PRESIDENT S ECONOMIC POLICY ADVISORY BOARD

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84B00049R001102640006-0
• Release Decision: RIFPUB
• Original Classification: S
• Document Page Count: 7
• Document Creation Date: December 22, 2016
• Document Release Date: March 15, 2007
• Sequence Number: 6
• Publication Date: September 8, 1982
• Content Type: REPORT

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PRESIDENT'S ECONOMIC POLICY
ADVISORY BOARD MEETING
8 September 1982
Please return to:
SA/DCI/IA
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Z)tURET DCI
8 Sept 82
President's Economic Policy Advisory Board
Personally share Walter's confidence in the resiliancy of international
financial system. But I will present somewhat less 'sanguine scenarios.
That's what we're paid to consider. In the interest of being prepared and
avoiding surprise, the intelligence community has been tasked to do an assessment
of the international financial system in support of an interagency study led
by Don Regan.
Last week we completed estimates on Poland's prospects for the next
12 to 18 months and on implications of Mexico's financial crisis. Suffice
it to say that we project no progress either financially or politically in
Poland--no payments, no new financing, continued stagnation from inability
to get Western inputs.
In Mexico we did something interesting in projecting the most likely
scenario for the next year as follows: (1) by the end of October Lopez Portillo
will allow an austerity plan--perhaps to be implemented in phases--that meets
the criteria of the IMF and the international banking community; (2) de la Madrid
will give low-key support to the plan before taking-.office in December; (3) the
leadership of organized labor will, after much groaning and some minor concessions,
come around to supporting the plan by late this year; (4) some demonstrations
by labor rank and file will take place, will be forcefully repressed, and will
die out; (5) the opposition will gain little from the crisis; (6) foreign
governments and the international banking community will, over time, give
Mexico the minimum support that it needs; (7) economic growth will be negative
and unemployment will skyrocket; (8) a substantial upsurge in illegal migration
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will take place; (9) oil production and exports will rise somewhat; and (10)
while the standard of living of the average Mexican will decline and his
cynicism will increase, the Mexican political-economic system will remain intact.
A worst case scenario would have both Lopez Portillo and de la Madrid
continue to shun responsibility for austerity measures, a spiral of negative
developments continue as unpopular economic measures provoke domestic unrest
leading to even more negative foreign reactions. Within Mexico, the leadership
vacuum would soon be recognized and the authority of lesser leaders undermined.
Vital imports would fall, businesses would go bankrupt, and unemployment would
rise to unprecedented levels. These developments would upset the patron-client
relationships that comprise the Mexican system, and class-oriented groups
might coalesce. Strikes, riots, and crime in the cities would be matched by
armed rebellion in the countryside. This could precipitate a revolt by the
right or the left.
We then stuck our necks out further by laying out a set of some 30 possible
future events and reactions as criteria which could indicate a worst case
trend and a rising risk to economic recovery and poltical stability in Mexico.
These criteria relate to six areas: (1) the prestige and leadership of the
President; (2) the attitude of labor; (3) the behavior of the militi y; (4) the cohesion of the ruling party; (5) the militance of the opposition; (6)
economic factors like the level of wage increases and inflation, a further
weakening of the peso by more than 20%, trouble with IMF agreements, extensive
defaults, mass reaction to food scarcities and unemployment. Significant
action in two or three of these six general areas or in a few of the economic
indicators could set alarm bells ringing about Mexican stability.
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In much the same way, it would take combination developments in a few
countries--Argentina, Peru, Eastern Europe, Brazil, Philippines, Chile,
France--all carrying heavy external debt and experiencing some degree of
falling internal confidence--to set bells ringing on the international
financial system. We've looked at scenarios on the potential and nature of
global financial panic. We view the prospects of panic as higher than usual
but still low because of the system's flexibility and the growing common
interest of both leaders and borrowers in a smooth functioning system and
the track record of bankers and official financial leaders in working together
effectively during emergencies.
Still, if you're looking for the signs of serious trouble you worry
about some combination of three types of general development: (1) severe
economic trouble resulting in severe capital outflows and foreign exchange
restrictions with inability to repay debts to foreign banks (try this one on
Mitterrand's France); (2) a breach in the prevailing code of financial conduct
like a populist seizure of power and repudiation of foreign debt (read Argentina);
or (3) the influence of the inability of a major debtor country to hold the
confidence of banks which freeze payments and precipitate some major bankruptcies
(read Mexico or Brazil). Some combination of shocks like these could trigger
a mass flow of funds, probably to the US, old loans being
denied and the interbank market shrinking drastically.
called, new ones being
This is far out speculation. I don't believe we'll let it happen, but
that's the kind of disaster we're paid to look out for on the basis that
thinking about the unthinkable prepares us to avoid it.
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Risks to the International Financial System
1. Mexico's financial crisis creates major new risks for
international financial stability.
o LDC long-term foreign debt increased about five-fold from 1973 to
1981, surpassing $500 billion. There has also been a massive
qrowth of short-term debt, especially since 1971.
o The LDC debt service problem was manageable so long as exports were
increasing rapidly and interest rates were low. But beginning last
year LDC exports have fallen while interest costs have surged,
reaching 50 percent of exports for some major countries.
o Until the Mexican crisis, LDCs encounterinq debt servicing problems
(payments arrears or debt rescheduling) were all small, although
the number had been increasing from year to year. In 1981 28 LDCs
were in arrears, but their aggregate bank debt was less than 2
percent of the total.
o The Mexican crisis, together with the likely rescheduling of
Argentine debt, increases the volume of debt subject to some form
of relief to nearly a quarter of total LDC debt.
o Although no other major LDC seems on the verge of losing access to
new credit, several of them, notably Brazil, Chile, Peru,
Venezuela, and the Philippines, will have a difficult time
balancing off,external creditor pressures on the one hand with
domestic political pressures for improved economic conditions on
the other.
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2. Because of the LDC financial problems and increasing bankrup t es
in the industrial world, the international financial system is now more
prone to a major crisis than at any time in the past thirty years.
o Nervous bankers are apt to react quickly to disquieting political
or economic shocks--shocks could come from anywhere, although they
would probably have to be large to trigger a major crisis--for
example, a total moratorium on debt servicing by Argentina or
Mexico.
o The most directly affected banks could rapidly be pushed to the
wall by withdrawal of other banks' deposits; one bank's failure or
threatened failure would in turn affect other banks.
o There is little doubt that the central banks of at least the major
countries would intervene to keep at least major commercial banks
afloat.
o However, the international safety net does not cover all banks, and
there may be enough legal and other complications to cause
delays. In the meantime, damage could be done.
3. Although a banking crisis is unlikely to lead to a major financial
crash, it could further undermine confidence in international lending.
o Many LDCs would then be unable to finance current account deficits,
and might even have to run surpluses.
o This means they would have to curtail imports even more drastically
than some have already.
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o In turn, lower LDC imports would slow economic recovery in the
industrial countries and could lead to political trouble 'in some
LDCs.
4. This pattern is already occuring in the Soviet bloc countries.
o These countries are cutting their hard currency imports, in some
cases sharply.
o Some,-like the USSR, are doing it voluntarily. Others, like
Hungary, are forced to do it because of a withdrawal of Western
funds.
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