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It’s said Europe could learn from previous debt crises, but what if ministers know this and are simply putting banks before people?
This week, while Eurozone finance ministers were agreeing their latest plan to not deal with the European debt crisis, they should have been listening to stories from across the Atlantic. The Institute for the Study of the Americas and the Development Bank of Latin America held a conference on learning the lessons from debt crises in Latin America. The conference provided strong examples of what to do, depending on whose interests you are acting in.
The Latin American debt crisis hit the headlines 30 years ago in August 1982, when Mexico announced it could no longer meet debt repayments. Large amounts of foreign loans had been given in the 1970s by financial markets awash with money from deregulation and high oil prices. This fuelled a boom; the bust came when the US raised interest rates and commodity prices collapsed.
Western, particularly US and UK banks, faced bankruptcy if Latin American debt payments stopped. Instead, the IMF â€“ and later the World Bank â€“ gave bailout loans. This was exceptional; for the first time in its history, default was not used by Latin American countries as a way to deal with a debt crisis.
The results were catastrophic. Economies shrank by an average of 7% in total through the 1980s. The percentage of Latin Americans living in poverty went up from 40% in 1980 to 48% by 1990. Around 6% of the region’s income each year was being lost overseas in debt payments.
Jose Antonio Ocampo, the former Colombian minister of finance, argued the response in the 1980s “was an excellent way to deal with the US banking crisis, and an awful way to deal with the Latin American debt crisis”. The current experience in Europe suggests not that the lessons have not been learned, but that those in power are once again acting to protect banks, regardless of the consequences.
By the end of the 1980s, western banks had reduced their exposure to Latin American debt. With the banks saved, the US now allowed a limited amount of debt reduction. The main result was an increase in private lending to the region; a short-term help, but ultimately another boom leading to further crises such as Mexico in 1995 and Argentina at the turn of the century. Argentina finally defaulted in 2001, and has had a growing economy ever since.
Other countries continue to suffer from high debt burdens first created in the 1970s boom. El Salvador, Guatemala and Paraguay all spend 10-20% of government revenue on foreign debt repayments.
Latin America is not the only region to have suffered from the boom-bust caused by what economics professor Stephany Griffith-Jones has labelled “unfettered global finance”. Much of Africa was effectively in a debt-caused depression through the 1980s, 1990s and into the 00s. The Asian financial crisis in the late-1990s was followed by similar events in Russia, before the US and European crises of today.
Ugo Panizza, from the United Nations Conference on Trade and Development showed that foreign lenders operate in line with Deep Throat’s advice in All the President’s Men: they “follow the money“, lending in the good times, taking it out in the bad. Griffith-Jones argued this boom-bust cycle is why countries should be very wary of foreign lending.
Much coverage of Greece has assumed that default would be a catastrophe. There is a clear correlation that countries default when their economy is doing badly. But Panizza showed which way the causation runs. Economic collapses lead countries to default, but economies tend to rebound having done so. As a Bank of England memo from the start of the 00s says: “The problem historically has not been that countries have been too eager to renege on their financial obligations, but often too reluctant.”
The one example of a country proactively defaulting is Ecuador in 2008. President Correa was elected on a platform of establishing a debt audit commission. The latter concluded much of the debt was illegal and illegitimate, a finding Correa used to justify a default that ultimately reduced debts by 65%. Alessandro Liepold, a former deputy director at the IMF, pointed to Ecuador as an unorthodox potential blueprint for others to follow. Crucially, the default came out of a popular movement for a debt audit and cancellation.
Of the lessons from Latin America’s experience, two stuck in my mind. First, when a debt crisis hits, the debt needs to be cut rapidly. The continually failing system to deal with debt crises â€“ bailout loans and austerity â€“ is a tool to protect the lenders, and shift all the burden onto debtor governments and their people. Several speakers suggested a debt restructuring mechanism is needed for governments, effectively a bankruptcy procedure for states, to make it easier for countries to default, reduce their debts, share the costs, and bring early recovery.
Second, debt crises come from foreign lending and borrowing in the “good times”, whether by private companies, public sector, or both. Preventing financial crises requires far less lending and debt between countries. Griffith-Jones pointed out that after the second world war the banks and financial sector were controlled by a global system of regulations, and there were hardly any debt crises until the system was broken up in the 1970s.
Liepold suggested it is crazy that European governments are not hosting conferences on learning the lessons from other people’s debt crises. I worry that they do know the lessons, and have sided with the banks against the people. Hope must therefore come from the people calling for debts to be reduced, and lenders to be brought under control. Otherwise, the current European debt crisis will not be the last; it’ll soon be returning to a region near you.