Mexico’s Market Reacts to the Big Squeeze : Free trade: The government is overly eager to conclude the treaty and attract investment; as tension mounts, stocks tumble.

MEXICO CITY — Everybody has bad days, and governments have bad weeks or months now and then. Carlos Salinas de Gortari of Mexico had been on a roll since 1989, and so it was only logical that his administration would encounter one of those fortnights when everything seems to go wrong. The events of the last couple of weeks are not lasting, and the Mexican mini-crisis will pass. Whatever other effects it may have, however, it underlined the regime’s extreme fragility.

The most spectacular manifestation of the problems Mexico has experienced since June 22 has been the sharp drop in the Mexico City stock market. Since early June, the price index has fallen nearly 20%, from a peak of 1900 to almost 1500 today, with most of the decline occurring in the last 10 days. This is the equivalent of almost a 700-point drop in the Dow, but the problem is more serious than it would be on Wall Street, given the key role the Bolsa has played in Salinas’ economic program.

The trade deficit, which sprung open with the government’s indiscriminate, overnight opening of trade in 1987 and has been ballooning ever since, was running at a monthly clip of $1.5 billion early this year. The only way to finance this gap was through huge inflows of foreign capital, which could be made possible only by generating confidence among potential foreign investors in the Mexican economy, and by guaranteeing high yields on their investments. Salinas accomplished the former through his policies and salesmanship; the Bolsa provided the latter. Since 1989, it has grown more than any other stock exchange in the world, with annual yields of more than 60% in dollars. The moment the yield falls, the smart money will move to safer or better havens; not only will money stop flowing into Mexico, it will flow out, by the billions. Estimates of the drop in Mexico’s reserves over the past two weeks range from $1.2 billion to $3 billion.

Without high yields on the Bolsa, interest rates have to rise to keep money in, or the economy has to be cooled down to cut imports and reduce the trade gap.

The origins of the mini-crash are still fuzzy, but clearly the narrow base of the Bolsa (six stocks account for 60% to 70% of trading) and the growing concern regarding the prospects for a free-trade agreement all contributed. This is why the other setbacks of the past few weeks acquired a greater dimension than they might have deserved. The U.S. Supreme Court’s ruling that upheld the kidnaping in Mexico of Humberto Alvarez Machain by operatives of the U.S. Drug Enforcement Administration represented an unquestionable setback to Salinas’ efforts to shelve his country’s traditional anti-Americanism. To many Mexicans, the court’s ruling showed that the United States’ duplicity and arrogance was not just a theme from history textbooks. What made matters worse was the Mexican government’s erratic behavior in response. First it suspended the DEA’s activities in Mexico; then, less than 24 hours later, it backed down and reauthorized them. It claimed that it had received assurances from the United States that there would be no more kidnapings, but the Bush Administration refused to go public, let alone give back Alvarez Machain. The divisions within Salinas’ government were clearer than ever, as was its vulnerability to pressure from Washington as the free-trade negotiations moved to closure.

Herein lies the real explanation for the fall in the Bolsa and the government’s about-face on the DEA. Because of U.S. legislative technicalities, the free-trade agreement must be completed by July 15 in order for President Bush to sign it before the November election. But there are lingering significant disagreements among Canada, Mexico and the United States on issues such as energy, agriculture and financial services. If Mexico maintains a tough negotiating position, it runs the risk of leaving the conclusion of the negotiations to a reelected but perhaps weakened George Bush--or to Bill Clinton or Ross Perot. The cost to the economy, in falling stock prices and draw downs on reserves, would be considerable, as current nervousness has shown. Or Salinas can rush the talks and try to cut the best deal he can, on Bush’s terms, in the next two weeks. This, too, could be costly, implying major Mexican concessions to meet the July 15 deadline.

Neither of these options is attractive, and despite the government’s heavy-handed and growing manipulation of the Mexican media to put the best face on the situation, the unpleasant choice is increasingly apparent to investors, politicians and commentators in Mexico. They are not bailing out or rising up in arms, nor will they soon. They are simply getting nervous, hoping that the bad weeks, which anyone has to expect, don’t stretch into bad months--or longer.