40 – Foreign Exchange

To understand the conditions which led to the Third World Debt Crisis, one needs to understand the mechanics behind Foreign Exchange.

“Foreign exchange” is the means or the ability to purchase materials, goods, or services from another country. If a Canadian, for example, places an order over the internet to buy something from a company in the United States, they will be asked to pay for it in US dollars–that’s the foreign exchange.

There are basically three ways to acquire foreign exchange. The first is to purchase it. The way one does that over the internet is to put it on a credit card. The credit card company will convert the Canadian dollars into US dollars by purchasing them. The monthly statement will tell the card holder what that purchase rate–the exchange rate–was. It is relatively easy for a Canadian to purchase US dollars. However, it is more difficult for someone using a less stable currency, one from a developing country for example, to find a source which will exchange that currency for either US or Canadian dollars.

A second method is to earn it. Developing nations which were not able to buy foreign currency could earn it by continuing to sell the commodity products that richer nations desired. So the Dominican Republic in the 1970s, pursuing the example we’ve been using, continued to produce sugar in order to acquire the money needed to pay for the developments occurring in that country during the Balaguer years.

But the prices earned by agricultural commodities on world markets fluctuate a great deal, while the price of manufactured goods can generally be expected to rise. It took six times as much sugar to buy one tractor in 1983 than it had in 1979.

If one can’t buy foreign exchange, and one does not have the ability to earn it, then there is a third way to acquire it. It can be borrowed. And during the 70s, that’s what countries like the Dominican Republic did. This eventually led to the debt crisis which they have never really resolved, and which, to some extent, they continue to suffer from today. More immediately, it led to events like the 1984 riots in Santo Domingo. But at the time the money was borrowed, it seemed like a good idea.

Countries always borrow money. That’s what bonds are, for example–a nation’s way of borrowing money from its citizens in order to pay for government operations. And most countries probably had their borrowing under control until about 1973. That’s when the price of oil went up. That single event changed the global economic situation.

What happened was that the petroleum exporting countries recognized they produced a commodity upon which the rest of the world depended. So they formed the Organization of Petroleum Exporting Countries–OPEC–and working together they were able to raise the price of oil world-wide. This had immediate repercussions throughout the world economy. Other nations–especially the industrially developed nations–went into recession as their fuel costs rose.