The roots of the debt crisis in the Third World lay not in the oil shock, but in contradiction in American foreign policy. Namely, the US believes that the Third World must import capital and that this capital flow can and should be handled by the private sector. But goals aren’t sustainable in long run with the favorable results. Following WWII, Latin American countries had a problem not of attracting foreign saving, but of keeping money from "leaking abroad." This was in part due to investor’s remembrance of Latin American bond defaults in the ‘30s. Money that was held by Latin Americans was often in European banks. As foreign aid programs became more popular as a means of supporting anti-Communist factions, they became increasingly tied to international business interest. Thus, "the distinction between aid and export promotion became blurred."

This "aid" was quite beneficial for the First World economy and government. It financed export surplus through domestic profit and added employment. But also, this aid was a purchase of "compliant behavior" as far as curtailing Communist power and meeting IMF economic restrictions of austerity. As a result, loans were encouraged by the government, and backed up by the American military and covert action. Indeed, this support was maintaining a capital flow that would have otherwise stopped.

This arrangement was problematic though: if banking corporations were making profit, then debtor states needed a reverse capital flow to pay them. This caused a cycle in which debt service (the combination of principle and interest payment) had to increase more slowly than the new loans used to pay them: if net transfer was to remain positive, debtor countries needed to (and did) amass more and more debt. While new loans from different creditor states kept the system alive for a time, the number of states willing or able to loan soon dwindled.

In the long run, payment needed to come out of foreign export earnings if the debtor state did not experience real economic growth. Domestic or exporting sectors could lead this growth, but there were problems with each. Domestic growth would increase the demand for imports, as the population had more money. And this would in turn worsen the balance of trade. Export led growth would benefit the economy if demand for imports was kept low, but a country willing to import needed to be found. In a time when most countries were attempting to better their balance of trade, this was difficult.

To add to this problem, neither the creditors nor the debtors knew the safe parameters of the debt-service ratio. In the past, states with high ratios had still paid their debts, while states with low ratios had defaulted. The problem was that this measure does not account for new capital inflow. Since states always received more lending, there was not reason to dip into export earnings. So debt skyrocketed. This continued into the '80s past the breakeven point. But it became clear that the creditor states really did not want the money back, so they kept reissuing loans.

The goal of government aid as maintained by the American government has been to prepare under-developed economies for private sector capital. By the '60s, private banks had forgotten the lessons of loan defaults from the ‘30s and poured investment into Latin American countries that were already forming high debt. They were doing this because attractive borrowing parties were not available in the traditional places. Also, large profits could be amassed quickly in the short run with little effort, as high risk factors were ignored for high profit possibilities. Too, bank officials used various changes in political leadership (coups and new military regimes) to convince themselves that past economic problems would be solved through new policy. Many of these changes had been precipitated by IMF supervised cuts in external credit, which gave bankers a false sense of security. Finally, banks assumed that past woes would be solved by rescheduling and new monetary infusion. These traditional solutions were not feared; in fact banks made even higher profits following the first rescheduling in the late ‘70’s, because they could increase spreads and charge higher set-up fees. But the most important aspect of this situation was that banks were sure of government bailout. Thus, they could take the profit from high-risk ventures without ever having to face the associated consequences.

After the first oil shock, superfluous OPEC money began to circulate through the world economy. Some oil exporting countries such as Venezuela, Nigeria, Indonesia and Mexico were even more eager to borrow to cover their high and costly import demand. Other countries like Brazil and South Korea needed to borrow more just to cover increasing energy costs. For all cases, this availability of petrodollars encouraged the previously held assumption that the US umbrella of loan guarantees would save from any shortfalls. But the banks didn't note that their loaning patterns were not only bailing out increasing government debt, but also that they were creating a system that couldn't be solved by traditional methods of rescheduling and new lending.

The first test came in 1982 when Mexico and Brazil defaulted on their loans. If left to the solutions of the marketplace, the world market would have been in complete disarray. The goal was to keep banks from simultaneously and completely pulling out, so the IMF and World Bank funneled billions into rescue packages. But these intermediaries were not able to put together enough to provide stability. Thus, banks were required to put up a percentage of their investment for new loans that debtor states could use along with a portion of their export earning to pay interest. But Third World governments were not prepared to make this policy shift from the tremendous inflow of capital-to-capital flight - they needed to spend a sizable part of their earnings to service debt, not buy imports as they had been doing. Suddenly, money was flowing to Industrialized countries, who formed the so-called "creditor cartel". These countries continued to treat the problem as one of liquidity, and thus supported IMF requirements of austerity and trade liberalization that served to make it more difficult for debtor countries to manage their slim resources to the best of their ability.

This new plan didn't work. Debtor countries continually sought the IMF for new loans, which were given upon economic requirements. But debtor governments were forced to not impose all of the requirements due to the deep social and economic costs they would cause. These governments would go back to the IMF asking for the loans to be rescheduled but still involving economic reform that could not be imposed. This lead to diminishing IMF authority, as the alternative to loan rescheduling was loan default.

This arrangement was also problematic for the US economy, as it was now taking on an import surplus, which leads to a loss of domestic jobs. Further, money used to pay back debt to the US banks was money that couldn't be used to pay for America's rising imports. These tensions lead to the Brady plan, which involved a decrease in imports and "recognition of losses." This was still reminiscent of imperialism, for the US was taking the right to call the shots that involved a renegotiation of trade and case-by-case debt forgiveness.

In 1987, Brazil announced that it would stop paying interest. This only added to the strain, as Ecuador, Peru and Bolivia has previously suspended debt payment. In response, Citicorp reversed policy, left the creditor's cartel and set aside $3 billion to counter Third World debt. Other banks followed suit.

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Summary by Cheryl Chancey