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REAL AND POTENTIAL PROBLEMS

1 December, 2015 - 10:05

The Bretton Woods system was designed to prevent foreign exchange shortages and exchange rate deterioration in the deficit countries. It never occurred to the designers of the system that there might be a global liquidity sqortage due to the accumulation of huge surpluses by the developed countries. In addition, no one predicted that the mechanism for clearing the deficit markets by borrowing in the open market at the going interest rates would saddle the developing countries with a tremendous "external debt."

During the 1970s most of the developing countries experienced an exponential growth in foreign debt. This growth was the result of the convergence of several factors:

  1. The inability of these countries to generate enough export-earned foreign currency
  2. Ambitious development programs requiring massive importation of expensive capital goods
  3. Conspicuous consumption of imported goods as a hedge against inflation and currency devaluations
  4. Accelerating global interest rates
  5. The change in the policies of the lending countries, especially the United States, away from grants, which were referred to as "giveaway programs," and toward interest-bearing loans

The explosive increase in foreign debt has created some chilling monetary crises with potentially catastrophic consequences. Figure 8.5 shows that the external debt of the developing countries is approaching the $1.3 trillion level. Ten years ago it was barely over $500 billion. In 1955 foreign debt was just $10 billion.

Most people think that it is only the poor countries that have a gigantic problem. Lord Keynes would remind them, however, that the problem belongs to the international bankers who so freely loaned these monies. As Lord Keynes so elegantly put it, "If you owe a pound to the banker you are at his mercy. If you owe a thousand pounds he is at your mercy."