In an Uncertain World Read Free Page B

private meetings ever leaked out. (For this book, they gave me permission to refer to these conversations.)
    I had seen Greenspan periodically during my time at the White House but hadn’t known him very well before I became Treasury Secretary. When we were both thrown into the peso crisis, we got to know each other rather quickly. I was deeply impressed with the way he thought about the problem. Alan, who believes strongly in the discipline of markets, was very focused on the issue of moral hazard. This was why he had opposed the government rescue of the Chrysler Corporation in 1979. But, despite his opposition to the idea of government intervention in markets, Alan weighed the moral hazard against the risk of having Mexico go into default. He was a pragmatist, trying to find the best way to balance competing considerations.
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    ALAN, LARRY, AND I AGREED about what had caused the crisis. Mexico, despite reforms in many areas, had made a serious policy mistake by borrowing too much in good times, leaving it vulnerable when sentiment shifted. And when markets began to lose confidence, the government put off facing reality for as long as possible. It borrowed still more, at shorter and shorter terms, issuing dollar-linked debt and spending its limited dollar reserves on holding up the peso, which had an exchange rate fixed to the U.S. dollar. At the same time, creditors and investors—both Mexican and foreign—were paying little attention to the buildup of economic imbalances. Their continued financing allowed the problem to become almost unmanageable when the crunch finally came.
    The trouble really began in the early 1990s, when Mexico’s current account deficit—basically the trade deficit plus net interest payments and some similar items—began expanding rapidly. To cover this gap, the country needed dollars, which it attracted by issuing government bonds. At first, it sold peso-denominated assets. But later, as investors became less willing to take on the exchange rate risk, the government started issuing large quantities of Tesobonos, short-term obligations whose value was linked to the U.S. dollar. For a while, these bonds proved attractive to Mexicans and foreign investors. But Mexico’s large current account deficit combined with a fixed exchange rate was not sustainable indefinitely. To make matters worse, Mexico’s banking system was weak and under strain.
    Underlying imbalances like Mexico’s are the real cause of resulting crises, but often some event that might otherwise not have created trouble serves as a trigger. In this case, a violent insurgency in the Chiapas region at the beginning of 1994 and the assassinations of two leading Mexican politicians created a deep sense of alarm in financial markets. Mexican bonds began to look much riskier and started to trade at steep discounts. Domestic and foreign investors became less willing to keep money in Mexico. The central bank had to sell more and more of its foreign exchange reserves as it struggled to meet the demand for dollars while holding the exchange rate unchanged. At the same time, the Mexican government found it more and more difficult to roll over its debt, despite offering higher and higher interest rates.
    As so often happens in financial markets, these negative effects became self-reinforcing. As investors feared that the exchange rate might fall, they moved into dollars and drove the government’s reserves down still further. This in turn made a peso decline more likely and exacerbated fears of a government default. The promise to repay Tesobonos with however many pesos were required to keep investors whole in dollar terms came to look less and less credible. With the foreign exchange reserves running out, the authorities made a last-ditch attempt to save the fixed-exchange-rate system with a partial devaluation, but that didn’t stem the tide. Domestic capital continued to flee, foreign market