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Hard Days For Lame Ducklings : Latin Debt

January 10, 1988|Walter Russell Mead | Walter Russell Mead is author of "Mortal Splendor: The American Empire in Transition" (Houghton Mifflin)

NEW YORK — When Treasury Secretary James A. Baker III left the White House he must have taken the Teflon with him. Since the swap that put Donald T. Regan in as chief of staff and Baker at Treasury, the White House has been rocked by one scandal after another.

Over at Treasury, meanwhile, three years of financial instability and worsening economic conditions have somehow failed to tarnish the reputation of the man who presides over America's chaotic economic policy. Most recently, weeks of turmoil in the currency markets have exposed the failure of Treasury policies on the dollar and trade while the Morgan Bank proposals on Mexican debt signal the demise of the "Baker Plan."

A genius for public relations combined with a blind spot for policy issues was always the hallmark of the Reagan team. It is becoming clearer who the chief source of both the genius and the blind spot must have been. Baker--a consummate survivor who was the only outsider to break into the Reagan inner circle--has survived the collapse of his economic policies and the Administration's disarray.

Baker took office at Treasury when the country faced two serious economic threats. The U.S. balance of trade had turned drastically negative, and a worsening Third World debt crisis was undermining the financial system. The new Treasury secretary approached these issues with two basic policies: He would drive down the dollar to cut the trade deficit and the Baker Plan would generate new growth in the Third World while relieving strains on the banking system.

During Baker's three years in office, the dollar has fallen lower than it did under Jimmy Carter, the United States has become a debtor nation for the first time since World War I and the trade deficit has reached unimaginable levels.

The latest example of Baker's problems came as Morgan Bank and the Treasury unveiled their new plan to solve a Third World debt crisis that has undermined the stability of the U.S. banking system--and crippled foreign trade--through most of the Reagan presidency. In essence, Mexico will use $10 billion of its foreign currency reserves to buy U.S. Treasury bonds, which will then guarantee a portion of its debt. Morgan and other banks will trade roughly $2 of their old unsecured debt for $1 of new, safer securities.

The proposal represents the final collapse of the touted Baker Plan. Baker's original program rested on the unlikely assumption that internal financial reforms and modest increases in aid would put debtor countries on the road to prosperity. They would begin to pay debts and, as they returned to stability, new private credit would flow to the improving debtor economies, financing further growth. The Baker Plan was an important step: It was official recognition that growth was the key to Third World health.

The Baker Plan was never healthy; banks were skittish from the start at making more loans to debtor countries; and without new private capital, the hoped-for growth could never occur. The Baker Plan received its first serious blow last spring when, led by Citicorp, major U.S. banks fattened reserves to cover expected losses on Third World loans. The Morgan Plan, by which the banks publicly acknowledge their Third World loans are worth far less than face value, confirms the private sector's vote of no confidence in the Baker Plan: Banks do not make new loans while taking payment of 50 cents on the dollar for old ones.

Unfortunately, sharp reduction in the trade deficit--one of Baker's goals--would worsen Third World debt problems because debts must be paid by earnings on exports. South Korea has a huge foreign debt, but bankers like to lend to the Koreans. Their balance-of-trade surplus with the United States helps them make prompt payments. The only hope for even partial payment of Third World debt involves massive trade surpluses in countries like Mexico, Brazil and Argentina.

The collapse of the Baker Plan came as Baker's other major policy initiative--reducing the trade deficit by letting the dollar fall--lay in ruins. Since February, 1985, the dollar has lost about 50% of its value against leading foreign currencies, but the trade deficit has increased. Events along the way have been less than edifying--many blamed Baker for precipitating the October market crash by talking down the dollar.

Now the dollar has fallen as far as it conveniently can, and the trade deficit is still at record levels. Foreign investors are picking up choice U.S. corporations and properties at bargain-basement prices and the United States is losing control over its economic future.

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