United States Bails Out Mexico

Date January 31, 1995

When the Mexican economy threatened to collapse and send shock waves throughout the world economy, the United States joined with the International Monetary Fund to create a multilateral financial package to bail out Mexico and prevent a global economic crisis.

Also known as Mexican peso crisis

Locale Mexico

Key Figures

• Ernesto Zedillo (b. 1951), president of Mexico, 1994-2000
• Jaime Serra Puche (b. 1955), Mexican secretary of finance, December, 1994-January,1995
• Carlos Salinas de Gortari (b. 1948), president of Mexico, 1988-1994
• Michel Camdessus (b. 1933), managing director of the International Monetary Fund, 1987-2000

Summary of Event

December 1, 1994, marked the inauguration of Ernesto Zedillo as the newest president of Mexico. The inauguration ceremony signaled the beginning of a promising presidential term and was a crowning event for outgoing president Carlos Salinas de Gortari, who was praised for his economic policies, which included the signing of the North American Free Trade Agreement (NAFTA) on January 1, 1994, and a set of economic reforms that helped Mexico achieve outstanding economic growth during the early 1990’s. The euphoria experienced by Mexicans and the Mexican government was not just a local feeling; other major world economic players such as the United States and the International Monetary Fund (IMF) were also praising Mexico’s economic performance in the 1990’s.

The feeling of confidence experienced during Zedillo’s inauguration festivities lasted less than a month, however. While Mexico was praised as a growing economy, it was far from a strong one, and after a few months of unexpected financial shocks within the country and worldwide, the government had to take action. On December 19, 1994, as a consequence of growing problems experienced by the Mexican economy, President Zedillo’s administration decided to change the value of the peso against the dollar, devaluating the Mexican currency by 15 percent, from 3.7 pesos to a dollar to 4 pesos to a dollar. At the time of the crisis, the Mexican economy was using what is known as a pegged currency—that is, the Mexican peso was worth a certain amount of dollars and it could not be worth more or less than that amount. The Mexican government’s move went against prescribed policy, and it led to a speculative run against the peso that forced the government to let the peso float freely against the dollar.

In a matter of days, the peso was highly devalued (at approximately 7.2 pesos to the dollar), and widespread panic started to hit not only the Mexican government but also investors. By late January, 1995, the newly installed Mexican secretary of finance, Jaime Serra Puche—a former secretary of commerce in the Salinas administration and an important player in the negotiation and creation of NAFTA—had resigned amid pressures from investors and the government. The quick devaluation of the peso led foreign investors to see the Mexican economy as unstable and unfit for investment, leading to a massive capital flight from the country.

Many see the beginning of the Mexican crisis as a self-fulfilling prophecy. Investors had worried in 1994 that the Mexican economy was not strong enough to sustain internal and external pressures, and this concern, together with a few dubious policies implemented by the Mexican government, led to the beginning of capital flight from the country. As the foreign reserves were slowly depleted, the government had no option but to let the peso float against the dollar, and as the peso floated, investors became worried that the peso would devalue dramatically against the dollar, leading to a dumping of pesos in the market and consequently leading to the dramatic devaluation of the peso. In other words, the fear of devaluation led investors to take their investments elsewhere, and this exodus of capital led to the devaluation of the peso.

As a consequence of the dramatic devaluation of the peso and the subsequent market panic, the Mexican economy was pushed to its limit, leaving the government on the edge of default. The possibility that Mexico could default on its debt payments was a dire prospect that the United States could not afford. Not only had Mexico become a more important economic partner with the United States since the creation of NAFTA, but also many of the Mexican government’s creditors were American companies that could not afford to have their biggest debtor fail to pay what it owed.

In addition to the direct interest the United States had in seeing Mexico’s economy stay afloat, other countries had a considerable amount of vested interest in the health of the Mexican economy. The developing nations especially were paying close attention to what was happening in Mexico in 1995. Many countries feared that the kind of economic crisis taking place in Mexico could spread to other developing nations and even developed nations.

On January 31, 1995, with Mexico on the brink of default and investors all over the world worried about the global economic environment, the U.S. government, together with the IMF, announced a financial support package for Mexico totaling $52 billion. Of this amount, $20 billion would come directly from the United States (through the U.S. Treasury’s Exchange Stabilization Fund), $17.8 billion would come from the IMF, and the remainder would come from other creditors. The main objectives of the United States and the IMF in offering this “bailout” package were to prevent the feared Mexican default and to increase confidence in the Mexican economy. The United States also helped Mexico in other ways during the crisis, such as by purchasing pesos in the market to help stabilize the country’s foreign reserves and consequently increasing the value of the peso against the dollar.

Significance

For the most part, the U.S.-IMF loan package did what it was intended to do. It prevented Mexico from defaulting on its debts, and it encouraged some much-needed confidence in the Mexican economy. After a bad year in 1995, the Mexican economy was able to bounce back in 1996, and its strong recovery continued through the end of the twentieth century.

The Mexican peso crisis was the first major economic crisis since the end of the Cold War, making it the first crisis of the “new world economic order.” The loan package offered by the United States and the IMF, the first of its kind, set a precedent for future bailouts, such as the one the IMF and the World Bank offered during the Russian financial crisis of 1998.

The Mexican crisis showed the world’s nations how dangerous economic crises can be in the new economic order and how reliant countries are on one another to create a stable global economic system. The assertiveness of the United States in providing the financial help that Mexico needed in its period of crisis was a very important moment in U.S. foreign policy, showing the direction of the American economy and American policy making not only in regard to Mexico and NAFTA but also in regard to the position of the United States in the world economy in the 1990’s.

Bibliography

Boughton, James M. “From Suez to Tequila: The IMF as Crisis Manager.” Economic Journal 110 (January, 2000): 273-291. Explains the role played by the IMF in the handling of the Mexican crisis.

Claessens, Stijin, and Kristin J. Forbes, eds. International Financial Contagion. Norwell, Mass.: Kluwer Academic, 2001. Collection of essays discusses not only the Mexican crisis but other financial crises of the late twentieth century, explaining the reasons and consequences of theses crises.

Edwards, Sebastian, and Moises Naim, eds. Mexico, 1994: Anatomy of an Emerging Market Crash. Washington, D.C.: Carnegie Endowment for International Peace, 1997. Collection of essays discusses different approaches to understanding the market crash.

Naim, Moises. “Mexico’s Larger Story.” Foreign Policy 99 (Summer, 1995): 112-130. Presents a detailed explanation of the factors (internal and external) that played a role in creating the Mexican crisis.

Sachs, Jeffrey, et al. “The Collapse of the Mexican Peso: What Have We Learned?” Economic Policy 11 (April, 1996): 13-63. Detailed economics essay describes the reasons for the Mexican crisis and the policies implemented afterward.