Mexico: Back to 3.5? Jude Wanniski January 23, 1995

On the weekend talk shows, both House Majority Leader Dick Armey and Senate Majority Leader Bob Dole indicated that the administration’s hastily conceived $40 billion Mexican bailout plan could not pass the Congress, but that a more carefully-crafted plan was being developed with GOP help. It will involve the goal of restoring the peso/dollar rate to its pre-devaluation level of 3.5 to the dollar, from its current 5.6. One schedule suggested a 4.5 rate on March 1, a 4.0 rate on April 1, the 3.5 target hit on May 1. Arguments raised against such a quick return were met by arguments that the devalued rate still had not taken root, as it is now only one-month old, and wages and contracts have not yet been recast at the higher rate. Objections to an immediate return to 3.5 were met by those advising the GOP leaders, led by former Fed Governor Wayne Angell, that there have been sufficient peso contracts entered into in this one month that require this three-month cushion. This permits those caught short to refinance. Insofar as a 3.5 rate would restore the creditworthiness of the Mexican government, we would expect to see the value of all Mexican financial assets move steadily back to where they were and beyond as May 1 arrives and the world sees the success of the operation. 

It is not yet clear how much money will be needed for the operation to succeed, but there is the high probability that the $18 billion in authority now possessed by the Fed and Treasury would be more than ample. The resources would be directed to where they get the biggest bang for the buck: the monetary base of Mexico, which is now worth only $10 billion. By shrinking the Bank’s balance sheet, its peso value in dollars would rise apace with the schedule set forth. Senator Dole, who told Face the Nation that he had designated Sen. Bob Bennett [R-UT] as his agent in pulling together a GOP alternative, indicated that while the administration plan would be voted down if there were a vote today, he wished to assure financial markets in Mexico City and here that a successful solution would be worked out with the 3.5 rate phased in. Dole mentioned the currency board idea for Mexico, but was subsequently advised by the Bennett team that while the idea was worthy, it would be inappropriate to impose a policy mechanism on Mexico as a condition for our assistance. We are informed that the Bennett team has been in direct contact with Treasury and is discussing the modalities. It could be that no congressional vote would be required, but merely decisions in both Mexico City and Washington to employ the simpler GOP alternative.

The Bennett team, which we advised, determined that the 3.5 rate was necessary as a political target. The reasoning is that the anti-NAFTA forces had based much of their argument on the idea that cheap Mexican wages would undermine American labor. Congress rejected that argument, but the anti-NAFTA forces had also warned that as soon as the ink was dry on the free-trade pact, Mexico would devalue its peso in order to undercut our workers to an even greater extent with cheap labor. The Mexican government insisted this would not be done. In his campaign for the Mexican presidency last year, in fact, President Ernesto Zedillo had pledged to keep the peso/dollar rate stable. The argument was made to the Bennett team that the 3.5 rate was essentially a part of the marriage contract between the U.S. and Mexico, and that the devaluation was being seen by the anti-NAFTA forces led by Ross Perot, Pat Buchanan, Ralph Nader and the AFL-CIO as proof of Mexico’s infidelity. If the devaluation were allowed to stand, it would poison the marriage, and lead to persistent arguments that NAFTA be dissolved. If the NAFTA contract is also to be the model for the rest of Latin America, it does not make sense to signal how little commitments mean.

It remains to be seen how Mexico would react to revaluation, in that the Zedillo administration justified the initial devaluation expressly on the grounds that it needed to cheapen the prices of its exports to the U.S. This, though, was the only argument it could dredge up to justify the devaluation after the decision was made to go ahead. The Bennett team is arguing that President Zedillo, who was only inaugurated on December 1, was blindsided by a situation that partly grew out of technical problems related to the peso’s linkage to the dollar at a time the Fed was raising interest rates. They essentially found the “bug” in the system which would permit a phased revaluation, enabling Mexico to quickly reestablish its creditworthiness and the value of its peso assets and those of Mexico’s workers, pensioners and businesses. It looks pretty good, but while this is cooking, uncertainty again has the peso in its grip.