End of the Death Star/Fedwatch
Jude Wanniski & David Gitlitz
February 02, 1995



Darth Vader, managing director of the International Monetary Fund, may not yet realize it, but he is about to become history. I think it is safe to say that never again, at least not in this century, will we see the IMF roam the world scheming on behalf of currency devaluations. The Mexico peso crisis has opened the eyes of the 104th Congress, Democrats as well as Republicans, who are finally realizing the giant swindles this corrupt international institution has been getting away with for years. Who controls the IMF? The international money-center banks, of course. The big guys. They spot a developing country that looks vulnerable and swoop in for the kill. They set up a run on the country’s currency -- let us say Nigeria -- by announcing their solemn opinion that the country’s currency is overvalued. They get their friends in the consulting business -- we all know who they are -- to issue reports on an imminent devaluation in Nigeria. Nigeria’s bank suddenly finds its reserves depleting. The IMF offers as “proof” the country’s current-account deficit and/or its internal budget deficit. In exchange for $100 million, Nigeria agrees to devalue in three weeks, and the IMF’s friends on Wall Street and in the City of London short the currency with impunity. For an investor, this is the closest thing to heaven, a sure thing. For the ordinary people of the country, it is pure hell. 

I can assure you one and all that Mexico has left this imprint on the minds of the most responsible people in our Congress. When Finance Minister Guillermo Ortiz last week told the Chamber of Deputies that the peso devaluation had been cooking since September, with the complicity of the IMF and World Bank, with the full knowledge of the key players in the financial markets, the jig was up. The House Banking Committee still hasn’t a clue as to what is going on, but the Senate Banking Committee and the Joint Economic Committee of Congress now have the scent and are hot on the trail. The individuals in the financial community who have been playing this game for years need not fear, as the swindles were carried out through an international bureaucracy that has no accountability, no courts and no jails. Their footprints will wash away in the sands. But a few heads may roll, at least politically speaking. Jack Kemp last week called for the resignation of IMF director Michel Camdessus, although the news media chose to ignore the event. It will soon be clear enough that the news cannot be suppressed.

In case you did not notice, the Treasury’s $40 billion plan to bail out Mexico was buried Monday night. I call it Rosemary’s Baby. It was devised by the same IMF swindlers who coaxed Mexico into the devaluation -- the way it has previously coaxed the Nigerias of the world. In Washington this week, I explained to a group of senators why I call the IMF evil. Isn’t it evil, I said, to coax the wife of another man into breaking her vows? Isn’t it evil to persuade a friend to break his promise to another person in order to profit yourself? These are small evils compared to evil on a grand IMF scale, when you can go to a country and persuade it to break its promise to its people in a way that wipes out their wages and pensions and life savings. “Each peso,” argues Domingo Cavallo, “is a contract between the government and the peso holder...If the government breaks that contract, it is breaking the law.” And the IMF economists, earning $100,000 and up, tax free, have the nerve to argue that the devaluations will increase the productivity of the workers -- the way a slave will jump at the lash. Senator Robert Bennett [R-UT], who is the point man for Senate Majority Leader Bob Dole in the Mexico matter, wonders how many suicides and divorces and alcoholic binges among the ordinary people of Mexico will be produced by this “productivity” enhancement. People are at their wits’ end, wondering how they are going to survive as Mexico closes down, and we get reports of festive celebrations on Wall Street last night, of bears planning to run the peso back over 6 and of attacking Argentina ASAP to get at the hated Domingo Cavallo, to prove that nice guys finish last. Evil is the thing!

The good news -- the gospel as they say -- is that the good guys are in control. Forget the White House announcement of its own $48 billion package of loan guarantees that requires no congressional approval. It is all window dressing. The IMF this afternoon announced its approval of a $17 billion bundle, which Mexico can have as long as it can squeeze a camel through the eye of a needle. The IMF believes its plan will work, it says, because it will require Mexico to run an enormous surplus in its budget, even as it is financing its debt at usurious rates, and that, hooray, the real wages of the workers of Mexico are being driven down to reasonable rates of 60 cents an hour. Do you think I am kidding? Check the IMF statement on the wires.

What can we expect instead? We can expect that none of the IMF “aid” or the U.S. “pledge” will find its way into the market. Why? Because Fed Chairman Alan Greenspan will be given full responsibility and accountability for managing the problem -- at the insistence of the Senate and House leaders. He will not waste a penny. He has all the power he needs to fix this. This is the big news. In Rosemary Baby’s $40 billion plan, Greenspan and the Fed were innocent bystanders, with Greenspan forced by institutional constraints to cheer the Treasury effort. Now, he is at the center of the action, and in Mexico City, I believe we can soon expect to find that Miguel Mancera has been given equivalent authority. This is where the “liquidity crisis” set up by the bears can be solved with ridiculous ease. The combined weight of the Fed’s portfolio and that of the Bank of Mexico, dancing in harmony, will not only slay the bear, but send the peso back where it belongs, at 3.5 to the dollar. The news media still do not realize that Senate Majority Leader Bob Dole and House Speaker Newt Gingrich are committed to 3.5, as it is the only way to forestall a national political movement to dissolve NAFTA, not to mention restoring to good health the Mexican economy. Will President Zedillo agree to restore the 3.5 rate, phasing it in over the next several months? Not only does he have no other choice, but it is also something he will wish to do when he realizes how easy it is, how little it will cost, and how much good it will do. 

[At some point when this history is written, a gold star will go to Rep. Charles Rangel [D-NY] for persuading White House Deputy Chief of Staff Harold Ickes that Senator Dole was serious about solving this problem in a way that would elevate, not diminish, the President.]

Jude Wanniski


Bond yields rose, the dollar fell, and gold held all of its gains yesterday afternoon when the Federal Open Market Committee approved its latest 50 basis point funds rate increase to 6%, double the rate of a year ago when this process started. These sensitive auction markets, which have already priced the inflation now in the system, were not cheered by the Fed’s Phillips curve rationale for the move, equating continued growth with a rising price level. “Economic activity has continued to advance at a substantial pace, while resource utilization has risen further,” the Fed explained, making the rate hike “necessary to keep inflation under control.” The notion that rising levels of resource utilization are inflationary, though, finds scant support in the data. The chart below, plotted with a one-year lag, shows there has been no reliable correlation between capacity utilization and consumer prices since 1982-83, when Paul Volcker engineered a severe deflation to rid the economy of its inflationary impulses.

The inflation expectations now in the system stem from excess liquidity creation, not excessive growth. Yet, for the most part, the Fed is compelled by its treadmill operating procedures to continue pumping in liquidity as it raises rates. Last week, for example, the central bank was in a rare draining mode to draw down the seasonal liquidity buildup of the pre- and post-holiday periods. This draining operation was widely expected to continue this week, with bank analysts observing a continued glut of reserves. Instead, expectations of yesterday’s move precipitated a firm funds rate all week, as banks sought the lowest cost funds available in advance of the FOMC session. Of course, the Fed met the higher funds rate with three separate liquidity injections during its interventions on Monday-Wednesday mornings. When the rate action was finally announced yesterday, funds actually dropped from near 6% back to the prior 5.5% target, as the banking system was fully stocked with reserves in advance of the Fed move! And this morning, with funds still trading 1/16 below the new target, expectations were for a round of matched sales to confirm the 6% target and resume meeting the need to drain that still exists. Instead, the open market desk passed, pursuing its pseudo-tightening of raising rates without restricting the availability of liquidity.

David Gitlitz