U.S. Bailout Is the Best Bad Choice : Mexico: The $40-billion loan guarantee should help avert total catastrophe. Doing nothing for our neighbor is not an option.

Just a year after Congress ratified the North American Free Trade Agreement, Mexico is deep in crisis. The $40-billion rescue plan proposed by the Clinton Administration would not be a gift. Instead, it would guarantee--in effect, co-sign--private loans to Mexico. American taxpayers would suffer losses only if Mexico defaulted on its existing short-term loans that are coming due.

No one relishes taking that gamble. But if Congress rejects it, a bad situation would be made much worse. Mexico would default and probably plunge into a depression. The peso, which has already dropped more than one-third against the dollar, might slide another 30%.

Moreover, the specter of a Mexican default might trigger a flight of foreign capital elsewhere, especially in Latin America. In 1993 alone, new foreign investment in developing nations exceeded $130 billion, estimates the International Monetary Fund. It is one thing for these in-flows to subside; indeed, that is already happening. It would quite another for masses of foreign investors to try to withdraw all of their funds simultaneously.

Mexico faces precisely this situation, because so much of its foreign investment consists of short-term loans that it now cannot pay. By floating medium-term bonds (say five to 10 years), guaranteed by the United States, Mexico would raise the cash to repay its short-term debts. This would also buy time to reduce its huge trade and current account deficits.

Mexico is treading between a steep slump and higher inflation, and it could end up with both. Although a cheap peso might spur exports, it would also increase inflation. If workers try to recover lost purchasing power, that could trigger a wage-price spiral and undo one of the government’s proudest achievements: lowering inflation from 138% in 1987 to 7% last year. At best, Mexico faces a few years of economic upset; at worst, economic and political turmoil could feed on each other.

The Clinton plan will not solve Mexico’s problems, and in some ways it will incite tensions. Mexico will resent needing us, and we will resent having to help. Any conditions tied to the guarantees will be seen by Mexicans as abridging their sovereignty and by Americans as prudence or social responsibility.

Inevitably, Mexico’s economic adjustment will mean fewer U.S. exports going south and more Mexican imports headed north. By themselves, these shifts will be modest in an economy as large as ours and with such low unemployment (5.4%). Still, some industries and border regions will feel the impact.

But if the Clinton plan is no panacea, it is the least bad choice. What matters most is whether Mexico can restore its economy and sustain a continuing reform of its democracy. If not, more Mexicans will migrate north; massive social dislocation benefits neither country. The case for the loan guarantees is the same as the case for NAFTA: It is the best we can do. We cannot be bystanders to Mexico’s fate, because we cannot insulate ourselves from its consequences. But neither can we determine it. What Mexicans do for and to themselves will be decisive.