[Congressional Record Volume 141, Number 26 (Thursday, February 9, 1995)]
[Senate]
[Pages S2392-S2394]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




                    DEVALUATION OF THE MEXICAN PESO

  Mr. BENNETT. Mr. President, I thank my colleagues for indulging me in 
this matter and I will attempt to be as brief as I can.
  Yesterday, at this time, the chairman of the Banking Committee, my 
friend, Al D'Amato from New York, took the floor and made a strong 
statement with respect to the peso situation in Mexico and the proposed 
solution to that situation from our Government. I wish to take the 
floor and respond and expand upon the statements made by my 
distinguished chairman.
  I agree basically with the position that he took. I do not share some 
of the outrage that he expressed with respect to the administration's 
action. I took the floor after the administration had announced their 
action and generally praised it because I do believe that if we had not 
taken some kind of action the Mexican economy in an atmosphere of panic 
would, indeed, have spun out of control and the Mexican Government 
would have been in default on their bonds within some 48 hours of the 
time the administration acted.
  However, I do not want to leave the impression that with my support 
of the administration's actions I support the notion that the Mexican 
Government acted wisely when they devalued the peso in the first place. 
And the outrage suggested by the chairman of the Banking Committee was 
appropriately placed when it goes to the question of those who planned 
this devaluation, those who approved of the devaluation, and those who 
took the position that the devaluation was inevitable and that it was 
proper.
  In the Wall Street Journal yesterday, Robert Bartley, the editor of 
the Journal, wrote a somewhat lengthy but in my view very perceptive 
summary of this situation called ``Mexico: Suffering the Conventional 
Wisdom.'' I ask unanimous consent that this article be printed in the 
Record at the conclusion of my remarks.
  The PRESIDING OFFICER. Without objection, it is so ordered.
  (See exhibit 1.)
  Mr. BENNETT. The reason I praised the administration action when it 
was announced was that unlike the original proposal, the administration 
action called for entry into the circumstance of the Federal Reserve 
Board. I have enormous respect for Alan Greenspan, the Chairman of the 
Federal Reserve Board, who has an understanding of the evils of 
devaluation that I think goes beyond that held by some policymakers at 
the International Monetary Fund and the World Bank.
  Devaluations are not inevitable. Devaluations are not good policy. 
Devaluations are usually an attempt on the part of one government to, 
in the phrase that's become known, beggar thy neighbor--punish another 
government on their borders, either physically or by trade.
  We went through the circumstance of passing NAFTA in this body and in 
the other body. I was a strong supporter of NAFTA for a variety of 
reasons that I will not review here.
  One of the fundamental pillars of NAFTA was that we would establish 
free trade between these nations, and the assumption was very specific 
that this free trade would continue on a dependable exchange rate 
between countries. For Mexico, once the free trade zone was 
established, to violate that assumption and say, ``Well, now we have 
free trade in our countries but we are going to try to make our goods 
more attractive in your country by devaluing the peso and thereby 
making our exports cheaper,'' was a violation of that agreement, 
certainly of its spirit if not its letter.
  The fact that the markets reacted so violently to the devaluation, 
catching the experts at the IMF by surprise with that violence, 
demonstrates the fact that moving away from the 3.5 relationship 
between the dollar and the peso was, indeed, a violation of the whole 
spirit of the NAFTA debate and represented a betrayal of those who had 
supported NAFTA.
  Conventional wisdom, as Mr. Bartley points out, says ``No, no, you 
can devaluate a little bit and everything will be fine.'' The reaction 
in this circumstance said you cannot devalue a little bit when the 
devaluation is a betrayal. You have destroyed the whole relationship 
that existed between the two countries. That, in my view, was what was 
wrong.
  Now, in the package put together by the administration, there is the 
opportunity for Alan Greenspan and his opposite number in Mexico, 
Miguel Mancera, to get together and say we will use these funds that 
are now available to us by virtue of the decision of the President of 
the United States, not to bail out investors in Mexico but to start to 
extinguish pesos. We can acquire pesos by virtue of the money that we 
have and then extinguish them--tear them up, if you will--and reverse 
the monetary policy that flooded the Mexican economy with too many 
pesos, which is what led to the devaluation in the first place.
  We can use this money, these two gentlemen can, because they have the 
expertise, they have the ability, and if the Treasury Department will 
back them, they will have the support they need to say we can use this 
money over time to reverse the betrayal of the devaluation. And if that 
is the approach, I am convinced we will see the Mexican crisis resolve 
itself happily.
  Unfortunately, if that is not the approach, if the money is used in 
the conventional wisdom fashion of trying to see to it that all of the 
investors in Mexico are made whole, then I think the dire predictions 
that we have heard on this floor will indeed come true.
  So, I salute the chairman of the Banking Committee. I am a member of 
that committee, and I look forward to the hearings that he has told us 
he will schedule. I think it is very appropriate for him to take on 
this watchdog role that he outlined for us in his floor statements 
yesterday.
  But I hope the administration will recognize that those of us who 
supported what they proposed are looking to them to try to move to undo 
that which triggered the crisis in the first place, which was the act 
of betrayal, the devaluation.
  It was not the trade deficit. This country had a trade deficit, the 
United States, until 1914. The part of the country from which I come, 
the West, was built by trade deficits. The railroad that linked the 
West to the East and created all of the economic opportunities that 
came in its wake was built with British money, not American.
  Trade deficits are normal and healthy in developing countries. No, 
[[Page S2393]]  this devaluation was caused by overprinting of pesos, 
and it can be solved by using the breathing time purchased for it by 
the administration to extinguish those pesos and move back to the time 
where two trading partners who have joined hands in good faith under 
the umbrella of NAFTA can once again say: We can trust each other. 
There will be no future betrayal. We will stand as we have stood in the 
past.
  It cannot be done overnight. But it can be done if it is announced as 
a goal, if it is announced as an open target, and the two central 
bankers, Mr. Greenspan and Mr. Mancera, then set about to find a 
program to have it come to pass in a legitimate, orderly and proper 
fashion.
  This is the way to get the Mexicans back on their feet and this is 
the way to protect the American taxpayer. I salute Chairman D'Amato in 
his vigilance to hold hearings to see to it that this is carried out in 
that fashion.
  I yield the floor.
                               Exhibit 1

              [From the Wall Street Journal, Feb. 8, 1991]
               Mexico: Suffering the Conventional Wisdom

                         (By Robert L. Bartley)

       Confusion number one is that the best exchange rate is one 
     that produces the ``right'' trade balance. With the collapse 
     of the Marxism now behind us, this has become the most 
     pernicious idea loose on the earth today.--``Dollar 
     Turmoil,'' Review & Outlook, The Wall Street Journal, May 23, 
     1989.
                                                                    ____

       So some 93 million Mexicans are learning to their sorrow. 
     But perhaps there is something to be redeemed from their 
     misery. Just possibly the debacle will spell the end of 
     devaluation as a policy instrument, not only in Mexico but 
     around the world.
       The initial conventional wisdom is quite the opposite, of 
     course. With the peso devaluation providing an utter 
     calamity, financial sophisticates have decided the mistake 
     was not doing it sooner. To the untutored, this logic may not 
     be intuitively obvious. Indeed, taxpayers who've poined up 
     some $50 billion in guarantees may be relieved to discover 
     there is another view: that the Dec. 20-22 devaluation was a 
     dreadful mistake, though one in which the Mexicans merely 
     followed prevailing conventional wisdom.
       That wisdom holds, for example, that Mexico was ``forced'' 
     to devalue, which is myth number one. A collapsing currency 
     is usually the sign of a economy with an inflationary spiral 
     and an uncontrolled fiscal deficit. But the Mexican budget 
     was nearly in balance, and the ratio of its debt to GDP was 
     below the OECD average. Inflation has subsided to single 
     digits. Exports were surging, up 35% to the U.S., scarcely 
     the sign of an ``overvalued'' currency. Growth, while not as 
     vigorous as some developing nations, was picking up in the 
     wake of the North American Free Trade Agreement. The real 
     sector of the economy was not sick but healthy.


                        foreign exchange legacy

       In the financial sector, the incoming Zedillo 
     administration did inherit a problem: Foreign exchange 
     reserves were declining. As recorded in the graphs Bank of 
     Mexico Governor Miguel Mancera published on this page Jan 31, 
     adapted alongside today, they'd fallen from a peak of nearly 
     $30 billion before the March assassination of Presidential 
     nominee Donaldo Colosio to about $12 billion at the Zedilo 
     inauguration Dec. 1.
       In dealing with this problem, however, the incoming 
     administration had a choice. The road not taken was simply to 
     tighten monetary policy. In the conventional view, this means 
     raising interest rates to attract dollar inflows and thus 
     stabilize reserves. In the more modern and more helpful 
     monetary approach to the balance of payments, the same 
     actions would be viewed as reducing the supply of pesos. A 
     lower supply of pesos relative to the supply of dollars would 
     increase the value of the peso, and a higher exchange rate 
     would reduce the incentive to cash peso for dollars. Reducing 
     the supply of pesos would also be likely to boost short-term 
     interest rates, though this is a side-effect, and long-term 
     rates might actually benefit.
    
    
       Instead the Mexicans chose to devalue, widening the bands 
     on the exchange rate on Dec. 20 and going to a freely 
     floating rate on Dec.22. The latter decision really was 
     forced because the earlier one collapsed investor confidence 
     in the peso. Widening the bands clearly presaged devaluation 
     and led to a massive flight from the peso, and the loss of 
     half of the remaining reserves in one day. Judging by their 
     public economic plans, the Mexican authorities had in mind an 
     exchange rate of 4.5 pesos to the dollar, a 22 percent 
     devaluation from the earlier 3.5 floor. But with confidence 
     imploding, the peso dropped immediately to 5.5 then as low as 
     6.33, a 45% devaluation. With more than $50 billion in 
     guarantees from the U.S. Exchange Stabilization Fund, 
     international financial institutions and commercial banks now 
     announced, the peso recovered to 5.335 yesterday, devalued 
     35%.
    
    
       Meanwhile, interest rates surged. In the wake of 
     devaluation, the rate on 28-day cetes, peso-denominated 
     Treasury bills, reached 39%, up from 13.75% in the Dec. 14 
     action. Even with the support package, the 28-day cetes rate 
     was 32.75% at the most recent auction Feb. 1. Foreign 
     exchange reserves were almost exhausted before the bailout 
     package, and the Mexican economy is visibly collapsing into 
     recession. The argument that Mexico was ``forced'' to devalue 
     rests on the notion that otherwise it would have vanished 
     foreign exchange reserves, a recession and soaring interest 
     rates. With devaluation more than doubling interest rates, 
     it' absurd to suggest that the same rates would not have been 
     enough to defend a 3.5 peso exchange rate when the former 
     level of confidence still prevailed.
       What's more, in all likelihood the damage has only begun. 
     Mexican living standards already are plunging. The 
     devaluation will surely result in a major surge of inflation, 
     which will offset any imagined trade advantages to a lower 
     exchange rate. The combination of inflation and recession 
     will throw the government budget into chaos. The economic 
     turmoil, especially the devastation of the nascent middle 
     class, will in turn produce political turmoil. Much of the 
     hard-won progress of the last 12 years will be reversed.
       The Mexican outcome provides a particularly clear empirical 
     test of a set of conventional wisdoms about economic policy, 
     trade and exchange rates. For this was not some backwater 
     decision. The key decision-makers in Los Pinos (the White 
     House) and Hacendia (the Treasury)
      boasted Ph.D.s in economics from Yale and Stanford. 
     Devaluation has long been urged by important business 
     sectors in Mexico, and advocated/predicted by various 
     commentators on Mexico, in particular journalist 
     Christopher Whalen and MIT economist Rudiger Dornbush. 
     When the action was taken, U.S. Treasury Secretary Lloyd 
     Bentsen immediately said it ``will support the healthy 
     development of the Mexican economy.''
       The arguments of this illustrious group are familiar: 
     Exchange rate pressures are caused and cured by trade 
     deficits. Thus the Mexican authorities thought their 
     fundamental problem was not purely monetary, but rather a 
     high current account deficit. And further that the deficit 
     could be cured by devaluation; a lower exchange rate would 
     make Mexican goods cheaper north of the Rio Grande and U.S. 
     goods more expensive south of the border. So Mexicans would 
     sell more and buy less, and the trade account would come into 
     balance, or at least to a ``sustainable'' level. Many 
     economists and such institutions as the International 
     Monetary Fund have long given the same advice to every 
     troubled economy in the world. It was the conventional wisdom 
     preached even to the U.S. in the 1980s, the occasion of the 
     ``Dollar Turmoil'' editorial quoted above.
       Yet in fact trade deficits are perfectly normal, if not 
     indeed a sign of health. The international balances are an 
     accounting identity, and trade deficits and investment 
     inflows are two sides of the same coin. So any developing 
     nation that succeeds in attracting capital must by definition 
     run a trade deficit. Or to put it another way, a rapidly 
     growing economy will attract more than its share of the 
     world's investment and require more than its share of the 
     world's goods.
       The key, then, is not to balance the current account with 
     the rest of the world, but to balance trade deficits with 
     voluntary investment inflows. Mexico ran current account 
     deficits of $25 billion in 1992 and $23 billion in 1993, and 
     during this time not only maintained the peso at around 3.1, 
     but accumulated large foreign reserves. In 1994, the current 
     account deficit was only slightly higher--$27 billion after 
     11 months. The problem came with the inflows, as political 
     turmoil shook investor confidence.
       The biggest shock was the Colosio assassination. The 
     Salinas administration responded by devaluing the peso to 3.4 
     from 3.1, within the previously announced bands. It also used 
     some of its foreign exchange hoard to buy pesos and 
     engineered a sharp boost in interest rates, taking 28-day 
     cetes to around 18% from 9.6%. This mix succeeded in 
     stabilizing foreign reserves from April to November, with a 
     blip over the threatened but ultimately aborted resignation 
     of Jorge Carpizo McGregor, widely seen as the Mexican 
     government's badge of integrity. In November, reserves 
     resumed their fall with the angry resignation of Deputy 
     Attorney General Mario Ruiz Massieu, who had been 
     investigating the assassination of his brother, Jose 
     Francisco Ruiz Massieu, secretary general of the ruling 
     Institutional Revolutionary Party (PRI) who had tried to 
     fight party corruption. The resigning official repeated his 
     suspicions that drug dealers were working with elements of 
     the PRI, and charged that high party officials had obstructed 
     his probe.
       Clearly these political events were shocks to monetary 
     policy and the exchange rate, as Governor Mancera argued in 
     his article here. He added, however, that in line with 
     standard central bank practice around the world, the 
     resulting foreign exchange transactions had been 
     ``sterilized,'' or offset with domestic transactions. The 
     idea is to insulate domestic monetary policy from the impact 
     of international markets (though in fact both turn on the 
     same money supply). So the central bank would sell its dollar 
     reserves, thus withdrawing pesos from circulation, but then 
     would buy domestic notes and bonds, putting the same pesos 
     back in circulation.
       So internal measures of ``the money supply,'' the monetary 
     base for example, displayed their usual growth path with 
     their usual seasonal variations. But the point was that the 
     political shocks changed the demand for money; the supply was 
     not allowed 
     [[Page S2394]]  to adjust. In effect, the central bank 
     created the pesos used to buy away its dollar reserves. With 
     a large stock of reserves and a store of credibility earned 
     with the Salinas reforms, the sterilized interventions did 
     buy time for a monetary correction, but instead the new 
     administration decided to devalue. The $50 billion support 
     package has restored some stability, but without policy 
     changes Mexico could sterilize its way through $50 billion as 
     it just sterilized its way through $30 billion.


                          a contrary principle

       It would be quite another matter if some of the $50 billion 
     were used for unsterilized intervention, buying pesos and 
     extinguishing them. And while sterilization is indeed 
     standard policy under the international conventional wisdom, 
     it is not the only possible one. Indeed, the currency board 
     policies adopted in Hong Kong, Argentina and Estonia operate 
     on a contrary principle. Local currency is issued only when 
     new foreign exchange reserves are earned, and is extinguished 
     when reserves fall. Interestingly, Argentina reacted to the 
     Mexican crisis by eliminating its remaining bands, not 
     widening them. Finance Minister Domingo Cavallo clearly has 
     not adopted the conventional wisdom; indeed, he consummated 
     his currency board by inviting IMF advisers out of his 
     nation.
       The currency board arrangement is reminiscent of the 
     classical gold standard before World War I, when the domestic 
     monetary base automatically rose or fell with the gain or 
     loss of gold reserves. The currency boards use foreign 
     currency instead of gold, of course. This means that while 
     all nations could use the gold standard, with currency boards 
     one central bank, presumably the Federal Reserve, would have 
     to use some other outside signal in setting the pace of money 
     creation.
       The new Republican Congress is gearing up for hearings 
     about what went wrong in Mexico, which promise to become a 
     reexamination of the prevailing conventional wisdom. Clearly 
     the Republicans recognize the devaluation as a mistake, as 
     Senate Majority Leader Bob Dole has plainly stated. What 
     advice, Republican committees want to know, did the Mexicans 
     get from the IMF and U.S. Treasury? And what advice will they 
     give the future Mexicos?
       When the GOP won in November, who would have guessed that 
     one of the first effects would be a far-reaching examination 
     of international monetary policy? Even for us who thought its 
     arcane mysteries were as dangerous as they've now proved in 
     Mexico, it seemed too much to hope.
     

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