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Unit 28 : International Debt Crisis

the issues. To most analysts, however, it is clear that lenders as well as borrowers are to blame for the Notes
abuses and excesses that occurred.
The OECD put it this way in its 1982 Survey : “It appears in retrospect that certain developing countries
have borrowed unwisely (as indeed have some other borrowers), using some of the resources to
finance consumption and investments of dubious value, rather than to strengthen their productive
potential.” They were able to do so because creditors, primarily banks, did not constrain their lending
by adhering to normal prudent standards. Rather, “overeagerness by banks to lend has sometimes
allowed borrowing governments to delay necessary adjustments.”
Some would absolve banks from blame. They argue that banks would have been less eager to lend to
developing countries if they had reliable, current information about the total indebtedness of the
countries to whom they were lending. Through 1982, each bank had timely information only on its
own loans. However, the argument is not persuasive. One large regional bank, the National Bank of
Detroit, as reported by Sanford Rose of the American Banker, stopped lending to Mexico by the end of
1981 based on an in-house analysis of the risk involved. Furthermore, all banks should have understood
the risk of operating without full information and tempered their eagerness to lend to developing
countries accordingly. As it was, some banks made loans in excess of their capital to countries that
are now having trouble meeting their debt-service obligations.
Regardless of how much blame should be assigned to borrowers and how much to lenders, by the
summer of 1982 it was clear that some LDCs and Eastern bloc nations were having trouble servicing
their debts, that their bankers were becoming concerned and reluctant to extend new credits and in
some cases to renew maturing credits, and that some banks, including some in the United States, had
made loans to these countries in excess of their capital, some-times in disregard of the advice of in-
house specialists on sovereign risk. These elements define the current crisis.
Those who look for proximate causes will tie the emergence of the present debt crisis to the 1981 to
1982 disinflation and recession. During recessions, especially when accompanied by substantial
disinflation (to build a springboard for sustainable growth), as in 1982, debts are not easily serviced
by debtors, nor are they automatically renewed by lenders. This view of the emergence of the debt
problem has been popularized by the press. The New York Times, for example, wrote on 9 January
1983, that “what has really gone wrong in the third world can be traced to the weak world economy
rather than to an overextension of credit by greedy commercial bankers or extravagant borrowing by
imprudent leaders of developing nations.” The Washington Post wrote on the same day, “The recession
has sent to the brink of bankruptcy countries once thought to be impeccable credit risks . . . [depressing]
demand prices for commodities that are the mainstay of the developing world.”
However, disinflation and recession in the 1981 to 1982 period did not occur in an historical vacuum
but followed a wave of inflation that began in 1977. The debt crisis can be tied to that inflationary
surge. Advocates of this view need not dispute that the debt build-up financed “a large amount of
inflation,” as Kaufman pointed out, or that initially the inflation was associated with robust growth
figures. Early on, the chain of causation definitely runs from debt accumulation and money creation
to inflation and growth. Later on, however, the chain of causation runs the other way—from inflation
to debt accumulation and recession. Inflation undermines household, business, and government
balance sheets. It creates an atmosphere in which debtors flourish and become eager to borrow, often
without regard to risk, while lenders downgrade risks. As a result, careless practices creep into the
lending process and indebtedness increases dangerously. At the same time, even if it is periodically
ratcheted upward, inflation inevitably produces recessions. Since, as balance sheets deteriorate,
production and spending fall, especially capital formation and investment spending.
The inflationary surge of the late 1970s to 1981 is legitimately viewed as the underlying cause of the
present debt crisis. The 1981 to 1982 recession period was the trigger event. The recession suppressed
demands for goods and services generally, and because commodity and raw materials markets are
relatively competitive, commodity and raw materials prices declined relatively more than the prices
of intermediate and finished goods. In fact, the latter continued to increase on average.
On balance, non-OPEC developing countries export commodities and raw materials and import
intermediate and finished goods. Thus, the 1981 to 1982 recession raised their trade and current

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