The ‘Lost Decade’: How the Struggle to Control Inflation in the US in the 1980s Triggered Latin America’s Biggest Debt Crisis in the Last Century

Two days later, the government resorted to its second devaluation of the peso in six months, taking it from 27 to the dollar in February to 80 to the dollar in August.

Soon after, President José López Portillo said that that the devaluation and partial exchange rate controls they imposed were necessary measures to avoid debt default.

In the end, however, that fate could not be avoided, and the then Minister of Finance, Jesus Silva Herzog, ended up asking for help from the IMF and agreeing with creditor banks a 90-day moratorium on the payment of Mexico’s public debt.

That moment is considered the turning point of the 1980 Latin American debt crisis, which was “the most traumatic economic episode that Latin America has experienced in its history,” according to economist José Antonio Ocampo, a professor at Harvard University and Colombia’s current finance minister.

However, it is interesting that one of the factors that strongly contributed to the outbreak of this crisis had nothing to do with the decisions made in the region, but with the economic problems of the United States, which then, as now, was faced with a significant wave of inflation.

In 1979 The United States was in the midst of a major economic crisis with inflation exceeding double digits for the second time in five years.: 11.3%.

The unemployment rate was over 7%, and the price of mortgages and the price of gasoline were skyrocketing.

But in August of that year, Econ Paul Volckerwho will soon begin trying to contain inflation with a sharp maneuver: a relentless increase in interest rates.

A) Yes, Interest rates rose from 10% in August 1979 to around 19% in January 1981.

Consider that these were Fed interest rates, which are the benchmark and floor for the interest rates that people, businesses and countries end up paying for their loans.

Rising interest rates caused two recessions in the United States, but ultimately helped bring inflation under control. When Volcker left the Fed in August 1987, inflation was 3.4%.

This shock therapy, however, also had serious repercussions in Latin America.

During the 1970s, macroeconomic imbalances increased in Latin American countries.

Some countries, such as hydrocarbon exporters, have greatly increased their consumption by taking advantage of the growth in revenues obtained from higher export prices, but even those that have not enjoyed this boon and whose accounts have worsened over the decades have maintained or increased their spending.

Both also coincided in a significant increase in the level of external debt.

“The region as a whole tripled its level of external indebtedness between 1975 and 1980, and several countries far exceeded that volume.. This dynamic was unprecedented, given the poor access to external resources the region had until 1975,” wrote former ECLAC Secretary General Alicia Bárcena in the introduction to the book “The Latin American Debt Crisis in Historical Perspective.”

In that five-year period, all countries in the region significantly increased their level of external indebtedness.

In Uruguay, where it grew the least, it grew by 74%; while in Venezuela, where it grew the most, the variation was 523%..

Economist Ricardo Ffrench-Davis, a professor at the University of Chile, explains that this indebtedness was favored by the boom in financial globalization generated by commercial banks that began lending to Latin American countries.

“They find Brazil, which is growing very strongly, and Mexico, which were the two countries with the highest growth rates in the 1960s and 1970s, and into which large capital began to flow. This is a phenomenon for many medium- and large-sized countries. companies in Latin America,” he says.

He explains that in the face of this massive influx of dollars into Latin America, many countries allow their exchange rates to appreciate and begin to accumulate liabilities.

“The accumulated debt is rising, but the lending banks are calm as Latin America recovers from the oil shock of 1973,” says Ffrench-Davis.

He points out that at that time interest rates were very low because it was a period of financial boom, thanks in part to the fact that the oil countries of the world – who were enjoying wealth – deposited their savings in bank deposits, so that financial institutions had plenty of resources to lend. .

The debt contracted by Latin American countries in those years had two other characteristics that increased their vulnerability when conditions changed: there was an increasing share of debt contracted in the short and medium term; and also that an important part of it was contracted at variable interest rates.

The share of short-term debt doubled between 1975 and 1981, while in the second year two-thirds of long-term debt was subject to variable interest rates.

“Precisely these conditions of growing external vulnerability, the progressive rise of international interest rates since 1978, intensified in October 1979 as a result monetary and credit control policy measures adopted by the United States Federal Reserve to deal with inflationwhich exacerbated the rise in the debt service burden, which in 1982 represented 47% of exports and consequently worsened the size of the current account deficit,” Bárcena wrote.

Ffrench-Davis explains how the effect of the rise in US interest rates has been felt sharply.

“Part of the money the banks lent was at a fixed interest rate, but a large part was at a variable rate. It was adjusted every 3 or 6 months and then, suddenly, there are countries in Latin America that go from paying 5% interest to 15% or 18% interestbut now it was not with the debt from 1973, 1974 or 1975, but with the debt accumulated in 1978, 1979 and 1980,” he says.

“These were debt levels that were already very high with a low interest rate, but now they had a high rate,” he adds.

Therefore, faced with this change in conditions, the countries of the region had increasing difficulties in paying their debts and were forced one by one to seek renegotiations with their creditors.

Although thought to have started with a partial moratorium declared by Mexico 40 years ago, the debt crisis of the 1980s affected 18 countries in the region.

Ricardo Ffrench-Davis assures that its devastating effects are summed up in the name given to that historical period: “the lost decade”.

“The whole of Latin America barely started raising its nose in 1990,” he points out.

The “lost”, however, goes beyond the fact that the region has not progressed, but rather its economies have in practice regressed.

“The region fell from an average of 121% of world GDP per capita to 98%and from 34% to 26% of GDP per capita in developed countries,” wrote economist José Antonio Ocampo in an article published by ECLAC.

This economic decline also had strong social implications. Thus, for example, poverty rose from 40.5% to 48.3% between 1980 and 1990, according to ECLAC data.

But the historical reality turned out to be worse because, as Ocampo pointed out, “Latin America will only return to the poverty levels of 1980 in 2004, for which not a decade was lost in this field, but a quarter of a century.”

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