The International Debt Crisis-Causes, Consequences, and Remedies - Research Paper Example

The international debt crisis-causes, consequences, and remedies Executive summary It is axiomatic to squabble that debt crisis has affected a number of countries across the globe. Being a financial management risks, every economy must ensure that reasonable and working policies are adopted to deal with the problem. To have an imperative discussion on the causes, consequences and implications of international debt crisis, it is in order to delineate the unblemished concept ‘debt crisis’ Debt crisis deals with national economies and their abilities to repay loans. It is a situation when nations are not able to pay the debt it owns and seeks. A nation usually runs a surplus in the capital account when it runs a current account deficit. A capital account surplus is an inflow of the foreign capita; in the nation which is often advantageous to a country. The main question that is posted by critiques is where these monies go and their role in the growth and development of the economies. If it is used for consumption, it will not have any injections and therefore more debts. It will be more stress to the country as opposed to when it is invested. The Problem It is unarguable that debt crisis is a challenge to a number of countries across the globe. In a number of economies, the crisis started during the mid-1970s when a number of the Organizations of Petroleum Exporting Countries (OPEC) managed to amass wealth and banks were willing to lend billions of dollars. A number of developing economies borrowed huge sums of money at floating and low interest rates. Due to the irresponsibility of the debtor governments and the creditors, the money borrowed was not used in the productive purposes, i.e. investment; rather it was used for immediate consumption. Consequently, these countries could not generate enough finances to repay the loans. The incidences of adjustable interest loans increased during Reagan’s administration in the United States to reduce inflation through the enforcement of stringent rules. (Madura, 2012) During this time, the prices of the raw materials collapsed, meaning that a number of poor countries did not have enough money to repay the debts. Most developing countries failed to pay their debts and have heavily relied on the International Monetary Fund and the World Bank. There was however a condition those countries were to adopt economic structural adjustments. The government of the affected countries was forced to cut costs on education, health, and other social services to be able to repay the debts. In Latin America, the per capita of most countries plummeted, the GDP stagnated and incidences of poverty increased. (Pilbeam, 1998) In Europe, the economic integration of 27 countries which was referred to as the Euro Zone aimed towards the stimulation of the economic growth of the member countries, encouraging industrialization and enhancing the gains of the international trade. Later, they intergraded with 17 other countries, and they adopted the Euro as their currency. The Euro faced a lot of distress in 2008 when the countries faced serious debt crisis. In 2012, the public debt in the Eurozone stood at 89% of its GDP. In the United States, on December 15th 2014, the country reported that the national debt had exceeded $18 trillion which is more than the economic output of America. The Debt to GDP ratio was last more than 100% when payment was being transferred in paying the World War II. The debt crisis in the US was created by political battles between Democrats and Republicans. The 2008 financial crisis and the Bush tax cuts were blamed for the crisis that lowered the tax revenues. The policy maker’s hoped that the reduction in the tax paid would increase demand that will then spur the economic growth of the country out of recession (Keynesian economic theory). An adoption of supply side economics led to the loss of focus by the policy makers, they ought to have concentrated on economic growth. The debt crisis in the entire region stated above posed the threat of regions facing recession. It is therefore important to have a comprehensive and thorough understanding of the causes, consequences and the remedies of the international debt crisis. Purpose of the Study Almost all countries globally have been faced with the incidences of debt crises. In a number of third countries mainly Africa, huge debts has been recognized as one of the major causes of low human development. The discussion in this paper will focus on the causes, consequences, and remedies of the global debt crisis. The crisis causes a lot of panic amongst investors resulting into demolition of the global financial markets. Therefore reasonable remedies should be adopted to address the consequence. (Yue, 2010) Theoretical Analysis In the below study, a number of scholars in Europe, Latin America and North America have presented a number of explanations with regards to debt crisis. They tag debt crisis to poor management and dependency amongst various countries across the globe. Below sections describes and analyzes some of the existing theoretical literature with regards to debt crisis which has been a problem in a number of countries across the globe. Debt Crisis: the causes There are a myriad of reasons that have been associate to debt crisis across the globe. The third world country debt is attributed to the continuing legacy of colonialism. The debt in a number of developing countries resulted from the huge transfer of debts by their colonizers. Third world countries present a history of continuous siphoning by the colonizers. In 1960 alone an estimated debt of $59 billion of debt was imposed on that states that had just gotten their independence. With the interest rate of 14%, the debt increased rapidly. As they worked towards organizing their economies, the debtors had started saddling with the huge debts. Another cause of debt crises is the mismanaged lending. In 1960, US spent more money than it had in the printing of dollars with the oil producing countries pegged to dollar with the value of dollar coming down. The oil producing nations increased the prices in 1973. It should be noted that millions of the money’s borrowed went to the hands of the Western dictators and therefore did not benefit the locals. (Habib, & Stracca, 2012) There were a number of incidences of excessive lending that left the governments with large fiscal deficit and banks with bad debts in the economies. In Europe for instance, some economists blamed the introduction of Euro that resulted to the Europeans nations to borrow at a very low costs. Another reason for the debt crisis according to this paper was the liquidity squeeze. A number of explanations of nations affected by the debt crisis indicate minimal emphasis to the vulnerabilities in the financial sector, especially the mounting maturity and the mismatches in the public debt and also within the banking system that rendered affected government illiquid. (Yue, 2010) Another point is the reduction in the exports and interest rates that was witnessed during the 1980s. The low exports figures recorded made a number of debtor nations to default the foreign loans. The frenzied borrowing and lending was halted with the beginning of global recessions in 1980s. The reduction in the debtor country exports associated with the high global interest rates and strong dollar played a role in the depletion of the foreign exchange reserves that most debtor countries depended on for their international financial transactions. A number of debtor countries ion 1980s felt the strain of remitting the monthly payments on foreign date which were expensive too pay since there were associated interest rates which increased as the global rates increased. The problem was worsened with continuously increased incidences of massive capital flights by private companies and individuals in the developing countries. (Pilbeam, 1998) Another reason for the continuous debt crisis is the fact that the world’s poor are subsiding the rich. One of the main reasons for debt crisis in most developing countries is the embezzlement of funds and corruption by few elite in developing countries. The moneys obtained from corrupt activities are usually placed in foreign banks. Loans also from the developed also come with a number of conditions and therefore making it almost impossible for the economies to grow to repay the loans. Another reason for the debt crisis in the European Union was the gap in terms of structure and strength of the member countries. The strong and weak economies were differently impacted with the divergence of interest rates within the European Union. But where they all name (come) as 1999 The last reason that has affected a number of countries affected by debt crisis is lack of decisive action. For example, countries within the Euro zone failed to take reasonable action to deal with the crisis. As the European was formed without the channel for a nation to quit the unity, some countries such as Spain and Greece left the control of their monetary policy to the union. They were not able to take decisions with regards to devaluing their local currency and flexibility in the fiscal regulations so as to take a reasonable action before opting for the European Central Bank bailout packages for the states. (Shafiee, & Topal, 2010) There were a number of countries in the world that were negatively affected by the debt crisis. Most of the countries are characterized by poor economic growth and unequal distribution of resources. One of the main causes of debt crisis in developing countries is the mismanagement of the borrowed funds. The below section discusses the consequences of debt crisis that has affected a number of countries across the globe. (Habib and Stracca, 2012) International effects- Most of the foreign banks that operate in the developing countries hold a bond in the host country. Therefore when the debt crisis starts, banks and other financial institutions are likely to loose large sums of money, which they attempt in recouping through raising of the interest rates and lowering of the deposit rates. When interests are high, the businesses will be shy from borrowing from the banks to expand their businesses. The result was a negative impact on the entire economy. The economies that are often reliant on trading partners often begin to experience downgrades in the credits resulting to the raised taxes and the reduction in the government expenses. In the long run, there will be a domino effect starts with the concerned countries pulling the trading partners into crisis. (Madura, 2012) The other consequence was the government cuts. During the debt crisis, government officials and the creditors often exert a lot of pressure on the country facing debt crisis to cut its expenditure. It translates to cutting expenses to some important public services like education, health care. Incidences of unemployment also rise resulting into increase in the levels of dependency (Shafiee & Topal, 2010). In most case, the government is forced to raise the taxes levied to the public with the hope of raising funds to cover the payments of the debt. When people loose tax, it is likely that they will not be able to pay taxes and therefore reduced economic growth. Unemployment often reduces the demand of products in a country. When demand for the products is reduced, production will come down as very low quantity will be supplied in the market. The result will be further job cuts in the country. (Pilbeam, 1998) The next consequence is associated with the credit ratings of the country. The government that is issuing the tax usually has credit ratings. At the onset of debt crisis, the credit agencies usually lower the credit rating of the affected government. In the long run, the governments will be forced to pay very high interest rates on its future bonds. Statistics show that the interest rates that are usually charged by the potential creditors are always positively high. Other nations and the corporations that have invested a lot of funds in bonds from the country that is facing crisis are also affected given that the loss in the bonds means that the creditors in the nation that is on crisis will begin facing shortfalls in cash. Remedies of Debt Crisis The debt crisis in the countries negatively affected the economy. It is necessary that nations adopt some of the remedies to help deal with the problem. Without clear solutions to the countries, it is unlikely that the financial problems and reduced GDP will continue to be witnessed in these countries. In Europe, due to the fact that the crisis did not originate from the public debt of the country itself, it was very clear that the problem was with constitution and the performance of the specific economies. Therefore the fist action that the European governments took was to look at the constitution and correct some of the weakness that existed. Countries were encouraged to discuss and adopt mechanisms to help in controlling their monetary policies. (Susan 1986) The problem of mismanagement and embezzlement can be corrected by ensuring that the existing institutions are able to monitor the actions of the leaders. In most developing countries, leaders have been accused of serious corruption and mismanagement. In a number of third world countries, most funds which are borrowed for development and investment purposes often end up in the hands of individuals. At the same time, the money is spent on consumables and therefore the nations are not in a position to pay back the funds. Therefore before a country access any credit, there should be clear structures and institutions that are working to ensure that the funds are given are used for the purposes they should be. A number of countries across the globe are associated with restrictions when it comes to trading with global partners. This paper believes that the economic growth and success is through opening its borders to global trading partners. Structural adjustments and ensuring that there are good and democratic leaders will be a plus. The level of unemployment will go down as multinationals will be investing in their countries besides the ease by which trained professionals will be able to work in other countries. To properly address the problem of liquidity in the countries, that arose from the financial crisis, the member countries held a summit in 2008 that marked the start of agreement on the plan of a bank with the aim of boosting their situations financially and ensuring that the lending of the inter-banks were guaranteed. The protocol is regarded as the most important coordination’s in the prevention of a country from harming others. Another reason for the constant debt crisis in most developing countries is the high debts owned to the former colonizers. Most of the countries are still paying huge debts to meet the costs of services that were performed during colonization. The affected countries have been going through discussions to ensure that the payments are waived. The cutting of the credit balances will facilitate the growth of the countries. Methodology The below study will adopt existing secondary sources such as article’s, journals, documented works and other online sources. The study will adopt both qualitative and quantitative technique to come up with the deductive results. The study intends to build a theory and hypothesis that will help in the understanding and analyzing of the results. Data Analysis Models for obtaining the results The study will focus on the analysis of the existing secondary data. The secondary information will be analyzed using E-Views, which is statistical software. The Chi-square will be used in the testing of the analysis while the ANOVA and regression analysis will be used in the measuring of the linear relationship. The model designed will help in the analysis of the collected data. The study will make the comparison of the results obtained with the existing data. Conclusion In the past years, the internal donors began responding to the high debt crisis of some of the poor nation through the combination of forgiveness in debts and strengthen the drive to fight poverty. A number of them are focusing on the funds to fight poverty in these countries. It is however in question on whether the strategy will work in helping poor nations to fight poverty. Organizations like World Bank and the International Monetary Fund has put a lot of emphasis on the growth of the economy of some of the nations. Some countries are also keen on discussions on the competitiveness as opposed to the focusing on support. The main focus should be on agriculture with added value, and industrialization to help in the creation of jobs. (Habib, and Stracca, 2012) Debt crisis has pointed existing weaknesses in structures of most countries across the globe. Some of the reasons behind debt crisis especially in developing countries can be dealt with when there is a reasonable political good will. The developed countries should support the developing countries to ensure that they formulate policies that will help them reduce the problem of debt crisis especially on economic structure adjustments. This paper also asserts that irrespective of the reform that is initiated in a country, the most important thing is the policies that are formulated to deal with the problem. Crisis should be dealt with presently because they might be full blown in the future. The paper argues that when debt crisis is not dealt with, dealing with unemployment will be a mirage. Irrespective of what the nations do, the most important thing is the formulation of working policies that will encourage the creation of jobs. This paper therefore suggests a further research and a projected analysis on the role of trade blocks in dealing with debt crisis in the developing countries. References Habib, M. and L. Stracca (2012): "Getting beyond carry trade: What makes a Safe haven currency?", Journal of International Economics, 87, pp. 50-6 Madura, J. (2012). Financial markets and institutions, South Western Educational Publishing. Pilbeam, K. (1998). Finance and financial markets,Macmillan Business Shafiee, S. & E. Topal (2010). "An overview of global gold market and gold price forecasting." Resources Policy 35(3):178-189. Susan A. (1986), The Marketing And Message Of The Baker Plan, The Bankers Magazine, Yue, V. Z. (2010). "Sovereign default and debt renegotiation." Journal of International Economics 80(2): 176-187. Read More