The Mexican peso crisis was a currency crisis sparked by the Mexican government's sudden devaluation of the pesos against the US dollar in December 1994, which became one of the first international financial crises lit by capital flight.
During the 1994 presidential election, the ruling government embarked on an expansionary fiscal and monetary policy. Mexican Finance began issuing short-term debt instruments in the domestic currency with guaranteed payments in US dollars, attracting foreign investors. Mexico enjoys investor confidence and new access to international capital following the signing of the North American Free Trade Agreement (NAFTA). However, the ferocious insurgency in Chiapas state, as well as the assassination of presidential candidate Luis Donaldo Colosio, resulted in political instability, causing investors to place an increased risk premium on Mexican assets.
In response, Mexico's central bank intervened in the foreign exchange market to defend the Mexican peso's peg against the US dollar by issuing a dollar-denominated public debt to buy pesos. The strength of the peso caused increased import demand in Mexico, resulting in a trade deficit. Speculators acknowledged pesos and overly high capital started pouring out of Mexico into the United States, increasing the downward market pressure on the pesos. Under election pressure, Mexico buys its own treasury securities to keep its money supply and avoid rising interest rates, reducing the bank's dollar reserves. Supported the money supply by buying more dollar-denominated debt while simultaneously honoring the debt spent the bank's reserves by the end of 1994.
The central bank devalued pesos on December 20, 1994, and the fear of foreign investors led to a higher risk premium. To prevent the runaway capital generated, banks raise interest rates, but higher borrowing costs are only detrimental to economic growth. Unable to sell new public debt issues or efficiently buy dollars with a devalued peso, Mexico is facing a failure. Two days later, the bank allowed a free-floating peso, after which it continued to depreciate. Mexico's economy has a hyperinflation of about 52% and mutual funds begin to liquidate Mexican assets and emerging market assets in general. The effects spread to the economies of Asia and throughout Latin America. The United States hosted a $ 50 billion bailout for Mexico in January 1995, administered by the IMF with support from the G7 and Bank for International Settlements. After the crisis, several Mexican banks collapsed amid an abundance of mortgages. The Mexican economy is experiencing a severe recession and poverty and unemployment are on the rise.
Video Mexican peso crisis
Precursors
With 1994 becoming the final year of his term, sexenio (six-year executive deadline), President Carlos Salinas de Gortari supports Luis Donaldo Colosio as the presidential candidate for the Democratic Institutional Party (PRI) for 1994 elections in Mexico. In accordance with the party tradition during the election years, Salinas de Gortari started an undisclosed shopping party. The current account deficit in Mexico grew to about 7% of GDP in the same year, and Salinas de Gortari allowed the Secretariat of Finance and Public Credit, the Mexican treasury, to issue short-term peso denominational treasury bonds with US dollar-denominated payment guarantees, " tesobonos ". These bills offer lower returns than the traditional treasures of Mexican pesos, called " cet ", but their dollar-denominated earnings are more attractive to foreign investors.
Investor confidence improved after the North American Free Trade Agreement (NAFTA) was signed. After NAFTA came into effect on January 1, 1994, Mexican business as well as the Mexican government enjoyed access to new foreign capital thanks to foreign investors who wanted to lend more money. The international perception of Mexico's political risk began to shift, however, when the Zapatista National Liberation Army declared war on the Mexican government and initiated a violent uprising in Chiapas. Investors further questioned Mexico's political uncertainty and stability when PRI presidential candidate Luis Donaldo Colosio was killed while campaigning in Tijuana in March 1994, and began setting a higher risk premium on Mexican financial assets. Higher risk premiums initially had no effect on peso values ​​because Mexico had a fixed exchange rate.
Mexico's central bank, Banco de MÃÆ'Ã… © xico, maintains the value of pesos through a benchmark exchange rate to the US dollar, allowing pesos to appreciate or depreciate against the dollar in a narrow band. To achieve this, the central bank will often intervene in open markets and buy or sell pesos to keep pegs. The central bank's intervention strategy partly involves issuing new short-term US dollar-denominated public debt instruments, then using borrowed capital dollars to buy pesos in the foreign exchange market, thus causing its value to be valued. The purpose of banks in reducing peso depreciation is to protect against inflation risks because it has a very weak domestic currency. With a stronger peso than it should, domestic businesses and consumers start buying more imports, and Mexico is starting to experience a huge trade deficit. Speculators began to recognize that the peso was artificially overvalued and led to a speculative capital flight that further strengthened downward market pressure on the peso.
The Mexican central bank deviated from standard central bank policy when fixing pesos to the dollar in 1988. Instead of letting its monetary base contract and interest rates rise, the central bank buys bonds to prop up its monetary base and prevents interest rate hikes - especially given that 1994 was election year. In addition, the serve of tesobonos with US dollar payments further attracts the central bank's foreign exchange reserves. Consistent with the macroeconomic trilemma in which a country with a fixed exchange rate and a free flow of financial capital sacrifices the autonomy of monetary policy, central bank intervention to revalue the peso causes the Mexican money supply to be contracted (without the benchmark exchange rate, the currency will have been left depreciated). The central bank's foreign exchange reserves began to wane and completely ran out of dollars in December 1994.
Maps Mexican peso crisis
Crisis
On December 20, 1994, the newly inaugurated President Ernesto Zedillo announced a devaluation of Russia's central bank peso between 13% and 15%. Evaluating the pesos after previous appointments not to do so caused investors to be skeptical of policymakers and fear of additional devaluation. Investors flock to foreign investment and place a higher risk premium on domestic assets. This increased risk puts additional upward market pressure on Mexican interest rates as well as downward market pressure on Mexican pesos. Foreign investors anticipating further currency devaluations began to quickly attract capital from Mexican investments and sell shares as a result of the Mexican Stock Exchange falling. To prevent such capital flight, especially from debt instruments, the central bank of Mexico raised interest rates, but higher borrowing costs eventually hampered the outlook for economic growth.
When the time comes for Mexico to roll over its maturing debt obligations, some investors are interested in buying new debt. To pay for tesobonos, the central bank had no choice but to buy dollars with very weak pesos, which proved very expensive. The Mexican government is facing an imminent standard of sovereignty.
On December 22, the Mexican government allowed a floating peso, after which the peso depreciated another 15%. The value of the Mexican peso depreciated by about 50% from 3.4 MXN/USD to 7.2, recovering only to 5.8 MXN/USD four months later. Prices in Mexico rose 24% over the same four months, and by the end of 1995, Mexican hyperinflation had reached 52%. Mutual funds, which have invested more than $ 45 billion in Mexican assets in the years leading up to the crisis, begin to liquidate their positions in Mexico and other developing countries. Foreign investors not only fled Mexico but the emerging markets in general, and the crisis caused financial contagion across other financial markets in Asia and Latin America. The impact of the Mexican crisis on the Southern Cone and Brazil is known as the "Tequila effect" (Spanish: efecto tequila ).
Bailout
In January 1995, US President Bill Clinton held a meeting with the newly confirmed US Treasury Secretary Robert Rubin, US Federal Reserve Chairman Alan Greenspan and then Under Secretary for Finance Minister Larry Summers to discuss the American response. According to Summers's memories of the meeting:
Secretary Rubin set the stage for it for a while. Then, like the way he turned to others, me, to explain the situation in more detail and our proposal. And I say that I feel that $ 25 billion is needed, and one of the president's political advisers says, "Larry, you're worth $ 25 million." And I said, "No, I mean, $ 25 billion."... There was a certain veil above the room, and one of his other political advisers [Clinton] said, "Mr. President, if you send the money is to Mexico and it's not back before 1996, you will not be back after 1996. "
Clinton decided to seek Congressional approval for the bailout and start working with Summers to gain commitment from Congress.
Motivated to prevent potential spikes in illegal immigration and to reduce the spread of lack of investor confidence in Mexico to other emerging nations, the United States coordinated a $ 50 billion bailout package in January 1995, to be administered by the International Monetary Fund (IMF)) with support from G7 and Bank for International Settlements (BIS). This package establishes loan guarantees for Mexican public debt aimed at reducing the premise of growing risk and increasing investor confidence in its economy. The Mexican economy is experiencing a severe recession and peso values ​​deteriorate substantially despite the success of the bailout in preventing a worse collapse. Growth did not continue until the late 1990s.
The requirement of the bailout requires the Mexican government to establish new monetary and fiscal policy controls, although it refrains from reforming balance of payments such as trade protectionism and tight capital controls to avoid violating its commitments under NAFTA. The loan guarantee allows Mexico to restructure short-term public debt and increase market liquidity. Of the approximately $ 50 billion collected in the bailout, $ 20 billion was donated by the United States, $ 17.8 billion by IMF, $ 10 billion by BIS, $ 1 billion by a consortium of Latin American countries, and CAD $ 1 billion by Canada.
The Clinton administration's attempts to set up a bailout for Mexico are finding it difficult. This invites criticism from members of the US Congress as well as scrutiny from the news media. The position of government centered on three major issues: the potential for unemployment in the United States in terms of Mexico should reduce US imports of goods (at the time, Mexico was the third largest consumer of US exports); political instability and violence in neighboring countries; and the potential for illegal immigration surges from Mexico. Some congressional representatives agreed with the American economist and former Federal Reserve Deposit Insurance Corporation chairman L. William Seidman that Mexico should negotiate with creditors without involving the United States, especially in the interest of preventing moral dangers. On the other hand, supporters of US involvement such as Fed Chairman Alan Greenspan argue that the fallout from the failure of the Mexican government will be so devastating that it will go far beyond the risk of moral dangers.
Following the failure of the US Congress to pass the Mexican Stabilization Act, the Clinton administration reluctantly approved the initially dismissed proposal to appoint funds from the US Money Exchange Stabilizer Fund as collateral for loans to Mexico. These loans resulted in a substantial profit of $ 600 million and even paid before maturity. Then-US. Finance Minister Robert Rubin seized funds from the Stabilization Fund Exchange to support the Mexican bailout scrutinized by the US House Committee on Financial Services, expressing concern about potential conflicts of interest as Rubin had previously served as co-chair of Goldman Sachs board of directors, in distributing Mexican stocks and bonds.
Economic impact
The Mexican economy is experiencing a severe recession due to pesos devaluation and flight to safer investments. The country's GDP fell 6.2% during 1995. Mexico's financial sector bore the brunt of the crisis when banks collapsed, revealed low-quality assets and fraudulent lending practices. Thousands of mortgages go into default as Mexicans struggle to keep pace with interest rate hikes, which result in widespread homeownership.
In addition to the decline in GDP growth, Mexico is experiencing hyperinflation and extreme poverty has soared when real wages have declined and unemployment has almost doubled. Prices increased 35% in 1995. Nominal wages maintained, but real wages fell by 25-35% over the same year. Unemployment increased to 7.4% in 1995 from pre-crisis levels of 3.9% in 1994. In the formal sector alone, over one million people lost their jobs and average real wages decreased by 13.5% throughout 1995. Overall household income fell by 30% in the same year. Mexico's extreme poverty grew to 37% in 1996 from 21% in 1994, canceling the previous ten years from successful poverty reduction initiatives. The nation's poverty rate will not return to normal until 2001.
The worsening poverty of Mexico affects urban areas more intensely than rural areas, partly because of the urban population's sensitivity to labor market volatility and macroeconomic conditions. Urban citizens rely on a healthy labor market, access to credit, and consumer goods. Consumer price inflation and credit market tightening during the crisis proved challenging urban workers, while rural households turned to subsistence agriculture. Mexico's per capita gross income declined only 17% in agriculture, compared with 48% in the financial sector and 35% in the construction and trade industries. The average household consumption decreased by 15% from 1995 to 1996 with changes in the composition of important items. Households save less and spend less on health care. Expats living abroad are increasingly sending money to Mexico, evidenced by net unilateral transfers doubled between 1994 and 1996.
Lower household demand for primary health care led to a 7% increase in mortality rates among infants and children in 1996 (from 5% in 1995). The infant mortality rate increased until 1997, most dramatically in areas where women had to work as a result of economic needs.
Critical scholars argue that the Mexican peso crisis of 1994 reveals the problem of Mexican neoliberal change in Washington's consensus approach to development. In particular, the crisis reveals the issue of the privatized banking sector in an institutionalized but internationally subordinated economy that depends on foreign capital flows that flow from abroad.
See also
- Mexican economic history
- 1998 Russian financial crisis
- Great Recession
- Index_of_Mexico-related_articles
- Latin American Economy
- Suddenly stop (economy)
References
Other sources
- Luis Pazos (January 1, 1995). DevaluaciÃÆ'³n: por quÃÆ' Â ©, quÃÆ' Â © viene, quÃÆ' Â © hacer? . Editorial Diana. ISBN: 978-968-13-2777-4.
External links
- Economic Riot in Mexico from Dean Peter Krogh Overseas Digital Archive
Source of the article : Wikipedia
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