Paul Volcker’s Latin American legacy

That is the topic of my latest Bloomberg column, the history with Latin America is also a big part of the Volcker story, here is one bit:

Global banks raised their interest rates for lending and shortened their repayment periods. In the mid-’70s real lending rates to Latin America hovered in the range of zero, but by the early ’80s they were between 8% and 10%. Liquidity was cut off, and the underlying growth potential of the region’s economies was not strong enough to sustain the debt. This affected other parts of the world as well and became known as “the third world debt crisis.”

The crisis came to a head in 1982, when Mexico announced it would no longer be able to service its debt, sparking a financial crisis and currency collapse. Ultimately, 16 Latin American countries also were forced to reschedule their debt payments. This created problems for the banks too, since by 1982 the nine largest U.S. money-center banks had Latin American debts equal to 176% of their capital, a figure which rose to 290% when lesser developed countries elsewhere in the world were included. Eventually the U.S. led a bailout and debt-reduction program, with the participation of the International Monetary Fund.

But for Latin America, things would never be the same. Governments had to cut spending, which in turn led to further adjustment problems, akin to the eurozone crisis of more recent times. Poverty rates rose sharply, and the general mood turned pessimistic. By the end of the 1980s, Latin American per capita GDP had fallen from 112% of the world’s average to 98%, a stunning plunge and by some measures the worst financial disaster the world had ever seen, albeit a regionalized one.

And this:

Repercussions in the U.S. were more modest. The potential insolvency of some major U.S. banks, such as Citibank, was ignored amid forbearance and hope about their return to profitability. They did, eventually, but in retrospect one has to wonder if allowing so much non-transparent bank accounting — with the blessing of regulators, including Volcker’s Fed — was such a good idea.

That all said, I do not think Volcker had much operative choice on most of these matters, and the excess Latin American borrowing certainly was not his fault.  Note: the inspiration for this column came from a tweet by Pseudoerasmus.


"the excess Latin American borrowing" (bad debt) is a fundamental pitfall of banking/lending.

Competent bankers carefully evaluate such risks on an individual basis ... unless the taxpayers blindly insure against such risks via national central banks

Spics are subhumans without a work ethic. Their IQ is 30% lower than that of actual people. Anyone investing in such shitholes would be irrational.

Mapping capital flows into the US over the past 30 years:

The dramatic shift in the direction of money flows that followed the 1980s profoundly affected Latin America, that's for sure. And that shift has continued right up until today. Is that a good thing or a bad thing? Did Volcker trigger the shift? Was it intentional? Has the cause of the shift shifted or is it essentially the same? What might shift the direction of money flows? And if it did shift, would it create a crisis? In Shakespeare's immortal advice, neither a borrower nor a lender be.

Do we owe much to Volcker? Does that include the shift of industrial production outside the US, recurring large US fiscal and current account deficits, and secular stagnation? Volcker is held in such high esteem that nobody is willing to make a sober assessment of what followed his reign at the Fed. He tamed inflation. And we've been battling windmills ever since.

Ray - do you really think the economy was better managed in the 1970's than say in the last 10 years? It seems to me that since Volcker we have had a pretty good run, the 2008 GFC not withstanding.

"He tamed inflation" that's all that needs to be said.

They redefined inflation to exclude the things that were experiencing actual inflation.

Neil Irwin's balanced assessment:

In retrospect the high interest rates seem a very brute force way to combat what was really a series of energy price shocks, rather than monetary inflation.

And in retrospect, the real action was in reducing oil use across all industries.

US oil intensity over time

But as you say, perhaps big visible action was politically necessary. Sad.

You can test that hypothesis easily by comparing Inflation to core inflation.

If your theory is correct core inflation will be low and stable through 1970s and 1980s, whereas inflation including food and energy will spike.

Feel free to check

The idea of "core inflation" was a good tool to address this issue, but it's imperfect, a rude division. In fact there is no human economic activity that does not use "energy."

It's interesting to note the timing. From my link:

"In 1974, energy prices rose 56% above the previous year, leading to changes in both national policy, such as the establishment of vehicle efficiency standards, and consumer attitudes."

from Wikipedia:

"The concept of core inflation as aggregate price growth excluding food and energy was introduced in a 1975 paper by Robert J. Gordon."

Maybe Tyler has written on this in his "progress" series, but human progress has been an energy story. First food and muscle in the hunter gatherer stage, then farming and domesticated beasts of burden, then "mills" driven by wind or water, then the most excellent steam engine, before the glorious age of petroleum.

But something happened in the ratio of consumers to producers, and energy got expensive. The new game became efficiency rather than gross power output. That trend continues today, and it's why there are hundreds of thousands of reservations on the Cybertruck.

You have a testable folk theory (and a much more bizarre folk theory of energy efficiency) on how inflation works. It doesn’t match the data at all.

If your folk hypothesis on inflation is immune to data or testing then we can safely add it to the crank pile.

This idea that core inflation somehow subtracts the economy wide impact (real and emotional) of higher energy prices is "folk" in its own way.

Core is not really "ex-energy" because the real calculation would be impossible. Every good and service has an energy component, and for every good and service that fraction is different. What is the energy cost in that 2x4? Well, what power did the lumber mill use, and how far the the finished lumber ship? There is not, and can never be, one answer. It varies with every lumber plant and every destination.

Subtracting one slug of energy, from one measure of inflation, is a wild assed guess.

Few people remember that Paul Volcker was actually appointed by Jimmy Carter.

If Carter had managed to get himself re-elected, perhaps he would have reaped the benefit of the early 80's boom and would be remembered far differently today.

Maybe. Volcker started his squeeze during the Carter administration, but backed off when he lost Carter's support. Something as big as purposely putting us into a recession requires a lot of political support. Maybe he would have given it again after the election, or maybe he lost faith. Either way, Reagan stood behind him, took the recession hit, and the rest is history.

Mr. Volcker had to fix the mess caused by many US bankers who lend to insolvent Mexico. The problem is that history remember him, not those bankers.

The IMF story of Mexico crisis mentions the "secret" meetings between Mr. Volcker and the Mexican Finance MInister (Jesus Silva Herzog) between March 1982 and the crisis onset on August 1982.

This paragraph on the IMF doc linked above is priceless:

"If Mexico defaulted on those payments, the lending banks would be subjected to heavy pressure from regulators (who could require them to write down the value of their loan portfolio, not just to Mexico but to other countries as well), depositors, and shareholders. Mexico faced a simple choice: default or obtain outside assistance. Because the amounts involved were large enough to threaten the stability of the financial systems of the major creditor countries, there was a good chance of getting help."

Mexico was too big to fail for many US banks. Volcker negotiated with Silva Herzog the final rescue deal that saved Mexico's regime and US commercial banks. Anyone remembers Greece sovereign debt and Deutsche Bank a few years ago?

So, it's not unreasonable that Mexicans may complain that the terms set by Volcker were too bad, as the Greeks mention Mario Draghi. US citizens may complain that Volcker worked for big fat bankers (Citibank, Chase Manhattan, etc) as other European citizens complained about the rescue of package for Greece.

The way to minimize this problem is transparency, but it was something Mr. Volcker and Mr. Silva Herzog didn't give a damn about.

And Mexico would be back, hat in hand, a dozen years later. This time, the terms required Mexico to run its oil revenues through the Federal Reserve Bank in New York, to collateralize the loan.

One good thing that came out of the first crisis was the start of Mexico's opening its economy to foreign competition and joining the GATT in the mid-1980s.

Except that the economy floundered. It suffices to say that the PRI regime, which had last decades, collpased.

I worked at the Fed in the Volcker years. I am not a fan.

(1) He tightened far too much to get inflation down. A more moderate tightening and a more gradual reduction in inflation -- which was the original agreement with the Reagan team -- would have been better. The long 1980-82 recession was longer and deeper than it needed to be.

(2) He got the support of Democrats by blaming large deficits for the high interest rates rather than blaming his own excessively tight monetary policy. Of course, high interest rates caused federal interest rates to surge and boost the deficit.

(3) At the NY Fed and then as Chairman, what did he do to rein in reckless bank lending to Latin America? It is not like the banks had nothing to do with the Fed.

(4) Latam debt was floating rate debt. Volcker blew up those countries' debt service. But the super strong dollar and collapse of commodity prices, connected to tight Fed policy, also damaged Latam.

(5) Volcker had modern leftists attitudes. The Fed has become quite transparent and communicates with the public and Congress. It may amaze younger readers that the Fed would adjourn FOMC meetings with no press statement or public policy announcement. Volcker figured you would find out what the Fed was up to when it did something. The Republican Greenspan and Bernanke started to let the sunshine into the Fed. The paranoid closeted quality of the old Fed generated resentment and conspiracy theories.

(6) Volcker had an authoritarian streak. He suppressed dissent within the Fed system, going after researchers at Fed banks who contradicted Fed dogma. The St. Louis Fed was particularly attacked, but others also.

(7) You might connect the death of Marvin Goodfriend with the death of Paul Volcker. Goodfriend was a critic of Volcker in the Fed. He said Volcker's tight policy pushed inflation down, but Volcker would not deliver an inflation target. His Fed had no credibility, no one was wiling to believe that the Fed would keep inflation low. One result was a high long bond yield and a steep yield curve. It was fine that Volcker wanted to reduce inflation, but it was the Fed that needed credibility, not its temporary chairman.

(8) I found the recent Volcker Rule worthless. Prop trading played no role in creating the crisis of 2008. The Volcker Rule has simply made markets less liquid. After 2008, as after 1932, the federal government imposes useless regulations just for fun.

You're right, B.B. Remember the First Law of Wall Street and Big Gamblers: "Always bet with someone else's money." And the Golden Rule: "Your gold, my rules." Wheeeeeeeee!!!!!!

That was not inflation Volker fought, that was pure pricing chaos

The so called inflation was a bunch of mis-pricing losses that got carried over onto the next 40 years. It will take us another 100 years of mild deflation to work off those losses. But we do not have the patience and will have another monetary adjustment. Google bots are spreading the word as we speak.

Why pricing chaos? Because the US Socialists were the major player in the precious metals market by virtue of socialized gold. We exited that market overnight, and left that market in utter chaos for five years. Socialist politicians who want to fix the price of a precious metal, how nutty can one get?

FDR and Nixon pulled the same stunt, take advantage of an arbitrage situation in precious metals. FDR worked the issue over months, and i involved making folks give up their gold, more monetary police, then a careful repricing of gold over a month. The economy could almost adapt,\. Nixon was an over nighter.

But they had one thing in common, it hits the precious metals market first, as those traders actually have to believe in the legal convertibility. They buy and sell the thing priced, not a derivative.

The true inflation for Nixon was a few trillion in losses on lost paper bills, mostly hitting the precious metals industry. But this was not true monetary inflation which is an innovative and anonymous actuarial lose by the currency banker. In the FDR and Nixon cases, everyone know who dunnit and the harmed parties were, and still are, out to recover their losses, it has not been sterilized. The effects are everywhere, like a financial system suffering post traumatic shock.

What is new? Black-Sholes and option pricing. We can have slightly less volatile inflation shocks because we can do innovative NGDP futures pricing. meaning, currency banker monetary losses and gains are sterilized upon discovery, arbitrage is extinguished as soon as it appears.

Hell is other people.

Are you an econ professor?

The years of high rates were accompanied by a series of crashes in commodities prices which, combined with other structural weaknesses, exacerbated the lesser-developed countries (LDC) debt crises; the early 1980's US Ag and energy crises - e.g., the failures of Continental Illinois Bank and hundreds of oil patch and farmland banks; the late 1980's/early 1990's S&L Crisis - failures of hundreds of S&L's - with the taxpayer covering the losses of insured depositors. The $22 trillion national debt includes approximately $250 billion, plus interest, from the S&L crisis,

Re: FDR/Nixon and gold. "it hits the precious metals market first" I don't see how huge rises (69% under FDR; 21% under Nixon - closing gold window) in PM prices harmed the markets unless of course you've heavily shorted them. Of course/naturally, soaring commodities prices followed the 1971 closing of the gold window/devaluations and the 1973 Yom Kippur War and concomitant OPEC oil embargoes.

People need to remember that not only was there high inflation, there were both high unemployment and sluggish GDP growth - stagflation.

Aside from that, I don't understand much of your comments.

Statistics like “Latin American per capita GDP had fallen from 112% of the world’s average to 98%” should raise a red flag. This relative “fall” is mostly due to strong growth elsewhere in the world rather than an actual decline in Latin America. After all, the 1980s saw strong growth in many parts of the world due to the end of communism in China, continued catch-up growth in the rest of Asia, and significant changes in monetary policy and economic liberalization in the Anglosphere.

And is it really accurate to call something a “Third World Debt Crisis” if it happened in countries that were above the average global GDP per capita?


This reminds me of something very interesting that is happening in Brazil (maybe Tyler should look into this one). For many years, interest rates in Brazil were sky high (it got to 14% a year in 2017) and since Bolsonaro took power, he has forced it to be much lower (it is around 5% now). What happened since then? Brazilian Real lost *a lot* of power against the dollar (from 2.5 to 1 in 2014 to around 4.2 to 1 now). So at the end of the day, it is all a big trade-off. However, what are the actual consequences of these trade-offs? What does a country get by lowering interest rates and getting a worse exchange rate to the dollar? It looks like Brazil's government is doing this to heat up the "real" economy (by lowering imports and increasing exports?) but does it work? Is this a different way to force austerity since foreign investment in Brazilian bonds will be lower?

It works. The government has decided to stop propping artificially the currency. The edonomy is recovering fast despite America's betrayal. The stockmarket is booming. Exports are up. Corruption is down. Consumer confidence is up. Brazil has just built a new Navy base at the Pole. Brazil has also installed the biggest Ferris wheel in South America.

If inflation is 12%, what would a free market interest rate be? 17%? Otherwise there is a loss.

As someone said to me at the time, there is no way an economy can function at those rates. In Canada and other places the inflation rate was baked into union agreements and any contract longer than a month was essentially cost plus. When the currency is losing value at that rate, the rationale for a state is being eaten away as well.

So how to fix it? It is easy to complain about the one who did the ugly job.

I remember many people saying that inflation is not so bad, we fixed it easily once. They weren't there.

All I know is that Canadian government when forced to live within the money they could raise by taxes was the best government in my lifetime. That is gone now. Harper to his shame opened the door to 1970's style Liberalism including the guy with the same last name and Liberal NDP minority parliaments. We were on our way to emulating Argentina but better minds prevailed. It seems it was a momentary interruption to the drive to oblivion.

What Volker, and others like Carter's deregulation and Reagan's opening of the economy was a very good 25 year run.

You wanna a safe space and tissues?

Canada is one big safe space.

"So how to fix it? It is easy to complain about the one who did the ugly job.". Exactly. I'm very thankful that Volcker did what he did.

Lessee here... banks get bailed out, vast swaths of a continent eat dirt.

rinse, repeat.

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