How did the debt crisis come about?

The international debt crisis became apparent in 1982 when Mexico announced it could not pay its foreign debt, sending shock waves throughout the international financial community as creditors feared that other countries would do the same. The immediate cause of the crisis occurred in 1973 when the members of the Organization of Petroleum Exporting Countries (OPEC) quadrupled the price of oil and invested their excess money in commercial banks. The banks, seeking investments for their new funds, made loans to developing countries, often without appropriately evaluating the loan requests or monitoring how the loans were used. In fact, due to irresponsible practices of creditor as well as debtor governments, much of the money borrowed was spent on programs that did not benefit the poor - armaments, large scale development projects, and private projects benefiting government officials and a small elite. The 1973 oil price increase also had the effect of triggering inflation in the United States and other industrialized countries.

In 1979, OPEC raised the price of oil a second time. Meanwhile, the US adopted extremely tight monetary policies to reduce inflation, producing a domestic recession. The combined impact of the rising price of fuel and rising interest rates led to a worldwide recession. Developing countries were hurt the most. Their exports declined as the domestic cost of production rose and the major importers reduced their purchase of goods from overseas. Latin American governments which had taken out loans from commercial banks at floating interest rates (rates that vary according to the current market interest rate) saw the interest on their debt skyrocket. African governments, reacting to the worldwide collapse in commodity prices, borrowed heavily from other governments and multilateral banks at both market interest rates and concessional (very low) rates. When Mexico finally announced that it could not pay its foreign debt, the international financial system appeared on the brink of collapse. The world's major creditors acted to save the commercial banks and the world economy.