The Lost Decade of the 1980s and the current Eurozone crisis

In August, 1982, Mexico stunned the financial world by announcing it could no longer pay back its debt. Dozens of countries followed suit. The 1980s is often referred to as the “lost decade” for Latin American countries because of the harsh economic repercussions of the debt crisis and the austerity measures taken from the various governments.   It took most of the next decade before lenders and borrowers were able to negotiate a solution (called Brady Bonds after then-Treasury Secretary Nicholas Brady) that reduced debt and lengthened the time to maturity.  There was a fundamental disagreement about whether countries were suffering from a liquidity or solvency crisis.  Banks, international institutions, and rich country governments were desperate to label it as a liquidity crisis and demanded that bankrupt countries enact strict austerity measures and pay back all of the debt.  It wasn’t until later, when banks were able get on a more solid financial footing and a secondary market had opened up for discounted Latin American debt, that banks would even broach the idea that this was a solvency issue and that debt reduction was the only way to move forward.

Yesterday, one of my bright undergraduate students asked whether European governments and banks had not reached this stage as well.  The Eurozone crisis has surely been going on for long enough that it seems like a reasonable question.  It reminded me of a recent article by Eduardo Porter in the NY Times, who asks that question specifically.  He writes,

“But the most relevant parallel is one that European leaders refuse to see. If there is one overwhelming lesson from the debt crisis that struck Mexico and other Latin American countries so hard three decades ago, it is that countries that cannot grow will not pay. It is up to creditors, too, to allow them to grow. It took Mexico and its lenders seven years to figure that out. The European crisis is in its fifth year. You would think they might have learned something by now, but no.”

There are obviously large differences between the Latin American situation and the Eurozone crisis, so at first I was pretty skeptical of the analogy.  But the more I’ve thought about it, the more I think we might be getting closer to what happened in the late 80s with Mexico.  I see increasing discontent with austerity measures amongst Eurocrats and European officials, which leads me to wonder whether the analogy isn’t closer than I originally thought.

By the way, if you want to learn more about the Latin American debt crisis, and Mexico’s experience in particular, check out my videos on the topic here at Marginal Revolution University.