Opinion pieces and speeches by EPI staff and associates.
THIS PIECE ORIGINALLY APPEARED IN THE HOUSTON CHRONICLE ON FEBRUARY 9, 1999.
Mexico — The Next Domino?
by Robert E. Scott
U.S. isolation from the global financial crisis could end later this year if Mexico is pushed into another peso crisis. Despite its sizable surplus with the U.S., Mexico has a large and rapidly growing trade deficit with the world as a whole – usually the first sign of a budding financial crisis in developing countries.
Rising interest rates are another indicator of Mexico’s problems. Commercial interest rates soared to 42 percent in September, nearly double their level in July, and have remained high since then. With an inflation rate of 19 percent, Mexican companies are being strongly discouraged from borrowing. The high interest rates are intended make the currency more attractive to foreign buyers, but this has failed to work as no one wants to invest in a depressed economy.
Unfortunately, as recently evidenced in Brazil, once markets decide that a currency is overvalued, it is nearly impossible to avoid devaluation. In Mexico’s last currency crisis in 1994 the peso lost more than a third of its value. U.S. imports from Mexico surged, our exports collapsed and hundreds of thousands of U.S. workers lost their jobs. Real wages also dropped and unemployment increased sharply in Mexico, as workers in both countries suffered.
Anyone who doubts that Mexico is headed for another crisis is ignoring at least two decades of Mexican economic history. The government, which has been under the control of the Institutional Revolutionary Party since 1946, has been successively increasing its authority to artificially sustain the domestic economy in the years leading up to elections (which run in six-year cycles).
As a result, international financial crises immediately following the election of a new president have been the norm in Mexico since 1976, when the peso was floated shortly after the election of José López Portillo. In 1982, Mexico became the first developing country to default on its debt, following Miguel de la Madrid’s election in August. The 1994 peso crisis occurred just after Ernesto Zedillo was inaugurated.
The global financial crisis has also contributed to Mexico’s economic problems. The growth in Mexico’s exports to the rest of the world slowed dramatically in the second half of 1998 in the wake of the Asian financial collapse. The Russian economic downturn in August added to financial market uncertainty and forced Mexico into its first round of interest rate hikes.
Mexico has $35 billion in public and private foreign debt maturing in 1999, in addition to $8 billion in IMF loans dating from the last peso crises in 1994-95 that will come due in the next two years. Mexican finance officials have already begun discussions with the IMF about an extension of credit through the elections of 2000, and they may request a much larger loan to protect against a sudden run on the peso.
Where the IMF goes, financial disaster usually follows. Their programs make bad situations worse by requiring budget cuts in the midst of downturns. There are several steps that the U.S. should quickly take to avoid the collapse of the peso and another Mexican crisis.
First, we should develop a program to reduce the crushing debt burden that forces Mexico to pay out enormous sums in interest and principal payments. Debt service consumes nearly half of all export earnings in Mexico. Huge payments on foreign loans contribute to the depth and frequency of financial crises. Banks should be forced to either stretch out existing loans, at reduced interest rates, or to sell them to a public fund at a steep discount.
Second, we should encourage countries to impose limits on short-term borrowing in the future, which can be done by taxing short-term loans from foreign sources. These regulations will signal markets to redirect international capital into productive, long-term investments. Large inflows of short run “hot money” usually result in inflated currencies, setting the stage for future currency crises.
Finally, we should act now to protect American workers from future import surges from Mexico and other countries. Several lawmakers have called for temporary quotas on imports of steel because of rising imports from Japan, Brazil and other countries. Standby authority should also be provided to limit surges of other imports including autos, textiles and electronics from Mexico and elsewhere, in the event of future crises. These measures would protect these vital industries, and their workers, from further harm. They would also increase pressure on the IMF and the Treasury to reform the international financial system.
We simply can’t afford to solve the world’s economic problems by sacrificing more of our industrial base. We should instead invest in meaningful reforms that protect American jobs, before the next peso crises arrives.
[ POSTED TO VIEWPOINTS ON FEBRUARY 18 ]
Robert Scott is an economist at the Economic Policy Institute. He specializes in international economic issues.