Mexico, Closing in on 3.5 Jude Wanniski February 10, 1995

The GOP leadership in the 104th Congress has now moved the Mexico peso crisis to a fork in the road that will determine whether the peso stays at 5.5 and produces the collapse of Mexico’s banking system, or travels a crawling peg back to 3.5, which produces an economic expansion that would not have been likely in the days prior to the devaluation. It is now up to the Clinton Administration to decide which path to take, but the Republicans have made it quite clear that they will shoulder responsibility only for the latter path. The GOP statements, made Wednesday afternoon on the Senate floor by Chairman Al D’Amato of Senate Banking, and Thursday afternoon by Sen. Robert Bennett a member of the banking committee and Senate Majority Leader Bob Dole’s spokesman on Mexico, together informed the administration in the most official forum available to the Senate that only if Fed Chairman Alan Greenspan deploys the Exchange Stabilization Fund to take pesos out of the system, to drive up its value, will the Republican leadership share blame or credit for what follows. The Treasury Department can, if it wishes, ignore the statements of D’Amato and Bennett (Dole) and crawl through a loophole in the ESF, and instruct Alan Greenspan to do precisely what Bennett says should not be done, i.e., refinance Mexico’s national debt by buying up tesobonos. But when the Mexican banking system implodes as a result of this unwise course of action, both D’Amato (loudly) and Bennett (quietly) indicated there would be full-scale congressional hearings that would surely end the public careers of all in the Clinton administration associated with it. 

The peso crisis is off the front pages and it will stay off if Treasury Secretary Bob Rubin now takes a hint and informs Chairman Greenspan that it is okay to proceed with the ESF along the lines recommended by Bennett (Dole). The Mexican stock market took a sharp hit yesterday, following D’Amato’s floor statement Wednesday, which made it appear there was a horrible glitch in the plan announced by President Clinton last week. The Bennett statement should clarify the GOP stance, which is most constructive. As far as we can tell, none of the $50 billion package announced by President Clinton has been touched by the Bank of Mexico, which is testimony to the patience of its director, Miguel Mancera. The Bank informed us Thursday afternoon, prior to the Bennett statement, that it still had not decided on a course of action. Mancera has to be relieved now that it may not be necessary to draw on the IMF credits available to him, which would require Mexico to meet the IMF’s poisonous conditionality (including continued double digit growth of the peso money supply!). As Bennett indicated in his floor statement, the GOP is very unhappy with the IMF in any case, and would prefer that Greenspan and Mancera take control of the problem. Bennett saluted D’Amato for his eagerness in playing the role of watchdog over the taxpayer monies in the ESF, and he again saluted President Clinton for his leadership in stepping up to the peso problem, which he had no hand in instigating. (It remains to be seen if Treasury bureaucrats were involved.) Thus every attempt is being made at these high levels to work out of this mess in a bipartisan fashion. We are advised that Democratic members of the Senate Banking Committee are in harmony with the idea of using Greenspan to get the job done.

A helpful story appeared in Thursday’s New York Times’ business section about the perilous weakness of the Mexican banking system, which, if the peso is not driven back to 3.5 on an orderly, announced schedule, would face implosion. Our assessment, conveyed to the Mexican government and both the Senate and House banking committees of Congress, has been that at the devalued rate, the banks would soon have to ask the government to nationalize them, as they would all be under water. A 35% devaluation would cause the purchasing power of all wages, pensions and life savings of all Mexicans to disappear within the calendar year, given the short maturities of peso debt. Households and all but the most robust enterprises would not be able to pay their creditors. As this house of credit cards collapsed, it would bring to its knees any number of financial institutions in the United States which have loans outstanding in Mexico.

We note in the Wednesday Journal of Commerce, page one, the comforting news that Mexico’s importers may not have to pay their suppliers in the United States on their full contract obligations. Why? Because of a United Nations accord that could be interpreted to allow private firms in countries that have devalued their currencies to stiff their creditors. In other words, the International Monetary Fund went into Mexico and persuaded the fledgling administration of Ernesto Zedillo to break its solemn contract with its creditors, its ordinary people and trusting foreigners. Now, the IMF’s sister international bureaucracy, the UN, says it is okay if all private promises are broken, because of a UN “accord.” Will now Boutros-Boutros Ghali send blue-helmeted UN troops to Chiapas and parts north, to keep the peace, when civil war breaks out in the wake of economic collapse, and send the bill to the US Treasury. Maybe, we now hope, it will not be necessary.

Can Greenspan and Mancera handle the task of putting the peso back to 3.5. We tend to think that as soon as they get the green lights from their respective governments, who really have no choice when you think about it, they will set about to get the job done. Senator Bennett suggested in his floor statement that they set the 3.5 rate openly, in order to allow the markets to observe it all at once, instead of having the news leaked out as it was when the bears were plotting the peso’s demise in their subterranean circles. The Bank of Mexico’s balance sheet indicates it possesses $27 billion worth of tesobonos, quite a war chest, considering the monetary base is under $10 billion at the current 5.5 rate. There are a dozen different ways Messrs. Greenspan and Mancera could turn their minds and their guns to the objective of making pesos more scarce. The monetarists still running around on Capitol Hill are insisting they cannot buy up pesos without shrinking the money supply and causing recession. It is clear enough to Greenspan, no monetarist, that what is important about Mexico’s “money supply” is not the number of zeroes it contains, but what it will purchase. By reducing the supply of pesos, in other words, the purchasing power of the monetary base will rise from a dollar equivalent of $10 billion to $16 billion.This great expansion of the value of the monetary base will restore the wealth and incomes of Mexico’s debtors, making them liquid enough to buy milk and groceries for the kids and pay their bills too. The banks will pop up to the surface, as this rising tide will restart the loan payment process and lift all banks. Moreover, Mexican interest rates will drop as the demand for peso-denominated assets rises along with the market’s perception of the plan’s credibility to restore 3.5.

Senator Bennett made it clear enough that 3.5 is not really a negotiable number as far as the Senate Republicans are concerned. He stated that the stable dollar/peso rate was part of the NAFTA agreement, which he supported, as did Bob Dole and Newt Gingrich. He said he considered it an act of “betrayal” to devalue the peso in order to gain unfair trade advantage with the U.S., although the tone of his remarks indicated he would lay the lion’s share of the blame on the IMF. Once 3.5 were restored, he said, the U.S. and Mexico could shake hands again, restore the bonds of trust that we believe NAFTA implied, and try it all over again. At this fork in the road, the next move is up to Treasury and the President. As the Republicans are offering to take blame (and credit) with the President for one path chosen, but not the other, it doesn’t seem a difficult decision for Bill Clinton to make.