Mexico: What's Next? [1995 assessment]
Mexico: What's Next?
Remarks by Christopher Whalen 1
Council on Foreign Relations
New York, N.Y.
March 6, 1995
This morning I will give you my assessment of the political and economic situation in
Mexico. I first propose to briefly review the important developments of the past year and
look at the current situation facing the government of President Ernesto Zedillo, then
make some general predictions about the financial and social developments that we will see
in Mexico in 1995 and beyond.
There is a great deal of debate in Washington about whether or when members of the
Clinton Administration knew or should have known about the impending collapse of the
Mexican peso on December 21, 1994. Speaking as someone who watches Mexican developments
full time and who warned of the unstable nature of the "Neoliberal" economic
model early on,2 let me just say that the financial meltdown that has been called the
"Tequila Effect" was inevitable and obvious to anyone who bothered to read the
One of the best selling books in Mexico over the past several years, called simply
"Devaluation 1994?", details the nasty implications of the impending devaluation
of the peso. And there are the obvious examples of leaked memos from within the U.S.
government that show at least some of the people responsible for American financial policy
knew about the impending crisis that has damaged many smaller markets around the world. It
seems to me those American leaders in politics and finance who claim to have been
"surprised" by the peso devaluation are either confessing gross incompetence or
are being disingenuous.
It is useful to think about Mexico as being comprised of three spheres or sectors of
economic activity: the productive sector, the speculative sector and the criminal sector.3
Let's consider the results of six years of economic reform under Carlos Salinas de
- The productive economy, excluding the small in-bond or maquiladora sector, has shrunk in
terms of the total number of jobs and private sector companies.4 Dislocation in rural
areas of Mexico has been massive, resulting in literally millions of impoverished people
being driven from the land and into already crowded Mexican cities, a rising flow of
desperate people who must eventually move north. High real interest rates and confiscatory
taxation have made it impossible to support most types of productive business activity.
Like Venezuela, defaults on business and consumer loans are rising very rapidly and the
austerity measures being implemented by the Zedillo government at the behest of foreign
creditors will only exacerbate credit quality concerns. On an aggregate basis, the Mexican
banking system is clearly insolvent and cannot survive in its present form. It is very
likely that many if not most of the recently privatized Mexican commercial banks will
require government assistance before year-end.
- The speculative economy, fueled by inflows of cheap dollars, inflated to vast size
between 1990 and 1994. Now this process is moving in reverse as the collapsing prices for
stocks, bonds and the peso destroy billions of dollars in wealth and reduce consumer
purchasing power. By shifting the dollar borrowing necessary to finance imports -- and
thus political stability -- from the public to private sector since 1989, Salinas and his
cronies in the previous government cleverly made Mexico's economy seem larger through new
dollar inflows, while leaving the ultimate liability with the private sector. The economic
policies of Carlos Salinas emphasized raising billions of dollars in new foreign debt
rather than boosting exports and job growth. The result is an economy that has more debt
and arguably less ability to generate dollar income than it did in 1989. Once again, as in
1982, Mexico is in trouble because of excessive offshore borrowing and spendthrift
economic policies, not because of a short-term liquidity problem, as the Clinton
- Finally we come to the criminal economy, by far the largest of the three sectors, which
is built around narcotics trafficking, arms smuggling, kidnapping and other forms of
illegal activity. The criminal economy has mushroomed in size and now clearly dominates
the entire political landscape. Today, the $20-25 billion in profits from the $100 plus
billion-per-year narcotics trade is twice the total revenues of the Mexican oil sector.
Drugs are not simply a threat to the authority of the Mexican government, as even U.S.
officials now grudgingly admit. Rather, as in the case of Colombia and Venezuela,
narcotics has come to permeate all aspects of Mexican official and even private life. It
is frequently impossible to do business or even live in many parts of the country without
making a compromiso with the warlords who govern the narco system.5 My friends and
colleagues in the political opposition, both on the left and the right, report that the
drug lords and their allies in the government apparatus are now the ascendant political
force in border states like Baja Norte, Sonora, and Cuahuila, and in many other parts of
In purely financial terms, the Mexican meltdown signals the end of the latest cycle of
offshore investment in Latin America, a reversal of falling monetary tides between 1989
and 1994. But the financial collapse of the past two months has as much to do with changes
in U.S. interest rate policy as with the peculiar relationship between Washington and the
nations south of El Paso. The real blame for the Tequila Effect and the extraordinary
accumulation of new debt by Mexico -- which totaled some $160 billion in offshore
obligations as of year-end 1994 -- largely belongs with Washington.
Foreign investors began to withdraw dollars from Mexico last year as a result of (1)
several drug-related political assassinations, (2) the Indian rebellion in Chiapas and (3)
the obvious fact that Mexico was borrowing excessively in order to finance its huge
imbalance between imports and exports. The collapse of Grupo Havre last year, the
subsequent failure of the Cremi-Union banking group, and even the decision by the Federal
Reserve Board to raise interest rates in February last year, constituted clear warning
signals that the proverbial party was over. With a current account deficit of $30 billion
for 1994, Mexico's use of debt to finance consumption rather than capital investment
proves that this latest episode was a Ponzi Scheme, not an exercise in free-market
renovation.6 Indeed, Mexico under Salinas gives free market economics a bad name.
One of the great misconceptions in the financial community is that the Mexican decision
to devalue the peso was a bad but voluntary choice; an active determination rather than a
necessary reaction to the reality of suppressed inflation and dollar-insolvency. Respected
thinkers ranging from Senator Phil Gramm (R-TX) to Robert Bartley, editor of the Wall
Street Journal, bemoan the fact that the Mexicans followed bad advice and "decided to
devalue the peso." In fact, the Banco de Mexico bank ran out of money -- that is,
dollars -- and was forced to devalue. This same inexorable process is now underway far to
the south in Argentina.
Over the past five years, Wall Street analysts have spent hours pouring over internal
monetary data, financial results for private companies, and other local currency
indicators from the Latin debtor nations. I would argue that when looking at any emerging
market, the exchange rate and the commercial account are the only two indicators that
really matter. If the developing country has a relatively balanced trade relationship with
the rest of the world or even runs a small commercial surplus, as in the case of Chile,
then the currency is probably fairly valued and the chances of default are relatively
small. Then and only then does it make sense to give great weight to local measures such
as money supply growth and company earnings.
In the case of Mexico and, to a lesser degree Argentina, however, the inflows of
foreign "capital" have been used not to create new, productive assets that
generate exports, but instead have simply created new dollar obligations for which there
is no clear source of repayment. The existence of a currency board in Argentina, for
example, provides short-term stability, but the fact remains that the present, 1:1
exchange rate of the Argentine peso against the dollar has been financed with offshore
debt, privatizations and other non-recurring hard currency inflows, and is thus
Today, as in 1982 and 1989, the chief external issue facing Mexico in 1995 is foreign
debt, not trade. Stripped of the glib rhetoric of the past 5 years, we find a Mexico that
has an economy with a GDP of less than $200 billion, that generates barely $20 billion in
net exports (including oil sales but excluding the in-bond maquiladoras) but that must
somehow come up with something like $25-35 billion this year in foreign debt service.7
Perhaps more importantly, the peso crisis of 1995 marks the end of Washington's
decade-long effort to maintain the illusion of political stability in Mexico. The internal
political scene is driven by a new and increasingly unstable factor, namely the ongoing
struggle toward a more free, open, and democratic political formulation. Hopefully it is
now apparent to all concerned that Mexico's political shortcomings caused the present
Thomas Jefferson said that a free society requires a little bit of revolution from time
to time, but I doubt that Mexico's political opening will be either violent or
anti-American. Indeed, the process should work to our great advantage if Washington can
end, once and for all, its mindless support for the world's oldest and most corrupt
authoritarian system. Investors and political leaders in Washington need to get accustomed
to the idea of political change in Mexico, change which must inevitably mean an end to
single-party rule as the opposition parties on the left and right gain greater power.
Despite its many unique aspects, Mexican society is now in the midst of a citizens
revolt not unlike the broad-based political opening seen in Central and Eastern Europe,
and even here in the U.S. last November. The relatively peaceful revolution that is now
underway in Mexico traces its origins not only to the New Year's Day 1994 rebellion in
Chiapas, but to years of electoral fraud, corruption, official tolerance of narcotics
trafficking and other types of official abuses by Mexico's single party state.
During a recent meeting of Washington activists, it was suggested that the peso debacle
might offer protectionist factions in the U.S. and Mexico an opportunity to renegotiate
NAFTA, but I respectfully disagree with this type of thinking. For the time being, NAFTA
as it refers to a new market for significant quantities of U.S. goods and services is
dead. The cash flow that made Mexico seem like a market for American goods has
disappeared, leaving behind a great deal of work for firms such as Legal Research
International. So long as foreigners lent Mexico money, the mirage of demand for foreign
goods was maintained. Now, debt and immigration, not trade and investment, are the two
issues that will dominate the U.S.-Mexico relationship in the years ahead.
Let me close my remarks with a few thoughts about what we may or may not see in Mexico
during the rest of this year:
- Politically speaking, the situation facing the government of Ernesto Zedillo is complex
and very dangerous, including a threat to the personal safety of Zedillo himself. I want
to applaud and encourage the steps taken by President Zedillo to deal with Mexico's
financial crisis and, most recently, by arresting Raul Salinas de Gortari, the older
brother of former President Salinas.8 Zedillo is currently involved in a desperate
internal struggle with the forces of reaction in Mexico, including Salinas, former
Agriculture Minister Carlos Hank Gonzalez, and other dinosaurios in the PRI old guard --
the same people who are suspected of engineering the murder of Luis Donaldo Colosio almost
a year ago. So long as the case against Raul Salinas is confined to the murders of Jose
Ruiz Massieu and Colosio, then the move by Zedillo will be a political affair to determine
how independent Zedillo will be of reactionary elements led by Carlos Hank and Carlos
Salinas. If the investigation begins to examine the vast corruption of which Raulito was
the chief nexus on behalf of his brother and his father, Raul Salinas Lozano, then Zedillo
will be declaring civil war on many powerful warlords who have the capacity to directly
threaten Zedillo and members of the government loyal to him.
- In terms of the larger tactical situation facing the PRI around the country, the ruling
party has suffered a grievous political blow due to the peso devaluation. The precipitous
drop of the peso has hurt the possibilities for the ruling party in future state and local
elections, even though public support for Zedillo himself has risen since the arrest of
Raul Salinas. The recent election victory by the conservative PAN or Accion Nacional in
the important central state of Jalisco came about for three reasons: (1) public anger over
the 1993 assassination of Cardinal Juan Posadas, (2) the political disarray and corruption
of the PRI inside the drug ravaged Pacific coast state, and (3) general public dismay over
the collapse of the implicit pacto between the government and the electorate. In a very
real sense, the people of Mexico cast their votes for Ernesto Zedillo in August of 1994
thinking that they were buying political and financial stability from the PRI. Now it is
shown that the very ill effects of devaluation and political conflict that were attributed
to a possible opposition victory have, in fact, come about under the PRI.
- Financially, Mexico faces the inevitability of private debt defaults during 1995 and the
very real possibility of a public sector debt default, particularly if the U.S. government
goes through with its threat to seize the country's oil revenues if a default occurs on
the $20 billion loan facility provided by the Treasury and Federal Reserve System. The
U.S.-led financial rescue package has no effect on the internal financial situation in
Mexico. Any viable program to revive Mexico's economy must begin with a complete
repudiation of the key flaw in the economic policy of the previous government, namely
pegging the peso to the dollar. Experience teaches us that a pegged currency implies a
future devaluation. From the very outset, Mexico's new government must publicly admit that
in the future the Banco de Mexico will target internal price stability rather than a fixed
exchange rate as part of a new program for stable economic growth and investment within
the North American Free Trade Agreement.
- Over the long-term, Washington must eventually address the issue of foreign debt.
Treasury Secretary Rubin has told members of Congress that U.S. loan guarantees are be
backed by oil revenues. I suspect that certain members of Congress are preparing to tell
Mr. Rubin in very blunt terms that much (if not all) of current Mexican oil exports are
pledged as collateral on existing loans and foreign debt. I myself am a director of a
Houston-based firm, Arriba Ltd., which is a creditor of Pemex. Moreover, since Pemex
regularly pays in excess of 95 percent of its gross annual revenues (including dollar
funds generated by exports) to the Mexican Treasury in the form of an energy extraction
tax, Mr. Rubin's claims as to the availability of collateral to secure the loan guarantees
are clearly incorrect. Were the Mexican government deprived of the revenues of Pemex, it
would be left in a financially untenable position and would be forced to default on its
foreign and domestic obligations. 9
Critics of free market economic reforms in the developing world are already using
Mexico and will use Argentina's disintegration as examples of the "failure" of
free market policies. The true blame for these unfortunate situations lies first and
foremost with the wide swings in U.S. interest rates from 1989 until today, and second
with the underlying political problems in each country, problems for which in the case of
Mexico the United States must share a large part of the blame. Putting aside the rosy
propaganda generated by the governments in Mexico City and Washington over the past 6
years, Mexico remains a country ruled for the benefit of the few at the expense of the
many. Corporate statism and personal corruption, not free markets and the rule of law, are
the governing principles.
During the past 5 years, numerous errors of financial prudence and due diligence have
been committed in the emerging markets, both by banks and their clients. Yet the greatest
mistake of all was made when foreign investors sitting far away in Boston and New York
actually believed that the likes of Carlos Salinas would treat them better than he treats
his own people. Thank you.
# 1 Mr. Whalen is chief financial officer of Legal Research International, a
Washington-based firm that advises and represents investors regarding due diligence,
payment and credit risk in international markets. He also publishes The Mexico Report, a
fortnightly review of political and financial developments in Mexico. Electronic Mail:
2 See Whalen, Christopher, "Mexico's Government Creates Another Debt Crisis,"
Wall Street Journal, March 12, 1992.
3 I owe a debt of gratitude to Mr. Eduardo Valle for this concept.
4 Employment in the maquiladora sector reached 550,000 by the end of 1994, although
these facilities are almost exclusively used for export and contribute little to the local
economy. For example, with the in-bond sector, Mexican manufactured exports in the first
10 months of 1994 were $41.485 billion, but excluding the maquiladoras drops the figure
down to $20 billion, including oil exports. See El Financiero, February 3, 1995, p. 28A.
5 See Whalen, Christopher, "Mexico: El Sistema Narco," Dinero of Bogota,
Colombia, November 1994, pp. 162-176.
6 See Osterberg, William P., "Capital Flows to Mexico," Economic Commentary,
Cleveland Federal Reserve Bank, December 1, 1994. He writes: "It may not matter much
that analysts have often ignored capital flows [to Mexico], depending on how such flows
have been used. Ideally, in the case of an economy as dependent on international trade as
is Mexico, capital inflows would be largely channeled into investments to boost
productivity and to lower prices, thus improving the current account balance, national
economic output, and employment. There is only mixed evidence that this has occurred,
however. While the volume of capital goods imports has risen steadily since well before
the surge in capital flows, there has been no clear increase in the share of imports
accounted for by capital goods. The capital flows have also apparently not led to
increased domestic expenditure on capital goods, because the share of gross fixed capital
formation to GDP has not risen appreciably since before the 1990 surge in capital flows.
Thus, there is only weak evidence that the capital inflows have been used mainly to invest
in productivity enhancement."
7 Mexico's total foreign debt, public and private, will require over $20 in principal
and interest payments in 1995. This figure does not include interest and principal
payments on domestic, peso debt instruments held by foreigners. See also Whalen,
Christopher, "South of the Bailout," The Washington Post, February 5, 1995.
8 For an excellent overview of the business and political dealings of Raul Salinas, see
the November 21, 1994 issue of Proceso (No. 942), which devoted almost half of the issue
to "El Hermano incomodo."
9 For example, the Mexican government must make payments on its external debt of
roughly $5 billion in 1995, compared with net dollar revenues from oil exports of about
$6.5 billion ($7.4 billion in oil exports, less imports of gasoline and other refined
energy products from the U.S.). When the service of Pemex debt is also included in the
calculations, it becomes clear that on a cash-flow basis, there is no free dollar revenue
available to provide security on the U.S. loan guarantees for Mexico. Indeed, as Mexico's
export revenues gradually dwindle over the next 4-5 years, it is virtually inevitable that
the Mexican government will ask the U.S. for subsidies to support capital investment in
oil production and refining capacity. Privatization of Mexican oil is not simply
desirable, but is in fact inevitable.
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