European sovereign debt crisis

Document Type:Research Paper

Subject Area:Sociology

Document 1

Previously, unindustrialized nations garnered loans from civic means like World Bank and IMF, but afterward, in 1973, commercial banks had and the influx of capitals from oil-rich states and thought that sovereign debt was a safe venture. However, the Latin American Dues to commercial banks accumulated to a yearly rate of 20. which led Latin America to multiply its foreign debt from US$75billion in 1975 to $316billion in 1983 (Feldstein 1998). Furthermore, Debt service multiplied even quicker as the international rates increased from $12 billion in 1975 to $66 billion in 1982. The 1982 Debt Crisis was one of the most serious in Latin America's history. Unemployment increased to unimaginable levels; commercial development deteriorated, both exports and imports plunged while inflation reduced the purchasing power of the intermediate class. According to Lane (2012), real wages fell between 20 and 40 percent ten years after 1980 and investment allocated to address poverty and social issues was used to repay the debt. Following the crisis, most states were forced to abandon their import substitution industrialization (ISI) prototypes and embraced the export-oriented industrialization strategy, the neoliberal approach by IMF. In the United States, a massive course of capital outflow denigrated the interchange rates which elevated the real interest rates (Diamond 2009). This essay will, therefore, provide an in-depth analysis of the causes and the solutions that were implemented to the European Sovereign Debt Crisis. History of the Latin American Debt Crisis After World War II, loans were given to sovereign nations under the Bretton Woods System. The system devised the International Monetary Fund that was aimed to grant loans to countries and prevent economic recessions.

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However, each state was limited to a loan depending on their contribution and compliance with certain stipulations that were designed to promote independence and financial freedom of the state. Despite these restrictions, the Bretton Woods System remained as the primary source of funding to sovereign countries through the 1960s. The IMF loans were issued to tide nations during the short term economic difficulties like economic restraints that could adversely affect both the economies of the affected country and other states. However, Bretton Woods System crumbled in the late 1960s and early 1970s since the contributions of the participant nations to the IMF did not sure in the same rate as inflation (Diamond 2009). The IMF purchasing power reduced instantly, and it was unable to monitor the currency exchange rates between nations which resulted in payment deficits and overvalued currencies.

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Additionally, the Bretton Wood System disintegrated which led to a tremendous increase to the loans granted to the sovereign countries by commercial banks. In the 1970s, financial bodies in the United States received an enormous amount of money deposited by wealth oil-producing nations, and they were, therefore, looking for the investment markets. However, Latin America exports increased in the first few years of 1970s which made it appear like a reliable target for investment. Regardless of the hazardous growth of international debt, the debt crisis commenced after the global capital markets realized that Latin America was unable to repay their loans. These was after Jesus Silva-Herzog, Mexico’s finance minister, acknowledged that Mexico was not in a position to deal with its debt in August 1982. Mexico indicated that it was unable to clear its payments in the outstanding dates and needed a renegotiation of payment periods and new loans for it to meet its prior duties.

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Following Mexico’s sovereign failure to pay, most commercial banks significantly abridged lending to Latin America. Other Latin nations including Bolivia, Argentina, Venezuela, and Brazil followed claiming that they were too incapable of servicing their foreign creditors (O'connor 2017). Debt-equity swaps and restructuring Even if bridge loans allowed sovereign debtors to keep paying the interests for their original loans, the banks also attempted to minimize their exposure to the more substantial default of the principal loan. Small banks withdrew themselves from the more significant percentage of their exposure to sovereign debt without the necessity of extending new loans to pay off the old loans. The banks thus joined the debt-equity swap which was the allocation of a loan from one bank to the other or the third party for an equity venture in the debtor country.

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However, this was a common practice for small banks and involved small amounts of debts (Beirne 2013). Following the Sovereign debt crisis, therefore, debt restructuring was the most effective means of restructuring the principal loan. Brandy plan excluded the worry by banks that they would collapse if debtor states in the case the debtor states were forced to default their loans (Aizenman, 2013). Moreover, investors who had purchased the bonds received payments periodically through a fund that was set up for this reason. Sovereign debtors also experienced numerous benefits from the scheme since the Brand bonds were dispensed at a discount from the original loans which reduced the debtor’s obligation. Additionally, the relationships had an extended maturity rate which ensured that the sovereigns had enough time to generate revenues and rebuilt their economies.

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The Brand plan also allowed individual investors to get involved and benefit from the sovereign debt market. References Aizenman, Hutchison, M. Jinjarak, Y. what is the risk of european sovereign debt defaults? Fiscal space, cds spreads and market pricing of risk.  Journal of International Money and Finance, 34, 37-59. Beirne, J.  American Economic Review, 606(10). Feldstein, M. Refocusing the IMF.  FOREIGN AFFAIRS-NEW YORK, 77, 20-33. O'connor, J. growth in a time of debt.  American Economic Review, 100. Reinhart, C.  M. Trebesch, C.

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