Mexican Bail-Out

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MEXICAN BAIL-OUT

In December 1994, as Mexicans watched their currency's buying power plummet 40 percent, President Ernesto Zedillo stunned world-wide financial markets by devaluing the peso. Zedillo blamed the crisis on his predecessor, Carlos Salinas, who had attempted to get Mexico out from under mounting foreign debt and national poverty by launching reforms that slashed triple-digit inflation, dismantled trade barriers, and opened the Mexican economy to foreign investment.

Part of Salinas' anti-inflation strategy was to tie the value of the Mexican peso to the U.S. dollar so that the value of the peso would not fall, and investments in Mexico would be safe. Since the beginning of this policy in 1988, investors in the United States and other countries poured $50 billion into Mexico. But with the passing of the North American Free Trade Agreement (NAFTA) in 1994, rising U.S. interest rates lured foreign investors to favor the dollar over the peso. To keep the peso's value on par the Mexican government was forced to use its foreign currency reserves to purchase pesos. Mexico's $30 billion foreign exchange reserves plummeted while the government spent as much as $1 billion a day. By December 19, reserves had dropped below $10 billion, with no end in sight.

By this time Zedillo, the new president, decided that devaluing the peso was the only way to end the situation. This was a drastic step to take, however, sure to cause turmoil in Mexico's economy. Zedillo did not prepare to deal with this impact very well. At first he denied that devaluation was in the works, and then, without unveiling a plan to counter the economic impact, Zedillo announced on December 21 that devaluation would happen. Foreign investors stunned by the news dumped Mexican stock, pushing the peso down even further. The peso's value relative to other currencies plummeted 70 percent.

The number of American investors in Mexico and the amount that they invested prompted U.S. President Bill Clinton (1993–) to attempt to bail out the Mexican government. He originally proposed a plan with $40 billion in U.S. loan guarantees, but Congress refused to authorize that amount. Undaunted, Clinton unveiled an alternate rescue plan that would "save" Mexico by letting Zedillo's government take money from the U.S. Treasury Department's Exchange Stabilization Fund, which was designed to help America's "friends" out of temporary currency crises. The Exchange Stabilization Fund had traditionally provided assistance for very short periods of time, usually less than a year. But under Clinton's bail-out plan, the White House allowed the Mexican government to withdraw at least $2.5 billion from the fund, with repayment schedules stretching out from 10 months to 10 years.

Clinton's original $40 billion plan consisted only of loan guarantees that might never have been activated. His new plan was a mix of guarantees and immediate loans and was therefore more risky. To minimize the risk, the he required that Mexico agree to divert proceeds from oil exports to the Federal Reserve Bank of New York in the event of a default, and demanded that Mexico pay fees to offset the risks of the loans and guarantees.

Clinton's plan was certainly not without its critics. Some charged that it would benefit only large, rich investors in Mexico, doing little for the Mexicans themselves and nothing for the average American. They questioned why Clinton was willing to lend billions to a foreign government without a vote of Congress, when thousands of investors within the United States lost money and were never offered bail outs. Surely, they claimed, $20 billion in additional loan guarantees to domestic inner-city investors would have provided more benefits to Americans at home. Detractors also focused on the risk involved in the loans. They contended that in order for Mexico to pay back the loans on time it had to succeed at many difficult tasks, including lowering its account deficit, controlling its money supply, privatizing more state companies, suppressing internal rebellion, and insulating its central bank from political interference.

The Clinton plan went into action despite these objections. While supporters conceded that there was no question Clinton took a risk with the loan, they believed that it was justified for two reasons. First, Mexico's problems always had a way of becoming those of the United States, through increased influxes of illegal immigrants, for instance, or through a decline in an otherwise mutually beneficial trade. Second, the Mexican government had been increasingly edging its way toward economically responsible policies, and needed to be encouraged to continue.

Three years before its deadline Mexico repaid its loans from the United States in total with interest. Clinton supporters hailed the achievement and argued that the amount repaid by Mexico amounted to about a half-billion dollars more than the United States would have made if there had been no loan at all.

However economists viewed the situation, most agreed that as of the end of the twentieth century approached, Mexico was still not entirely out of trouble. They felt that more reform along free market lines would be necessary if Mexico was to become a major creator of jobs, products, services and wealth, all of which its growing population badly needed. Still, most acknowledged that the situation had been successfully stabilized, and that recent progress in Mexico was unmistakable.

See also: General Agreement on Tariffs and Trade, International Monetary Fund, Free Trade