Riding the Debt Spiral

Like other developing countries, Mexico became indebted to the private banking community because of its attempts to escape the restrictions of official aid agencies and because of the structural transformation of the capital market (Wood 1986). Both the private and public sectors in Mexico relied heavily on foreign loans to finance the phenomenal growth of the 1970s, because during this period the Mexican economy turned toward import substitution manufacturing of consumer goods instead of the previous industrial production, which depended on capital goods importation. Ironically, the rapid expansion of Mexico's petroleum industry aggravated the dependence on foreign loans because Mexico had to import the technology required for that industry's development. While export earnings soared from $6 billion in 1977 to $19 billion in 1981 (75 percent of which derived from petroleum), imports nearly quadrupled from $6 billion to $23 billion (Hamilton 1986b, 154–155). Earnings from petroleum exports were wiped out by the cost of the imported goods required to support the growth of the oil industry, producing a balance-of-trade gap.

Getting into debt came quickly and easily for Mexico. Pemex borrowed $10 billion in 1981. (Its previous total debt was $5 billion.) Mexico's total debt increased in 1981 from $55 billion to $80 billion (New York Times , 17 Aug. 1982, D17). It owed almost $34 billion (60 percent) to U.S. banks, which shortened the maturities on this debt (U.S. Congress, House 1982, 6–7; Joint Session 1984, 46; see also New York Times , 21 Aug. 1982, 32; 31 Aug. 1982, D1). In the first half of 1981 only 5 percent of Mexico's debt was due within one year. That proportion climbed dramatically to 22 percent by the end of that year. The majority of the new loans were due in six months (U.S. Congress, Joint Session 1984; Kraft 1984, 35).

López Portillo refused to cut government expenditures or raise new taxes despite Mexico's quickly deteriorating situation (New York Times , 9 Sept. 1982, D19). Instead Mexico devalued the

peso several times, further eroding its balance of payments (U.S. Congress, Joint Session 1984; Barkin and Esteva 1986; Hamilton 1986b).

In addition, because of internal political struggles Mexico's leaders often made contradictory decisions. For example, only days after announcing a devaluation in March 1982, the government allowed a wage increase that reduced the benefits of the devaluation. Austerity measures that were supposed to accompany the devaluation (including decreases in public spending, increased interest rates, and more price increases to discourage food and oil overconsumption) never materialized. The capital markets responded by raising the interest rate on Mexico's $100 million Eurodollar loan to 18.5 percent (Kraft 1984, 37; see also New York Times, 19 May 1982, D8; 25 May 1982, D1).

Although high inflation and interest rates and repeated currency devaluations seriously hurt Mexican industrialists, Mexican bankers benefited from the situation (Hamilton 1986b). Mexico's economic expansion of the 1970s included a significant transformation in its banking community. The number of banks fell from 243 in 1976 to 63 in 1981 as a result of a streamlining program by Finance Secretary David Ibarra Munoz in which many small banks were combined into large ones. At the same time Munoz urged Mexican banks to join major Western banks in lending consortia, thereby increasing their access to international financial resources. The resulting concentration of resources was dramatic: "By 1982, 65 percent of [Mexican] banking assets and 75 percent of profits were concentrated in the three largest banks" (Hamilton 1986b, 155). This concentration and access to foreign capital resources benefited the Mexican banks during the continued devaluations because they earned high interest rates on assets and earned profits from dollar investments ouside Mexico. But Mexican industrialists, who had no access to international financial resources, suffered from the devaluations of the peso and high interest rates on their outstanding debts (Hamilton 1986b).

Further devaluations of the peso and increases in imports produced a flight from the peso. Some foreign banks whose loans were maturing refused to renew them (U.S. Congress, House 1983a; Kraft 1984, 37; New York Times , 17 Aug. 1982, D1). Mexico's new finance minister, Jesus Silva Herzog, instituted a se-

ries of emergency measures that failed to ease the country's economic crunch. In mid-August 1982 Silva approached the U.S. government for a rescue plan.

Meanwhile López Portillo had another approach in mind. He believed that Mexico's problems derived from the massive transfer of money out of the country by the banks and the wealthy and middle classes. He wanted to plug that drain by nationalizing Mexico's banks and by using exchange controls (New York Times , 9 Sept. 1982, D19; Hamilton 1986b). The measures were supposed to produce funds that the government could invest productively. The business community and several Mexican government officials, including Finance Minister Silva, opposed the plan. Silva argued that these measures would not stop capital flight from Mexico, but rather would aggravate it by provoking a loss of confidence in the Mexican government and economy (New York Times , 3 Sept. 1982, 2).

On 31 August 1982 López Portillo sought to pacify increasingly militant workers and peasants by signing decrees that nationalized the banks and imposed exchange controls to stop the flight of pesos (Cockcroft 1983). Americans with business investments and fixed-interest dollar documents in Mexico were "angry and alarmed" at the continual devaluation of the peso, the freezing of dollar assets, and the imposition of currency exchange controls (New York Times, 24 Aug. 1982, D13). The devaluations also placed Mexican corporations in a debt crisis. Grupo Alfa, Mexico's largest private corporation, was among the hardest hit by the devaluations; it responded by suspending payment on the principal and most of the interest on $2.3 billion in foreign debt (Business Week, 23 Aug. 1982, 41; see also New York Times , 12 Sept. 1982, F1; Hamilton 1986b).

Currency controls frightened and infuriated the upper classes. Corporations, which could only meet their foreign obligations with dollars, were also angered by the uncertainty about their access to dollars and the rate at which access would be achieved. Groups such as the National Association of Exporters and Importers lodged accusations of governmental incompetence and panicky decision making (Business Week, 30 Aug. 1982, 38; Hamilton 1986b). The devaluations and currency controls also worried and antagonized U.S. corporations. John F. Beck, vice president of

North American Vehicles Overseas (a division of General Motors) warned that the devaluations would generate severe price increases that the market would not bear. Many other business leaders noted that if the Mexican government's extreme measures were not temporary, they would be considered expropriation (Business Week, 30 Aug. 1982, 38).

The U.S. government, alarmed by the implications of Mexico's debt crisis, arranged a package in August 1982 in which the United States agreed to buy $1 billion of Mexican oil for its strategic reserve at prices well below market value, and to pay in advance (Cockcroft 1983). Mexican steel and cement corporations found eager markets in Texas and other U.S. Sunbelt states that were still enjoying growth (Business Week, 13 Sept. 1982, 106).

The Mexican debt crisis and the subsequent currency controls and devaluations also affected U.S. multinational corporations and threatened corporate loans. Many firms had to reexamine their corporate priorities as profits and earnings fell and shipments were interrupted. As one reporter noted, "Many U.S. corporations have Mexican affiliates with substantial dollar debt being placed in overdraft" (Business Week, 4 Oct. 1982, 87; see also Erb 1982; New York Times, 7 Oct. 1982, D1). Most firms ceased all but the most critical shipments to Mexico, and some companies supplied their Mexican subsidiaries with just enough capital to ensure the subsidiaries' survival. When non-Mexican suppliers to the subsidiaries nervously demanded that the U.S. parent company guarantee payment in advance, most of these corporations refused. The suppliers, meanwhile, risked losing their market shares by refusing to make unguaranteed shipments to long-standing customers. One banker summed up the corporate dilemma: "If you want to continue to do business down there, you have to do it on open account and risk not getting paid" (Business Week, 4 Oct. 1982, 87). Interestingly, the banks were unwilling to accept this risk and later struggled for state bailouts of their investments in Mexico (U.S. Congress, House 1983b; Senate 1983a).

The weak peso and uncontrolled inflation sent unemployment soaring in a country where underemployment already stood at 50 percent. More than a million Mexican workers lost their jobs in 1982. Half the layoffs were in construction (Cockcroft 1983; Hamilton 1986b). General Motors had laid off 1,000 of its 9,000

Mexican workers by September 1982. Severe declines in auto sales prompted massive layoffs in Mexico's steel industry (Business Week, 13 Sept. 1982, 104). The new layoffs, together with the old underemployment and inflation, seriously eroded Mexican consumer demand. Workers' purchasing power declined because of the labor unions' agreement to support López Portillo's job creation objectives by accepting more modest wage increases during Mexico's more prosperous years (Business Week, 13 Sept. 1982, 104). Antagonisms between labor and the state were already heated because López Portillo had recently increased the price of such food staples as corn, tortillas, and bread by 50 to 100 percent and of beans (Mexicans' major protein source) by 265 percent as a means of reducing the subsidy burdens of the crisis-ridden state (Business Week, 13 Sept. 1982, 104; Cockcroft 1983; Hamilton 1986b).

Although López Portillo imposed exchange controls to reduce the budget deficit, most social expenditures continued. He argued: "Government spending . . . is the most useful means for achieving the redistribution of income. . . . There has been no squandering of resources. Every program has its own justification" (Kraft 1984, 38–39). These measures made the banking community extremely nervous, and some banks began to take action. They inundated Mexican branch banks in New York with demands for over $70 million in repayments and deposits. At the close of business on 7 September 1982, two major U.S. banks (Chemical and Manufacturers Hanover) found themselves $70 million short, a situation that, left uncorrected, jeopardized the entire clearinghouse system of the banking community (Kraft 1984, 40–41). Paul Volcker, chairman of the Federal Reserve Board, arranged to deposit $70 million into the two banks' accounts from money the Bank for International Settlements (BIS) had advanced to Mexico (New York Times, 31 Aug. 1982, D5). But he emphasized that this was merely a temporary solution, since any demand for Mexico to pay all its $6 billion in obligations would absorb all the money advanced by BIS, the United States, and the IMF. An advisory committee told Mexican officials not to pay the demands in full yet.

At this point negotiations between the IMF, Mexico, the United States, and the banking community began to develop an austerity program for Mexico. A great deal of struggling between Mexican

officials and Jacques de Larosière, managing director of the IMF, ensued in the negotiations. De Larosière rejected López Portillo's approach, insisting instead that Mexico develop policies to cut government expenditures and hold down wages (U.S. Congress, House 1983a; Joint Session 1984). Mexican officials Carlos Tello (director of the central bank) and Fidel Velazquez (head of Mexico's unions) opposed the IMF's standard austerity program. They advocated an administrative retrenchment program involving "a preset and generally overvalued exchange rate, exchange controls, and import licensing." Mexican leaders viewed this alternative approach as Mexican nationalism, facilitating a reduction in "trade and financial dependence on the U.S." (Business Week, 22 Nov. 1982, 55; see also New York Times, 9 Sept. 1982, D19). Volcker, Mexico's advisory committee, and Silva all supported the IMF's position.

These struggles and the mounting pressures prior to the August crisis had a political impact. López Portillo and PRI selected Miguel de la Madrid Hurtado to succeed as president. De la Madrid shifted Mexico's economic policy away from the populist alternative toward compliance with the IMF's austerity program. In his inauguration speech de la Madrid announced his plan to reduce the country's deficit, a plan that included a tax increase, cutbacks in public works programs, and the elimination of subsidies on domestic consumer products such as tortillas and gasoline. Indeed, the next day de la Madrid "doubled the cost of gasoline—twice the increase anticipated by most Mexicans" (Business Week, 13 Dec. 1982, 55). Whereas López Portillo firmly resisted the IMF in his last days as president, de la Madrid committed Mexico

to cut the budget deficit drastically—from an estimated 16.5% of gross national product in 1981 to 8.5% in 1983. Foreign borrowing was to be reduced by three-quarters—from $20 billion in 1981 to $5 billion in 1983. Inflation was to be cut from roughly 100% in 1982 to 55% in 1983. Subsidies, imports and wage hikes were to be lowered accordingly, and taxes raised. Inevitably growth would be negative for a long time to come. (Kraft 1984, 46; see also New York Times, 11 Nov. 1982, A1; Taylor 1984, 147–150)

Silva hoped to use the agreement to raise the banking community's confidence in Mexico. Mexican officials wanted the banks

to extend the ninety-day moratorium on payment of principal, granted in late August, for another ninety days (Kraft 1984, 46; see also New York Times, 17 Nov. 1982, D9). But the banks refused to agree to the extension unless Mexico satisfied two conditions. First, the banks wanted Mexico to maintain its interbank deposits to ensure that other foreign banks would not gain access to Mexico's finances at the expense of the major banks. If Mexico did not comply, the major banks threatened to declare the country in default. Second, the banking community wanted Mexico to address the debt in the private sector. The currency exchange controls imposed by the Mexican government made it impossible for Mexican firms (including those with healthy balance sheets) to find the dollars necessary to pay off or service their debts. The banks wanted the Mexican government to rectify this situation, which threatened to force the banks to reclassify the loans for nonpayment of interest—a move that would have negative consequences for the banks (Kraft 1984, 47; New York Times, 15 Dec. 1982, D2). The banks also wanted Mexico to guarantee the private sector's debt (Wood 1986). Although Mexico basically agreed to establish a mechanism to satisfy these conditions, it hinged on the Mexican central bank's ability to accumulate dollars and on the approval of the U.S. Federal Reserve.

Despite those misgivings the U.S. banking community generally applauded de la Madrid's program to shift the Mexican economy toward a free-market orientation. His approach transferred the blame for Mexico's economic woes from greedy bankers and exploitative industrialized countries to "the Mexicans themselves" (Business Week, 13 Dec. 1982, 27; see also Cockcroft 1983). In line with this position, he reinstated Miguel Mancera as head of the central bank and retained Jesus Silva Herzog as finance minister. Both men opposed López Portillo's program of exchange controls and bank nationalization (Business Week, 13 Dec. 1982, 27; Hamilton 1986b). Members of the Mexican labor movement and leftists in the ruling party were not among de la Madrid's appointees. The pattern of appointments silenced labor and alternative populist viewpoints in favor of the approach preferred by the IMF and the banking and business communities. Willard D. Andres, president of the Latin American division of the U.S.-based Becton Dickinson and Co., noted, "Business supports this guy, and busi-

ness is prepared to wait to get some of the fruits" (Business Week , 13 Dec. 1982, 28). Business interests had a strong ally in the new state administration, which would work on their behalf in negotiations with the IMF and the banking community. The wait was worthwhile for the business community. De la Madrid denationalized 33 percent of the banking industry in 1983 by selling shares in Mexican banks to the private sector (Business Week , 10 Jan. 1984, 40; Hamilton 1986b). He also sold shares in "nonessential" firms held by the nationalized banks (New York Times , 22 May 1984, D8; Hamilton 1986b).