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1982 Mexican Financial Crisis

© 1982, 2001 Donald J. Mabry

The purposes of this presentation are limited just as its contents are tentative. One goal is to outline the chronology of the Mexican financial crisis By doing so, it may help one,understand better what has happened in Mexico in 1982. The other purpose is to suggest some of the consequences of the crisis for the United States. Mexicans will pay the greatest price for the fiscal mismanagent by and greed of a few but U.S. citizens will also pay.
One fundamental problem for the Mexican economy is that it is a satellite of the United States economy. Mexico is the third largest trading partner of the United States, which buys over 65% of Mexico's exports and accounts for a similar percentage of Mexico's imports. Tourism from the United States and border transaction produce billions of dollars for Mexico even after subtracting the large amounts spent by Mexican tourists in the United States Remittances by Mexicans working tn the U.S. contribute more billions to the Mexican economy. More subtle, perhaps, but of critical importance to the financial crisis is that Mexico borrows extensively from US citizens.
The US economy has been sick and the germs have spread southward with a marked virulence. Mexico has caught pneumonia from the US head cold. The US recession eventually caught up with Mexico, which had previously countered international trends in 1977-1981 by increasing its gross domestic product by an average of 7% a year. As interest rates rose, money supplies contracted, inventories grew, and unemployment increased in the United States. The US purchased less and charged more for its exports. The cost to Mexico of imports and capital increased sharply while the value of its exports fell. For more than a year, the prices of petroleum, silver, coffee, cotton, copper and other important Mexican exports declined. In 1981, for example, Mexico projected some $20 billion in oil revenues but received about $12 billion. This year brought similar short-falls as petroleum prices continued to decline. The value of tourism to Mexico fell some $900 million. The staggering budget deficit programmed by the Reagan administration and Congress and the decision of the Federal Reserve System to charge more for money drove interest rates up (the prime rate went up to 17%) and increased Mexico's debt burden by some $2.5 billion.
The Mexican government, for its part, had chosen an economic development strategy which increased its exposure to the ills of the United States economy. It borrowed extensively from foreign, principally US sources to finance investments in infrastructure and industry, social services, and debt service. The projected national budget of 1982 called for 34% of its revenues to come from borrowing. Mexico gambled that its income from tourism and exports, particularly petroleum, would enable it to service its debt and that banks, cognizant of Mexico's position as a major oil power, would continue to rollover the debt if difficulties developed. The very size of the debt which was approximately $70 billion in January, 1982.and some $80 billion in October, seemed to demand cooperation from international bankers. After all, the United States and others had anguished for months about possible default on the Polish national debt of $25 billion, puny compared to Mexico's.
Mexico lost this gamble, The United States government raised the cost of dollars to slow down the rate of inflation and, in the process, inflated the Mexican economy, which depended so much on borrowing. Interest costs to both. the public and private sectors of Mexico skyrocketed.. In 1978, these charges had been $2.606 billion; in 1981, they were $8.2 billion. They continued to climb in 1982. The Mexican economy, already heated up by President José López Portillo's policies, overheated. By January, 1982, Mexican economists were projecting a 60% inflation rate for 1982. Trying to obtain enough dollars to service the foreign debt became critical.
Private citizens in Mexico had not been as optimistic as their government and had been taking steps to insure the integrity of their wealth. They began switching from pesos to dollars. In January, 1982, they had $9 billion deposited in bank accounts in Mexico; by August, they had converted another $3 billion from pesos to dollars and stashed them in such accounts. Ninety percent , of the bank accounts in Mexico were in dollars even though peso accounts paid 23% higher interest. Less optimistic Mexicans sent money out of the country or never brought it in. By July, 1982, some $14 billion had gone into foreign bank accounts and another $25 billion invested in US real estate. Some $6 billion was invested in Texas alone and Texas banks held $16 billion in accounts. It is perhaps no coincidence that the recent downturn in the Texas economy paralleled Mexico's financial troubles in August.
Mexicans were betting that the peso would be devalued and, in February, the government did so. On February 17th, the Banco de México allowed the peso to float; the devaluation that followed eventually amounted to 43%. Besides stimulating exports, the government hoped that devaluation would slow capital flight. The government also cut its own spending and put a price freeze on fifty additional items to mitigate the effects of the subsequent inflation. In March., to pacify workers, the government granted its employees pay raises ranging from 10-30%, retroactive to February 18th. Private employers normally follow suit.
The difficulties in which Mexico was finding itself can be illustrated by the experience of the Grupo Industrial Alfa, the largest private business in Mexico. This Monterrey conglomerate owned a variety of enterprises including steel mills, breweries, food processing plants, and tourist facilities, The company bit off more than it could chew and lost $124 million in 1981 and forecast losses of $304 million in 1982, considerable amounts for a $1.9 billion company. Alfa had also borrowed extensively and was having trouble servicing its debt. On April 21st, the company announced that it was suspending payment on the $2.3 billion debt principal owed to domestic and foreign banks. On April 30th, its representatives met in Houston with representatives of 135 US banks to discuss solutions to the debt problem. The February peso devaluation had increased the company's dollar debt by $140 million, more than it could bear.
US banks were also vulnerable. Citibank and Continental Illinois had each loaned $100 million to Alfa. On August 5th, the company proposed a six-month suspension on 70% of the interest payments on its debt. So, by April, Mexico's largest private enterprise was close to bankruptcy; its shakiness certainly must have encouraged capital flight.
The Mexican government continued to cut back its expenditures but attempted no drastic measures, perhaps because elections were to be held in July. By the end of April, the national budget had been cut 8%; in May, the expensive nuclear energy program was suspended. In August, continued capital flight and shortfalls in dollar reserves forced the government to act. On August 5th, the peso was again devalued, bringing the total decline in the value of the peso in 1982 to 67%. In addition, the government created a two-tier exchange system. To pay international debts and pay for necessary imports, the exchange rate would be 49 pesos to the dollar. For non-essential imports, the rate would be 69.5 to the dollar. On August 12th, the government ordered all bank accounts to be paid out in pesos, thus "freezing" the accounts and eventually recapturing the $12 billion deposited. Trading in foreign currency was suspended, To offset criticism, income taxes were lowered but the government also raised the prices of the basic consumer commodities it had been subsidizing, thus passing some of its financial burden to the consumer. On August 20th, the government got a 90-day extension on repayment of short- and medium term-loans from 115 international banks. Dollar flight was temporarily halted and the government had bought time to negotiate foreign banks
President López Portillo took drastic steps to reorganize the Mexican financial system with one decisive blow. On September 1st, he nationalized all private, Mexican banks and converted the Banco de México into a decentralized government agency. Strict currency controls were adopted. The president accused Mexican financial speculators, aided and abetted by these banks, of having looted the country and brought the nation close to financial collapse by withdrawing some $50 billion from the economy (the Mexican GNP in 1981 was $120 billion). Henceforth, the government would control domestic credit, and, of course, the flow of dollars. Some 80% of the economy was now in government hands, a situation which would force the international bankers to cooperate with Mexico. On September 6th, Mexico suspended payment on all debt principal until the end of 1983.
Washington, for its part, has little choice but to help Mexico. It started helping in August by making a $1 billion advance payment for petroleum and by arranging a near one bi ion dollar loan from the Commodity Credit Corporation. Mexico's importance to the US as a trade partner means that the US needs a healthy Mexico. Congress was considering ways to stop the flow of illegal aliens, most of whom are Mexican, but any hope of expelling those currently in the US were dashed because Mexico needed the $4-7 billion they remit each year. Equally, if not more, important for US policy is the fact that the nine largest banks, in the United States had the equivalent of 40% of their capital and reserves loaned to Mexico. If Mexico defaulted, these banks would collapse and other countries might default as well.
The United States has little choice but to cooperate with Mexico and perhaps there is justice in that. It was US tight money policies that squeezed Mexico and the bad judgment of US bankers in continuing to loan money to Mexico that contributed to the crisis.
New president Miguel de la Madrid took office on December 1st and had to clean up the mess left by his predecessor's irrationality. Most of what López Portillo had done in August was reversed. Mexico could not continue those policies if it wanted foreign investment.