Party of the Damned
Michael Mussa on the Liquidity Tsunami

Eichengreen (1997): The Baring Crisis in a Mexican Mirror

Barry Eichengreen (1997), "The Baring Crisis in a Mexican Mirror" http://repositories.cdlib.org/cgi/viewcontent.cgi?article=1031&context=iber/cider:

Conventional wisdom has it that the Mexican crisis of 1994-5 was "the first financial crisis of the 21st century." In this paper I argue that it may be better understood as the last financial crisis of the 19th. The crisis in Mexico exhibits striking similarities to the Baring Crisis of 1890, an event that did much to shape modern opinion about the causes and consequences of financial crises and the role for official management.

Parallels between the two episodes are extensive.... Mexico was the benchmark for investors in emerging markets in the 1990s (it was the single largest borrower, and the spreads it commanded set the floor for other borrowers), Argentina, the country whose financial difficulties ignited the Baring Crisis, was commended to investors as "The United States of South America"... the single most important destination for British capital outside the United States and the British Empire... the wheels of international finance were greased by declining interest rates worldwide, associated with Goschen's debt conversion in the 1880s and recession- induced cuts in interest rates by the Federal Reserve in the 1990s. In both cases investors who had been slow to join the bandwagon climbed on board in the final stages of the boom.

While foreign borrowing was portrayed as financing investment in productive capacity, in both cases capital inflows fueled rising levels of consumption. Foreign capital flowed through the banking system, and bank lending financed purchases of luxury imports as well as capital goods. Governments failed to boost their savings to offset dissaving by the private sector. In both cases powerful opposition existed to the government in power, leaving officials reluctant to tighten monetary and fiscal policy for fear of alienating their core constituencies. Hence, they did little to damp down the impact on the economy of international capital flows.

But increased demand did not automatically elicit increased supply. Investment in capacity took time to translate into improved export performance.... Political shocks (strikes and an incipient coup in Buenos Aires in 1889-90, the Chiapas revolt and Colosio assassination in 1994) then raised doubts about the ability of the government to carry out adjustment. Better-informed investors grew wary significantly in advance of the crisis.

The crisis itself drove the Argentine government, like the Mexican government after it, to the brink of default. The fallout destabilized the banking system. It provoked a major recession. And it spilled over to other countries. In 1995 the Tequila Effect was felt in Argentina, Brazil, Thailand and Hong Kong. In the wake of the Baring Crisis, interest rates rose in Brazil, Uruguay, Venezuela and Turkey. Countries as far afield as Australia and New Zealand found it difficult to access external finance....

At the same time there are important differences.... Monetary and fiscal excesses were more clearly evident in Argentina in the 1880s than in Mexico in the 1990s.... In 1995 the Clinton Administration and the IMF saw the need to help Mexico avert a suspension of debt-service... in 1994 there was no single financial institution as exposed as Baring Brothers. In 1890 the fear was for the stability of financial markets in the First World, not the Third. Where the U.S. government's first reaction in 1994 was to assemble financial aid for Mexico, in 1890 the Bank of England and the British Government arranged a rescue fund for Baring Brothers, not for Argentina....

Where the Bank of England could make arrangements with other financial institutions before news of Baring's difficulties became public, the 1995 crisis was a very public affair....

In a sense, then, the Mexican crisis is both the last financial crisis of the 19th century and the first financial crisis of the 21st. Its implications resemble those of the Baring Crisis.... But today's international financial today being even more nimble and decentralized than that of the 1880s, it anticipates the kind of crises that will become increasingly prevalent in the 21st century....

Information on the recent Mexican episode is abundant, and interpretations abound. Hence, I assume that the reader is familiar with the outlines of the Mexican crisis. I concentrate mainly on Argentina in the 1880s, providing just as much information on the Mexican crisis as is needed to place the comparison in relief...

Comments