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Created 2/21/1996
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Peso Footnotes

*. Bradford DeLong is an associate professor of economics at the University of California at Berkeley, a research associate of the National Bureau of Economic Research, and was deputy assistant secretary of the Treasury for economic policy from 1993-1995; Christopher DeLong is an associate at the New York law firm of Howard, Darby, and Levin; Sherman Robinson is director of the trade and macroeconomics division of the Washington D.C.-based International Food Policy Research Institute, was senior staff economist specializing in NAFTA issues at the President's Council of Economic Advisers from 1993-1994, and is one of the intellectual parents of the North American Development Bank.

The views expressed in this essay are those of the authors alone, and not of any organization or govenment.

1. For analyses that note the repeated nature of the "surprise" capital-inflow crises of developing economies, see Barry Eichengreen and Albert Fishlow, Contending with Capital Flows: What Is Different About the 1990s? (New York: Council on Foreign Relations, 1996); and Jeffrey Frankel and Andrew Rose, "Exchange Rate Crashes in Emerging Markets: An Empirical Treatment," Journal of International Economics (forthcoming). We are indebted to these authors for helpful discussions.

2. In June 1985, 92 percent of Mexico's domestic manufacturing production was protected by a restrictive trade régime by which imports had to be licensed; the average Mexican manufacturer was protected by an additional tariff of about 25 percent. By mid-1990 only 19 percent of domestic manufacturing production was protected by import licenses, and the average tariff had been cut in half. In 1989 Mexico began to relax the restrictive, foreign investment-limiting requirements of its 1973 Law and Foreign Investment. As of today, state-owned banking, insurance, and telecommunications companies have been privatized.

3. Raul Hinojosa-Ojeda et al., Job Loss in the USA Due to NAFTA (WWW Site of the North American Integration and Development Center at UCLA;, updated Feb. 20, 1996). We would like to thank Raul Hinojosa-Ojeda for helpful discussions on this issue.

4. See Congressional Budget Office, An Analysis of the Economic and Budgetary Impact of NAFTA (Washington: GPO, 1993).

5. He discussed an essay he had written with Alejandro Werner. See Rudiger Dornbusch and Alejandro Werner, "Mexico: Stabilization, Reform, and No Growth," Brookings Papers on Economic Activity 1994:1 (Spring 1994).

6. See Andrew Warner, "Was Mexico's Exchange Rate Overvalued in 1994?" (Cambridge, MA: Harvard Institute for International Development Disc. Paper 525, 1995) for another estimate of the degree of peso overvaluation in 1994.

7. As of the end of January 1996, U.S. lending to Mexico under the terms of the support package amounted to $10.5 billion. See U.S. Department of the Treasury, The Treasury Secretary's Monthly Report to Congress on Mexico (WWW Site of the U.S. Department of the Treasury;, updated Feb. 2, 1996).

8. For a survey of the state of the Mexican economy six months after the crisis, see OECD, OECD Economic Surveys: Mexico 1995 (Paris: OECD, 1995).

9. Even in retrospect it is hard to judge the true risks. Sergio Schmukler and Jeffrey Frankel argue that the risks of "contagion" and world-wide financial crisis were less than thought in the heat of the moment. See Sergio Schmukler and Jeffrey Frankel, "Crisis, Contagion, and Country Funds" (Berkeley, CA: U.C. Berkeley xerox, 1996). Guillermo Calvo argues that the risks were very great. See Guillermo Calvo, "Capital Flows and Macroeconomic Management: Tequila Lessons" (College Park, MD: University of Maryland xerox, 1996); and Guillermo Calvo and Enrique Mendoza, "Reflections on Mexico's Balance-of-Payments Crisis: A Chronicle of a Death Foretold," Journal of International Economics forthcoming.

10. Consider the Buchanan radio commercial: "I'm Pat Buchanan. Friends, we have to balance the budget, but Congress is going about it the wrong way. Before we cut Medicare for Senior Citizens, why don't we cancel the $50 billion bailout of Mexico?" The implication is that grandma will get dumped out of the hospital into the snow because the money to pay for her hospitalization is going to the plutocrats of Wall Street and Mexico City. Never mind that U.S. exposure is not $50 but $10 billion, that regional recessions in Texas and California that would have been likely in the absence of the rescue package would diminish Treasury receipts by far more, and that the peso support package looks likely to make not lose money for the U.S. Treasury.

11. The interest rate premium of Tesebonos over U.S. Treasury Bills in early 1994 was some 4 percentage points, suggesting that investors foresaw a risk of, say, 10 percent per year that something would destroy 40 of the real value of their investment. At the height of the crisis in early 1995, Tesebono interest rates were 20 percentage points above U.S. Treasury Bill rates, suggesting that those holding three-month Tesebonos then saw a 10 percent chance that they would have lost an average of 50 percent of their real value by the time the crisis had passed.

In addition, it appears likely that investors in Mexico did see the likelihood of a serious peso crisis before investors elsewhere, did begin to pull their money out of Mexico into New York before foreign investors began to do so, and so did bear a smaller share of the capital losses from the crisis. See Jeffrey Frankel and Sergio Schmukler, "Country Fund Discounts and the Mexican Crisis of December 1994: Did Local Residents Turn Pessimistic Before International Investors?" (Berkeley, CA: U.C. Berkeley xerox, 1996).

12. See, for example, Allan Meltzer, "A Mexican Tragedy" (Pittsburgh, PA: Carnegie-Mellon xerox, 1995). Meltzer says that "... once there is agreement on the terms of the [debt] renegotiation [after default], capital flows to the country soon resume." He is careful not to tell readers how long such debt renegotiations typically take.

13. Critics of the support package like Allan Meltzer, "A Mexican Tragedy" (Pittsburgh, PA: Carnegie-Mellon xerox, 1995), deal with the possibility of a spread of the crisis by assuming it away.

14. Neither expansions of foreign aid (to compensate for the unequal impact across countries of the crisis) or an increase in the progressivity of the tax system (to compensate for the fact that financial benefits for U.S. citizens from the rescue package flowed mostly to the rich) appear politically popular today, yet these are the substantive policies to which worry about the "$50 billion bailout for Bob Rubin's friends" should lead.

15. See George Graham et al., "Mexican Rescue: Bitter Legacy of Battle to Bail Out Mexico," Financial Times (February 16, 1995), on this website as IMF Directors Balk. The strangest argument made--an argument also made in Meltzer, "A Mexican Tragedy"--is that providing financial support risked creating "moral hazard": that in the future similar crises would repeat because investors and governments would expect a support package. As far as investors are concerned this is the point: we do not want investors to hesitate to commit their money to emerging market economies with strong fundamentals because they fear a liquidity crisis, and thus we hope that investors will anticipate a support package in cases of liquidity crisis when underlying policies are sound and fundamentals are strong. In the case of governments, does anyone believe that the government of Mexico--even with the support package--is happy with the outcome, and would repeat the chain of decisions that led to the crisis had they the chance to do it over again? From the government of Mexico's perspective, their country's economy is in a serious recession; their international reputation is shot; and economists conducting post mortems debate whether their errors of policy were fatal or just serious.

16. Barry Eichengreen, Golden Fetters: The Gold Standard and the Great Depression (New York: Oxford University Press, 1992).

17. Jorge Casteneda, The Mexican Shock: Its Meaning for the U.S. (New York: The New Press, 1995).

Econ Articles

Created 2/21/1996
This is
Brad DeLong's Home Page

Professor of Economics J. Bradford DeLong, 601 Evans
University of California at Berkeley
Berkeley, CA 94720-3880
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