COLUMN ONE : Global Money--Free Flows, Free Falls : In a world of fast-moving capital, Mexico and other financial fiascoes raise a tricky question: Have nations given up too much control over how money is valued and invested?

The new President had barely taken office when the financial panic began.

Foreign investors who had supplied much of the money to build up the country’s developing economy began to fear a currency devaluation by the new regime.

Eager to preserve their capital, the foreigners started to sell their stocks and bonds. A trickle of selling soon became a torrent, causing a collapse of the country’s stock market and a surge in interest rates.

With his Treasury nearly empty, the desperate President turned to powerful foreign bankers for an emergency loan to restore confidence and stabilize the country’s currency.

Mexico, 1995? No--the United States of America, 1893.

More than 100 years after the Panic of 1893 nearly destroyed Grover Cleveland’s presidency and the finances of a still-young nation, the world is again caught up in two peculiar debates over money: how to set its value from nation to nation, and whether to control its international movement.

The past three months have seen a frightening series of crises in global markets, all tied to either the question of paper currencies’ true worth or the speed and force with which investment capital can be moved around--or both.

Once, these were arcane topics for diplomats and central bankers. Now, in a world of nations intertwined as never before by trade, tourism, technology and investment, currency values and cross-border money flows are issues that affect billions of lives--as recent events have painfully shown:

* The surprise 50% devaluation of the Mexican peso since mid-December has sparked a devastating flight of capital out of much of Latin America, causing stock markets there to crumble, plunging Mexico into recession and threatening the same for much of the region.

The fiasco has sparked renewed criticism of Wall Street, as both the builder and alleged destroyer of Mexico’s markets.

* The United States, after fashioning a $20-billion aid plan for Mexico, suddenly saw the dollar plummet in value versus the German mark and Japanese yen. The decline became a virtual free fall at the beginning of March, resurrecting worries that U.S. interest rates will have to rise again--the classic defense of a falling currency as a nation tries to hold money within its borders.

* Illustrating the unprecedented ease with which gigantic sums of money now fly over the world’s phone lines, a 28-year-old British employee of London’s venerable Barings Bank sat in Singapore this year and bet an unauthorized $27 billion on Japanese stock and bond markets, only to see the bets go awry and cause Barings’ failure after 233 years in business.

With the near-total embrace of capitalism worldwide since 1989, governments have for the most part decided that the free flow of money is a good thing--the only way to guarantee that the resources to build companies and create jobs will get to capable people.

But the current era is, in many ways, a grand experiment. Never in history has the planet been populated by so many capitalists, and never before have they had the ability to transfer entire fortunes across borders in the blink of an eye, thanks to technology.

Mexico’s debacle, a case of a tsunami-like inflow then outflow of money from abroad, has thrown a harsh light on the downside of the new world order: It threatens to increasingly cede control of markets and economies to “hot” money players--that is, speculators and others who deal in what might be called impatient capital.

“Mexico is an example of the free market gone absolutely wild,” said Gert Von Der Linde, a veteran Wall Street economist.

What’s more, true long-term investors--the U.S. company building a plant in Mexico, or the individual buying an international stock mutual fund for retirement savings--may view themselves as only slightly less victimized by hot money’s actions than, say, the Mexicans themselves.

Because of that, the notion of stronger government regulation of money’s movements worldwide--what might have sounded like heresy to ardent capitalists a few years ago--may now be more palatable.

“It seems like we’ve evolved to a situation of a total lack of control” of markets, said William Gross, head of bond investments at giant Pacific Investment Management Co. in Newport Beach. “It’s wonderful for people to have freedom, but even a democracy doesn’t mean total freedom--you can’t just do anything you want.”

*

In the realm of global finance, paper currencies are the medium that carries the market message.

The wild shifts in world currencies in recent months have served to remind us that money’s value is subjective, as reflected in exchange rates among countries. For example, one dollar is now worth 89 yen; it takes 3.57 French francs to buy one German mark.

At home, a dollar seems to be a dollar, pure and simple. But in Tokyo, that dollar has depreciated so sharply that it buys 33% fewer yen than it did five years ago. Whether they know it or not, Americans are in a sense poorer, and the Japanese richer.

But who decides what a currency is worth? Today that role is largely assigned to the “market”--made up of banks, brokerages, corporations, speculators and others worldwide, all freely trading an estimated $1 trillion a day in currencies, electronically and virtually nonstop.

It was not always thus, however. From 1945 until 1971 the world operated on the “gold standard”--a system of mostly fixed exchange rates, with the dollar the central, or “reserve,” currency whose value was anchored to the price of gold. Gold in turn was fixed at $35 an ounce. Dollars were convertible into gold at that price.

The idea of a gold standard exchange-rate system was simple: Something concrete and universally valued, at least in theory, had to back up all paper currency, thus providing stability for the system. Paper money couldn’t be printed with abandon, which avoided the classic inflation trap--too much money chasing too few goods.

But the fixed exchange-rate system began to show strain in the 1960s as Japan and Europe grew wealthier while the United States tried to finance both the Great Society anti-poverty program and the Vietnam War.

As federal spending surged, inflation pressures mounted in the United States, and the dollar’s value came under pressure as foreign nations became more interested in holding gold than dollars. As they exchanged more of the latter for the former, the U.S. Treasury’s gold hoard was cut 50% between 1958 and 1971, according to Neil MacKinnon, chief currency strategist for Citibank in London.

Something had to give, MacKinnon says, or the United States risked the depletion of all its Treasury gold in Ft. Knox, Ky. So in 1971, President Richard Nixon took the country--and the world--off the gold standard in the name of retaining America’s fiscal and monetary flexibility.

Currencies began to float freely, their values set by market forces. With the dollar no longer convertible into gold, its value began to sink, a reflection of the already heavy buildup of dollars in foreign hands.

Since 1971, governments have periodically tried to limit currencies’ swings in value to narrow bands by using central banks to buy and sell massive amounts of one another’s money. But those efforts have mostly failed when “the market” had other ideas.

Indeed, the dollar’s recent plunge and the disastrous collapse of the peso are only the latest in a number of stunning market-driven revaluations of currencies since the gold standard was abandoned.

In 1992, for example, the Europeans’ “exchange-rate mechanism” designed to keep their currencies more or less aligned--a step toward the dream of a single, unifying European currency in the late ‘90s--crumbled as wily speculators drove the German mark up and weaker currencies down.

Perhaps more than any other market, the gyrations of world currencies have frustrated policy-makers--and led to calls for a fettering of hot-money players who roam the world’s electronically linked markets.

“The floating-rate (currency) idea was based on valid theory, but it’s been done in by abuse,” contended economist Von Der Linde. The value of money, he said, is “too important to be left to the overshooting and undershooting that all free markets are at times possessed to do.”

*

It’s easy to see why the idea of greater stability in world currencies appeals to many. In theory, at least, had Mexico followed the conservative tenets of the gold standard, it might have avoided the classic boom/bust cycle.

Mexico began to lure significant international investment in the late 1980s as the country’s slow recovery from its oil-price bust earlier in the decade picked up speed.

The early foreign investors looked upon Mexico as merely an interesting Third World speculation, an oil exporter in a slow transition to a more sophisticated manufacturing economy.

But that view changed dramatically after 1990 as the “Mexican Miracle” increasingly became a staple of conversation among large and small U.S. investors.

With its proximity and cheap labor, Mexico touted itself as a natural business partner for the United States. The proposed North American Free Trade Agreement, or NAFTA, portrayed a Mexico whose future would be tied irrevocably to that of the United States--which appeared to lower the assumed risk in Mexican investments.

For Wall Street brokerages eager to make a sale, the Mexico story came along at a particularly fortuitous time. Dull gains on U.S. stocks in 1992 and 1993 and low yields on U.S. bonds created an appetite for more exciting securities, especially on the part of mutual funds flush with hoards of cash from individual investors.

While foreigners poured billions of dollars into “hard” assets like factories, the more dramatic rise was in “portfolio” investment--foreign purchases of tradable Mexican stocks and bonds, including government and corporate bonds.

Bid up by bullish foreigners, who controlled an estimated 75% of Mexican stock trading by 1993, the market value of the Mexican Stock Exchange exploded from $4 billion in 1985 to $200 billion by 1993.

Yet through most of 1994, Wall Street largely ignored the Mexican government’s increasing reliance on tens of billions of dollars in short-term debt securities--money that could be pulled from Mexico in a matter of days or weeks--to fund itself and its growing trade deficit. That hot money kept the economy propped up and the peso strong in the face of social unrest.

By December, new President Ernesto Zedillo faced a rapidly emptying national Treasury and a mountain of short-term debt, neither of which had yet been reflected in the most visible symbol of a nation’s health and wealth--the value of its currency.

When the government finally chose to stop supporting the peso’s value Dec. 20, it created a catastrophic downward spiral for Mexico’s economy and markets.

As the peso lost value, it automatically devalued foreigners’ holdings in Mexico. As foreign owners of Mexican stocks and bonds rushed to exit--converting their peso-denominated securities back into dollars--the peso lost more value, increasing foreigners’ losses and fueling more selling.

Blaming Wall Street, of course, is easy enough. But many foreign investors in Mexico had been there for years, and hardly considered themselves hot money. The self-preservation motive that drove their selling when disaster struck is understandable, economists say. What’s less understandable to many is why Mexico let so much foreign money in to begin with.

*

“Mexico experienced the kinds of capital inflows which, when reversed, can cause tremendous damage to the economy,” said Edward Leamer, UCLA professor of economics. “They would have been better off if they had in some way managed the flows.”

But the notion of controls on capital entering or leaving a nation runs counter to the thinking that has dominated governments since the Berlin Wall fell in 1989.

The International Monetary Fund, which assists many developing nations with their economic policies, has largely opposed limits on the movement of money.

Rather, the IMF argues that the increasing freedom with which money has moved since the early 1970s is directly responsible for the dynamism of the world economy today--the astounding boom in trade, and the growing wealth of many developing nations, Mexico’s fall notwithstanding.

Manage your economy soundly, the IMF says, and investment will come, and stay. If it doesn’t stay, then the message is your economic policies aren’t working.

Even so, some countries have regulated capital flows in recent years, essentially saying no to hot money. Chile, for example, has long had strict limits on foreign portfolio investment. South Korea also has limited foreigners’ ability to invest in its stock market. Both countries are among the greatest economic success stories of their regions.

In the wake of this year’s financial crises, the idea of re-regulation of markets and money is finding wider reception. China in January decided to tighten controls on currency trading in an effort to stop hot foreign money from chasing high domestic interest rates.

Canada is pushing for major industrialized nations to slap a tax on currency trading as a way to dampen what it views as rampant and harmful speculation.

And some economists remain strong advocates of a return to the gold standard. Even Federal Reserve Chairman Alan Greenspan has said he favors some link between gold and currency values, if not an outright gold standard.

Yet turning the clock back would be extraordinarily difficult. One simple problem: The volume of paper money in the world has exploded in 25 years, while nations’ gold reserves have not.

Don Doyle, chief executive of bullion dealer Blanchard & Co. in New Orleans, estimated that to back currencies “with some reasonable fraction of gold, the price (of the metal) would rise to $40,000 an ounce” from about $384 now.

A far more practical problem harks back to what prompted the gold standard’s abandonment in the first place: It would require countries to follow the same basic conservative economic policies that can potentially rein in government spending and growth.

In the 1950s and ‘60s, when the United States dominated the economy of the Western world, a singular approach to currency values and controlled growth was far easier to maintain. Now, “most countries feel like they’re sacrificing something” to join such a policy regime, said Anna Schwartz, a research associate of the National Bureau of Economic Research in New York and a money historian.

Moreover, some experts say such inflexibility could be devastating for the global economy by forcing a mindless adherence to similar monetary policies among nations with different problems and goals.

“We didn’t leave the gold standard because we didn’t know what it meant,” argued Allan Meltzer, economist at Carnegie-Mellon University in Pittsburgh. “We left it because we did know.” In its first go-round in this century the gold standard produced the Great Depression, Meltzer contended. He asked, “Is that what we want?”

But Meltzer and other critics of fixed exchange rates concede that the risk of an unanchored currency is that the government behind it will print too much of it, borrowing and spending itself into ruin--or at least certain devaluation. That was Mexico’s mistake.

The United States has done the same thing. Indeed, unlike Grover Cleveland in 1893--who had no choice but to take painful steps to defend the currency of his young nation--presidents since Nixon have presided over trade and budget deficits that have flooded the world with dollars.

Just by virtue of the U.S. economy’s size and its still-dominant position in the world, that dollar “overhang” hasn’t led to disaster, even though it has significantly devalued the currency.

But the penalties of such behavior for Mexico and other, smaller nations are steep. To free-market proponents, however, the discipline enforced by markets remains a thing to be celebrated, not vilified, for its ultimate contribution to world development.

“In every case where foreign money leaves a country,” Schwartz said, “it’s because something is wrong in that country.”

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World Trade: End Game of Capital Flows

The freer movement of capital that has characterized the world financial system since the early 1970s has spawned periodic currency crises and stock market crashes, but it also has helped fuel an explosion in world trade, economists say.

Value of total world exports, in billions of dollars ‘75: $803 ‘93: $3,751 Source: International Monetary Fund

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Money Makes News . . .

The advent of floating exchange rates for world currencies in 1971 produced ‘the growth in the foreign exchange market . . . a boom in international capital flows . . . and the end of dollar hegemony. As a result, we now have an international financial system which is often seen as being run by the global investor, where global portfolio preferences determine the fate of currencies.’

--Richard O’Brien, in his 1992 book, “Global Financial Integration: The End of Geography”

*

‘My view is that what happened to the Mexican peso was well deserved. Mexico wasn’t the wonderful new country that it was touted to be.’

--Anna Schwartz, research associate of National Bureau of Economic Research in New York and a money historian

*

‘In general, if you’re not getting and keeping capital because of good policies, putting controls on capital is not the answer.’

--Susan Schadler, analyst at International Monetary Fund

*

‘People are quick to blame the speculator, but the speculator sees (economic) policies that aren’t working and goes after them.’

--George P. Schultz, former secretary of state, now a distinguished fellow at the Hoover Institution

*

‘Mexico made its own bed here. Every election year the same thing happens. They pump up the peso to help the economy, but it can’t be sustained. As investors, it seems like we don’t learn very well our lessons in this regard.’

--Charles Plosser, professor of economics, University of Rochester