1979 Monetary Policy & 1983 International Debt Crisis

A CRITICAL ANALYSIS OF THE U.S. FEDERAL RESERVE SYSTEMS 1979 MONETARY POLICIES RELATIONSHIP TO THE 1983 INTERNATIONAL DEBT CRISIS

The purpose of this term paper is to provide a critical analysis of the United States Federal Reserve Systems 1979 Monetary Policy and the relationship of that policy to the International Debt Crisis of 1983. In particular, the causes of the Federal Reserve Policy of 1979 will be examined along with the long-term effects of the policy. It is the aim of this paper to show that the Monetary policy of the U.S. Federal Reserve System affects not only the economy of the United States of America, but the international economy as well.

The concepts of debt, inflation and interest rates, recession, and the business cycle will be shown to be central to the analysis as these issues were of primary importance in establishing a paradigm for analyzing the relationship between the Federal Reserve Systems Monetary Policy of 1979 and the International Debt Crisis of 1983. Also, the political and economic implications of American foreign trade during this time period will be shown to be directly linked to the two issues being analyzed.

REVIEW OF LITERATURE

Philosophical Foundations of Debt

The term debt is derived from the Latin word debere, which means 'to owe' and is defined as "something that is owed; something that one person is bound to pay to or perform for another; a liability or obligation to pay or render something; the condition of being under such an obligation". Historically, the concept of debt is as old as humankind. In the holistically (spiritually and physically balanced) high cultures of the Kemetiu (Egyptians), Ta-Nehestiu (Sudanese and Ethiopians), Hindu (Indian) and Khanaanite (Palestine) a promise or agreement between two individuals was considered a sacred contract that placed the two into the debt of one another. Should one break the contract then that person was considered disgraced and forever in the debt of the other.

Beyond the human state of debt these high cultures conceptualized a state of debt between humanity and the Creator. By the very act of creation man was believed to be forever indebted to God for his very existence. From the sacred act of creation the ancients believed that man owed a duty to God to obey His every word. The rational for this aspect of debt was intricately interwoven within the belief of the importance of God and His activities. Were man to disobey the commands of God, then he would be viewed as being in the debt of the Creator and, as such, would need to be redeemed. The ancient high cultures of the African and Hindu regions also conceived of an aspect of debt that existed between men that required the repayment of debt with interest. In the biblical tradition this aspect of the concept of debt was called usury. Beyond the general meaning of usury as interest on a debt is the conceptualization of usury as an excessive or exorbitant amount of interest. In the ancient high cultures this form of interest was frowned upon.

Governments and Debt

The primary form of debt that concerns governments is the borrowing of funds from an external agency with the funds containing a specific amount of interest. This type of government debt is obtained in accordance with an agreement to pay back the principal amount of money borrowed and interest on the principal amount on either a short-term or long-term basis. The United States Bureau of The Census defines debt incurred by governments as:

All long-term credit obligations of the government and its agencies, and all interest bearing short-term (i.e., repayable within one year) credit obligations. Includes judgments mortgages, and "revenue" bonds, as well as general obligation bonds, notes and interest bearing warrants. Excludes non-interest bearing obligations, amounts owed in a trust or agency capacity, advances and contingent loans from other governments and rights of individuals to benefit from employee-retirement funds.

Within the American system of government budgeting the central focus is on long-term debt and the amount of interest that the debt contains. Similarly, this philosophy of government debt is the proper paradigm for understanding government debt throughout the Western world, i.e., France, Germany, Britain, Russia, etc., as well as in all of the former colonial possessions, namely, Asia, Oceania, Africa, Latin America, etc.

Governments incur debt because: a) there is a consistent need for cash that can not wait to be satisfied by the annual collection of revenues; b) there is a need to balance expenditures and revenues; c) there is the need to finance capital construction programs and to purchase equipment; d) there is sometimes the need to refinance an existing debt; and e) there is sometimes the need to finance operating deficits. The existing needs that a government has to satisfy are far too great in many instances to be handled by the revenue sources that a government has at its disposal. For example, the following addresses the incurring of debt by the Indonesian government to meet its fiscal needs:

Trying to boost its fragile economy, Indonesia is taking steps to open its market wider to foreign competition as part of a massive rescue plan designed by the International Monetary Fund. The government adopted measures to revamp what was once one of Asia's fastest growing economies, stripping the state company Bulog of its monopoly on key imports such as wheat, soybeans, and garlic. The changes, announced Monday, comply with conditions attached to $33 billion in foreign loans linked to the IMF's second-biggest bailout package. The largest, $50 billion, went to Mexico in 1995.

Due to this and other constant and important situations debt is necessarily incurred by governments. The situation of Indonesian and Mexican government debt show that the issue of governments incurring debt has its best example in the issue of Developing country indebtedness to the International Monetary Fund (IMF) and commercial banks.

Developing Country Debt

The issue of developing country indebtedness to multilateral lending agencies such as the International Monetary Fund (IMF) and commercial banks came to the forefront of international public policy in 1982. During the fall of this year several developing countries, beginning with Mexico, found themselves unable to meet their debt payments to creditors. A sign of this predicament was the number of developing countries (56) which were in arrears or behind on their debt payments by 1988.

The total amount of debt for developing countries by January 1988 was $1.3 trillion. This figure does not include both the principal amount of debt and the interest accumulated on the principal amount, but rather the $1.3 trillion is only the principal amount of debt incurred. During the first seven years of the 1980s developing countries paid $10.5 trillion on the interest of their accumulated external debt. The interest attached to the accumulated external debt when originally incurred during the years between 1973 and 1979 reached levels as high as 35% to 40% with a low of about 15%. The $10.5 trillion in paid interest is nearly an $11 trillion transfer in resources from developing countries to developed countries.

Figure 1 outlines this situation. These are fiscal resources, which could have been used to provide the necessities of life for the developing country citizens; instead, the funds provided physical aggrandizement for a fraction of the population of the developed nations. The majority of developing country debt is owed to commercial banks. Many developing countries declined to accept loans from the IMF as they felt that the probing questions asked by the multilateral agency and the conditions attached to IMF loans infringed on their national sovereignty. For this reason those developing countries that were considered as good credit risks by private lending agencies chose to accept loans from commercial banks, even though the commercial rate of interest was double the rate of interest of the IMF. Some of the countries, which were considered as good credit risks, were Argentina, Brazil, Mexico, Israel, Venezuela, and Nigeria. Nigeria was the only African governed country south of the Sahara to be heavily indebted to private lenders, due to their oil resources and membership in the Organization of Petroleum Exporting Countries (OPEC).

Origins of Developing Country Debt

The origins of the International debt crisis of 1983 are to be found in the 1971 economic policy of President Nixon to devalue the dollar on the International Market to be followed by the ending of the Bretton Woods Agreement and the use of the gold standard. In 1946 as apart of the Bretton Woods Agreement the international community established a fixed exchange rate system for setting the value of competing currencies. The foundation currency was the U.S. dollar which could be redeemed by a set amount of Gold. This system was abandoned in 1971 by President Nixon in favor of a floating exchange rate, which took the U. S. of the gold standard and effectively ended the Bretton Woods Agreement.

In 1973 in response to the constantly changing values of international currencies due to the weak dollar and the floating exchange rate system, as well as in response to the U.S. foreign policy of providing aid to Israel during the Yom Kippur war, the Organization of Petroleum Exporting Countries (OPEC) increased the price of oil by 400% and instituted an Oil embargo against the U.S. The oil embargo would last from October 17, 1973 to March 18, 1974. This event caused the developed countries of the Organization for Economic Cooperation and Development (OECD) to have to absorb significant increases in the level of price inflation and produced within the developed community "...the deflation of demand as income was transferred from users in the oil-importing countries to governments in exporting countries". This move by OPEC allowed the oil exporting countries to recover their economic losses that were caused by the U.S. establishment of the floating exchange rate. In reaction the developed nations became incensed that their former colonial possessions (Nigeria, Saudi Arabia, Yemen, etc.) were benefiting from their indigenous natural resources as opposed to having their resources siphoned off by the developed community to benefit their former colonial exploiters. In short, the developing countries were acting like rationally economic actors, with the singular goal of the efficient utilization of their scarce resources for a maximization of profits.

This occurrence led to the financing of the balance of payments of the indebted OPEC countries by the OECD countries, through their internal lending agencies. The financing of the balance of payments was possible as "...the eurocurrency markets, operating in conditions of ample liquidity, provided the vehicle for a rapid expansion of bank lending to developing countries". This strategy was derived by the developed community as a response to the OPEC oil embargo and price increase. The intention was to place the developing community in a perpetual state of debt and was implemented as the developed community analyzed the then developing community prosperity as a short-term phenomena to be countered by Western reliance on Western oil reserves. The ensuing debt to be incurred by the developing community would provide the developed community with fertile ground to reinstate its neocolonialist policies.

Within the community of developing countries there were two reasons as to why they sought to borrow from commercial banks. The first was that those developing countries that were importing oil needed additional revenues to maintain economic improvements. In the second, the exporting developing countries borrowed in expectation of increased future revenues. Figure 1.2 illustrates commercial bank lending from 1977 to 1982. These two scenarios set the stage for developing country debt. When the international demand for OPEC oil declined due to Western use of Western oil reserves. The future revenues expected by the exporting developing countries never materialized in the amount expected. This caused the exporting countries to have larger debt principal and interest to be paid in comparison to revenues generated by oil exports. The oil importing developing countries by incurring debt to maintain economic growth soon found that growth stifled by Western foreign policy and were left with massive debt to western lending agencies.

U.S. Federal Reserve System Monetary Policy

In 1979 in reaction to the domestic inflation that had constantly increased since the 1950s and had been further stimulated by the 1973 oil price increase by OPEC, the United States Federal Reserve began a monetary control policy that led to a drastic increase in the interest rates. The Federal Reserve decreased the amount of money in circulation, thereby, increasing interest rates. The resulting interest rate issue could have been avoided; however, the Federal Reserve chose to follow the new course no matter what the cost. Greider (1987) attributes this situation to the Feds desire to appease the financial markets, in particular the bond market. Also, to hold to the rigid policy, which had been chosen was considered to establish the Feds credibility.

The Feds policy of decreasing the amount of money in circulation was followed by a second increase in the price of oil by the OPEC countries during the same year. The OCED countries reacted to the second price increase in the same manner that the United States had by implementing new monetary control policies, through their central banks. These economic adjustments, begun in part by the United States Federal Reserve System caused the worst recession that the international economic community had seen since the Depression of the 1930s. The effects of the recession were "...transmitted to the developing countries through foreign trade, commodity prices and interest rates".

The decrease in the flow of money in circulation caused the international recession as the following attests: "The Global recession induced by the Federal Reserve had collapsed Latin economies...rendered their swollen debt burdens unsustainable and put the major banks at risk". The 1979 economic monetary control policy caused a short break in the international economic business cycle that had continued to grow and bring prosperity since the 1950s. The period of 1946 to 1979 had witnessed one of the greatest economic growth cycles.

The economic atmosphere of this time contained the European Recovery Program. This program was developed by United States Secretary of State George C. Marshall in 1947 to provide U.S. economic aid to rebuild Europe following World War II. In 1948 the program was passed and appropriated by the United States Congress as the Marshall Plan and was administered by the European Cooperation Administration.

This program coupled with the United States program to rebuild post WWII Japan, the emergence of the Soviet Union as a nuclear superpower and the attainment of political freedom by former colonial possessions in Asia and Africa led to increased international economic speculation and investment. The atmosphere of economic growth and development was from 1950 to 1973 primarily centered in North America, Europe and the Far East. When the countries of Latin America, the Caribbean, Africa, the Middle East and Western Asia began to benefit from the situation, Western economic policy changed drastically.

The Western powers provided aid and a stable international economic atmosphere to rebuild the former military powers of genocidal Germany, socialist Russia and imperialist Japan. All of these countries sought prior to their defeat in 1945 to gain a stranglehold on world economic conditions. However, the former colonial possessions of the Western powers received less than a fraction of the economic aid given to the former Axis powers and none of the genuine commitment in their efforts to rebuild their societies, whose infrastructure had been destroyed by over 500 years of Western imperialism, exploitation and genocide.

As a result of the monetary policy changes in the United States in 1979, the amount of commercial bank debt of the developing countries continued to increase. The U.S. Federal Reserve Monetary Policy caused an upward redistribution of wealth in the United States. The creditor classes experienced an increase in their accumulated wealth. The primary interests of this class were represented by commercial banks and their affluent constituents.

The major banks, which were supposedly regulated by the Fed, engaged in speculative lending to developing countries in Latin America. However, the restrictive monetary policy decreased the supply of money, while increasing interest rates. In order for the developing countries to keep up their payments on the loans in an economic atmosphere of decreasing money and increasing interest rates, which created an international recession, and greatly affected the industrial sectors of the international community, they had to either increase their exports to foreign markets to increase their revenues or borrow further to make interest payments. The only available solution was the later.

In 1979 developing country commercial bank debt increased at an annual average of approximately 32-34% and in 1980-1982 the average was approximately 16-17%. By the fall of 1982 the situation had reached a point, due to the recession, where the developing countries could not make any payments on their debts. The first developing country to reach this point was Mexico to be followed by nearly one third of the international community. Several U.S. based banks, namely, Citibank, Chase, Chemical, Morgan Guaranty, Bank of America, Bankers Trust and Manufactures Hanover together with several foreign banks held loans, which Mexico alone owed which totaled more than $80 billion. If Mexico had defaulted on its loans followed by nearly 60 other developing countries, a massive panic would have resulted which would have worldwide financial implications. To avert this situation, financial representatives of the Western interests arranged a solution to the crisis.

The inability of the developing countries to meet their debt payments led to a legal authorization to delay debt repayment. This legal delay or moratorium was declared by the developing countries with an agreement from their creditors. The moratorium on the debt repayment was followed by the rescheduling of the payment of debt and to changes in furthers lending policies by debt creditors. Rescheduling sought to allow the developing country to make debt payments at a level that they could afford, while still allowing them to sustain sufficient import level for the purpose of economic growth (severely limited economic growth in the face of the exorbitant interest payments). In addition it allowed the bank to maintain the worth of the loan and not have to absorbed substantial financial losses. In short:

When a debtor country declared a moratorium on capital repayments of medium-term debt, and even if it still kept interest payments up to date, banks naturally ceased new voluntary lending....The essence of a rescheduling exercise was therefore to stretch out the period of capital repayments due in the years covered by the negotiations (initially only one or two), and since debtors were almost all-running current- account deficits, they needed some balance- of-payments financing, of which part would be the banks' new money, during the period necessary to adjust their economies.

To monitor the rescheduling process the Institute of International Finance (IFF) was founded by major US, Japanese and European bankers in 1983. The purpose of the IFF was to perform research and provide the member nations with information on international financial issues such as: lending policies and credit risk. The Japanese also established the Japanese Centre for International Finance (JCIF), which was composed of banks and other interested and related Japanese organizations for the purpose of researching those aspects of international finance relevant to Japan.

Many developing countries became so deeply indebted to commercial banks due to their hostility toward IMF conditionality. The developing countries stated that the IMF did not consider individual country differences and sought to have all countries adhere to the same repayment principles. Secondly, the developing countries believed that they should be allowed to create individual repayment policies. The IMF on the otherhand, stated that individual country policy creation would be unsustainable by the separate countries and if there was no IMF conditionality then countries could only borrow from the fund when all resources which were on loan were repaid.

IMF Conditionality

IMF conditionality seeks to assist IMF members with their payment deficits, while promoting financial prosperity in the international community. This meant that the IMF had to prevent member countries from practicing deflation, competitive depreciation and from creating trade restrictions, all in an effort to repay the debt. The following is one author’s explanation of the reasons for the existence of IMF conditionality:

... First, the fund must protect its own liquidity by making sure that its members repay...Second, the Fund has more information and experience than any single government and can therefore give policy advice that promotes the interests of the individual member that seeks to use Fund credit. Third, the Fund can take account of externalities and other systemic effects and give policy advice that promotes the interests members collectively.

The lending policies of the IMF are jointly designed by the Fund and the World Bank. The distinction between the two multilateral lending agencies is that the Fund is and adjustment agency that requires a country to establish an adjustment or stabilization program. This makes the short-term loan provided by the Fund to the country to satisfy the countries deficit or balance of payments needs to be of a temporary nature. The World Bank is a development agency that provides long-term loans to a nation for internal project development. The loan is provided if the project is determined by the World Bank as being financially sound.

Low and High IMF Conditionality

The IMF policy of conditionality seeks to satisfy two financial situations and is of two distinctive types: low conditionality and high conditionality. In low conditionality a country shows that it has a deficit and is seeking to provide a solution to it. This type of conditionality is normally not contested by the IMF. The countries, which receive low conditionality, are developed countries and creditworthy developing countries. High conditionality occurs when a county has a definite plan that is designed to solve its deficit problem and to which it is dedicated to carrying through to fruition. This plan must be deemed by the IMF as being capable in all of its aspects to solve the countries deficit problem. Developing countries, which are considered high credit risks generally, can only receive this type of IMF loan.

The types of deficit associated with IMF conditionality are temporary deficits and fundamental disequilibria deficits. The temporary deficits are caused by changes in the cycle of trade terms or foreign demand-the business cycle or fluctuations, resulting in either, a shortage or surplus. As they operate in a helical manner, a characteristic of their temporary nature, they are generally financed. However, if the temporary deficit is caused by surplus then the deficit should be adjusted through formulation of a policy that will liquidate the surplus. Financing of surplus is not, therefore, necessary to solve the deficit. Fundamental disequilibria deficits continue throughout the changes in the cycle of trade or foreign demand and with or without the existence of a surplus The solution to this deficit is "...devaluation to improve competitiveness, reinforced by demand restraint if needed to prevent the emergence of excess demand, and accompanied by financing if a deficit persisted during the period of adjustment".

The IMF generally provides assistance to two groups of countries. In the first group are those countries that are either developed or are newly developing countries. These countries use the IMF low conditionality resources only in limited situations as they have access to commercial bank resources. In the second group are those developing countries that do not have access to commercial bank resources. These countries need both IMF high conditionality and low conditionality loans; however, they are generally only given consideration for the high conditionality loans, which provide for less government independence. Thus an infringement on national sovereignty. Due to the stringent nature of IMF conditionality many developing countries that did not have access to commercial bank resources faced increasing arrears on their balance of payments.

Figure 1.2 delineates the fact that those countries that were not considered creditworthy received little or no loans from commercial banks. These countries are those located in the region between India and Africa inclusive of the sub-continent and the continent. It is this group of countries which faces the greatest dilemma. For they are most in need of IMF and commercial bank resources, and yet are unable to receive them on terms that will facilitate economic growth and development.

CONCLUSION

By decreasing the amount of money in circulation, to curb the rise of inflation, the U.S. Federal Reserve System caused an increase in the price of money. The longer the flow of money was restricted the higher the interest rates. This means that with the increase in the price of capital the economy moves into recession. In a recession there is a decline in the normal growth rate of business activity. When this occurred in the U.S., all credit dependent industries suffered massive liquidation. This liquidation trickled down to the blue-collar worker and the poor. The credit institutions benefited to a point from this situation as the liquidation of businesses and jobs resulted in increased financial assets for the lender institution.

The economic contraction of the U.S. economy, also affected the international economies. When the U.S. economy moved into recession, international exporters were deprived of one of the largest consumers of international goods. For developing countries with export based economies, the U.S. Fed induced global recession crippled the growth of their economies. With the reduction of overseas consumption of their goods, developing countries, which were not highly diversified, ended up with huge surpluses, which further drove down the price of their goods on the international scene.

The decline in their primary source of income caused developing countries to begin to fall behind in their debt payments to commercial banks. They were forced to have to borrow more money from the commercial banks at the higher interest rates, in order to make payments on the interest of the original debt. As the recession continued developing countries began to fall further behind in their payments, until a moratorium was declared. The moratorium led to the structural adjustment of the developing country economies by the IMF and the World Bank. The governments were required to assume hands off policy in the areas of public enterprise, and the provision of health and welfare services for the poor. The primary concern was upon exports that would earn foreign exchange; instead, of on the production of domestic goods and food.

The issue of developing country debt is based on two principle underlying assumptions. First, it is of the utmost importance within the present European dominated international economic system to maintain a weak and manageable Africa, Middle East and Western Asia. One probable reason for this assumption may be that it is from these regions that the most successful conquests of Europe have been executed.

The Carthaginian invasion of Western Europe under the leadership of General Hannibal (c. 247-183 BC) first exposed the European weakness by way of its Mediterranean corridor. Of equal importance was the Moorish invasion of the Iberian peninsula and continental Europe as far as France by General Tarikh in 708 AD The Islamic invasion of the Moors lasted from 710 AD to 1492 AD when the last Islamic stronghold of Granada under the rule of the Moorish king Abu Abdallah fell after an eight month siege to the Christian forces of the catholic Spaniard monarchs king Ferdinand V and queen Isabella I.

This European paranoia of a strong Africa, Middle East and Western Asia accounts for the vast discrepancies that exists in the amount of IMF and commercial bank loans to Africa, the Middle East and India, when compared to the economic strategies employed by the United States and Europe towards many of the Latin American and Far East Asian countries (NAFTA, the development of post-WWII Japan, Singapore, Hong Kong, etc.). These regions account for nearly 90% of the resources invested by the IMF and commercial banks.

It is somewhat surprising that the European community would take its technology and money and implement them in the Far East as opposed to using them in the regions closest to Europe. A rational, efficient, cost-benefit, product maximization European would invest his money and technology in Africa, Middle East and Western Asia and not in the Far East. To do otherwise is to defy all of the economic principles espoused by European scholars (unless regional instability, which is caused by socio-economic deficiencies, is the 'reason'). Second, the foundation of the European community and the United States is the continued exploitation of the community of developing countries, in particular Africa, the Middle East and Western Asia. The situation of the indebtedness is comparable to the sharecropping system that existed in the post-Civil War United States.

Following the Civil War the former Southern Confederates sought a new method to return the emancipated Africans to enslavement without infringing on their constitutional rights. The system that was derived was sharecropping. In sharecropping the farmer was provided with a parcel of land by the plantation owner to cultivate and as payment the farmer was allowed to keep a portion of the crop. The plantation owner would then provide the farmer with equipment, seed and food on loan. The farmer would be expected to pay for these items out of his share of the crop. The price for these goods would exceed the amount of the farmer’s share of the crop so that a perpetual state of debt existed between the farmer, who was known as the sharecropper and the plantation owner.

The self-same situation exists between debtor nations and their financial creditors. Developing countries are generally indebted to the IMF and commercial banks, which are controlled by the developed countries. The high interest rates attached to commercial bank loans; the neglect of long-term development policies by the IMF and the World Bank; and, the structural adjustment stipulations of the IMF all hinder developing country economic growth. For the interest payments far exceeded the revenues of the developing countries.

The inability of the developing countries to generate wealth for themselves due to neo-colonialism, economic exploitation and mis-education leads them to borrow from agencies that are controlled by the developed countries or to receive aid from the developed countries themselves. This situation places the developing country in a perpetual state of indebtedness to which there is no clear end within the present international system of economic arrangements. The circumstances are even worse in those developing countries that receive very little in the way of aid or loans from multilateral lending institutions and developed countries. For these conditions lead to starvation, epidemics and under-development. And once again these conditions are particularly confined to Africa, the Middle East and Western Asia.

The solution to the economic problems of developing countries does not exist in one simple statement but is rather a complex and intricate state of interrelating aspects. First, the perception of economic salvation residing in the Western community or in Western economic theory must be systematically dissolved. That this is true is proven through historical research. Developing countries must look at their present situation as being the result of conquest, and 500 years of economic, social, political and religious colonization from the West. Then an appraisal of pre-colonial economic, social, political and religious ideologies and institutions must be conducted so as to determine the proper course of each group with the developing whole. For the concepts, institutions etc., of the West are generally incompatible with the temperament of the 2/3 majority of the world's cultures. If, however, a concept of Western origin is deemed as compatible it will only be capable of being used only after adaptation to the given culture and situation.

Next, the developing countries must realize that their development is dependent on one another. By this is meant that Latin American and Caribbean community, the African community, the Islamic community and the Hindu community must understand, develop and build upon their resources for their collective good. That there is strength in numbers and accumulated resources to be used for the collective whole of a spiritual people must be the hallmark of this pan-holistic outlook. Beyond this point the situation can be surmised in the following manner: If the designer of the game has no opponent or prey, he can have no true game for he sits and plays alone. The situation at present is a game of Western origin and design with all rules and regulations being written to maintain Western world hegemony. Developing countries must cease to play the Western social, political and economic game. Developing countries must set about doing the work of nation building on a collective scale. This will only be accomplished through the cultivation of their culture, and the use of it as the foundation for true development that benefits their citizens.

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