The New Debt Crisis By Christopher Whalen (617) 747-0115 www.rcwhalen.com Washington's decade-long effort to maintain the illusion of stability in Mexico collapsed on December 21 when the new government of Ernesto Zedillo announced a 15 percent currency devaluation. Financial markets, reacted to this sudden betrayal by pushing the peso down over 35 percent, confirming this writer's long held view that the neoliberal model is both unsound economically and politically reckless. High-flying Mexico is again a ward of the International Monetary Fund and seems headed for a new round of hyper- inflation and debt default, but this should come as no surprise. Mexico first defaulted on foreign debts in the 1820s and has repeated the process half a dozen times over the past 170 years. The peso crisis of 1995 is a replay of the financial collapse of 12 years ago, except that private investors and companies have taken the place of commercial banks as the losers. In 1982, when Mexico devalued its currency and defaulted on $80 billion in public sector debt, the world financial system almost collapsed. Yet the cost of fixing the 1982 financial crisis was tiny, a couple billion dollars, petty cash compared to the looming default on tens of billions of dollars worth of hard currency obligations of private Mexican companies and banks. Today, just servicing Mexico's external deficit costs over $2 billion a month, swelled by a flood of imports. When Mexico defaulted in August 1982, the Reagan Administration immediately extended $2 billion in order to refloat the country's battered economy and insure a smooth political transition for the new government of Miguel de la Madrid. Another $2 billion came from the Commodity Credit Corp. and U.S. commitments to buy Mexican oil for the Strategic Petroleum Reserve. Through the mid-1980s, foreign banks refused new money to Mexico and even pressed demands for repayment, although the IMF and other multilateral agencies continued to lend. By 1987, net flows of capital from Mexico back to its creditors in the industrial world were actually positive as it slowly repaid its hard currency debts. In 1987, Brazil declared a moratorium on foreign loans and Washington feared that Mexico would follow. The larger banks, led by Citibank and J.P. Morgan, reluctantly began to reserve against the eventual write-off of loans to Mexico and other debtor nations. Federal Reserve Chairman Paul Volcker, a fierce opponent of debt forgiveness, left his post later that year. In the July 1988 elections, Carlos Salinas de Gortari was defeated by Cuauhtemoc Cardenas Solorzano. Through electoral fraud and another $1 billion "bridge loan" from Washington to the De la Madrid government in August of that year, Salinas prevented Cardenas, the son of nationalist hero General Lazaro Cardenas, from taking office and fulfilling his vow to repudiate Mexico's then $105 billion in foreign debt. In February 1989, food riots in Venezuela caused nervous bankers and their servants in Washington to capitulate on the issue of repayment and extend new loans. The abortive debt reduction plan named for then-Treasury Secretary Nicholas Brady was completed roughly a year later. It afforded Mexico little real debt relief, but did provide the first substantial new money in almost seven years. The Brady Plan was followed with a proposal for a "free trade" agreement by former CIA director and then-President George Bush. More than 15 years before, when he worked in the oil business in Texas and Mexico, Bush built a close personal relationship with Salinas and his father, Raul Salinas Lozano, the power behind the state oil monopoly, Pemex. It is no coincidence that Tidewater Marine Services, a private firm owned by Bush and several former Cabinet officials, recently won a lucrative tender from Pemex. As American politicians argued the merits of free trade, Washington and Wall Street engineered a vast new flow of loans and private investment that kept Salinas and Mexico's ruling party one- step ahead of an increasingly impoverished and restive population. Wall Street bankers, including Treasury- Secretary designate and former Goldman Sachs partner Robert Rubin, convinced thousands of American investors to believe in the "new" Mexico. Washington's task to money to support Salinas was helped by the fact that the Fed maintained artificially low interest rates from 1989 through 1993, this in order to rescue the big U.S. banks from their latest folly: commercial real estate. Fed Chairman Alan Greenspan's easy money policy encouraged an enormous transfer of wealth from American consumers to commercial banks, and from investors to risky "emerging markets" like Mexico. NAFTA was approved in November 1993 and Mexico seemed safely in the hands of the foreign banks, buoyed by $50 billion in new portfolio investment and tens of billions more in private loans. With total foreign debt over $160 billion at the end on 1994, Mexico boasted no fewer than 24 billionaires on the Forbes list, at least before the December 21 peso devaluation. This group does not include several Mexican drug lords and corrupt politicians whose net worth easily reaches into 10 figures. Yet contrary to the glib optimism of Washington and Wall Street research analysts, all was not well. In the southern state of Chiapas the reaction to the financial excesses of salinismo erupted in armed rebellion on New Year's day 1994, plunging Mexico into political chaos and causing the peso to drop 10 percent. In February 1994, the next shock came when the Fed changed policy and began tightening the money supply to defend the battered dollar. The end of the latest cycle of boom and bust in Mexico was in sight, but few in Washington or on Wall Street took heed of the warning signals. Indeed, unlike previous Mexican financial debacles, neither the Treasury nor the Federal Reserve anticipated the latest peso devaluation. The effects of the crisis are numerous. Measured in dollar terms, the Mexican market has shrunk to roughly half of its size at the time NAFTA was approved. The cost of Mexican labor has fallen by the same proportion, adding to the competitive pressure on U.S. workers. Mexican exports will be boosted by a cheaper peso, but Mexican companies and banks have taken huge losses, making it more difficult for them to compete with better capitalized foreign rivals. As Mexican firms gradually default on foreign loans, the huge scope of the new debt crisis will be painfully clear. Individuals, banks and mutual funds that put money in the hands of Carlos Salinas will find few assets remaining to repay their investments. Once again, the ongoing criminal conspiracy outsiders mistake for a government in Mexico has deprived hapless foreigners of their money. And once again, the people of Mexico are left holding the bill. Christopher Whalen is Chief Financial Officer of Legal Research International in Washington and edits The Mexico Report, a fortnightly newsletter. He is currently working on a book on foreign investment in Mexico.