How petrodollar recycling into Latin America, the Volcker rate shock, and Mexico's August 1982 default triggered a decade-long regional debt crisis that reshaped the IMF's role and produced the Brady Bond solution.
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The Latin American debt crisis was born from a specific and identifiable cause: Western banks, flush with OPEC petrodollars after the 1973 oil shock, recycled them as loans to Latin American governments at floating rates. When Paul Volcker raised the Fed funds rate to 20% in 1980-1981 to break US inflation, those loans became unpayable.
After the 1973 OPEC embargo, OPEC nations deposited hundreds of billions in petrodollar surpluses at Western banks. Banks needed to deploy this capital — Latin American governments (Mexico, Brazil, Argentina, Venezuela) were eager borrowers. By 1982, Latin America had accumulated $327B in external debt. The loans were at floating rates pegged to US interest rates.
Fed funds rate reached 20% in June 1981. Latin American interest payments exploded. Export revenues collapsed as global recession suppressed commodity prices. On August 12, 1982, Mexico's Finance Minister told the US Treasury it could not meet its debt obligations. The crisis spread instantly to Brazil, Argentina, Venezuela, Chile, and beyond.
The IMF organized rescue packages contingent on austerity: slashing public spending, devaluing currencies, liberalizing trade, privatizing state enterprises. GDP fell 7-10% in crisis countries. Poverty rates surged. The 1980s became 'the Lost Decade' for Latin America.
US Treasury Secretary Nicholas Brady devised the solution: banks converted their bad loans to tradeable bonds backed by US Treasury zero-coupon bonds as collateral. Debt was restructured at a discount, giving banks exits while giving countries a fresh start. Brady Bonds launched the modern emerging market sovereign debt market. Mexico completed its Brady restructuring in 1990, Brazil in 1994.