Mexico is draining the U.S. treasury.

• Author: Schnepper, Jeff A.

IN DECEMBER, 1994, Mexico stunned the financial markets by devaluing the peso. Pres. Ernest Zedillo, who took office that month, has seen his country's currency, and buying power, fall more than 40% since he was inaugurated.

Zedillo has blamed the crisis on his predecessor, Carlos Salinas. During Salinas' presidency, he launched reforms to slash triple-digit inflation, dismantle trade barriers, and open the Mexican economy to foreign investment. His objective was to get Mexico out from under a mountain of foreign debt and to propel his people out of poverty.

Part of Salinas' anti-inflation strategy was to tie the value of the Mexican peso to the U.S. dollar so that the value of the peso would not fall. A failing peso would have pushed up Mexican inflation and substantially increased prices on imports. This strategy worked so long as investments flowed into Mexico, providing the foreign currency needed to finance a growing trade deficit. Since 1988, Americans and others poured $50,000,000,000 into Mexico. Foreign investment flowed in at a rate of $2,000,000,000 a month in 1994.

However, foreign investment could not continue at that rate forever. and the peso eventually would have to be cut loose from the dollar and allowed to float freely. This became clear in 1994, when the North American Free Trade Agreement (NAFTA) was passed, as rising U.S. interest rates lured foreign investors to dump the peso in favor of the dollar, and Mexico's foreign exchange reserves plummeted. Salinas' government began using its $30,000,000,000 in foreign currency reserves to buy up pesos, at times spending $1,000,000,000 a day.

Zedillo asked Salinas in October to allow the peso to fall, but was rejected. By Dec. 19, reserves were below $10,000,000,000 and dropping fast. Salinas never acted, and Zedillo compounded the problem first by denying that a devaluation was in the works, then announcing one on Dec. 21 without unveiling a plan to counter the economic impact. Stunned foreign investors dumped Mexican stock, pushing the peso down even further. The peso plummeted 70% before it began climbing back.

The impact on Mexico could be devastating. Devaluation means renewed inflation. Going from a high of 150% in 1987 to eight percent in 1994 required astronomical interest rates and huge cuts in social spending. Those high rates and huge cuts will have to be endured again by the Mexican people. Mexican companies will have their growth strangled by these same high...