IOU: The Debt Threat and Why We Must Defuse It. Noreena Hertz

who did recognize the precariousness of the situation and advised caution were viewed as doomsayers. The late Senators Frank Church of Idaho, Clifford Case of New Jersey and Jacob Javits of New York criticized the Ford and Carter administrations’ ‘laissez-faire approach to petrodollar recycling’ and warned that the American taxpayer would ultimately have to pay the price for the banks’ lax lending. They were ignored. ‘As a loan officer,’ an ex-banker who did his share of lending at the time said, ‘you are principally in the business of making loans. It is not your job to worry about large and unwieldy abstractions, such as whether what you are doing is threatening the stability of the world economy.’

      But the bankers should have worried.

      If they had studied their history books, they would have realized that the path they were taking was neither new nor safe. Since its independence from Spain and Portugal in the 1820s, Latin America, for example, had gone through several cycles in which it had borrowed extensively, seen long periods of economic expansion, and then in the inevitable post-boom stagnation, found itself unable to service its debt obligations. In 1827, almost every Latin American government had defaulted on its debt. And this had happened again in 1873. The defaults of 1930 had been no anomaly.

      And at the end of the 70s the merry-go-round which enabled banks to keep on lending to Latin America and elsewhere, once again came to a screeching halt.

      The morning after

      In 1979, the Shah of Iran was deposed, an event shortly followed by the Iran-Iraq war. A second oil price hike occurred, with the price of oil more than doubling within two years. This put pressure on the economies of oil importing countries and created further demand for credit which, in turn, created a new boost of lending. On the other side of the ledger, the added costs stretched the ability of borrowing countries to service the debt they had already contracted. In developed countries, the hikes caused prices of many consumer goods to rise, which triggered inflation.

      To curb inflation, industrial countries, led by the US, raised interest rates. There was an enormous global recession. The markets for developing countries’ products shrank, which meant that these countries’ capacity to pay back debts drastically diminished. Developing countries that had taken out loans with commercial banks had done so under variable interest rates. These now jumped up markedly – interest rates rose from an average of 0.5 per cent on commercial bank loans to an average of 13.1 per cent. Developing countries’ debt payments skyrocketed. Argentina, to provide just one example, saw its interest payments rise from $1.3 billion in 1980 to $3.3 billion in 1984 and $4.4 billion in 1985. Projects that had originally made good economic sense now saw their costs go through the roof – the Brazilian-Paraguayan Itaipu Dam Project