Crisis in Mexico
Jude Wanniski
December 22, 1994


The announcement today that Mexico will float the peso against the dollar, after its 15% devaluation Tuesday, is a not only a staggering blow to that nation's promising economic future, but also a harsh blow to the entire hemisphere. The peso has now lost 37% of its value since the decision was made during the weekend in Mexico City, driven by Mexico's industrial elites. The devaluation pressure came from those who have been squeezed during these last three years of budget austerity imposed by former President Salinas. These corporate oligarchs, who obviously continue to control the ruling PRI, have now persuaded President Ernesto Zedillo and Finance Minister Jaime Serra Puche -- both of whom have a Ph.D. in economics from Yale, the center of devaluation theory -- to embark on an export strategy, which means lowering the real wages of Mexican workers. The International Monetary Fund this morning issued a statement from its deputy director, Stanley Fischer, an MIT economist, applauding the move, which will almost surely lead to a new tidal wave of emigration from Mexico into the U.S. Southwest. It could also possibly lead to civil unrest as a betrayed Mexican citizenry magnifies the populist calls for revolution coming from the impoverished state of Chiapas. We have yet to see a statement from Miguel Mancera, the supposedly independent head of the Central Bank, who is now seeing all his hard work go down the drain. 

On Monday, prior to the devaluation, we advised our Global 2000 subscribers of the first unfortunate economic moves of the Zedillo administration. Finance Minister Serra Puche canceled the small changes in the capital gains tax meant to benefit small business that outgoing Finance Minister Pedro Aspe had incorporated in his last budget submitted in November. "Alas," we reported, "even the 'cosmetic change' -- which would permit corporate equity not traded on the Bolsa to escape the tax -- was thrown out by the incoming team, responding to tax accountants who said it would be too difficult to administer. In fact, the accountants suggested that to equalize treatment of big business and small, it would be easier to remove the exemption of equity traded on the Bolsa!"

In February 1989, the Salinas-Aspe team confronted demands for a 20% devaluation from the incoming Bush Administration and Treasury Secretary Nick Brady. Alerted by then-Fed Vice Chairman Manuel Johnson, I flew to Washington and met with Brady, Vice President Dan Quayle, and White House Chief-of-Staff John Sununu, warning that this would destroy the new Mexican government's chances of success. A similar IMF program forced on Venezuela in 1988 led to riots that killed 300. When the U.S. Treasury demands were withdrawn, speculative pressures against the peso collapsed and interest rates on Mexico's debt began a steep decline from the 55-60% range to less than 15%. Capital flowed to Mexico in a tidal wave and paved the way for NAFTA. In the three years from 1990 to 1992, Mexico's stock market led the world in percentage increase in capitalization. The advance halted midway in Salinas' six-year term as the decision was made to put all surplus revenues from privatization toward a budget surplus instead of hacking away at tax rates that continue to smother entrepreneurial capitalism -- rates that now have to be dramatically adjusted to prevent deep recession. 

When Mancera began the peso stabilization process six years ago after 12 years of devaluations, the average maturity of government debt was no more than four months. He had brought this up to more than 15 months as the financial markets came to believe he would do whatever it would take to prevent devaluation. This still leaves Mexico in a terribly vulnerable position for the next few months. At the Fed yesterday, I explained to a high official that the inflation resulting from the devaluation would quickly hit the economy, whereas the Fed's 10% dollar devaluation against gold would be spread over several years and could be offset by a capgains tax cut. Indeed, part of the problem that precipitated this crisis was the peso's link to the dollar during the dollar's decline, which caused Mexico's factors of production to take almost the entire brunt of the Fed's 10% devaluation against gold in one year instead of several. I warned Aspe and other officials of the Salinas Administration of this silent poison in their system and was repeatedly promised an audience with Zedillo to transmit this warning in person, but it could not be managed.

The aftershocks of this calamitous event in Mexico City are being felt throughout Latin America. There is now suddenly the political risk that export industries that had been held in check in their demands for cheaper currencies will be strong-arming their governments into competitive devaluations to keep pace with Mexico. The chances of NAFTA spreading across Latin America into a hemispheric free trade zone will be crippled as U.S. nationalists in the AFL-CIO and the Perot movement argue "I-told-you-so" in warning that we could not trust Mexico to refrain from peso devaluation to undercut U.S. labor. 

There is absolutely no global leadership available at the moment to treat this malady. President Clinton has no idea what the Mexican crisis is all about. His Treasury Secretary, Lloyd Bentsen, is on his way into retirement, leaving a caretaker behind until Bob Rubin gets through his confirmation hearings in January or February. Treasury Undersecretary Lawrence Summers, the senior international economist in the administration, is a good buddy of the IMF's Stanley Fischer, and is presumably joining with Fischer in welcoming the peso float. The 103rd Democratic Congress is gone for good and the 104th is Christmas shopping. The only possible leadership is at the Federal Reserve, which today offered its $6 billion in swap lines to help defend the peso, a move that would have meant something before the float was announced. In a bulletin to our Global 2000 clients yesterday, "Ominous Developments," we felt we could still take heart in the news that the devaluation would not necessarily be permanent; the first announcement was that the peso/dollar trading band would be widened by 15%, which left open the possibility that Mancera could inch his way back to the central anchor. All of that has been wiped away by the government's decision to throw in its hand, wait for the smoke to clear, and figure out what to do next. At the New York Fed today, Serra Puche displayed a simplistic Yale textbook approach toward his problems that shocked the private financiers who heard him.

The solution to Mexico's problem is similar to Greenspan's problem at home: Instead of raising interest rates to offset speculation against the currency, the government should sell bonds to mop up pesos. Even as the peso was plummeting on the exchange markets yesterday, the central bank was buying government assets with unwanted pesos, as if the problem it confronts were a shortage of liquidity! If I were Greenspan, I would urge them to reverse themselves before the inflation error can take root. The announcement that the float will be accompanied by wage-and-price controls is a feeble attempt to hold back the tide that will pound the economy through uncontrolled international prices. Three years ago, I told Greenspan and Mancera that I considered them the two best central bankers in the world. If the Yale Ph.Ds. would stand aside, a joint effort by Greenspan and Mancera could run the peso back up to where it was a week ago. Unlike toothpaste coming out of a tube, a monetary error of this dimension can be reversed before it solidifies. Greenspan is well aware of such reversals in other countries in relatively recent history.

If this isn't done, someone has to explain to our NAFTA partners that they must adjust their tax system to offset the inflationary impact on real wages, and they must permit labor to regain the purchasing power of wages that enables them to survive. And they must break the grip of the corporate elites and political dinosaurs that have led to this ugly impasse. From the mountains of southeastern Mexico, Subcommander Marcos, in his black ski mask, on December 3 warned President Zedillo that the two of them would be destroyed together in the coming conflict: "You made us possible; you made us grow. We are the other you, your Siamese opposite. For us to disappear, you must disappear." 

Marcos, who is as eloquent a political leader as any in the world, is clearly a populist revolutionary in the mold of young Fidel Castro, before Castro became a communist. He warned Zedillo: "If it is true that the entire nation is willing to renounce its hopes for liberty and democracy, then the clamor demanding our annihilation will be gigantic and you will have nothing to worry about. High-ranking federal leaders said that they will eliminate us in a matter of hours; if there is bad weather, in a matter of days. Thus the stock market, the currency market, and the balance of payments will suffer for only a few more days." 

From all of us at Polyconomics, Merry Christmas and a Happy New Year.