debt crisis included reckless lending by creditors, misuses of funds by debtors and the worldwide recession (Cline 1996).
This evokes the question, why loan funds to Less Developed Countries (LDC)? The rationale behind the lending was tied down to the economies of scale. The reasoning is that it is far much easier and more profitable lending a loan worth $100 to a Single government as opposed to issuing hundreds of different loans to American developers or business owners. The banks took advantage of the LDC government in that instead of it investigating individual borrowers, it issued loans to the LDC who had the mandate to investigate and issue the loans to the borrowers within the state. In addition the loan carried with it an appealing factor in the form of guarantee from the borrowing states. The banks didn`t see the possibility of a sovereign state capable of collecting tax to fail in paying back the borrowed funds. Furthermore the loans had high returns. Many of these loans carried floating interest rates. These rates were 1.5 % to 2% more than the London Interbank Offered Rate (LIBOR). A floating interest rate meant that the loans had little risk of inflation in the future which significantly eliminated the bank`s loan asset value. In comparison, the domestic loans were issued at fixed rates which were viable to interest rates ceiling and a lower return rate (Calvo 2000).
The developing countries seized the opportunity to borrow due to various reasons. First is the economic philosophy which had gain popularity in LDCs. The developed economist influenced the economics mentality of these nations to a greater level. The economic ideology which was being passed by the developed nations was that a directed economy was the solution to achieving real economic development. It is unfortunate that in giving out their economic insight and advice, these western advisors skipped the very theory that saw their economic success. It included private property rights including private investment. They regarded this as an obstacle to economic development and in its place they put huge capital inflow as the solution. The LDC could achieve this through state borrowing. This misleading concept was in line with the thought of the authorities of LDC who were eager to attain power and prestige through the perceived borrowing and economic development planning.
In addition, massive borrowing was triggered by the depreciation of the value of the dollar in 1970. During this time, the dollar lost value at a higher rate surpassing the borrowing rate of the LDC. These means that back in 1970 the loans carried negative interest rate; ironically borrowers were being paid to borrow. The LDC expected this inflation to be persistent and thus borrowed heavily with a mindset that they will repay with dollars having less value. However, this was a misjudgment because the value of the dollar increased. This was realized by slowing the rate of the monetary growth by the Federal Reserve under the chairmanship of Paul Volcker. These led to doubling of interest rate in 1981 to 1982 from the rate at 1978 to 1979. The depreciation of the dollar ceased and it gained value. This was a major blow to the debtors who never expected the interest rates to increase.
The table below summarizes developments since 1980 according to data for the baker fifteen rep...