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the crash interview: jorge casteneda
jorge casteneda
He is a leading Latin American political scientist and professor of political science at the National University of Mexico. He writes a monthly column on economics and politics of Latin America for The New York Times and is the author of The Mexican Shock. (Interview conducted in the spring of 1999.)
You've written that what you call, "cold turkey free market policies" were not going to be the solution to Mexico's problems. Why not?

Well, I never thought they were going to be the solution because they implied a level playing field for unlevel competitors or teams. That is, if Mexico established itself as an open economy with no state regulations--everything to the market, everything to the private sector, everything to international trade--it did not have the institutions, it did not have the private sector, it did not have the rule of law. It did not have a series of factors that are indispensable for this model to work.Supposing it worked somewhere. I'm not really sure I know where it works, but let's suppose there is somewhere in the world where that model works, say the United States, or maybe England ... Mexico simply doesn't add up to that type of an equation. So all that would happen is these vices, these defects, would appear at some stage, and they would appear in one form or another, and they did.

So who was pushing this? ...

The fund people love to say, 'If you have your fundamentals right, you're in good shape.' It's not true. The markets' speculative flows attack people with good fundamentals, bad fundamentals, no fundamentals. You had a convergence of factors. You had the Americans who were pushing. They were pushing, firstly, because during most of the early '80s and early '90s, the United States was running an increasingly large current account deficit with the rest of the world, and wanted to try and redress that as much as it could. Although it couldn't get too much leeway in Latin America, it could get a lot of leeway for very little. That is, it's easier to push the Latin Americans around than it is to push the Japanese. It's easier to force the Mexicans to open their economy than it is to force the Chinese or the Japanese to open their economies. The U.S. deficit is bigger with Japan or with China than it is with Latin America, but they can't push those guys around as easily as they can push us around.

At the same time, the Latin Americans, this was particularly true in Mexico in the case of the Salinas de Gortari regime, wanted U.S. legitimacy, friendship, seal of approval for a personal long term political ambition. They figured rightly, the Mexicans that is, that if they did what the Americans wanted, the Americans would be very happy and would basically go along for the ride, and they did.

... the Americans had this problem of the current account deficit. How were they going to help solve it by changing things in Mexico?

Essentially, what the Americans wanted all of Latin America to do, and everybody with the exception of Brazil went along, was to totally open up their borders to trade with the United States on the understanding that that would signify a huge increase in U.S. exports to Latin America. And, perhaps, a minor increase in Latin American exports to the United States, particularly raw materials, commodities and some low technology manufactured goods or some assembled goods like automobiles in Mexico. This would improve the U.S. trade position with the rest of the world. It wouldn't do it overnight. And as I said, it wouldn't do it terribly significantly, but on the margins it would and it would do so cheaply.

This was not presented in those terms. The United States never presents things in terms of its own interests. Unlike former imperial powers who said, "You should do this because I want you to do this," the United States always presents things in terms of, "It's in your best interest to do this. You should open up your borders because trade liberalization is good for you ... Not because I want you to do it, but because it's the right thing to do." That's the way the Americans do it. They've been doing this for 100 years. It's not terribly new. That's how it was presented to the Mexicans and the Latin Americans.

Did opening up also include getting rid of any regulations on the flow of capital?

Well, inevitably the two go together. It's very difficult to open up trade barriers and to bring down tariffs and non-tariff barriers and other restrictions without also freeing up capital movements. Because if you're going to have, for example, what Mexico had in the early '90s--huge current accounts deficits because of huge import bills, among other things--you have to bring in capital to finance it. You can't bring in that capital, particularly speculative capital, unless you remove domestically in Mexico, or in Brazil, or in Argentina, the restrictions on entry to those capital flows. If not, you're going to end up with an unmanageable deficit overnight.

By 1994, Mexico was running a $30 billion current account deficit or 8% of GDP. That's unfinancable whatever you do, but it's certainly unfinancable if you're not attracting around $30 billion of speculative capital per year. You can only do that if you have high domestic interest rates to make it interesting. And secondly, if you have no restrictions.

So was there any debate in Mexico or in Latin America about the wisdom of suddenly opening up to the world economy?

Well, you have to distinguish between the situation in Mexico and the situation in most of the rest of Latin America. Mexico was then and up to a point still is today, living under a terribly authoritarian system; today, under an authoritarian system that's on its way out. But 10 years ago when all of this began, the Mexican political system did not allow much debate. It didn't kill people for arguing, but it simply silenced them. The debate did not take place. So in the case of Mexico, all of this was done by the Salinas regime without much debate or discussion internally.The case of the rest of Latin America, there was a great deal of debate, but it was a very biased or skewed debate by two factors. One, all of this was happening at the same time the Berlin Wall was collapsing. The fall of the socialist world was taking place. This gave an ideological impetus to the other trend. In fact, the two things had nothing to do [with each other]. It's not because the Polish economy didn't work that Brazil had to open up to international capital flows, but that's how it came to be viewed.

The second element, that skewed the debate that did take place in the rest of Latin America, was that the Americans were presenting this as something that was also apparently taking place within Western European and North Atlantic countries. That is, the Latin Americans were being told, "This is the tide of history. You have to go along with it."

The fact that it never really happened, even under Mrs. Thatcher in Britain, let alone in mainland Europe or in Japan, that nobody else really did this, was not apparent to the Latin Americans. They couldn't figure it out very well. So where the debate did take place, it took place In a terribly skewed or unfair way. That is, on the one hand you had a bunch of crazies who were against the tide of history in Eastern Europe and in Western Europe, who were fighting the last ditch battle to keep their economies closed. On the other hand, you had the reformers, the whiz kids, the visionaries, the people that were moving along with the tide of history. Well, I mean, it was open and shut who was going to win that debate.

So essentially, is the United States presenting opening everything up as the price of admission into the global economy?

That's the way it presents it. That is, what it says is, "Everybody is like us now. Before there were the Japanese. There were the Europeans. There were the East Asians. Forget it. Now, everyone in the world wants to be like us. Look, everybody drinks Coca-Cola and eats hamburgers ... You are not like us. If you want to join the club, you have to be like us."This is a sophism. It's false. The rest of the world is not like the United States. The Japanese are not becoming like the Americans and the Western Europeans are not becoming like the Americans. They may drink Coca-Cola and eat Big Mac hamburgers, which is fine, but they are not running their economies or their societies the way the Americans are. The Americans want them to, but they're not. And a lot of time has gone by now ... everything that the Americans said was going to happen inevitably, has not happened. The only people who believed them were the dumb Latin Americans because they believe everything they're told by the Americans.

... So the Latin Americans and Mexico agree basically to the rules of the game that the U.S. has set forward. Then what starts happening in Mexico?

Mexico begins first opening up to trade, then to capital, and then privatizing, in order to get the capital to pay for the deficit coming from the trade opening. Then it begins also having to carry out a series of other policies in order to keep attracting that capital. Among those policies are high domestic interest rates and a stable, virtually frozen, exchange rate so that investors don't get scared about devaluations.

Very quickly, two things happen during the early and mid-1990s. First, domestic interest rates were so high in order to attract capital that the economy can't grow. Because if domestic interest rates paid out to foreign investors are high, they're also high as charged to domestic borrowers. Nobody can borrow. Nobody lends. Nobody invests. The economy remains relatively stagnant. Better years or worse years, but on average. Secondly, the exchange rate becomes rapidly overvalued, because if you can't play with it, you can't move it. Your inflation is still higher than elsewhere. You're beginning to overvalue in real terms.

Overvalue the peso.

Overvalue the peso. This happens between 1990 and 1994. The third element, NAFTA, which is the instrument designed by the Mexican government, not by the Americans, to get out of the mess they had gotten into. That is, a way to attract enough U.S. foreign investment, direct foreign investment, to be able to finance this huge current account deficit without high domestic interest rates and without, at least in the long term, having to prop up the peso indefinitely. That's what NAFTA was for from the Mexican perspective. But all of this, of course, got messed up. It didn't work and you have the crash.

Before we get to the crash, explain what the Mexican government faced when it promised ... to keep the value of the peso as things begin to change.

Well, you have two different problems. You can have general problems that are applicable almost in all cases and in all countries when something similar arises. And you have specific problems that a given country can have at a given moment in history.

The general problem that a country like Mexico faced, on several occasions, the '70s, '80s and '90s, that Brazil has just faced now late 1998 or early 1999, is that you commit yourself to an exchange rate in order to guarantee returns on investments in the domestic currency to foreign investors or to domestic investors, and in order to guarantee prices, incomes to your domestic economy.

That guarantee is only worth how much money you have in the bank. And it's only worth the confidence, the trust, you can instill in investors and speculators that you will have enough wherewithal to sustain your currency. If they decide you can't, you've had it. Because they will end up getting you. Because they're acting rationally. They have to speculate against you if they think that you will not be able to sustain your currency.

Now, specifically in the case of Mexico in 1993 and 1994, there was a problem involving NAFTA. There is increasing evidence, this has not been proven yet ... that makes it probable to say that the Salinas administration made a tacit or explicit commitment to the Clinton administration in early 1993 that there would be no devaluation of the peso through '93 and '94 or at least through mid '94 so that Clinton could get NAFTA ratified in the U.S. Congress.

Why? If you recall, the main argument used by opponents of NAFTA in the United States from Ross Perot to the AFL/CIO and including Congressmen Gephardt, Bonier ... was that Mexican labor was too cheap and that new Mexican exports to the United States skyrocketed, U.S. jobs would flow to Mexico. Now, if there was one policy that could make this much worse, that could accentuate this, it was a devaluation of the Mexican peso. So, in a sense, what Clinton needed was a promise from the Mexicans that at least while the process was moving forward, they wouldn't do something stupid like make him look like a fool and make his opponents look right by devaluing the currency.

So they made a commitment not to devalue the currency during all of '93. But also during the first few months at least after ratification. Because if not, Clinton would still have looked like a fool. Imagine what Perot and others would have said if a week or a month or three months after NAFTA was approved in the Congress, the Mexicans go ahead and do exactly what the opponents of NAFTA had said they were going to do, devalue the peso.

So there was a commitment there not to touch it. Then that commitment ... gave way to a domestic political constraint. There were presidential elections in Mexico in August of 1994. If there's one thing governments don't do it's devalue a currency before elections. It's just not done. There are things you don't do in life and that's one of them. If you want to win an election, you don't devalue a currency before the election. So that meant Mexico couldn't devalue before August.We had, by then, almost two full years of an overvalued currency for political reasons. It had nothing to do with economics. It had to do with NAFTA and it had to do with elections. Then Salinas was leaving office ... in December of 1994 ... He had three months left. He could have devalued the currency during those three months. But, hell, you almost made it. It's really not nice to be the president who devalues. Let's have the other guy do it. It's only three months away. Why don't I hand the whole problem over to him and he'll know what to do, I'm sure.

So during these two years ... for political reasons the peso is being held up. What's happening to the foreign currency reserves?

Well, step-by-step what's happening is really quite simple. Mexican exports are becoming more and more expensive in dollars, so they're becoming less and less competitive. Foreign goods are becoming cheaper in Mexico because of the overvalued currency and they're flooding the country. Mainly from the United States, but also from elsewhere in the world. The trade deficit is skyrocketing. The need to bring in more speculative capital from abroad is growing to finance that skyrocketing current account deficit. You have to raise interest rates and you have to make more promises that you won't devalue the exchange rate. Once people stop believing you, you have to start then assuming commitments or obligations in dollars. These are the famous instruments that emerged in Mexico called, peso bonos.

In the middle of 1994 when investors, particularly American ones, started getting nervous and started telling the Mexicans, "Look we're leaving." And the Mexicans, "Hey, wait, don't go away. You don't like our pesos? Fine. I'll transform your investment in pesos into dollars and I'll pay you back dollars. I won't give you pesos as any exchange rate since you don't believe me anymore. You don't trust me. I'll give you dollars. Don't worry about it. And I'll pay you 12, 13, 15, 16, 17% per year on your dollar investment, three to four times what you can get money market funds in dollars in the United States." This was a great deal--16% in dollars? Backed by the Mexican government and turned back by the Federal Reserve and NAFTA. This is as good a deal as you can get.

So, of course, they stayed in. But the danger was, of course, Mexico didn't have the dollars to pay those investors back if they all wanted their money at some point because reserves were dwindling. All throughout 1994, reserves were dropping precipitously. By the end of the year, there's only about $6 or $7 billion left in reserves and short term dollar denominated liabilities are over $30 billion. Well, it's pretty simple what happens--collapse.

What was the response in the U.S.?

I think there's a double response. The first one is of disbelief and confusion, partly because it occurs in December of 1994 when Secretary of Treasury Bentsen is just leaving and [Robert] Rubin has not yet been confirmed ...... This was not something that was supposed to happen. Even if they had information that made it clear to them that something along these lines was supposed to happen. So, on the one hand, you have confusion. You have disbelief and you have a little bit of panic. Although in the first few days they don't think it's going to be that bad. Then by January of 1995, they realize that they have a major crisis on their hands and they try to cobble a package together quickly to try and save this.

They underestimate the magnitude of the problem in the first few days or weeks. The package that they need to put together keeps growing and growing. It will end up being a $50+ billion package, which never really materialized. That is, the $50 billion was never needed by Mexico. What was necessary was to give the markets the sense that those $50 billion were available. So that the Mexican government could stabilize the currency at some level in a credible fashion.

Why were they so upset and panicked in Washington? Well, essentially there were all these American investors, both institutional and sort of mom and pop investors, who had money in these Mexican bonds. These $30 billion of dollar denominated Mexican financial instruments which were not going to be paid. This was your pension fund or your pension account even, because you maybe decided that you wanted to put your money in Mexico--telephone bonds or whatever. You had seen Salinas on television and said, "My, he went to Harvard, he speaks English; this is a very intelligent young man. Let's give him some money." All of a sudden your life savings were on the brink of collapsing.

So, the Clinton administration essentially guaranteed those investments. Since they couldn't say so in those terms, they presented it in terms of a systemic crisis. That if the Mexican crisis was not solved, it would spread to the rest of Latin America--the famous Tequila effect--and from there to Malaysia, to it doesn't matter, whatever, Singapore, Korea, what have you.

It was partly true and partly not true. That is, on the one hand, the crisis actually spread anyway three years later despite the bailout; it happened anyway. Secondly, it's not entirely clear that there really was a systemic crisis. Unlike the debt crisis of the early 1980s, which probably was a systemic crisis and where if there hadn't been a concerted action, things could have gone very serious.

In the case of the Mexican crash of '94, it was probably the investors who would have taken a hit, but that's it. Nobody else. In any case, the Clinton people bailed out the Mexicans. The Mexican political system was propped up. The same people who had been running the country for the previous 70 years, and particularly the previous 10, stayed in power despite their fifth consecutive mess-up or crisis each time power changes in Mexico. And they're still there.

And Washington imposed conditions on this money.

Washington essentially imposed conditions of a very abstract nature, because by that point, Mexico had already done just about everything Washington wanted it to do. It had liberalized trade. It had privatized just about everything there was to privatize except the oil company. It had gone for NAFTA and become involved in NAFTA. It had deregulated capital flows, etc. There wasn't a whole lot left to do.

The only significant impositions were, once again, of an adjustment nature, not of a structural nature. In other words, Mexico had to cut spending, devalue the currency, raise domestic interest rates, going to a recession, etc. But there weren't that many strategic demands made because Mexico had already complied with most of them. There wasn't a whole lot left to pressure the Mexicans to do ...

You said [that Mexico] had to go into recession. That seems to be a bigger deal ... Did it necessarily have to go into recession? Did it make any economic sense to throw the country into recession?

Well, once you accepted the fact that you had to massively devalue the currency, raise interest rates, cut spending and raise taxes, you were going to go into a major recession. It was probably unavoidable in Mexico given the magnitude of the collapse, the magnitude of the crash. They were falling from so high that it was very difficult to avoid a recession in 1995.

Probably what could have been avoided was for it to be that big a recession, and mainly to transform all of those peso liabilities from before and then short term dollar liabilities into long term liabilities. Because what it means today is that we're still dragging that along with us in Mexico. This is particular true of the banking crisis. All of the recently privatized Mexican banks in 1995 went down the tubes, essentially because all of their loans became non-performing. With the tremendous rise in domestic interest rates, people couldn't pay back their domestic loans.

So all of these banks went technically broke. Then the Mexican government had to step in and bail them out, like the savings and loan crisis in the U.S., with money borrowed from abroad. All of us, now in Mexico, owe that money to foreign lenders. The magnitude of the bank bailout, which is bigger than the international bailout ... so far has cost the country about $65 billion. And it's still going.

At the time that this bailout was being put together, was there the sense that the U.S. government, the U.S. Treasury, was trying to micromanage Mexico's economy?

There was more than the sense. There was the reality. The treasury team, so-called country team, went straight into the Mexican treasury and the central bank and sat there and basically monitored everything hour by hour, day by day. This was a lot of American money that was behind this and in a sense the Americans sort of said, "Look. You guys have crises every six years. Before we'd give you the money and you would manage it, but frankly this is getting a little repetitive. So this time we're going to give you the money, but we'll monitor it and manage it much more closely and carefully than on previous occasions." I think that's largely what happened.

So who, in the end, was rescued by this bailout money?

First, investors were rescued unquestionably. Nobody lost their shirt. That was very important from Clinton's Wall Street connection, bond market connection policy. Not because he has friends and he rescued his friends. That's not the issue. The issue is that there was not a revolt on Wall Street and among investors and in the bond markets because of a Mexican collapse. It didn't happen. There is a marked difference between that and the Russian collapse of August '98, when some investors, did lose their shirts.

Secondly, the Mexican banks were rescued. They were all technically broke if it had not been for the Mexican governments plowing in an enormous amount of money, $60-, $70 billion to bail them out. But that money came from abroad because the Mexican government had no money to do this on its own. It borrowed money from abroad and lent it to the banks to bail them out. So they were bailed out.

Finally, the Mexican political system was bailed out. Probably, it would have collapsed if there had been no financial bailout. Probably, the government of Ernesto Zedillo in one way or another would have collapsed, and a new political system would have finally emerged in Mexican, painfully. There's no way you can move from 70 years of authoritarian rule to a democratic system easily. There would have been a price to pay. I think it would still have been a lower price, a cheaper price, than the one we will end up paying. But that is, obviously, a different argument.

In your opinion, if investors had lost their shirts ... would the rolling crisis that we've been experiencing since East Asia, through Russia and now into Brazil been as likely to have happened?

Well, probably not, because they would have really have had to face the risk and premium dilemma more forcefully. When people invest, whether it's banks, who don't do this a whole lot, but brokerage firms, institutional firms, mom and pop investors; whatever, when they invest in Mexican paper, Brazilian paper, Ukrainian paper; whatever, they know somewhere that the reason they're getting three, four, five, eight, 10 points above Treasury bills in the United States is because it's riskier. But they don't really face up to what that means. What it means is you might not get your money back. That's what it really means. The logic of that investment is that you're getting more because you might not get anything. And you decide you want to take that risk.

That relationship or that dilemma has been skewed or nullified by these bailouts. A banker once said to me [when] I asked him, "Why are Mexico premiums now fall[ing] so low when apparently the place is collapsing?" He said, "Because you Mexicans," referring to me, "you have a rich uncle ... he'll post bail every time you get drunk and get thrown into jail overnight."

The rich uncle is, of course, the United States. Everyone thinks that whatever happens there are some countries that the U.S. will not allow to sink: Mexico, Brazil, perhaps Russia, although that didn't turn out to be totally true, a few others. So you can invest in those countries risk free. You can sort of win on both sides of the ledger.

... after Mexico has opened its markets, opened its financial sector ... describe for me the kinds of people, specifically Americans, who come rushing in. How much do they know about Mexico, about this new market, etc.?

They have no idea. Investors who are playing with their own money or even direct foreign investment, people who go in and build a factory, who want to export or buy land, build a hotel, they don't know what they're getting into.

Now, in theory, they don't have to know. That is if the markets are open and are stable, even if the rule of law is a fact of life, if the governments are more or less democratic, if the U.S. embassy and trade bureaus are doing their job, they don't have to know much. They just have to know what they know how to do whatever--build cars, widgets--it doesn't make any difference.

Unfortunately, those other givens don't always hold. The markets are not really even fair, because of corruption, because of the cartels, because of insider information, etc. The rule of law does not exist in most of these countries. The democracies they have are very superficial, very thin skinned.

And the U.S. embassy most of the time doesn't do its job in the sense that most of the time it's in bed with the local ruler whoever he or she may be. It may be a Democrat and a decent, intelligent individual like Fernando Henrique Cardoso in Brazil. Or it may be an ... authoritarian ruler ... like Salinas.

It doesn't make any difference. In both cases, the American embassy is not going to tell somebody, "Hey. If I were you, I wouldn't put my money in Brazil or Mexico right now because God knows what's going to happen." It's not going to do that because the embassy's in bed with the local system ... they know it would become a self-fulfilling prophecy ...

... Who's in charge in this new global economy?

To a large extent, no one is. This is one of the problems that there is no regulation anymore of international capital flow. At the same time, it's impossible to live without some form of regulation. Since you can't have it on a national scale or it's very difficult to have it at a national scale, you have to have some form of regional or international regulation.

There simply hasn't been the leadership, there hasn't been the vision to build that new type of international regulation of capital flows in this new era. There hasn't been a Bretton Woods. There hasn't been, consequently, an international consensus hammered out by the leading economies about how those international flows are going to be regulated.

It's not true that it can't be done. It can be done. It was done then and it can be done again. It's not that big of a problem. It's just a question of the largest economies in the world deciding to do it and to establish the regulations that have to be followed. But for the moment they don't want to, largely because the United States doesn't believe in it.

And as long as the United States doesn't believe in it, it's pretty tough. It can't happen.

It can't happen.

So does that leave the markets in charge?

No, because the markets aren't an agency. There's no one there. The markets don't exist in that sense. That is, there's no one. George Soros doesn't decide he's going to attack the real [currency] and consequently if you sit down and talk with him and convince him that he shouldn't, he won't. That's not the way it works. There's no one in charge. The markets as a subject or as an agency don't exist. They're just trends and processes and movements, which can have these devastating effects, which we've now seen ... The fund people love to say that, "If you have your fundamentals right, you're in good shape." It's not true. The markets' speculative flows attack people with good fundamentals, bad fundamentals, no fundamentals. That's not the way that works.

How is the U.S. increasingly viewed?

Well, I think it depends, in many ways. Obviously, it's still the country that puts together the bailouts. So you can't be too upset at them, because these are the guys who save you when you're in trouble. It's also the country that is seen as the only one that could put together a new consensus for some form of international regulation.

And finally, it's also seen as a country where that leadership doesn't exist because American ideology gets in the way. Americans don't believe in regulations. So how are they going to build a consensus for regulation? They would be the first ones to be against that consensus. And this is a real problem, because you can't do anything without the United States. But the way things are, you can't do anything with the United States.

Are we looked at as a bully?

I don't think so much as a bully as rather a combination of altruism for bailing people out, selfishness because of having your own ideology about how the world works, and a certain amount of naiveté and ignorance, of not understanding the way the world really works ...


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