The Fall of the Peso and the Mexican "Miracle"

by Andrew Wheat

 A MONTH AFTER THE MEXICAN GOVERNMENT devalued the peso and triggered a spectacular meltdown of Mexico 's economy, U.S. Treasury Secretary Robert Rubin described this economic disaster to the Senate Foreign Relations Committee as a "low probability" event that few analysts could have anticipated. Rubin suggested the peso crisis struck like a lightning bolt from a clear blue sky. Yet, despite Rubin's testimony, such a crisis had been foreseen even before the North American Free Trade Agreement (NAFTA) was approved.

 To cite one example, Representative John LaFalce, D-New York, then chairman of the House Small Business Committee, held hearings in February 1993 to examine how dollar-peso exchange rates might affect NAFTA . LaFalce and some of the experts who testified at that hearing considered a peso meltdown to be a high probability almost two years before the crisis transpired. At the hearing, LaFalce observed that:

 o a U.S. dollar that bought 25 pesos in 1981 bought 3,270 pesos at the time of the hearing (actually 3.27 new pesos, which moved the decimal on old pesos three places to the left);

 o Mexico's current account deficit was projected to reach $27 billion in 1994 (it reached $28 billion), which would amount to 8 percent of its gross domestic product, a strikingly high amount that many economists consider unsustainable;

 o Because the current account deficit and the threat of devaluation spooked investors, Mexico had to pay interest rates of 18 percent to attract foreign capital.

 "The exchange-rate relationship between the dollar and the peso will profoundly affect how any NAFTA operates and the distribution and nature of the benefits and burdens of NAFTA," LaFalce said. "Yet NAFTA establishes no mechanism to coordinate monetary policy between the United States and Mexico, nor does it provide for consultations or corrective measures if exchange rates are used to promote competitiveness." LaFalce noted that devaluation was likely. "If the [current account] deficit widens faster than the inflow of capital to finance it," he said, "the Mexican Government will have to decide what to do about the peso, and it will not be an easy decision."


No honeymoon

 Despite warnings from LaFalce and many others, NAFTA criticisms went unheeded. In November 1993, most members of Congress put their faith either in the "magic hand" of the marketplace or in Clinton's impotent labor and environmental side agreements and voted for NAFTA. During NAFTA's maiden voyage, however, the vaunted Mexican miracle went up in smoke - gun smoke:

 o As NAFTA took effect on New Year's Day 1994, rebels calling themselves the Zapatista Army of National Liberation took over towns in the poor Mayan Indian- inhabited southern state of Chiapas, announcing that NAFTA "represents a death certificate for Mexico's indigenous ethnic groups."

o Then-President Carlos Salinas' anointed successor, Luis Donaldo Colosio, was killed by two gunshots in March 1994 while campaigning in Tijuana near the California border; the government presented a young factory worker as Colosio's lone, demented assassin.

o Ruling Institutional Revolutionary Party (PRI) Secretary General José Franciso Ruíz Massieu was gunned down in September 1994.

 o In February 1995, new Mexican President Ernesto Zedillo's Attorney General, the first opposition party cabinet member in PRI's history, announced that there was a second Colosio gunman, a member of the candidate's own security team.

o Former president Salinas' brother, Raúl, was arrested in February 1995 and charged with masterminding the assassination of Ruíz Massieu, though the government did not declare what motive it attributes to Salinas, a businessman who allegedly has ties to drug traffickers and enjoyed lucrative contracts with his brother's government.

 o Salinas administration Deputy Attorney General Mario Ruíz Massieu, who also has alleged drug trafficking ties, was charged with a cover up in the investigation of the murder of his brother, José Francisco Ruíz Massieu. The former deputy attorney general was detained and imprisoned when he tried to enter the United States, home of the bank accounts in which he deposited at least $17 million, with too much undeclared cash.


Rattling investors

 Despite oft-expressed kudos for the Mexican economy's "sound fundamentals" from Clinton administration officials and Federal Reserve Chair Alan Greenspan, Mexico's problems were not just political. One troubling indicator that LaFalce noted in 1993 was Mexico's current account data. The current account measures the net flow of goods, services, investment capital and unilateral aid transfers between a country and the rest of the world. Mexico's current account deficits, then, reflect the net excess of foreign-supplied capital inflows over domestic capital outflows. In the first eight years after Mexico's 1982 debt crisis, Mexico's current account stayed within $8 billion of a balanced account. In 1991, Mexico's current account deficit doubled to $15 billion and almost doubled again by late 1994. This statistic alone suggested that Mexico was living beyond its means. Given that large amounts of Mexico's capital inflow went to short-term government debt and to speculative rather than productive investment, these numbers were especially alarming. Foreign debt investors would expect rapid repayment and were likely to withdraw from Mexico altogether if Mexico's luck soured.

 Investors continued their stampede southward, however, because Mexico's interest rates and investment returns in the early 1990s were bullish, especially compared to those of the United States. This speculative financial stampede created its own momentum. The more investors shifted dollars south, the higher Mexican stocks climbed and the easier it became for Mexican companies and their government to borrow seemingly endless sums of dollars. As investors hit grand slams in Mexican markets, they began to get careless about peso-denominated investments, which one steep devaluation could wipe out. Added to this risk was the danger that investments would not be repaid; many Mexican corporate and government bonds received junk-bond ratings, which are reserved for the riskiest investments.

As investor dollars washed across the border, Salinas technocrats refused to devalue the peso. A strong peso kept foreign investors happy (because a peso devaluation would reduce the value of peso-based investments when they were converted back to dollars), advanced their obsessive war on inflation and treated Mexican consumers to a cheap-import shopping spree going into the August 1994 elections (conversely, a weak peso makes foreign goods prohibitively expensive for many Mexicans).

 This and similar political schemes spurred politicians on both sides of the border to ignore the warning lights that flickered across their control panels throughout 1994. Instead, they clung to a fictitious script: that of the Mexican miracle. U.S. and Mexican officials always seemed to need the miracle script for just one more joint political campaign: the November 1993 NAFTA vote in the U.S. Congress, the Mexican presidential election in August 1994, the November-December 1994 U.S. congressional vote on the new General Agreement on Tariffs and Trade (GATT) and the failed subsequent campaign to make Salinas the first head of the World Trade Organization that the new GATT established. In early 1995, desperate Clinton administration officials even resorted to the Mexican miracle script - albeit with a few new caveats - to rationalize their bailout schemes.

 By 1994, however, what was once billed as a miracle began to resemble a hoax. Under the strain of the Zapatista rebellion, the political assassinations and the current account deficits, Mexico's debt underwent a disturbing shift. The Federal Reserve - which doubled U.S. interest rates in the 12 months ending in February 1995 - was making investments more attractive in the United States. Foreign investors in Mexico increasingly demanded higher interest rates, shorter maturities and dollar-denominated debt that would be insulated from a peso devaluation. As the year wore on, foreign and domestic investors dumped cetes, Mexico's peso-denominated treasury bonds, for its dollar-denominated tesobonos. Foreigners, who held less than $5 billion in dollar-linked tesobonos at the beginning of 1994, held 10 times that on the eve of the devaluation, much of it converted from the riskier cetes holdings. Almost every week, the Mexican government rolled over another maturing debt issue with average maturities of just 10 months.

 The 1994 debt shift made Mexico a hostage of short-term market jitters and dramatically increased the importance of the foreign currency reserves that the central Bank of Mexico maintains as a cushion against economic shocks. Yet, the Bank of Mexico ate into these reserves voraciously during 1994, using them to buy pesos to prop up the peso's value. Foreign reserves, which peaked in February just shy of $30 billion, dropped below $18 billion in April after the Colosio assassination and below $15 billion on the eve of the August elections. Reserves fell again in November, declining to around $5 billion in December.

On December 18, Zedillo met with some of Mexico's wealthiest business people to discuss a crackdown on a new Zapatista offensive; many analysts believe Zedillo hinted to the chosen few that a peso devaluation was in the works. The next day, rich Mexicans converted billions of dollars worth of pesos into dollars. One day later, the Mexican government announced a 13 percent peso devaluation.

Angered by the breach of Mexican officials' repeated promise that they would not devalue the peso, foreigners converted pesos to dollars and pulled out of Mexico as fast as possible. By mid-March, three months after the initial devaluation, the peso had lost half its value and Mexico was accepting aid on foreign-dictated terms to pay off billions of dollars worth of maturing bonds that it could not cover. For Wall Street, more than the Mexican standard of living was at stake. Between 1992 and 1994, securities firms billed an average of $133 million a year in Mexican securities underwriting fees and mutual funds raked in $240 million in annual revenue on $17.1 billion in Latin American assets. U.S. banks had $15.9 billion loaned to Mexico in March 1994.


Bailout número uno

 Faced with a run on Mexico that was evaporating perceptions of U.S. NAFTA benefits, the Clinton administration masterminded a series of bailouts. On January 3, 1995, a year and two days after NAFTA took effect, the administration proposed an $18 billion rescue plan. The plan consisted of $9 billion in expanded currency swap arrangements from the United States, $1 billion worth of swaps from Canada, $5 billion in Bank of International Settlements (BIS) credit and $3 billion in private bank credit. On January 12, as Mexico's economy continued to unwind, the administration boosted the U.S. commitment to $40 billion worth of U.S. loan guarantees. Exercising political finesse, the Democratic administration first sat Senate Majority Leader Robert Dole, R-Kansas, and House Speaker Newt Gingrich, R-Georgia, down with Treasury Secretary Robert Rubin and Federal Reserve Chairman Alan Greenspan. These political heavyweights got the Republican leaders to sign off on the proposal on the spot.

 Dole and Gingrich's prior consent severely limited the ability of the Republican Party to make partisan hay out of the Clinton administration's bailouts. The chief reason the bailouts were unpopular was the widespread perception that it was structured to reward the very co-dependents who caused Mexico's economic crisis: the Mexican government and its foreign investor creditors. The main purpose of a bailout was, by the Treasury Department's own admission, to address Mexico's liquidity and foreign exchange crisis. But what does this jargon really mean?

The Mexican government issued excessive short-term, dollar-denominated bonds to raise money from investors who, knowing the risks, provided the money in exchange for the promise of handsome returns. Now, the Clinton administration wanted to draw on the funds of U.S. taxpayers and international agencies to make good on Mexican government debt to Wall Street bond holders. This prompted an outcry among liberals and conservatives alike, including most of the large new Republican class in Congress.

Lawrence Kudlow, economics editor of the conservative National Review magazine, testified January 26 before the Senate Foreign Relations Committee, "This is not a bailout of the Mexican peso or the Mexican economy. It is a bailout of U.S. banks, brokerage firms, pension funds and insurance companies who own short-term Mexican debt, including roughly $16 billion of dollar-denominated tesobonos and about $2.5 billion of peso-denominated Treasury bills (cetes). It is also a bailout of the Mexican government which incurred these liabilities. Finally, it could be a bailout of another $20 billion of Mexican private-sector bank certificates of deposit, commercial loans and trade credits."

 Voters in November "voted for smaller government and lower taxes," echoed Representative David Funderburk, R-North Carolina, in a February 10 hearing of the House Banking Committee. "If Wall Street wants a sure thing, it should invest in U.S. Treasuries and blue chip stocks," he said.

Rubin insisted the unpopular bailout was needed to defend a broad array of interests: 700,000 U.S. jobs that he claimed depend directly on Mexico's market; illegal Mexican immigration that he claimed could increase 30 percent in a "protracted crisis;" and "the financial prospects of all emerging markets."

What seemed to move Rubin most was the loss of Mexico as a model for all Third World countries, a model that Rubin and Goldman Sachs helped construct. "Mexico has been, in several ways, a prototype for countries that are striving to put inward-looking, state-controlled models of economic development behind them," he told the House Banking Committee. "A new prosperity based on open markets, a welcome-mat for investment, and privatization is beginning to emerge. But Mexico's financial crisis shows that these emerging markets are still vulnerable to financial shocks. Helping Mexico through its current difficulties can keep alive the promise of market-oriented reform - the key to growth and stability over the longer term for all of us."

 Critics of the Goldman-Mexico model suggested that few Mexicans wanted to be "a welcome-mat for investment" and raised questions about who Rubin's "us" referred to. "For 10 years now, Mexico has followed the free-market, free-trade creed to a T: trade liberalization, privatization and cultivation of foreign investment," National Autonomous University of Mexico professor Jorge Castañeda, wrote in the January 17 Los Angeles Times. "The results have been dismal: mediocre and sporadic growth (if any), a gigantic current-account deficit stemming from continuing high debt service and a huge trade gap, persistent low savings and a private sector that, with a few exceptions, simply cannot hack it in world markets and takes its money out of the country at the first sign of trouble."

Beset by strenuous objections from liberal and conservative opponents of the $40 billion bailout, and wearying of the administration's latest threat that the sky would fall if Congress did not carry out Clinton's trade agenda, Congress balked. Its leaders reported in late January that they could not deliver the bailout votes.


Congressional bypass

 Faced with overwhelming congressional opposition to President Clinton's initial bailout plan, the administration announced an even bigger bailout package on January 31 that made an end run around Congress. Again, Clinton first got Dole and Gingrich to sign off on the plan. The centerpiece of the second package is an unprecedented $20 billion in currency swaps, loans and loan guarantees from the Treasury Department's Exchange Stabilization Fund (ESF). Congress established the ESF in the 1930s to defend the dollar in the event that the U.S. currency lost an excessive amount of its value relative to other leading currencies. More recently, the Treasury has used the ESF occasionally to defend foreign currencies, but never to the extent now being pursued. The largest ESF amount that the Treasury had previously approved was $1 billion to respond to the 1982 Mexican debt crisis. Previously, ESF credits had been limited to maturities of one year or less. Some credits under the new bailout are to extend up to one decade.

The next-largest component of the Clinton administration-orchestrated package is $17.8 billion in International Monetary Fund (IMF) credits. Like the ESF funding, the IMF package for Mexico was out of line with anything the IMF had ever done before. It was three and one-half times bigger than what had been the IMF's largest loan and almost seven times Mexico's IMF quota. IMF Managing Director Michel Camdessus promised the Clinton administration the funds in the early hours of January 31, before the IMF board voted on the matter. Many nations on the IMF Board did not want to set such a massive precedent and objected that U.S. and IMF staff consultation with the IMF Board amounted to too little too late. Many also viewed Mexico's problems as primarily a crisis for the United States and Mexico. Britain, Germany, Belgium, Switzerland, Norway and the Netherlands asked that their votes be recorded as abstentions, an unusual dissent in the consensus-run body.

The Switzerland-based Bank for International Settlements (BIS), run by the central bank heads of industrialized countries, provided another $10 billion. But the terms and solidity of the BIS funds are also questionable. A European finance official told the Financial Times in February that the BIS credits amounted to a bookkeeping trick: Mexico could count the funds as part of its reserves but, in fact, it would never access the money.


Liquid gold

 The lack of enthusiasm among IMF member countries and BIS central bankers for the bailout is hard to square with the Clinton administration's presentation of the bailout package. Defending the administration's approval of the $20 billion ESF package by executive fiat, Rubin claimed hard-nosed business terms underlie the credits, which he said are backed by rock-solid collateral. In the event of a default, he promised, the New York Federal Reserve Bank would garnish Mexico's oil export revenues. In making the collateral claim, Rubin never directly addressed critics, who suggested that such a foreign garnishment of sovereign revenue was unenforceable, that much of Mexico's oil revenue was already pledged to other debt obligations and that Mexico, which faces dwindling oil reserves coupled with a rising domestic demand for oil, is expected to become a net oil importer early in the twenty-first century.

 Hours after Clinton unveiled his congressional bypass bailout plan on January 31, Texas billionaire Ross Perot offered his perspective on the oil collateral. "The Treasury Secretary and the administration assured us that they have liquid gold collateral," the Texan told the Senate Banking Committee. "Terrific. That's what bankers fight over." If Mexico really had hard collateral to offer, Perot reasoned, there was no reason for the United States to intervene. The Mexican government with its oil collateral and investors with their troubled bonds could restructure the debt on whatever terms they could work out.

 Perot had called Rubin's bluff. Wall Street did not want to redeem its bonds at less than face value and its financiers would examine the underlying oil collateral revenue with more skepticism than Rubin had. In fact, three weeks later, private commercial banks pulled out of their relatively modest role in the bailout package. Mexico's negotiations to obtain a $3 billion line of credit from 20 international banks led by Citibank and J.P. Morgan & Co. fell through on March 23. The banks balked, according to the Financial Times, because the Mexican government would draw on their funds only after it used up the other funds in the U.S.-arranged package, and, at that point, Mexico presumably would be beyond salvation. Rubin had told members of Congress repeatedly that it was unlikely that Mexico would draw on the whole bailout package but that the huge sums were needed to restore investor confidence. But the fact that the big banks - whose funds would be drawn upon last - chose to undermine confidence perceptions that affect billions of dollars of their investments in Mexico by reneging on their pledge, suggests that they believed Mexico was much more likely to burn through the full bailout package than Rubin had acknowledged.

 Apart from the inevitable post-devaluation improvement in Mexico's trade balance with the United States - as Mexican goods became cheaper in the United States and many U.S. goods became prohibitively expensive south of the border - Mexico's situation continued to worsen in late March. Despite a massive injection of foreign funds and the Mexican government offers of interest rates of 58 percent on 28-day cetes, bond holders continued to redeem their bonds for dollars and retreat from Mexico, which reportedly had already burned through at least $13 billion of its bailout package. Mexico is entering a serious recession. The crisis could become even worse if bailout funds prove to be insufficient to stave off widespread Mexican bank failures as heavily leveraged consumers and businesses find it impossible to pay off their debts. Acknowledging the problem, the Mexican government has pledged to make $11.6 billion available to commercial banks, an amount equal to 17 percent of their loan portfolios.

 Barring a quick second coming of a Mexican miracle, the Clinton administration will face an agonizing decision soon. One option is to stick to the bailout plan and go further out on a limb by continuing to release new, multi-billion-dollar installments to the Mexican government despite a lackluster response from investors and the Mexican economy. Another option is to declare that the plan is not working and leave Mexico to its own resources. Either way, the political damage to the administration, which made a controversial end run around Congress to put billions of taxpayer dollars at risk, would be enormous. Policymakers on both sides of the border have few options left, save to pray fervently for the appearance of another Mexican miracle.



Forcing Mexicans into the Streets

THOUGH U.S. TAXPAYERS and member countries of international agencies objected to extending $48 billion to bail out the Mexican government and its creditors, the economic crisis in Mexico will extract its highest price from the Mexican people.

 Newly inaugurated Mexican President Ernesto Zedillo was paralyzed in the first months of the crisis as he tried to balance the irreconcilable interests of two key constituencies, the Mexican people and the U.S. government. By March, U.S. government interests prevailed. The United States would arrange to pay off Mexico's bond investors, many of whom were U.S. citizens. Meanwhile, the Mexican people would pay for their government's transgressions through severe austerity measures.

 After unveiling a minimalist austerity plan in January that the markets dismissed as insubstantial, the Zedillo administration imposed a shock plan March 9 that amounts to an assault on Mexican businesses and consumers. The plan: increases the federal value-added sales tax from 10 percent to 15 percent; raises fuel prices by 33 percent and residential utility rates by 20 percent; pushes up user fees on ports, airports and toll roads by 2.5 percent each month; and limits minimum wage increases to 10 percent, which, based on the government's projection of a 42 percent inflation rate in 1995, will inflict an 18 percent decline in buying power on minimum wage workers. Government action also pushed interest rates on consumer credit up to 125 percent.

 In addition to these cost increases, says Alfredo Dominguez of the Authentic Labor Front, Mexico's leading independent labor organization, basic food costs have increased dramatically. "Poor families are getting by only by miracle," Dominguez says. "The minimum wage in the Valley of Mexico [surrounding Mexico City] is 18 pesos, which is $3 a day at the current exchange rate. Workers making minimum wage must make their children, spouses and parents work to survive. A minimum basket of goods [that the government estimates is necessary to support a family] requires at least three minimum wage salaries to purchase." To add insult to injury, Dominguez says, "the government is telling people they must increase their savings rates."

 Mexican Labor Minister Santiago Oñate said 250,000 jobs were lost in the first two months of 1995. Oñate predicted that by the end of the year more than one million Mexicans may have lost their jobs.

 As the crisis took its toll on Mexican households and businesses, Mexicans took to the streets. Appropriately, debt has been a major organizing theme. Those who have filled the streets in cities across the country include people who cannot pay loans for cars, homes, office equipment, farm credit and credit cards. El Barzón, an organization of small- and medium-sized businesses, organized a national debtors' strike March 8. Protesting debtors blocked the doors to more than 800 bank branches around the country. The ruling Institutional Revolutionary Party (PRI) responded to a wave of street protests by issuing a new law banning interruptions of traffic. But given the level of protest, the law is unenforceable. A huge demonstration is being planned for May 1 and it is likely that a national strike will be called for mid May, Dominguez says.




Rubin's Moral Hazard

IN SELLING THE BAILOUT PACKAGES that it proposed after the peso meltdown, a recurring challenge for the Clinton administration was to counter the perception that the primary bailout beneficiaries would be Wall Street financiers, billionaire Mexicans and their cronies in Mexico's ruling party. The fact that Treasury Secretary Robert Rubin, who had close ties to all of these elite interests, was the administration's leading bailout salesperson hindered the administration's unsuccessful attempts to counter this perception.

 The perception that the bailout would benefit elites on both sides of the border unleashed criticism from liberals as well as from conservative economists, who said the bailout posed a "moral hazard," protecting the Mexican government and Wall Street from the repercussions of risky investments and policies. Because of Rubin's background, the bailout posed certain moral hazards for him, as well.

 The Clinton administration recruited Rubin from his former position as co-chair of Goldman, Sachs & Co., the investment bank that has aggressively carved out a niche for itself in recent years in emerging markets, especially Mexico's.

 Mexico has been first and foremost among Goldman Sachs' emerging market clients since Rubin personally lobbied former Mexican President Carlos Salinas de Gortari to allow Goldman to handle the privatization of Teléfonos de México. Rubin got Goldman the contract to handle this $2.3 billion global public offering in 1990. Goldman then handled what was Mexico's largest initial public stock offering, that of the massive private television company Grupo Televisa.

 In the financial disclosure form that Rubin filed after joining the Clinton team, he listed 42 Goldman Sachs clients with whom he had had "significant contact," including six powerful Mexican clients. The public sector clients were the Mexican government, Mexico's finance ministry and Mexico's central bank. The private sector clients were Teléfonos de México, Cemex S.A., the largest cement firm in the Americas, and Desc, Sociedad de Fomento Industrial, Mexico's seventh largest manufacturing conglomerate. Rubin reaped $25 million in compensation from Goldman, Sachs & Co. in 1992 alone.

 Just before coming to Washington to head Clinton's National Economic Council, a leaked letter Rubin wrote to his former clients drew attention to his potential conflicting interests. "I also look forward to continuing to work with you in my new capacity," said the letter. "I hope I can continue to rely on your interest and support ... and would be grateful for whatever suggestions you would offer."

Goldman Sachs has steered billions of dollars of its clients' money into Mexico. The bank's clients, partners and reputation all stand to suffer large losses in Mexico unless a successful bailout can be engineered. Heavy losses could encourage lawsuits from disgruntled clients.

 The conditions of the bailout require Mexico to privatize more of its economy, including such sectors as oil, highways, ports and electrical power. Such privatizations could offer Goldman Sachs major new business opportunities. Despite this web of connections, Rubin has declined to recuse himself from heading up the bailout. In testifying before Congress, Rubin has said he had only had one conversation with his former Wall Street contacts since the crisis began. "We have no interest in bailing out investors," he told the Senate Foreign Relations Committee in January 1995.

 Rubin's refusal to sidestep this appearance of a conflict of interest falls short of the White House's rhetoric of two years ago, when Clinton claimed he would impose the toughest ethics standards ever. Rubin's refusal to recuse himself also sets him apart from Secretary of State Warren Christopher. Christopher recently recused himself from involvement in the administration's position on a proposed oil deal between a Dutch subsidiary of Conoco and Iran, which the United States has been trying to isolate economically. Christopher recused himself in March after learning that O'Melveny & Myers, the Los Angeles-based law firm that he left to join the Clinton administration, was representing Conoco in the deal. "In conflict of interest matters I think you have to take a conservative position," Christopher said. Conoco has since cancelled the Iran deal.

 Treasury spokesperson Howard Schloss says Rubin and the Treasury's Office of General Council have concluded that Rubin has no conflict of interest on the Mexico bailout. Schloss declines to say what differentiates Rubin's case from Christopher's.

- A.W.



Peso-Dollar Contagion

ONE CRITICISM OF THE CLINTON ADMINISTRATION'S tapping of the Treasury Department's Exchange Stabilization Fund (ESF) to bail out the Mexican government and Wall Street is that, if fully used, little would remain for the original purpose of the fund: to defend the U.S. currency by buying up dollars when their value slips excessively against other major currencies.

 Protecting the U.S. dollar is of particular concern not only because the currency has been steadily eroding against the German mark and Japanese yen but also because the bailout itself dragged down the dollar. Another factor in the dollar's decline is the record trade deficit that the United States is running, including the recent transformation of a U.S. trade surplus with Mexico into a trade deficit.

When the Clinton administration announced its plan to bypass Congress with $20 billion from the ESF in January 1995, the fund had about $25 billion available to lend, according to a Congressional Research Service report.

 Three months after Zedillo's peso devaluation, the peso had lost 50 percent of its value against the U.S. dollar. In the same period, the dollar had lost 15 percent of its value against the mark and about 10 percent against the yen. This erosion in the dollar's value came despite coordinated efforts by central banks in the leading industrialized countries to drive up the U.S. dollar. "The U.S. monetary authorities are, in effect, loaning dollars to the Mexican monetary authorities," John Mueller, chief economist of Lehrman Bell Mueller Cannon, Inc., said in testimony before the Senate Banking Committee on March 9. "We give dollar IOUs and receive peso IOUs in return. Until Mexico repays these loans, which will take five to 10 years, this amounts, in effect, to issuing new dollars backed by pesos."

 Not everyone would agree with Mueller's contention that the bailout "is almost certainly the biggest single factor in explaining the dollar's recent decline." But the bailout is widely recognized as an important factor. - A.W.



The Squandering of Mexico's Debt

Christopher Whalen is the chief financial officer of Legal Research International (LRI), a Washington, D.C.-based financial services firm. LRI assists people with Mexican investments by doing background checks, litigation management and asset search and seizure. Previously, Whalen, a self-described libertarian, was a financial analyst with the Bear Stearns investment bank and worked in the foreign department of the Federal Reserve Bank in Washington. His newsletter, The Mexico Report, predicted the peso devaluation two years before it happened. This interview was conducted by Russell Mokhiber.

Multinational Monitor: What lies at the root of the Mexican peso crisis?

Chris Whalen: The Mexican model was never free market. It was never designed for growth in terms of jobs or exports. It was designed solely to raise dollars, to borrow dollars. Most of these dollars were used to either pay for imported consumer products or they were siphoned offshore in the form of flight capital. [Former President] Carlos Salinas, for example, who has never held a real job in his life, leaves office with a net worth estimated in the range of several billion dollars.


MM: How did that happen?

 Whalen: He has received gratuities from those below him. Carlos Hank Gonzalez, the outgoing Transportation Minister, has been in politics for 40 years. He used to own a Mexican airline. His son just bought control of Laredo National Bank. This man has billions of dollars in visible net worth - airstrips, ranches, aircraft, real estate holdings all over the world, bank accounts.


MM: Where did he get the money?

 Whalen: Corruption. We believe he is one of the biggest money launderers in the country. So, you have this state that oppresses its own people, steals elections, lacks transparency, lacks a legal system that functions. And you ask yourself the basic question - why do we believe that they are going to treat foreign investors any better than they are going to treat their own people? And the answer is that there is no reason to believe that. In fact, the foreign investors once again have been badly mistreated because, by and large, of the $70 billion or so that flowed into Mexico over the last five years, perhaps as little as $10 billion or less went into real hard assets - that is, plant and equipment, capital or new factories that could produce export revenues.

 Mexico is extremely over indebted. They probably have more debt service than they have exports this year. And they are headed for another default.


MM: Where did all the money go?

 Whalen: It was used to subsidize a very large current account deficit. Most of that deficit was consumer products - food, Barbie dolls - all sorts of things from offshore that they really couldn't afford. But because the Salinas government kept the peso pegged to the dollar, for a while it worked. Now, as soon as the Federal Reserve started raising interest rates last year, the game was over. The cash flow disappeared.

Keep in mind, if you have [such a large] current account deficit and you are bleeding $2.5 billion a month then you have to raise that amount of money just to stay even. And when you add actual dollar outflows by investors who were selling their peso assets and going back into dollars, the thing just collapses. That is what happened in December. Mexico ran out of money.

The illusion of the North America Free Trade Agreement [NAFTA] was that somehow this country, Mexico, with all this debt and all of these other problems, could be a market. But in point of fact, it is going to be a net cost to the United States for the foreseeable future. And it is going to be an extremely dangerous place for investors.


MM: What is the profile of the average American investor in Mexico?

 Whalen: Joe Six-Pack got a call from his broker a year and a half ago. The broker tells him, "They are doing another piece of the Telmex [Teléfonos de México] privatization. I think you ought to buy some." He comes in and buys some at, say, $56 a share. He rides it up to $72. His broker convinces him to hang in there because he thinks it's going to $80. Now, Telmex is trading at about $30. And that is about the loss the average investor has taken in this thing.


MM: Wasn't most of the investment from institutional investors?

 Whalen: Yes, but they represent individuals. The vast majority of the $70 billion - probably $50 billion of it - was short-term portfolio investment. It was not direct investment in plant and equipment.


MM: What was the basis of your prediction two years ago that the peso would be devalued?

Whalen: Mexico was essentially a debt-driven Ponzi scheme. In other words, [Mexican government officials] were borrowing dollars, but they weren't creating any means of repayment. There were no new assets here.

The Mexican model gives free market economics a bad name. This is not free- market economics. This is corporate statism. Salinas turned public sector monopolies into private cartels run by his friends. He did not create more opportunity. He did not really open these markets to competition.

Banks in Mexico, for example, were charging people real interest rates of 30 to 40 percent over their cost of funds. What is that? That is usury. The whole system was set for a fall from the outset.

MM: What does this say about NAFTA?

 Whalen: NAFTA was designed first and foremost, in my view, to perpetuate single party rule in Mexico. It had very little to do with free trade. Many innocent people were sucked into NAFTA thinking that we were fighting for free trade, when in fact, we were fighting to keep Carlos Salinas in power and keep him liquid.

 The people who sold NAFTA were the same people who were on Wall Street selling these investment deals - the largest broker/dealers, the investment banks, the 15 or 20 big U.S. firms with major investments down there. This is the group.


MM: Who is behind the bailout?

 Whalen: Wall Street - the friends of Robert Rubin, as I like to put it. It is a subset of the group that pushed through NAFTA. It is basically Fidelity, Trust Company of the West, Alliance - they have been huge buyers of peso treasury bills. They are caught.

Now, these big funds want to socialize the loss. In the past, we have been privatizing the profit. I don't see them offering to give back some of their profit to help pay for this.


MM: You say that the bailout is being pushed by Friends of Rubin and Goldman Sachs. What is their interest?

 Whalen: They have clients who are thinking about lawsuits. If you can keep that exchange rate from sinking further, maybe not as many lawsuits will be filed, á la the derivatives debacle. Why is Dave Malpass, a former State Department official who is an emerging market economist with Bear Stearns, going around saying that the peso has got to go back to 3.5 [pesos to the dollar]?


MM: You seem to believe that the crisis was inevitable. Why?

Whalen: The domestic situation with peso loans by Mexican banks is horrific. If you were a businessman in Mexico for the last three years, your cost of funds has been 20 percent to 30 percent higher than Mexican treasury bill rates - 40 percent, 50 percent, even 60 percent.

 At the beginning of 1994, the Mexicans were claiming that inflation was in the single digits. The treasury bill rate fell down to 10 percent. To finance a little export business, you were paying 35 to 40 percent. Nobody can afford that.

 What they were doing was rolling the credit. They would give you a little new money. The bank would capitalize the due interest. And they would write you a bigger loan. They would just roll it and pretend that the loan was performing.

 But now, at the behest of the foreign creditors, Mr. Zedillo is imposing austerity. He has cut bank on bank loans, banks aren't making any new loans any more. So, guess what is happening? Everyone is defaulting on loans and tax payments. You are going to have 60 percent to 80 percent default rates on Mexican loan portfolios and credit card portfolios.

 We had two warnings of this. One was the collapse in Spain at the end of 1993. In early 1994, Banco Latino in Caracas collapses. The whole Venezuelan banking system is now gone. They have had to refund the deposits. They have now nationalized the whole banking system in Venezuela.

 The same thing is going to happen in Mexico. They are going to have to refund deposits. They will have rioting if they don't refund everybody's deposit at par. They will have to print money to do it, because they don't have the revenues. That is a lot of cash - $80 billion to $100 billion in deposits.