Mexico on the Rocks Jude Wanniski January 12, 1995

The Clinton administration’s decision to help Mexico has given pause to the bears in Mexico City and Wall Street. Until we see the shape of the rescue, however, we have to assume the bleeding may stop, but that Mexico will be crippled for years. At the moment, we see no signs that the political establishment in Washington has any plans to reverse the peso devaluation, and the Bank of Mexico seems happy enough to have stopped the peso slide at 5.5 to the dollar. It is now intervening to prevent the peso from strengthening! The op-ed piece in yesterday’s Wall Street Journal by David Malpass provides a foolproof guide to getting the peso back to 3.5, where it belongs. Malpass, a Bear Stearns economist who was an assistant Secretary of State for Latin American affairs in the Bush Administration, says what we have been saying for three weeks -- that the Bank of Mexico has been expanding its balance sheet -- printing pesos into the teeth of the peso slide. Two weeks ago, I talked by phone to an official of the Bank of Mexico that I’ve known for six years and told him I’d seen a report on the wires that indicated they were buying cetes instead of selling them, as they should have been doing to mop up unwanted pesos. “Don’t believe everything you read,” he admonished me. It now turns out the Bank was doing exactly that, and is still doing it to prevent the peso from recovering beyond the 5.5 level.

What we have brewing here is an international scandal that should wreck a lot of reputations in Mexico and on this side of the border, once we get to full-scale hearings by the Senate and House Banking Committees, happily now under Republican control. We are now finding that the Evil Empire reaches into the Federal Reserve, where its chief international bureaucrat, Ted Truman, is said to have been recommending a peso devaluation for the past year. Chairman Alan Greenspan, the man in charge, will have to answer for Truman’s involvement in this intellectual cabal. The scandal, after all, is not one of venality, but of intellectual corruption. The hubris of these young Ph.D. economists who believe in devaluation as a matter of public policy has now brought the Mexican economy to the breaking point -- with horrific implications in the Southwest and California if, as night follows day, a flood of emigres in the coming weeks and months pour out of a crippled Mexico. The Fed’s Truman, a devaluationist who controls the paper flow at the bank’s international division, is of course part of the network of academics who engineered this crisis. The network includes Stanley Fischer, the MIT economist who is now chief economist at the IMF. It includes Lawrence Summers, formerly chief economist of the World Bank, now Treasury Undersecretary for International Affairs, and a Harvard Ph.D. with two Nobel Prize-winning economic uncles. It includes Guillermo Ortiz, Mexico’s finance minister, whose Ph.D. in economics is from Stanford. It includes Rudiger Dornbusch of MIT, who is celebrated in today’s New York Times by the newspaper’s chief economic correspondent, Peter Passell, Ph.D., formerly Professor Passell of Columbia U. It includes, of course, Fred Bergsten, chief economist of the Institute for International Economics in Washington, D.C., who was instrumental in the big push of 1971 to blow up the Bretton Woods system. Bergsten, who I’ve long described as a manic-devaluationist, doesn’t go to the john without recommending devaluation to someone. It is Bergsten’s responsibility to make sure devaluationists get appointed to positions throughout the international bureaucracy. The network also includes Harvard’s Jeffrey Sachs, who with Fischer and Summers designed the “shock therapy” that now afflicts the Balkans and the Russian Federation.

The idea that this Evil Empire of demand-side economists should be allowed to roam the world, persuading governments to cheat their people out of their wages, pensions and life savings, in accordance with Keynesian economic theory, is the kind of intellectual scandal that drove Karl Marx to denounce capitalism. The people who benefit from devaluation are those who use their influence with government to bring it about -- always a nation’s biggest debtors, usually the oligarchs who have inherited their wealth and have the collateral against which they can borrow. The pressure for peso devaluation in Mexico came from this privileged class, and they had willing allies in the devaluationist network in Washington. The only way ordinary people can protect themselves when they see this coming is to get rid of pesos and go into debt to buy real goods. In the last year, consumer debt in Mexico has in fact climbed steadily as the masses of people have used what collateral they have to hedge against the peso. 

Not since April 1994 has the Bank of Mexico “tightened” by selling cetes into the banking system, to mop up peso liquidity. After the Chiapas uprising of January 1, 1994, which was the first signal for the market to hedge against peso assets, the Bank continued adding liquidity to a market that was not interested. The assassination of PRI candidate Luis Donaldo Colosio also spurred the decline in the demand for peso assets. The peso drifted steadily toward the outer edge of the trading band set by the Bank, and to keep it from breaking through, the market sold pesos for the dollars in the Bank’s portfolio. The huge cushion of dollar reserves that had been accumulated -- more than $30 billion -- began to run down as Mexicans and foreigners cashed these pesos for dollars. At any time, the Bank could have stopped adding liquidity to the banking system, or even sold cetes until the surplus pesos were absorbed. In our April 21, 1994 bulletin, “Peso Devaluation Jitters,” we asserted: “Under the circumstances, and given the attendant risks, we would not advise the purchase of Mexican financial assets until there is clear evidence of a Salinas decision to defend the peso.” 

Five days later, we took as a positive sign the government commitment of its dollar reserves to shore up the peso. [”Government Calms Devaluation Fears”] As dollar reserves dwindled, though, the PRI opposition candidates to Ernesto Zedillo, taking their cues from economists and advisors who smelled devaluation, came out flatly for “an orderly devaluation,” which almost instantly caused Zedillo, who had pledged to keep the peso stable, to shoot up in the polls. We issued a Global 2000 bulletin at the time, noting the rally on the Bolsa reflected the good news that the peso was in good hands and that Zedillo was now a sure thing to win by a wide margin. [”Political Risk in Sharp Decline,” July 27]. Our complaints about Zedillo from that moment were entirely concentrated on his budget, which showed neither inspiration nor plans for growth, only cosmetic changes in the tax on capital gains that is strangling capital formation at the grass roots. 

We frankly assumed, as did Wall Street generally, that the Bank would defend the peso at its outer band, that director Miguel Mancera -- head of the bank, would, as he had during previous threats to the peso, find the creative solution for its defense. Mancera still has not uttered a word in public as far as we can tell, but our sources elsewhere now advise us that he in fact threw in the towel on the peso defense without putting up any fight and that he remains a source of the problem. The Bank of Mexico today offered to buy 1.9 billion pesos of 30-day paper with printing-press money, an outrageous act of folly, even as Fed Chairman Alan Greenspan and Treasury’s Larry Summers prowled the corridors of the Congress, asking for a $25 billion fund with which to defend the peso!!!! The American taxpayers, of course, should not be required to ante up a penny to defend the peso, when the Bank of Mexico is printing them with abandon. The Federal Reserve and the Treasury have ample reserves in their currency stabilization funds from which they can lend to Mexico at market rates of interest. The fact is, the Bank of Mexico has almost the entire interest-bearing national debt of Mexico in its portfolio of assets, perhaps $75 billion, and the mere threat of throwing it at the speculators would send the peso through the roof. Former Fed Governor Wayne Angell, now chief economist at Bear Sterns, correctly insists that any funds loaned to Mexico be accompanied by the destruction of an equivalent number of pesos. Even Angell is being too timid, I think, in shying from the idea of driving the peso back to 3.5, to stuff this unnecessary evil back into the bottle. His colleague, David Malpass, is absolutely correct in his argument that Mexico can do it, should do it, and can do it without outside help. 

If this colossal “aid package” is put together with the aim of leaving the peso where it is, the only people who will make out are the banks, who will buy up pesos with dollars on behalf of the Bank of Mexico and the Federal Reserve, keeping a percentage of the transactions for their trouble. This is the madness of a sterilization operation, which is also taught in all the best Keynesian textbooks. One bank is hired to print pesos, another hired to tear them up. The taxpayers of both countries get the bills. In fact, the private Mexican banks would be far better served with a rescue that put the peso back to 3.5. It is their debtors, the oligarchs -- who have their assets in dollars and their debts in pesos -- who would have to pay their debts in full.

At 5.5 pesos to the dollar, it will not take long before economic decline causes many of those Mexicans with heightened consumer debt to be unable to pay their bills. Out of a peso paycheck, the part reserved for current expenses will shrink by 30%, and rather than deny baby its milk, it will stiff the banks and other sources of credit. As all of Mexican business and industry downsizes, many of those families who can no longer keep the wolf from the door will send their sons and daughters to Texas, California, Arizona and New Mexico to make a few dollars to send home to make ends meet. Or, some of the sons and daughters will sign up at the local HQ of subcommander Marcos. 

We will now see what this new Republican Congress is made of. Is it going to cough up the billions to clean up the folly of the Evil Empire? Or is it going to instruct the administration to tell Mexico how to clean up the folly on its own? Newt Gingrich and Bob Dole should not let one dollar of appropriated funds squeak out of the 104th Congress to finance this scandal.