Creative Destruction?: Economic Crises and Democracy in Latin America

6. 1982 Debt Crisis and 1997–2002 Emerging Markets Crises

The Bretton Woods system delivered relative international financial stability between the aftermath of the Second World War and 1971. The system’s anchor was pegging member countries’ currencies to the US dollar, which was credible , given the free convertibility of dollars into gold at $35 an ounce, a parity that had been established in 1934.1 This anchor did not prevent national financial crises from happening—and, when they did happen, countries had the option to borrow funds from the IMF, which had not been the case in the Great Depression years—but it helped to contain the potential contagion and spread of a given national financial crisis into an international one. After all, holders of US dollars anywhere in the world knew that they could redeem them for solid gold. Therefore, the international dominolike financial crises that came to be common around the world after 1971 were rare during the years when the US dollar was convertible to gold. 1982 shock and debt crisis Global Imbalances in the 1970s The first shock to the international system was US president Richard Nixon’s decision to take the dollar off the gold standard in August 1971 in the face of growing trade and fiscal deficits amid a decelerating economy. These conditions had led economic agents to dump dollars in the expectation of dollar devaluation before the 1972 presidential elections. By breaking the dollar-gold parity, the US government was able to devalue its currency to restore macroeconomic equilibrium in the face of sustained overspending, due to the Vietnam War and the social expenditure commitments incurred by the federal 1982 Debt Crisis and 1997–2002 Emerging Markets Crises chapter six 120 l at e t w e n t i e t h c e n t u r y government in the 1960s through redistributive programs like the War on Poverty and the Great Society. Excess dollar liquidity internationally had also given way to what came to be known as the Eurodollar market as international banks,stuffedwithUSdollars,triedtofindborrowers.Anearlyspurtindemand for foreign credit in Latin America therefore occurred between the late 1960s and early 1970s, when international private banks joined the fray. Most credit until then had been channeled through official sources: bilateral ones, such as the US Export-Import Bank (Ex-Im Bank) or the US Agency for International Development (USAID); or multilateral ones, such as the IMF, the WB, and the IADB. Lending by these private banks accounted for almost half the increase in thepublicexternaldebtincurredinLatinAmericabetween1966and1972.2 Themainconsequenceofthesechangesintheinternationalmonetarysystem thataffectedtheindependentvariableofmyanalysis(financialshocks)wasthat, as Frieden puts it, once the dollar was taken off gold, “short-term investors— speculators, to use a loaded term—could move money in response to differences in national monetary conditions and could threaten the independence of nationalmacroeconomicpolicy ”inthecontextofgovernments’growingindebtedness .3 End result? Out with international financial stability and in with a brave new world of currency exchange arbitrage that profited from betting against the capacityofnationalgovernmentstokeepup(ordown)witharoughpegtotheUS dollar,whichwasnowafloatingcurrency. inflationary takeoff and puzzle of stagflation Without the straitjacket of automatic adjustment forced by fixed exchange rates, governments gained a degree of autonomy in monetary and fiscal policies . One outcome was that governments in both advanced and developing countries turned to expansionary policies to stimulate growth, and the international economy surged between 1970 and 1973. This surge was nonetheless inflationary, because rather than being a function of rising productivity, it was the consequence of sharp growth in both the money supply and public spending . Economic stimulus in the advanced countries created higher demands for commodities and raw materials, which (in the short term) benefited exporters of these goods, such as a majority of the Latin American countries. However, expansive growth—courtesy of a commodity boom—was short lived in the face of a second shock to the system. In tandem with the end of dollar-gold convertibility and the rise of expansionary, inflation-producing policies, the Organization of Petroleum-Exporting Countries (OPEC), the oil cartel that had existed since 1960, called an embargo during the Arab-Israeli d e b t c r i s i s a n d e m e r g i n g m a r k e t s c r i s e s 121 WarofOctober1973.Thisshockledtoaquadruplingofoilpricesinafewweeks (fromjustabove2USDperbarrelto5andthen12USD),andtheembargolasted from October 1973 to March 1974. The steep rise in oil prices dramatically alteredinternational financialcurrentsbycreatinghugeinflowsintooil-exporting countries and equivalent out...