External Debt Crisis (This Time is Different)

An external debt crisis occurs when a government defaults on its external debt obligations. Typically, but not always, this loan is denominated in a foreign currency, and held mostly by foreign creditors. The largest default on record is held by Argentina. In 2001, it defaulted on more than $95 billion in external debt.

Domestic debt crisis is the same as an external debt crisis, but in addition, they involve the freezing of bank deposits and/or forcible conversions of such deposits from dollars to local currency.

In most countries, for most of their history, external public debt (debt under the jurisdiction of foreign governments) is denominated in foreign currency held by foreign residents – while domestic public debt is under a country’s own legal jurisdiction, denominated by the local currency , and held mainly by residents.

There have been many domestic debt crises, but most go unnoticed because they are not as severe as external debt crises, with a few exceptions, such as Mexico’s domestic default in 1994-1995.

The Debt Crisis of the 1990’s in Asia

Asia was the darling of foreign capital in the mid 1990’s. 1) Households had high savings rates that governments could rely on in the event of financial stress. 2) Governments had strong fiscal positions; most borrowing was private. 3) Currencies were quasi-pegged to the dollar, making investments safe. 4) It was believed that Asian countries never experience financial crises.

But even a fast-growing economy with sound fiscal policy is not invulnerable to shocks. One big weakness was Asia’s exchange rate peg against the dollar. These pegs made countries vulnerable to a crisis of confidence. As of 1997, that is what happened. Thailand’s government lost a lot of money on foreign exchange interventions when efforts to prop up the currency failed. Korea, Indonesia, and Thailand were forced to go to the International Monetary Fund (IMF) for gigantic bailout packages. But this was not enough to prevent deep recessions and huge currency depreciations.

The Debt Crisis of the 1990s and early 2000s in Latin America

The debts were bond debts, not bank debts. The thinking constantly swings when it comes to which type of debt is safer. Since credit was channeled through bonds, the rationale was that it would be harder for banks to renegotiate as they did in the 1980’s, so the chances of default were non-existent. Other factors were in play, such as political change. Many Latin American countries had changed from dictatorships to democracies, assuring “greater stability.”

Mexico was not at risk because of the North American Free Trade Agreement, which started in 1994. Argentina was not a risk, since it had “immutably” fixed its exchange rate against the dollar through currency board management. But the boom of the 1990’s ended in a series of defaults, starting with Mexico in 1994, and Argentina’s massive $95 billion default (the largest in history at the time), and Brazil in 1998 and 2002, and Uruguay in 2000.

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1. Debt Intolerance (This Time is Different)
2. Domestic Debt (This Time is Different)
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4. Myth 8: Most People Experience a Midlife Crisis in their 40s or Early 50s (50 Great Myths of Popular Psychology)