Challenges to the Global Economy: Decline of the US Dollar, Oil Crises, and Debt Crisis
Challenges to the Global Economy
I. Decline of the US Dollar
Impact on Developed and Developing Countries
- Caused uncertainty and instability in both developed and developing countries.
1971 Nixon Shock: Announcement that the US dollar would no longer be convertible to gold.
1973 Collapse of the Bretton Woods System: Devaluation of the US dollar to US$38 per ounce of gold.
By 1973, all major economies were floating, which led to wild and inexplicable fluctuations in exchange rates.
- UK GDP declined by 3.9% from 1973-1975, and inflation peaked at 20%.
- From 1972-1974, USA GDP slowed from 7.2% to 2.1%, with inflation jumping from 3.4% to 12.3%.
1980s Volcker Shock: American interest rates were kept at extraordinarily high levels of 20%.
- Created a global recession that slowed demand in industrialized economies and adversely affected the fortunes of developing countries.
Trade Imbalances and Protectionist Measures
- The decline of the US dollar was exacerbated by trade imbalances and protectionist measures.
- By 1980, the US$40 billion trade imbalance became US$140 billion in 1985.
- New protectionism and managed trade deployed non-tariff barriers (NTBs) and voluntary export restraints (VERs).
- Trade relations between the US and Japan became fraught with tension in the 1980s. The US restricted exports of cars from Japan to no more than 1.68 million per year.
- These measures slowed trade growth and hindered competition through artificial barriers.
- 48% of imports of industrialized countries were affected by NTBs in 1986.
- The dollar value of world trade grew only 5% in 9 years.
- World trade fell in 1982 by 2.2% for the first time since 1945.
II. Oil Crises of 1973 and 1979
Impact on Developed and Developing Countries
- Although the oil crises affected both developed and developing countries, developing countries suffered a more damaging impact.
1973 Oil Crisis
- Due to the 1973 Yom Kippur War, OPEC retaliated against the US by imposing an oil embargo, increasing prices by 70% to US allies in Western Europe.
- World oil prices rose from $3 to $11.65 per barrel.
- High production costs resulted from the relatively price-inelastic demand for crude oil.
- The developed West suffered increasing stagflation, compounded by the Nixon Shock and the collapse of the Bretton Woods System.
- The sudden shock caused New York Stock Exchange shares to lose $97 billion in value in six weeks.
- Developing countries’ overborrowing rose from $100 billion to $600 billion within six years.
1979 Oil Crisis
- As a result of the 1979 Iranian Revolution and the 1980 Iran-Iraq War, oil production fell significantly, more than doubling crude oil prices.
- The average price of oil increased from US$15.85 per barrel to US$39.50 within 12 months due to oil shortages.
- Developed countries were better prepared due to better plans for conservation and allocation of oil, such as the International Energy Agency (IEA).
- Developing countries had even fewer funds to finance investments in alternative energy sources.
Mitigation of the Oil Crises
- Although the era of cheap oil had ended, mitigation of the crises was relatively successful.
1973 Oil Crisis Mitigation
- The US’ National Energy Act of 1978 explored renewable energy sources such as wood fuel, solar, and wind power.
- France embarked on a new nuclear power program, reducing its dependence on oil in the long run.
- Britain exploited its own oil fields in the North Sea and became self-sufficient by the 1980s.
- However, developing countries continued to face increasing distress from low demand for their exports and mounting debts.
1979 Oil Crisis Mitigation
- By 1981, other countries, such as Mexico, surpassed OPEC in oil production.
- The global economic recession in 1980 caused oil consumption to decrease significantly, with imported oil accounting for only 40% of total consumption in industrialized economies.
- By the 1980s, the price of a barrel of oil decreased from US$80 to US$38.
- However, Third World oil-producing countries like Mexico and Venezuela suffered severe economic repercussions.
III. Debt Crisis of the 1980s
Impact on Developing Countries
- The debt crisis significantly affected the economic and social stability of developing countries.
- Petrodollar recycling from the oil crises increased the debts of developing countries.
- Third World debt grew to $1.3 trillion in 1988.
- Brazil’s external debt increased from 7.9% to 15.2% of GDP in 1978.
- African nations used 25% of their foreign currency earnings to repay foreign debts, resorting to dismantling social and economic development plans for repayment.
- Inflation was about 1000% in many Latin American countries.
- Between 1985 and 1992, 56 major IMF riots broke out.
- In 1989, incidents of unrest left 200 dead in the Dominican Republic and 300 dead in Venezuela.
- In 1990, 1.5 million Brazilian workers participated in 300 separate strikes.
Threat to the International Financial System
- The debt crisis threatened the international financial system.
- Defaults were triggered when countries like Mexico declared they would not be able to service their $80 billion debt.
- New lending to Latin America was reduced or halted.
- Confidence in the international banking system collapsed, disrupting financial markets.
Alleviation of the Debt Crisis
- Although not eliminated completely, the debt crisis was alleviated in some ways.
- The US lent $2 billion to Mexico and pressured banks to reschedule payments.
- By 1983, 27 countries owing $239 billion had rescheduled their debts to banks.
- However, the number of people living in absolute poverty rose to 730 million.
- By 1993, $1.6 trillion in loans remained outstanding.