Tragedy Of The Mexican Bailout
January 2, 1996
Supporters claimed that the $50 billion bailout of Mexico by the United States and the International Monetary Fund (IMF) in January 1995 helped Mexico and prevented an international financial crisis. However, analysis indicates that the crisis was caused by the inflationary policies of the Mexican government.
- The policy of tying the value of the peso closely to the dollar and limiting government spending was abandoned leading up the Mexican presidential elections of 1976, 1982 and 1994, when the government increased debt-financed spending.
- In 1994, there was a 12 percent increase in budgeted government spending during the first six months, a 10 percent increase in annual spending for social development and increased off-budget lending by state development banks.
In addition, between February and March 1994 the Bank of Mexico, the central bank, bought government bonds as citizens dumped them, recognizing a return of inflation. The government continued these policies after the election, while the Bank lost most of its foreign reserves trying to prop up the value of the peso. Still, the peso fell by 35 percent against the dollar in three days, December 20-22, 1994.
History in Mexico and other countries shows that even had the government defaulted on its bonds, once it had adopted anti-inflationary policies and renegotiated its debts, foreign capital would have flowed into the country again. Instead, the U.S.-IMF bailout shifted the burden from bondholders to the Mexican public.
As a result of the government's policies and the bailout:
- The direct cost to the citizens of Mexico of the 50 percent devaluation of the peso and the loss of reserves will be about $15 billion, which is approximately $175 per capita or 5 percent of average income.
- Future export earnings will be used to service and repay the $50 billion in international debt instead of expanding the economy and raising living standards.
- Mexico's real per capita income for 1995 was back to the level of 1970 and only 54 percent of the 1980 peak.
This analysis suggests that international bailouts encourage governments to engage in such risky behavior, just as deposit insurance encouraged weak U.S. banks to engage in risky behavior, worsening the failures and raising the costs to taxpayers.
Source: Allan H. Meltzer, "A Mexican Tragedy," On the Issues, January 1996, American Enterprise Institute, 1150 Seventeenth Street, NW, Washington, DC 20036, (202) 862-5800.
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