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The Mexican Peso Crisis


Throughout the 1990s Mexicos was a healthy economic country. After undergoing a debt
crisis in 1982 and affected by the collapse of oil prices, they had been reducing the inflation and
attracting foreign investors that was reviving the economy to the point that the central bank had
accumulated billions of dollars in reserve. Summing all the positive economic factors, NAFTA
was created in order to promote trading benefits between Canada and their largest trading
partner United States. The agreement was put into action at the beginning of 1994. On
December 20 of the same year the government of Mexico announced the devaluation of the
peso.

The devaluation of the Mexican peso came after maintaining for three years the exchange
rate between the peso and the US dollar in a very similar range. The Mexican deficit rose about
$29 billion dollars, the international reserves declined by two thirds and the government of
Mexico issued more than $25 billion pesos in short term debt created many questioning whether
the Mexican economy was about do crash. The large size of the deficit was the reason why
economists and Mexicans worried that the Mexican peso was overvalued. They knew that it will
discourage exports, stimulating imports and leading to a crisis. As mentioned above the
government intervening by keeping the exchange rate between the US dollar and the peso to
almost the same range band, but with time the upper limit was raised slightly creating a nominal
depreciation. But in reality the peso was appreciating, which contributed to the deficit. There are
many articles that point out many factors that contributed to this crisis, some point out the
political instability at that time. Others tend to point out that the origins of the crisis can be
traced to the trends in the globalization of finance over the past decade. In which factors such as

technology of markets, liberalization of financial systems and diversification of investors


portfolios, couldve been regulated with the appropriate economic policy. But as I read many
articles that had different theories behind the causes of the crisis, there is no formula that
explains what are the exact reasons why the Mexican crisis occurred or what should had been
done. There are similarities that can be traced to other economic crisis in other parts of the world
such as the European monetary crises of 1992 and the bond market collapse in 1994.

According to Joseph Whitt an economist in the macropolicy in Atlantas Federal


Department, a currency is said to be overvalued if its value relative to foreign money is higher
than can be justified by long run economic fundamentals. In this situation, if the government
intervene in the markets to hold the currency at the overvalued level, the trade and accounts will
go into a deficit and this will cause the foreign exchanges reserves to shrink. Since Mexico had a
slightly current account deficit in the early 90s, some believed that the deficit was an indicator
that the peso needed to be devalued.

There were three main forms in which private capital inflow from 1990 to 1994 which
affected the economy when things started to get shady. The first was direct investment by
foreigners, in which most companies would either buy or build factories or retail stores. This
became a long term investment due to all the commitments related to building of this
enterprises. From the 90 to 94 the private capital inflow direct investment totaled $24 billion,
which represented one quarter of the total capital inflow in Mexico through those years. The
other type of capital inflow was the purchase of Mexican stock. The inflow totaled $28 billion in
the period of 90 to 95 but as foreign buyers ceased to buy and started to pull out their stocks of

the Mexican market the governments reserves was affected. The largest form of capital inflow
was the purchase of bonds, from which the mainly were issued by the government. This
represented a $43 billion income to Mexico, from which a large portion was short term
securities. Once again putting in danger the billions of dollars Mexico had in reserve, when
foreign investors had taken their money out as the securities matured.

Due to the large amount of capital inflow into Mexico their interest rates remain high,
even higher than the US interest rates. As the reserves continue to increase it was a misleading
impression to the financial stability, first by increasing the centrals bank reserves related to the
increase of short term foreign liabilities. Since the crisis started to create panic, many residents
started take their money out of the country forcing Mexico to use more of their reserves.

The Mexican policy and the devaluation were another big factor that contributed to the
crisis. Mexican economic policymakers treated most of the internal and external shocks with
temporary solutions, avoiding to change the major policy changes. In order to defend an
exchange rate that is under pressure is to tighten monetary policy, but many question if the
central bank of Mexico did.
Some analysts believe that Mexico depended a lot on short term foreign portfolio capital
for its economical growth. Mexico should have depended more on long term foreign capital and
saved more domestically. It can also be contributed to the lack of reliable economic information,
due to all the unstable political issues there are many people that believe that if there was more
transparent and reliable information the economy wouldnt been affected that drastically. But the
president at time and his administration did not disclosed the real situation of what was going on
leaving the Mexicans with many doubts and creating economical and political fear throughout

the country. If most of the investors would had knowledge that the issue in Mexico at the times
was because of trade deficit and rapid depletion of foreign exchange reserves the peso as
mentioned above would had depreciated gradually avoiding the drastic collapse.

To conclude and summarized all the factors that led to the Mexican peso crisis, one must
understand how does the government policies and actions can affect the economy. Despite that
Mexico had go through continuous trade deficits, the peso was not allowed to depreciate for
political reasons. There were many reasons why the government did not want the peso to
devaluate before the Presidential election, but if the peso would had been let to gradually
depreciate along with other major currencies, the crisis most probable wouldve been prevented.
This would be a lesson for many financial systems around the world and other that might be in
the same path as Mexico to avoid the steps Mexico went through.

Work Cited

Truman, Edwin M. "The Mexican Peso Crisis: Implications for International Finance." Boards
Division of International Finance, Mar. 1997. Web. 15 Dec. 2012.

Whitt, Joseph A., Jr. "The Mexican Peso Crisis." Federal Reserve Bank of Atlanta. Federal
Reserve, Jan. 1996. Web. 15 Dec. 2012.