The way it should be

"It should not escape notice that gold and silver after circulating in every other quarter of the globe, come at length to be absorbed in Hinduston"

                         ~Francois  Bernier

World Debt Crisis

Posted by VASUDEVA REDDY on Thursday, July 28, 2011 Under: economic articles

THIRD WORLD DEBT CRISIS, I think many haven’t heard of this as I didn’t till last week. It is not the 3
rd debt crisis that the world has faced (to be precise facing), as the name suggests, but it is the crisis of the third world nations. Seriously, there is a very interesting story, at least I felt it is interesting, behind the world debt crisis. We need to go back to the Second World War time to get good understanding about the roots of this crisis.

The story begins…..;)

During the world war 2, every country needed some weapons to participate in the war. To buy those weapons they desperately needed money. Because of which they minted money as much as they can without considering the gold reserves they have. If one or two countries did the same thing, there wouldn’t be a problem. But unfortunately, every nation got the same idea and minted as much as they can, which resulted in devaluation of money. Somehow the World War ended by the year 1945, but by that time most of the countries are in severe debts or devalued currencies. By the year 1945, USSR and US became the two most powerful nations in the world. Economics suggested to have a common exchange currency for the sake of easiness of exchange and trading. Being the largest/strongest nations they had a responsibility to take up that task. Being the socialist nation, USSR refused to take up that task. The only remaining option is US.

To rebuild the world economy, 730 delegates from 44 different allied nations came together at the Mount Washington Hotel, Bretton Woods, New Hampshire, for the United Nations monetary and financial conference. Which is popularly known as Bretton Woods agreement, from which international monetary fund(IMF), world bank and three institutions were created.

The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value-plus or minus one percent-in terms of gold and the ability of the IMF to bridge temporary imbalances of payments.  But as I mentioned before, every country minted as much as they can without considering the reserves. Many nations had a doubt US also minted as much as they wanted. To take up that challenge, US finance minister started a ‘great’ scheme that any nation that brings the dollars will be given the equal worth of the gold. That means any nation can buy gold from the US with the dollars they have. The very smart move they have made is, they asked for the currency which was outside of US, which was very limited. Even though the every country poured the dollars into the US, it wont be a 10% of their total reserves. Hats off to that finance minister.

By the 1971, world had believed that US didn’t mint any extra money, of course they didn’t have any choice, and they accepted the American Dollar as the reserve currency for the countries which had signed the Bretton Woods Agreement.

As the dollar became the reserve currency, the demand for the dollar became high resulted in increased value of the dollar. America started importing the deflated goods and exporting the inflated goods. Even oil is one of those, as it was and is the largest worlds oil importer.

In the meantime OPEC had formed and those fellows also became smarter. They felt like without our supply how the world can get oil and increased prices with the decreased production. On October 16, 1973, OPEC announced a decision to raise the posted price of oil by 70%, to $5.11 a barrel. As the production decreased, demand has increased and within a short span of time the barrel oil price has reached $12 and it was expected to reach around $70. Even though America didn’t stop importing and didn’t tap their ‘strategic oil reserves’, but it ultimately affected the poor oil importing nations. OPEC started build the muscle with the increased rates and they did, actually. But there will be no value for money if it sits idle, so they need to invest it somewhere (main priority was US).US were very confident that the dollars should reach their nation, at the end of the day. Subsequently American Federal Bank had decreased the interest rates (as low as 2% from around 10%) on treasury bills and on external savings, which leaded to think OPEC countries again. OPEC countries took a very brave, or strange whatever you call it as, decision that they lend money to third world nations (majorly Latin America Nations) which were ready to give good interest rates.

As interest rates increased in the United States of America and in Europe in 1979, debt payments also increased, making it harder for borrowing countries to pay back their debts. Deterioration in the exchange rate with the US dollar meant that Latin American governments ended up owing tremendous quantities of their national currencies, as well as losing purchasing power. The contraction of world trade in 1981 caused the prices of primary resources (Latin America's largest export) to fall.

While the dangerous accumulation of foreign debt occurred over a number of years, the debt crisis began when the international capital markets became aware that Latin America would not be able to pay back its loans. This occurred in August 1982 when Mexico's Finance Minister, Jesus Silva-Herzog declared that Mexico would no longer be able to service its debt. Mexico declared that it couldn't meet its payment due-dates, and announced unilaterally, a moratorium of 90 days; it also requested a renegotiation of payment periods and new loans in order to fulfill its prior obligations.

In the wake of Mexico's default, most commercial banks reduced significantly or halted new lending to Latin America. As much of Latin America's loans were short-term, a crisis ensued when their refinancing was refused. Billions of dollars of loans that previously would have been refinanced, were now due immediately. The banks had to somehow restructure the debts to avoid financial panic; this usually involved new loans with very strict conditions, as well as the requirement that the debtor countries accept the intervention of the IMF.

However, some unorthodox economists like Stephen Kanitz attribute the debt crisis not to the high level of indebtedness nor to the disorganization of the continent's economy. They say that the cause of the crisis was leverage limits such as U.S. government banking regulations which forbid its banks from lending over ten times the amount of their capital, a regulation that, when the inflation eroded their lending limits, forced them to cut the access of underdeveloped countries to international savings

Still all the countries paying debt, which is major part of their GNP. Like Brazil, with $211,400 million, and Mexico, with $174,300 million debt, there are several more countries that paying debt. Take the region of Sub-Saharan Africa, for example. This region pays $10 billion every year in debt service. That is about 4 times as much money as the countries in the region spend on health care and education.  

It seems the crisis is not going to end soon, at least till the time some other currency replaces the Dollar as the reserve currency, which is not in near future……..


In : economic articles 

Tags: debt  crisis  dollar  history  opec  america  us  third  world  nations  currency  oil  crisis 

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