101. Memorandum From Secretary of the Treasury Simon to President Ford1
SUBJECT
- Mexico’s Financial Situation
1. Mexico is in perilous financial condition. Their total external debt is more than $22 billion. Five years ago it was about $6 billion. We estimate that in the next twelve months, debt service requirements will total perhaps $5 billion. In the past year, external debt has increased by about $5 billion. This combined with an $800 million use of reserve assets has financed an estimated $3½ billion current account deficit and a substantial capital outflow of nearly $2½ billion. Mexico, like the U.K., has borrowed large amounts of short-term “hot money.”
2. Recently, Mexico has been losing reserves at a rate of $150 million per week. If this rate obtains in the immediate future, Mexico will be out of reserves in 2½ weeks. Because of their structural current account deficit, the near exhaustion of their reserves and the reported (by them) inability to borrow further significant amounts in the capital markets, a default is quite possible. (A $360 million swap with the Federal Reserve is due on October 9.)
3. This situation is the result of severe economic mismanagement. The Mexican budget deficit has increased from 2 to 3% in the early 1970s to 7% of GNP last year and 9% this year. The rate of monetary creation has been about 20% per year. Wage policy has exacerbated the situation. Last year, Federal workers were given a wage increase of about 17% when they were expecting about half that much.
4. Last week a delegation led by Fernandez-Hurtado visited Treasury and the IMF. We were asked to increase our credit line to Mexico by [Page 325] a “phantom” $500 million. An integral part of the Mexican proposal was that an increase in the line be illusory (the agreement would prohibit effective use of the increase). We indicated we could not recommend such a course for the following reasons:
a. The “announcement effect” of such an increase is pale in comparison to the realities of the situation, which would ultimately become known. If the announcement of such a swap failed to produce a reversal of capital flows of fairly dramatic proportions, Mexico would be out of usable reserves in a matter of weeks. The announcement effect would quite likely be zero, or even minus.
b. If Mexico exhausted its “usable” reserves and was forced by the market to adjust its exchange rate policy and at the same time had an unused swap with the U.S. Treasury outstanding—observers would rightly suspect the Treasury of having participated in a “phantom swap.”
5. Extension of a sizable usable credit on a swap basis would be almost as irrelevant.
a. Unless this swap alone turned the tide (highly unlikely) the borrowings from the swap would add a few more weeks to the effort to avoid a series of measures. It would also mean the absorption of part of the limited amount of official credit available to Mexico for maintenance of an untenable exchange rate.
b. If we unilaterally tried to apply conditions for Mexico, it would place the U.S. in the undesirable position of ordering its southern neighbor around. We would be blamed for politically unpopular measures.
c. Mexico’s problem is acute, it needs long-term money, not short-term debt.
d. There is no visible means of repayment of the swap.
6. As we see it, the Mexicans have three alternatives:
a. Apply exchange controls (difficult to do in Mexico) and declare a moratorium on external debt.
b. Float their exchange rate. Floating would not by itself produce a capital inflow or a positive current account balance. Default on external debt would result in the absence of an almost instant turnaround in current account and/or substantial capital reflow.
c. A drastic change in exchange rate policy plus substantial changes in domestic economic policy and provision of transitional multilateral credit.
After some discussion, the Hurtado delegation indicated their preference for the third option, the only one affording any chance of reasonable results. But the Hurtado delegation does not necessarily represent the judgment of Mexico’s political leaders. They also pointed out that the IMF had told them it would take two months to process an application; two months the Mexicans feel they don’t have.
In conversations with William Dale, Deputy Managing Director of the IMF, we obtained agreement from the Fund to participate in a [Page 326] process which would compress the time needed for Mexico to obtain credit. The plan to which the IMF has agreed is as follows:
1. Secret negotiations would begin almost immediately between the Fund and Mexico. (In fact, a large part of that work has been done—agreement at the technical level that a 40–50% devaluation would be needed; that the budget deficit would need to be reduced sharply from the present 9% of GNP; and discussions are progressing re a program of wage restraint. At present the last area, wages, appears likely to be a sticking point.)
These negotiations would need to be concluded before “free” reserves are totally exhausted. Negotiations would result in a written agreement between the Fund management and Mexico as to the terms under which Mexico would borrow from the Fund (about $750–$1,000 million).
On the basis of that written agreement and a letter from the President of Mexico stating the Government’s commitment to draw from the Fund on the agreed upon terms, the Treasury could consider providing swap credit above the $150 million effectively available to them under the present Treasury swap agreement. This incremental credit would be for a short-term period, to be repaid out of the funds received from the IMF.
2. At the conclusion of the secret negotiations, the Mexican Government would announce the following:
a. Change in exchange rate policy—implementation of this part of the agreement with the Fund.
b. Changes in economic policy—the beginning of the implementation of the economic part of the Fund-Mexico agreement.
c. An increase in the U.S. Treasury-Mexico swap.
d. Announcement of an application to draw from the Fund.
There are several potential flaws in this program:
a. Echeverria might not accept what has to be done and simply opt to default and close the market (note: default would cripple Brazil as well as other LDCs).
b. The announced economic programs might not get implemented, in which case default would occur.
c. The program might not be large enough—outflows of the large balances in very short-term funds might not be stopped by the brutal devaluation contemplated. (Note: we know that their banking system has at least $2 billion in spot dollar liabilities against which there are Mexico’s meager reserves.)
These risks reflect the severity of the situation. We could beef up the swap part of this program. We could probably tap some other countries—Germany and Japan. But the size of the swap credit needs to be keyed to the amount that could be loaned to Mexico by the Fund since [Page 327] usable reserves are almost exhausted and, thus, the IMF is the only source of repayment for lenders of swap-type credit.
The Hurtado delegation returned to Mexico City August 18. They were to discuss their conversations here with President Echeverria and President-elect Lopez-Portillo, and others. A decision as to what course to adopt—whether to open conclusive negotiations with the Fund—is expected shortly.
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Summary: Simon summarized Mexico’s financial situation for the President, noting that Mexican authorities would likely make drastic changes to their exchange rate policy while pursuing additional credit from the International Monetary Fund.
Source: Ford Library, National Security Adviser Papers, Presidential Country Files for Latin America, 1974–1977, Box 5, Mexico 4. Top Secret. In telegram 11213 from Mexico City, September 1, the Embassy reported on Echeverría’s August 31 decision to float the peso against the dollar. (National Archives, RG 59, Central Foreign Policy File, D760332–0072) In telegram 216408/Tosec 250009 to Kissinger, September 1, the Department reported that Echeverría’s decision to change his exchange rate policy and to make “major domestic, economic and financial adjustments” had resulted from negotiations with the IMF. (Ibid., D760330–1182) An September 14 memorandum from Hormats to Scowcroft noted that the initial reaction to news of the float had been mild but that unease was growing as Mexicans came to realize that austerity measures would likely cause hardship. (Ford Library, National Security Adviser, NSC Staff for International Economic Affairs, Box 2, Country File, Mexico)
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