Theme 8: 1973 Oil Crisis to Debt Crisis PDF

Latin America debt crisis - Context. ==================================== The mass migration of the 1st globalization. -------------------------------------------- During the first globalization a lot of European families, especially from Italy, Spain and other southern european countries, moved t...

Latin America debt crisis - Context. ==================================== The mass migration of the 1st globalization. -------------------------------------------- During the first globalization a lot of European families, especially from Italy, Spain and other southern european countries, moved to Brazil, Argentina. These countries should have been the next United States. Export of raw materials. ------------------------ South American countries export a lot of raw material to the "first world". Some of these countries have minerals. The best minerals to have are of course ; oil, silver and gold, but few countries possess these. However, a lot of countries possess agricultural minerals such as tobacco, soja, cacao etc. Foreign investment. ------------------- The largest countries of the continent were granted investments from abroad. In Argentina for example, the investment came from the United kingdom. The UK installed railways in the country. II. Debt crisis. ================ Debt crises occur when the borrower can't give back or needs help with giving the money back to the lender. The consequence is that the lender will suspend all activity. This situation was the case of Latin American and Africa in the 20th century. Back at the time all the system was at risk, in fact just one bad operation or bad payer could have repercussions on all the system and not just on one participant. Default by one market participant will have repercussions on other participants. Latin America in the 1920s. --------------------------- A little bit of context ; Europe is paying for imports and the war debt to the United States. But how will Europe have dollars ? Well the United States gave Latin American dollars and Latin America will repay Europe for their investments. Latin America in the 1930s. --------------------------- During the 1930s, the prices of primary products declined. It had a bad economic impact especially in countries whose economy heavily depended on exporting these goods. ### Primary product and their price decline. +-----------------------------------+-----------------------------------+ | Chili & Mexico | Both countries are major | | | exporters of minerals like copper | | | / cuivre (chili) and silver or | | | oil (Mexico). A decrease in | | | global demand or overproduction | | | can lead to lower prices. | | | | | | This negatively impacts their | | | trade balances and fiscal | | | revenues, as these exports | | | contribute substantially to | | | government budgets and GDP. | +===================================+===================================+ | Brazil and Argentina | Those countries rely heavily on | | | exports of beef, sugar and | | | coffee. A decline in global | | | agriculture prices, due to | | | factors such as increased | | | competition, climate change or | | | reduced demand can hurt rural | | | economies and reduce exports | | | earnings. | +-----------------------------------+-----------------------------------+ During the great depression there was ; - - - - - - +-----------------------------------+-----------------------------------+ | Short term effects of the 1930s | Long term effects of the 1930s | +===================================+===================================+ | - - | - | +-----------------------------------+-----------------------------------+ Debt crisis in the 1980s. ------------------------- ### Background and causes. **Export decline.** Post 1973, exportations dropped. After the oil crisis of 1973, many well developed countries saw their revenues shrinked due to ; - - Lower revenue made it difficult to pay back external debts. **Shift to tight monetary policies.** It was also in the 1980s that we witnessed a shift to tight monetary policies. In the late 1970s and early 1980s, Central Banks in advanced economies (particularly the US Federal Reserve) implemented tight monetary policies to combat inflation (end of Keynesianism methodes). These shifts caused high interest rates, increasing the cost of debt servicing and a surge in the value of USD, raising the burden of dollar-denominated debts. **Petrodollars and lending surge.** Oil-exporting countries accumulated vast amounts of capital ("petrodollars") during the 1970s. These funds were deposited in international banks which aggressively loaned them to developing countries. Loans were often extended at variable interest rates, which rose sharply in the 80s, causing debt cost to skyrockets ### Debt crisis dynamics. **Systemic risks in the banking sector.** Unlike the 1930s, the debt wasn't held by private investors but by a small number of major commercial banks in the US, Europe and Japan. A wave of default of payments could have triggered a global banking crisis. **Bargaining power shift.** Banks and institutions like the World Bank or the IMF had more leverage and could threaten to withhold future lending. (Debtor countries rely on external-capital, so they would avoid this "punishment") **Avoidance of default.** Unlike the 1930s, a wave of default would have been seen as unacceptable because of the potential collapse of the global financial system. Instead the crisis was managed through ; debt rescheduling, re-lending, re-negociations. ### Outcomes. - - - II. The fall of Bretton Woods. ============================== It is important to know that even today some parts of Bretton Wood remain alive. Not everything died with it. After it fell, there were some institutional reforms to provide more liquidity to the system, the suspension of convertibility and the end of fixed exchange rates. - - - - - In 1962, France began a program to progressively change their dollar reserves into gold, thing that they could do thanks to convertibility. By 1967, the US' gold reserves dropped significantly. After France, Germany also did it. - The US owed more and more money to other countries while having less and less gold reserves. Dollars in circulation did not match the existing gold reserves. - It was an effort by major Western economies to defend the fixed price of gold at \$35 per ounce under the Bretton Woods system. Context ; The US has issued far more dollars than the reserves → inflation and trade deficit → speculation. To stabilize the situation, the US and seven other major economies found the London gold pool. ***Mechanism.*** Members agreed to supply gold to the London gold market when speculative demand caused prices to rise above \$35 per ounce. The Bank of England managed the operations, with member governments collectively reimbursing gold outflows monthly. Even if it was successful for a time, systemic issues persisted (continuous gold outflows, France's withdrawal and Vietnam war spending). It collapsed in March 1968. - Between September 1967 and March 1968 there was a speculative attack to gold and during this period → 42\$ per ounce. After selling gold in South Africa it went back to normal at 35\$ per ounce, but so many reserves were already lost by then. - The 15th of August 1971, president Nixon announced the suspension of convertibility. However, in December 1971, the Smithsonian Agreement was created. It tried to keep a fixed exchange rate between the main economic powers (group of 10 G-10). The dollar was devalued at 38\$ per ounce. Even if the fixed exchange rate was kept, there is now a fluctuation accepted of more or less 2,25%. The system became unsustainable in 1973, floating currencies entered. - In the 1970s, stagflation challenged Keynesian economics. Economist Milton Friedman and the Chicago School proposed ; monetarism, emphasizing control of the money supply to fight inflation. This approach influenced leaders like Margaret Thatcher in the UK and Ronald Reagan in the US, who prioritized anti-inflationary policies over stimulating demand. Their measures, including tight monetary policies and deregulation, deepened the initial recessions but marked a shift away from Keynesianism, reshaping economic policy in the 1980s. III. Oil crisis 1970s. ====================== Contexte. --------- - - - - - Different point of view. ------------------------ ### The demand. During the golden age, oil was considered as the main energy source in the West and Japan. Before it was coal. The demand was concentrated on manufactures, transports and heating. From 1960 to 1973 the supply had risen by 8 times and the middle east had become the main provider to Europe (in the 1970s, USA also became a net oil importer). ### The supply There were 7 big multinationals that we called the 7 big sisters ; 5 were from the US (2 standard oil, mobile oil, texaco and gulf oil) and 2 from Europe (Royal Dutch Shell and British Petroleum). They imposed low prices to the oil-exporting countries keeping for themselves the high value faces of production which is the process of refilling it and transforming it into gas. They kept it away from the producers countries - the poor countries - *"Rich people take the oil and then run"* In 1960, 5 countries founded the OPEC (Saudi Arabia, Iraq, Iran, Kuwait and Venezuela). Later some other countries joined them ; from 1961 to 1973, 6 more countries were added (½ of the world's production). A first embargo happened in 1967 but it did not really work as the US was still a net exporter. They wanted to do an embargo so the importing countries would give them more money for their oil. The rich countries are now in a weak position even if the US exported them oil (it will not have enough). **Beginning of the desequilibria.** In 1971/73, this was the end of the international monetary system, the world was facing inflation ; rise of the salaries (end of social consensus), of the price of oil in 1973, the demography and of the public spending. C. Oil shocks ------------- ### The first oil shock - 1973. In 1973, a surprise attack on a Jewish festivity marked the beginning of the Yom Kippur War (Egypt and Syria against Israel). The OPEC decided to suspend oil exports to the countries that would support Israel (like the US, the Netherlands or Japan). The price was unilaterally decided, without consultation of the 7 sisters. The first shock had immediate consequences such as an unprecedented rise in the oil price creating deficits in the balance of payments of the importer countries (inflation autumn 73 to spring 74 ; +400%). ### The second oil shock - 1979. Between 1979 and 1980 the islamic revolution broke off in Iran. There was a lower production in this country (-4%) while assuming a rise of its prices of 2,5 times in 2 years. This had serious consequences, the 7 sisters lost their ability to control the market and can't limit the damages. While the 1973 oil embargo demonstrated OPEC\'s collective power, its unity weakened over time. Tensions emerged between populous member countries, which needed higher revenues to support their large populations, and sparsely populated nations, which could sustain lower prices. By the 1980s, internal divisions and increased non-OPEC oil production eroded OPEC\'s influence. In 1986, a counter-shock occurred as oil prices collapsed, reflecting oversupply and reduced demand, signaling the decline of OPEC\'s dominance in the global energy market. For OPEC it was a success, but how to employ the new incomes ? Iran, Iraq Military expenditures. ---------------------- ------------------------------------------------ Saudi Arabia, Kuwait Short run deposits in the West (petrodollars). Furthermore, both EEC and Japan adopted a more pro-arab policy just to be sure to have the supply they need. D. The world after the oil shocks. ---------------------------------- The world after the oil shocks assumed slower economic growth. - - - **Was it only the fault of the oil shocks ?** The oil shocks were a key factor, but not the only cause of the economic challenges in the 1970s and 1980s. Rigid labor markets, high unemployment, and the failure of Keynesian policies contributed to stagflation. In response, governments adopted neo-liberal policies focused on deregulation and controlling inflation. Energy diversification reduced reliance on oil, while most economies moved toward rationalization and efficiency. Environmental concerns also grew, leading to greater focus on sustainable energy. IV. Second globalisation and third industrial revolution. ========================================================= The emergence of new technologies and the relocation of production marked a major transformation in the global economy, beginning with the advent of information and communication technologies (ICT) in 1971, when Intel introduced the microprocessor. This innovation sparked the beginning of the "first phase" of the technological revolution in the 1980s, during which technologies like fax machines, video games, and personal computers began to be widely adopted. These advancements laid the foundation for the "second phase" in the 1990s, when ICTs were increasingly integrated into both businesses and homes, leading to the rise of a \"new economy\" driven by technological progress. This technological revolution introduced several critical changes to the production process. Flexibility in production allowed companies to adapt more quickly to market demands, while the internationalization of production enabled companies to relocate their manufacturing processes to countries with lower labor costs, leading to a globalized supply chain. Moreover, informatization - the use of digital technologies to process and store data - streamlined production processes, reducing the need for labor and increasing productivity. As a result, there was a significant reduction in manual labor, which further decreased production costs. The new economy was characterized by a shift toward an economy centered around information and knowledge as key production factors. It was a global economy, where the technological and organizational capacities allowed countries and businesses to function as a unified entity in real-time across different regions. This economy was network-based, with digital technologies facilitating instant communication and the exchange of information across borders. The technological advancements of this period not only improved productivity in sectors that relied on high-tech innovations but also contributed to a broader economic transformation. As a result, the structure of employment began to shift. There was a movement from industrial to service-based jobs, reflecting the growing importance of knowledge and intellectual capital over traditional manufacturing. This shift led to the production of higher-quality and more complex goods, as businesses leveraged new technologies to innovate and improve their offerings. The productivity of the economy as a whole saw significant increases, particularly in industries utilizing advanced technologies. This was a monumental shift, with the \*\*new economy\*\* being compared to past revolutionary changes such as the steam engine or electricity, underscoring its transformative impact on global production, labor markets, and the way economies functioned. In this new technological era, the relocation of production became increasingly common, with companies moving their manufacturing operations to countries with lower labor costs, such as in Asia or Latin America. This trend was fueled by advances in transportation and communication, which made it easier to manage production across distant locations. However, despite the increased globalization of production, technological innovations, particularly in ICT, played the most significant role in reshaping economies. This period witnessed the emergence of more sophisticated, digitalized, and interconnected global markets, fundamentally altering the way business and trade were conducted. V. The 2008 great recession. ============================ All the countries integrated and related with the international economic and trade system found difficulties during the recession of 2008. (Principaly European, Asian/ Oceanian and North American countries.) The countries that are not relying on other countries to do trade are not really affected (Africa and some LATAM countries). +-----------------------------------+-----------------------------------+ | 1929 ; great depression | 2008 ; great recession. | +===================================+===================================+ | - - - - - | - - - - | | | | | People were queuing in front of | | | the banks to get their money | | | back. (we never thought that we | | | could see this happening again.) | | +-----------------------------------+-----------------------------------+ Involved economic agents. ------------------------- ### Mortgage Market. In the early 2000s, the mortgage market expanded significantly, driven by an increase in subprime loans (high-risk loans given to borrowers with poor credit histories). These risky loans were bundled into mortgage-backed securities (MBS) and sold to investors, spreading the risk across the financial system. The expectation of rising housing prices made lenders and borrowers overconfident, leading to reckless borrowing and lending practices. ### Banking system. Banks and financial institutions played a central role by securitizing mortgages into complex financial products, such as collateralized debt obligations (CDOs). These products promised high returns but were based on subprime loans, creating a hidden fragility in the system. Many banks heavily leveraged their assets, making them vulnerable to a downturn in the housing market. ### Rating Agencies. Rating agencies like Standard & Poor's and Moody's gave high ratings (e.g., AAA) to MBS and CDOs, even when these products contained a significant portion of risky subprime loans. Investors trusted these ratings and poured money into these securities, unaware of the true risks involved. This miscalibration of risk amplified the bubble and spread toxic assets globally. ### Regulators. Regulators failed to adequately oversee the growing risks in the financial system. For example, weak regulation of mortgage lending standards allowed subprime lending to flourish. Additionally, derivatives markets, including credit default swaps (CDS), were largely unregulated, enabling excessive risk-taking. Regulators underestimated the systemic risk posed by financial institutions deemed \"too big to fail.\" II. Causes. ----------- There was an excess of savings in the world. ### Real economy ; industrial relocation. A lot of USA and European multinationals moved their production to developing/emerging countries like China or India. ### Monetary economics ; financial bonanza abundance. The Federal Reserve (Fed) often uses expansionary monetary policy to stimulate economic growth, especially during periods of economic downturn or crisis. This policy involves two key actions: lowering interest rates and increasing the money supply. Between 1996 and 2006, the U.S. trade deficit (M \> X) was financed by China\'s large-scale purchase of U.S. Treasury bonds, which provided cheap capital. This inflow kept interest rates low, encouraging borrowing and fueling a credit boom. Easy credit led to excessive consumer spending and speculative investments in housing, causing home prices to rise by 92% over the decade. The rapid price increase created a housing bubble, driven by overconfidence in ever-increasing property values. When the bubble burst in 2008, it triggered a financial crisis that exposed vulnerabilities in the global economy. B. Causes of debt in Spain. --------------------------- +-----------------------------------+-----------------------------------+ | 1 : Going to euros in 1999 | When Spain adopted the euro in | | | 1999, other countries in the | | | Eurozone could buy Spanish debt | | | in the same currency, the euro. | | | This made it easier for Spain to | | | borrow money, as it eliminated | | | the risk of exchange rate | | | fluctuations. As a result, | | | investors demanded lower returns | | | (risk premium decreased), making | | | borrowing cheaper for Spain. With | | | access to low-cost loans, | | | Spain\'s debt levels increased | | | significantly, contributing to | | | economic imbalances that became | | | problematic during the 2008 | | | financial crisis. | +===================================+===================================+ | 2\. Structure of financial | After the 1992 European | | system | deregulation, savings banks | | | expanded beyond local services, | | | competing directly with | | | traditional banks by offering | | | broader financial products. This | | | increased their market share but | | | also their exposure to risks. | | | | | | a. b. c. | +-----------------------------------+-----------------------------------+ | 3 Features of mortgage loans. | Variable and adjustable interest | | | rate. | +-----------------------------------+-----------------------------------+ | 4\. Traditional culture. | Homeowners vs rent. (Spanish | | | people prefer to be homeowners.) | +-----------------------------------+-----------------------------------+ | 5\. Demography. | - - - | +-----------------------------------+-----------------------------------+ All those factors led to a housing bubble (private debt 300% of the GDP.) ### Construction sector crisis. The \"Crisis del Ladrillo\" (Brick Crisis) hit Spain in 2007-2008, caused by a collapse in the construction sector following an unsustainable housing boom. At the same time, Spain faced low productivity growth, which worsened the economic situation. By 2013, warnings about the severity of the crisis became clear, as public revenue fell, leading to a rise in unemployment. Despite this, the crisis was somewhat delayed in Spain, with the country\'s economic downturn unfolding at a slower pace compared to other European nations, which contributed to prolonged economic challenges. ###