Mexico: A Republican Answer? Jude Wanniski January 16, 1995

The chances that the 104th Congress is going to approve a $40 billion loan guarantee to bail out Mexico’s creditors are next to zero. House Speaker Newt Gingrich and Senate Minority Leader Bob Dole on Friday more or less gave their commitment to the Clinton Treasury to try to work things out in bipartisan fashion. The GOP leaders were essentially hustled by Treasury Undersecretary Larry Summers, who is the real culprit on this side of the border. Neither Gingrich nor Dole (who was a bit more circumspect in his commitment than the effusive Speaker) know their way around the financial world. They have since been learning fast, though, and it has become clear to them that if the United States is to help Mexico -- as it surely must -- the terms of credit must be worked out on Capitol Hill, where the responsibility lies. By Friday evening, the word coming out of Congress was that the $40 billion package being flogged -- by Summers and his babe-in-the-woods new boss, Bob Rubin, and Fed Chairman Alan Greenspan (who trapped himself with iron-clad commitments to the White House) -- will not fly in the House, where the anti-NAFTA forces are in full I-told-you-so fury. Party whips figure they would lose by at least 100 votes if they tried to rush it through as is. Between noon and 5 p.m. Friday, I’m told, Dole’s office logged 500 phone calls denouncing the bailout. 

The good news is that the GOP leaders are now learning some simple facts that fly in the face of Treasury’s razzle-dazzle. First and most importantly, they are learning that the entire monetary base of Mexico amounts to a measly $10 billion (at the 5.5 rate) and only $16 billion (at the 3.5 rate). The combined resources of the Fed & Treasury, at $18 billion, are sufficient to buy up every peso in Mexico nearly twice over!! We literally can’t support the peso more than that. The only reason to ask for $40 billion would be to help Mexico refinance its national debt, a part of which is now guaranteed in dollars. This is not necessary. Members of the U.S. Congress should understand that to buy $2 billion worth of pesos in the monetary base, by draining pesos from the banking system, would put the Bank of Mexico back where it was last April, before Larry Summers and his friends began planning the devaluation. David Malpass of Bear Stearns, who was Republican staff director of the Joint Economic Committee a few years back, reckons that the base had grown to $16 billion from $14 billion just since April, which is of course the source of the crisis. Malpass, who correctly argues that any U.S. assistance should be conditioned on getting the rate back to 3.5, understands how simple it would be to do at this point, less than two months after the fact -- which even now is impoverishing the people of Mexico and threatening massive emigration into the American southwest. Read Anthony de Palma’s excellent report on Page One of Sunday’s New York Times to get a real sense of the impact devaluation will have on the masses of ordinary Mexicans.

What is likely to happen from this point forward? First of all, the most important member of Congress in dealing with this issue is Sen. Robert Bennett , the 60-year-old freshman Utah Republican whose talents in finance have landed him assignments to the Senate Banking and Appropriations Committees and the Joint Economic Committee. Bennett’s father, Wallace Bennett, was for 24 years a leading member of Senate Banking. Starting from scratch as an entrepreneurial capitalist 20 years ago, Bob Bennett amassed a $60 million fortune building Franklin Quest, now traded on the NYSE. In the two years he has been in the Senate, he has become one of Dole’s closest and most trusted advisors. Dole last week, with the concurrence of Chairman Al D’Amato of Senate Banking, asked Bennett to be the Mexico man. In the House, Rep. Chris Cox [R-CA] was so designated by the GOP leaders, but Bennett’s expertise in the area easily tops all 535 members of the two houses. 

It is extremely important to make note of Bennett’s involvement because if the Republican Congress is going to get involved in Mexico, it is going to have to assume responsibility for setting the terms that places U.S. taxpayer money at risk. It cannot hand over $40 billion to Larry Summers to play with. Bennett will wind up serving as the point man for the Congress on Mexico, and his objective will be to get the peso revalued to as close to 3.5 as is possible. Otherwise, the recession in Mexico will spawn a fiscal crisis in Mexico City, a runaway budget deficit, and new demands for U.S. aid. Meanwhile, the beleaguered Mexican citizenry, suddenly finding the value of their current and past labors shrunk by 35%, will have no choice but to bail out of the country. Instead of Mexican tourists flooding across the border with cash, as they have these last four years, they will be coming to look for work. And because the volume of two-way commerce is now collapsing in the southwestern U.S., the Mexican emigres will be competing for low-wage jobs with newly unemployed Americans. Before when devaluations hit Mexico, the impact on the U.S. economy was relatively minor because the level of commerce was tiny. After six years of peso stability and tax cuts in the Salinas-Aspe years, the level of commerce was at an all-time high before Summers, the IMF’s Stanley Fischer, the Fed’s Ted Truman, and MIT’s Rudi Dornbusch went to work.

The rally in Mexico assets Friday has stalled, with word leaking out that all is not well with the GOP commitment to a bailout. The peso has begun to slide again, and the Bolsa has too. The Dole-Gingrich congressional leadership, which thought it had its hands full running the GOP domestic agenda, now realizes there are these foreign complications. They can’t really buck the problem back to the administration, telling the White House to get the House Democrats in line. This immediately would be viewed as a cop-out. Nor can it realistically happen, as the Democrats would insist as their price for support on loan conditions impossible to be attached -- a higher minimum wage for Mexicans, the saving of the Mexican spotted owl, a Mexican agreement to join the embargo against Fidel Castro, and on and on and on, until it is clear no authorization would be possible. I’m told that David Mullins, former vice chairman of the Fed, believes the Treasury plan would balloon into a new S&L crisis. For Dole & Gingrich to rally Republican majorities for legislation, they would have to control the conditionality to make sure this would not happen. A key player now is Jack Kemp of Empower America, who last week issued statements to the effect that he would oppose any plan that merely ratifies the mess created by Summers and will support efforts to restore the 3.5 rate. Kemp spent the weekend making telephone calls to congressional Republicans, to explain the situation and pull them back from endorsing a scheme that will not work.

To rescue the Mexican economy at this point will of course require working with the Zedillo government. As it is now more than obvious to Zedillo that he should not have devalued the peso, it should be a relatively easy matter to persuade him to revalue -- restoring the status quo ante. If the devaluation had occurred several months ago, it would be difficult to do, but at this moment the only losers would be those speculators still short the peso, who would hang on to their bear positions after revaluation was well under way. Informed opinion in Mexico City this morning, being reported in El Economista, is guessing the peso would settle below 5. With the government getting ready to dump another $2 billion in pesos into the system, to solve this “liquidity problem,” as the Clinton people are calling it, there’s no reason to expect the peso to stabilize at all. This is why former Fed Gov. Wayne Angell, now chief economist at Bear Stearns, is advising that loan conditionality include a commitment by Mexico to not only manage its balance sheet to prevent the dollar/peso rate from diverging, but also to publish its balance sheet daily instead of three times a year. 

The immediate problem Mexico has is in its dollar-guaranteed peso debt, the $29 billion in tesebonos it issued -- $17 billion held by foreigners -- while it was allowing its balance sheet to get away from it. The weakness of the peso following the uprising in Chiapas should have been countered by sales of peso interest bearing debt from the Bank of Mexico’s portfolio to mop up the surplus in cash. Now, this dollar-guaranteed debt is coming due in 1995, and if the Bank of Mexico doesn’t have the dollars it promised, it will have to supply pesos in the amount of the floating rate -- which will vastly expand its balance sheet. Alas. Larry Summers and Bob Rubin (and Greenspan) are saying we must make good on Mexico’s dollar pledges. An auction of $300 million worth is scheduled for tomorrow. The answer, boys, is to phase the rate back to 3.5, peg it there, and watch the global scramble to buy Mexican assets. We would happily recommend to Dole, Gingrich & Co. that we take as many three-month peso notes from the Bank of Mexico’s vast hoard, at 20% interest rates, until the peso is at 3.5. In fact, I would waive all other fees in the interests of being a good neighbor, and still make a bundle as the notes fell to 10% or below. As David Malpass put it this noon on CNBC, debating the crazed Rudi Dornbusch, “Mexico’s problem is a $10 billion problem,” i.e., the size of its monetary base.

Will the good guys win? Watch closely so you do not get caught on the wrong side. The good news is that the GOP Congress has some good people on top of the problem.