The International Debt Crisis, Government Influence on Financial Markets - Research Paper Example

Student’s Name Professor’s Name Course Name/Code Date The International Debt Crisis 1.0 Introduction Individuals and families often borrow money from private and public financial institutions to fund projects like investment, education, and housing. In a similar manner, governments too enter into debts so as to facilitate infrastructural developments in their countries, buy weapons, provide services such as education and health1. Just like individual families, countries too need to pay back the money borrowed together with some interest. Unlike individual borrowing where the individual can use the loan to benefit oneself, in government borrowing, the loans taken from other countries might not be used for the benefit of the citizens of that country. Accumulation of debts by countries is what leads a debt crisis. The second half of the 20th century witnessed eight major debt and currency crisis in different parts of the world. This was largely contributed by failure to regulate cross-border financial transactions. In 1994-95 Mexico experienced the famous ‘tequila’ crisis. In the period between 1997 and 1998, the Asian countries were faced with the Asian financial crisis. At the same time, Brazil too had a crisis. In the early 2002, the world economy experienced the Argentine economic meltdown. Perhaps the most recent crisis the economic recession of 2007 had adverse effects on the economies of super powers like the US. As Eatwell and Taylor notes, international debts crisis is becoming a defining characteristic to the contemporary global economy2. This particular research report undertakes to explain the meaning of international debt crisis, trace its development over years among selected countries. The report will further discuss the causes of the international debt crisis, give its impact, and suggest a few approaches that can be taken to avert the debt crisis. 2.0 The Concept of International Debt Crisis A debt crisis as a result of failure by countries to repay the loans they have borrowed. An international debt crisis relates to international loans, national economies and their budgets. Various monetary organisations have come up with their own definitions. International monetary fund defines a debt crisis as a situation where a country cannot repay its outstanding debt and consequently seeks help from some other 3.According to Raffer, an international debt arises when the total sum of a country cannot repay its cross –border financial obligations4.Payment of such loans in this situation demands instituting very radical changes in terms of expenditure or negotiating the repayment terms afresh. Given that parties in cross-border debts are not bound by common law whoever lends money assumes that the recipient’s national government bears the responsibility of paying the debt. When the existing debts cannot be met due to prevailing exchange rates then a currency crisis occurs. 2.1 History of International Debt Crisis The history of the international debt crises has a long history just like the flow of international debts. Some scholars have defined the financial integration as taking the shape of letter U. Bordo says the history of financial integration over years follows a U-shaped pattern, with high levels in the period before the 1st World War, a collapse during the inter-war period and high levels in the late 20th century5.The low levels witnessed in the inter-war period is due to the collapse of the then existing cross-border relations and the breakdown of the banking system of the time. The economic depression of the 1930s. It provoked researchers like Charles Kindleberger to conduct studies into the causes of the depression and possible mitigation measures. In his volume published in the year 1937, Charles Kindleberger, identified four key areas that motivate cross-border transactions6.Firstly, he noted that if there are stable exchange rates it would facilitate capital flows from one country to the next. The next thing that motivates cross-border capital flows is the elimination of fear among one state and the other. At the time of the depression, Richard noted that existence of fear among countries that had initially been in combat prevented them from conducting cross-border capital flows. Further, there was concern over irregular capital movements as they posed a great liability for nations that took loans. In 1944, Bretton Woods system was estabilished. This system ensured fixed exchange rates that made the USA an financial hegemon. Prior to establishment of the Breston woods, there were tight regulations initiated by banks that beeped up vigilance on cross-border borrowing and lending. This measure consequently limited any possible chances of crises arising as a result of national debts. In any case, the Marshall Plan of 1950s proved that money lending among nations was beneficial. However, things changed in the 60s when financial crises started. These events led to the creation of the financial instability crisis hypothesis of 1975. This hypothesis insisted that uncertainty and competition leads to the overvalue of assets. 2.2 The Asian Financial Crisis It should be noted that the Asian region became a preferred channel for cross-border capital flows in the 1990s. Thus; the Asian crisis like the “tequila” crisis came as a surprise to many. The Asian crisis slowly began in Indonesia and later spread to Thailand. The effects were felt in Taiwan. Later on, global prices of the equity markets fell down and the effects felt largely in Turkey, Russia, and Brazil. The events that led to the Asian crisis and its effects provoked a number of debates. The key debates in regard to this crisis concentrated on the policy related issues and economic research. Guitan (56) appreciated the fact that most countries that borrowed money prior to this crisis had proper macroeconomic strategies7.However; they were susceptible to vulnerability consequent to their prevailing weak banking systems. The developing countries were viewed as having inadequate financial instruments and institutions to affect money borrowing. It was suggested that developing countries needed tighter regulations. 3.0 Causes of the International Debt Crises 3.1 Government Borrowing Government borrowing is the primary cause of debt crisis. As mentioned earlier, governments borrow money to finance their infrastructural projects, investments, and education or health sectors. There is not government that fully relies on its wealth to finance its projects. The US national debt toll as at January 2015 stood at $ 16,787,451,118,1478.It is assumed that it will take the next seven generations to repay this debt. This represents 108% of the GDP. The US national debt was highest in the period that preceded the 2nd World War. Over time this has been minimised as a result of economic growth that the US has experienced over years. However, there are possibilities that this debt might not decline owing to the prevailing economic strains experienced as a result of aging population that propels immense demand of healthcare. In the Ukase a result of government borrowing, the total national debt has risen to 1.56 trillion pounds. The total annual amount of money spent to repay the debts is close to 43 billion pounds. With the examples of debts illustrated above it is definite that debts are poised to generate a crisis if not well-managed. At times the debts accumulate to such an amount that the borrowing countries cannot sustain them. For instance, in the 1970s development of countries like Brazil and Mexico reached a point and declared that they couldn’t pay their debts. The schedule of interests on the loans that Brazil and Mexico had taken had rapidly expanded to a level that repaying the loans would be unsustainable. Following this crisis developing countries whose cumulative debts had risen to $800,000,000,000 by mid 80s, cooperated with financial institutions to reschedule repayment methods. 3.2 Mismanaged Lending More often, the intentions for lending money are just but it has been observed in the recent past that funds borrowed are misused or used for intentions that they were not meant for. For instance, money would be borrowed to be invested, with the hope the profit generated from the investment will be used to repay part of the loan 9.In the event that the loans are mismanaged there is a likelihood of difficulty in loan repayment. For instance, in the 60s and 60s funds were wasted by the west in numerous ways. The United States misused money more than it had leading to printing of more dollars. As a result, oil producing countries that had pegged their price on the dollar suffered a great deal since the value of the dollar went down a great deal. In order to avert the fluctuating oil prices, oil producing countries at the time escalated their oil prices. They earned lot money which they in turn invested in western banks of the time. Most third world countries have had to repay loans that were borrowed in ancient times to do projects that were never realised. Most of the money is third world countries ends up in the pockets of a few individuals who embezzle it. The citizenry has to pay debts whose benefits they never saw. In some circumstances, some of these countries have had to seek loans to pay other loans whose interests are aggravating. Worse still, some of these third world countries have to repay these loans in harsh currencies like the dollar. Often currencies of the borrowing countries are weak and thus making the repayment much more difficulty. Therefore, as examined above mismanaged lending can cause an international debt crisis. This, as explained, is due to accumulation of the debt over a period of time together with the principal interest. 3.2 Odious Debt An odious debt is referred to as a debt that is created as a result of a debt taken by a aristocratic or illegitimate government10.Such money is used erroneously to mete oppression on the people of that country e.g. by purchasing weaponry to fight the citizens and carry out other atrocities. In some instances, a loan that has been used in a manner that is contrary to the interests of the citizens of that country and with absolute knowledge of the creditors is equally termed as an odious loan. In the event that the creditors are aware of the circumstances prevailing in the borrowing country but still go ahead to lend them money, such creditors cannot legitimately expect to be paid back. The principle of odious debt was applied to stop Spain from imposing loans on Cuba in the year 1898. In this case it was determined that the Spanish government was imposing such loans on Cuba by force for the interest of the Spanish people. Britain too suffered a blow in 1923 when its claims to impose loans on Costa Rica were rejected. Most of the debts that most poor countries have today are odious. When most countries in Africa attained their independence they inherited debts that their colonisers had accrued. These debts are odious in the sense that the loans were used by the dictatorial colonial governments. South Africa is the perfect example in this regard. As we all know, South Africa attained its independence from the apartheid regime in 1994. It inherited a debt of close to 46 billion dollars. An amount of 11 billion dollars out of the 46 billion dollars was used to maintain the apartheid regime and the rest was the amount that South Africa’s neighbours borrowed to quench the aggression caused by the apartheid regime. In Argentina, the government has paid close to 77 billion dollars of odious debts. The situation has been worse in Nicaragua which has paid an odious debt that equals to the country’s total GDP. Repayment of such debts has not only offended the countries paying them but has also resulted to serious economic impacts. The countries repaying the debts have had to stagnate because they are paying odious debts to regimes that oppressed them. The cost of repaying the loans has similarly made them poorer thus provoking them to borrow more in order to service the loans and also sustain themselves. 3.3 Economic Policies The choice of economic and development policies that countries make can cause a debt crisis as it was witnessed in the 70s and 80s11.The fluctuation of oil prices in the 70s due to fall in the value of the dollar saw oil producing countries quadruple the oil prices. As a result of this, they made tremendous profits from the oil sales which they in turn invested in Western bank. Western banks at the time lacked ineffective loan policies. They thus lent out money to countries without giving thought of what the money would be used for or monitoring and supervising expenditure of the money. Most of the countries that took loans at the moment did not use them for the purposes that they were meant for. Consequently, most of the money was misused. In addition to this, with the economic recession of the US, interest rates skyrocketed making it virtually impossible for the countries to repay their loans. The US’s monetary policies at the time too contributed to the worsening of the problem. The tight monetary policies at the time led to an acute increase in the interest rates. All these factors contributed to the debt crisis in the 60s. In the recent years, some countries have adopted economic policies that have contributed to the debt crisis in the world. For instance failure of government to put in place balanced lax lending standards and procedures for balanced international trade are factors that contributed to the emergence of the economic recession of 2007. This particular recession has been the cause of the recent international debt crisis. This is because most countries’ economies were adversely affected propelling them to enter into loans to revive their economies. A good example is the UK that has since enlarged its national and international debts to help revive sectors that were adversely affected by the economic recession. In the third world countries, it even became more difficult for them to repay debts since the interest rates had sharply increased. The very same countries had to ask for more loans so as the help they revive their economies. 3.4 Fall in Value of Exports Debt crises can be worsened when a country’s exports fall by huge amounts. Note that, exports is a major sector for such countries that enable them generate revenue. Thus, when such exports fall down there are chances that the same countries will experience difficulty in repaying these loans. A perfect example is in Latin America where the exports are falling down. Earnings from exports in Latin America are on the downfall making it very difficult for the countries to repay their debts. 4.0 Impact of the International Debt Crisis 4.1 Structural Adjustment As a result of the heavy debts that some countries have they are compelled to generate more foreign exchange. The aim of the generating foreign exchange is to pay the debts and import goods and services. When countries are in such predicament some international monetary organisations often offer a helping hand but not without any strings attached. More often IMF demands structural adjustment policies that will help the countries stabilise. One of these policies is austerity measures that encompass cutting down on government spending. In Greece, for instance, the EU’s demands for austerity measures has paralysed provision of government services to the Greeks12.A similar outcry has been felt in Spain where austerity measures have been proposed. Other structural adjustment policies include; increase in the tax levied so as to balance the budget, privatisation of parastals, minimising tariffs on foreign trade and doing away with the government’s control on interest rates and prices. All these strategies have severe consequences though. For example, it cuts down government expenditure on most social sectors, kills local investment, slow down investment, and creates unemployment. 4.2 Social and Financial Implications Countries that are heavily indebted have been characterised by numerous social problems. They include illiteracy, malnutrition, and infant mortality rates. This is because most of these countries spend huge sums of their GDP paying their debts thus leaving them with very little money to provide basic services to their people. The highly indebted countries do not have the ability meet development goals. One financial implication of the high indebtedness of these countries is manifested through failure to attract investors. The high debt label the country an investment risk. Countries in this category are left out of the global financial markets or compelled to pay more credit. On the other hand, payment of debts (both principal payments and interests) means that the country has very little money left to develop infrastructure which can in turn help combat poverty. 5.0 Solutions to the International Debt Crisis The international debt crisis has over time dominated global debate. The causes, as outlined in the previous section are complex and that they are often deeply rooted in the development and economic policies and other factors. Solving the debt crisis has both straightforward strategies and other complex ones that heavily rely on understanding of some facts about debts .There are two primary approaches to problem solving. One understands the problem and the other is the willingness to solve the problem. Thus, in debt crisis there is need to understand the causes of the current debt crisis and then make policies necessary to solve the problem13.Consider the scenario in developing countries. Most of them are cognisant of the debt crisis and have outlined possible remedies but they lack the motivation to implement the remedies. On the contrary, countries with the largest amount of debts have the motivation to solve the debt crisis but are ignorant of the alternative solutions that can be used to solve the debt crisis. 5.1 Understanding the Debt Crisis There are numerous propositions that one needs to understand in order to find a solution to the debt crisis. Firstly, the debt crisis is a paramount crisis but one among the many crises that are facing economies of the world. Other problems facing economies are inflation rates that are affecting the highly indebted countries. Secondly; a crisis is for the creditors but not for the highly indebted countries. The creditors are not the ones to pay the accumulating interest rates but the debtors. Moreover, creditors will finally be on the receiving end. Thirdly, and in an attempt to promote development at any cost most countries are finding themselves in debt crisis. This is called the populist approach. Thus, based on this understanding; approaches can be taken to avert the debt crisis. There is no single approach that is appropriate. Every strategy has its own strengths and weaknesses. The discussion below critically looks at the various solutions to the debt crisis. 5.2 Finance Adjustment Strategy This strategy employs two methods. One of them is lending more money to repay an existing debt and the other is having in place austerity measures. The latter implies cutting down on government spending. In the recent past austerity measures have been employed in Greece and Spain. The aim of cutting down on government spending is so as to help cut down on government borrowing-one way of reducing government debt. While the two methods have succeeded, there are criticisms on their effectiveness. Borrowing money to pay an existing debt is not a definite solution since it does not solve the problem in entirety. What it does is to postpone a debt. The debt still exists. Austerity measures have in the past few years been opposed in Spain. Reducing government spending is not a populist approach as it may affect important public sectors like health and education. Moreover, there is no sector that can be said to be unimportant in the country. 5.4 Voluntary approach As the term “voluntary” suggests that this approach entails both parties willingly entering into an agreement that stipulates how the debts are to be cleared. The creditors have a choice of deciding whether or not they want to participate in the scheme14.This approach has been used in the past to repay debts. For example, Mexico in cooperation with the international monetary organisations like IMF consented to renegotiating its debts with the creditors who allowed rescheduling payment. Debt-equity swaps have been introduced in most countries and objected except in Chile. In voluntary approach, debt reduction procedures the credit worthiness of the debtor is measured against the scheme itself. The goals of any debt reduction scheme include ;(1) to permit the debtor country to repay its loans without necessarily altering the principal interest ;(2) to enable private sectors of the countries in debt to be able to attract foreign investors. The major disadvantage of this approach is that a meagre section of the banks can opt to hinder the process of debt resettlement. 5.4 Debt Cancellation Creditor countries can opt to write off debts that countries owe them. This has happened in the past where the US has cancelled some of the debts that some third world countries owe. Cancellation can be voluntary or forced like in a case where other parties realise that the debts accrued are odious. Perhaps Britain needs to write off some of its debts to South African given that they are odious. The importance of debt cancellation is that they help cut down the international debts. However, this approach has some disadvantages. One of them is losses to the creditors since they lose both their principal interest and money lent out. Secondly; this tendency is likely to set a bad precedence. Countries may be reluctant to repay their debts in the hope that they might be cancelled 5.5 Economic and Development Policies As discussed earlier the complexity of the debt crisis is vested in the development and economic policies of a country. Some economic policies like the stringent monetary measures taken by the US in the 1960s largely contributed to the international debt crisis at the time. Thus; there is need for effective economic and development policies. In the current era, economic and development policies should be based on the need to sustain growth and development while at the same time reducing debts15.The populist practices that insist on the need to develop at whatever cost ought to be discarded and in their place sustainable development adopted. The banking system too ought to adopt stringent measures that guide cross-border capital movements. In addition to this, governments should come up with development strategies to steer growth and generate more income. Part of this income can be employed to repay the debts. Conclusion In conclusion this particular research report has examined the topic “international debt crisis”. The report begins by explaining the concept of “international debt crisis”. It then attempts to trace the origin and development of international debt crisis from the inter-war period to the present time. In the report an examination of the major causes of the crisis have been cited. They include; government borrowing, poor economic, and development policies, mismanaged lending, fall in exports and odious debts. The impact of this debt crisis is manifested in the structural adjustments, social and financial implications. The report goes ahead to expound on some of the possible solution to the international debts crisis and evaluates the various approaches given. The international debt problem can be eliminated if proper diagnosis of its root causes is identified and mechanisms laid down on how to curb it. The most important factor is that countries should have the motivation to cut down debts. Works Cited Bassan, Fabio, and Carlo D. Mottura. From Saviour to Guarantor: EU Member States' Economic Intervention During the Financial Crisis. , 2015. Print.(10-15) Bordo, Michael, Barry Eichengreen, and Jongwoo Kim, “Was There Really an Earlier Period of International Financial Integration Comparable to Today?” Cambridge, MA: National Bureau of Economic Research, Working Paper No. 6738, September 1998.(60-66) Celasun, Oya, and Senay Agca. How Does Public External Debt Affect Corporate Borrowing Costs in Emerging Markets?Washington: International Monetary Fund, 2009.(15) Chinn, Menzie D, and Jeffry A. Frieden. Lost Decades: The Making of America's Debt Crisis and the Long Recovery. New York: W.W. Norton & Co, 2011. Print(25-30) Eatwell, John, and Lance Taylor, Global Finance at Risk, New York: New Press, 2000.(40) Guitián, Manuel, “The Challenge of Managing Capital Flows,” Finance and Development, June 1998. Washington, DC: International Monetary Fund(46) Lynn, Matthew. Bust: Greece, the Euro, and the Sovereign Debt Crisis. Hoboken, N.J: Bloomberg Press, 2011. Print.(33-40) Gordon, Robert J. Macroeconomics. Boston, MA: Pearson Education, 2009. Print(10-25) Kindleberger, Charles P. Comparative Political Economy: A Retrospective. Cambridge, Mass: MIT Press, 2000. (10) Nehru, Vikram, and Mark Thomas. The Concept of Odious Debt: Some Considerations. Washington, D.C: WorldBank, 2008. Internet resource(1) Peterson, Peter G. Steering Clear: How to Avoid a Debt Crisis and Secure Our Economic Future. , 2015. Print.(10) Raffer, Kunibert. Debt Management for Development: Protection of the Poor and the Millennium Development Goals. Cheltenham, UK: Edward Elgar, 2010. Print.(4) Restis et al.,. The Euro Crisis. Houndmills, Basingstoke, Hampshire: Palgrave Macmillan, 2012. Internet resource.(60-80) Roodman, David M, and Jane A. Peterson. Still Waiting for the Jubilee: Pragmatic Solutions for the Third World Debt Crisis. Washington, DC: Worldwatch Institute, 2001. Print.(50-70) Sobel, Andrew C. International Political Economy in Context: Individual Choices, Global Effects. Thousand Oaks, Calif: CQ Press, 2013. Print.(14) Read More