The Mexican Peso Crisis

Mexican Peso Crisis Student’s Name Institutional Affiliation Table of Contents  TOC \o "1-3" \h \z \u  HYPERLINK \l "_Toc19956600"
The Mexican Peso Crisis  PAGEREF _Toc19956600 \h
3  HYPERLINK \l "_Toc19956601"
Key Economic Indicators  PAGEREF _Toc19956601 \h
3  HYPERLINK \l "_Toc19956602"
The Causes of Mexico’s Balance of Payments Difficulties Before the Peso Devaluation  PAGEREF _Toc19956602 \h
5  HYPERLINK \l "_Toc19956603"
Policy Actions that might have Prevented or Mitigated the BOPs Problem and the Subsequent Collapse of the Peso:  PAGEREF _Toc19956603 \h
6  HYPERLINK \l "_Toc19956604"
Lessons that can be derived from the Mexican experience  PAGEREF _Toc19956604 \h
7  HYPERLINK \l "_Toc19956605"
Balance of Payments  PAGEREF _Toc19956605 \h
7  HYPERLINK \l "_Toc19956606"
The Importance of Examining a Country’s Balance of Payments Data  PAGEREF _Toc19956606 \h
7  HYPERLINK \l "_Toc19956607"
United States: Continuous Current Account Deficits  PAGEREF _Toc19956607 \h
8  HYPERLINK \l "_Toc19956608"
Japan: Continuous Current Account Surpluses  PAGEREF _Toc19956608 \h
9  HYPERLINK \l "_Toc19956609"
Comment on: “Since the U.S. imports more than it exports, it is necessary for the U.S. to import capital from foreign countries to finance its current account deficits.”  PAGEREF _Toc19956609 \h
9  HYPERLINK \l "_Toc19956610"
Conclusion  PAGEREF _Toc19956610 \h
10  The Mexican Peso Crisis Countries all over the world engage in international transactions, where the statistical data that is documented in a record known as the balance of payments. Some of these transactions include cross-border investments, bank accounts, bonds, securities, and real estate, and the export and import of goods and services. The balance of payments data is essential in several ways, including providing information regarding the supply and demand of a country’s currency and as a signal of a country’s potential in becoming a business partner with other countries. Countries can run balance of payment deficits or surpluses by engaging in various approved central bank reserve transactions. Key Economic Indicators U.S. Dollar versus Mexican Peso Exchange Rate (November 1, 1994–January 31, 1995)
Source: Eun and Resnick (2015, p.50) Spot Exchange Rates 1994 (January-December): Mexican Pesos/US Dollars
Source: Curtis, Gladish, Guntupalli, and McElnea (2005, p.2) Mexican Foreign Reserves Source: IMF Statistics
Source: Curtis, Gladish, Guntupalli, and McElnea (2005, p.4) Lending Interest Rates in Mexico
Source: Curtis, Gladish, Guntupalli, and McElnea (2005, p.4) The Causes of Mexico’s Balance of Payments Difficulties Before the Peso Devaluation Two significant causes can be blamed for Mexico’s balance of payments before the peso devaluation. First, the government, under president Ernesto Zedillo, devalued the peso against the dollar by 14 percent. This decision by the Mexican government led to a rush sale of pesos and Mexican bonds and stocks, which, subsequently caused the peso to fall against the US dollar by as much as 40% by early January 1995 (Eun and Resnick, 2015, p.48-49). Consequently, the government was forced to float the peso. The second cause is the decline in investor confidence as a result of the deficit of the current account and the overvalued currency. Political instability in Mexico caused by various events such as the Chiapas uprising in the early January of 1994 and the August presidential elections, the assassination of Jos Francisco Ruz Massieu, and subsequent political kidnappings eroded the confidence and trust of investors, who subsequently reduced their holdings in Mexico (Eun and Resnick, 2015, p.49; Whitehead and Kravis, 1996, p. 7,9). The two reasons were the primary causes of the challenges in Mexico’s balance of payments before the peso devaluation. Policy Actions that might have Prevented or Mitigated the BOPs Problem and the Subsequent Collapse of the Peso: Government transparency regarding the actual state of affairs in the economy would have averted the Mexican peso crisis. According to Eun and Resnick (2015), The Salinas administration was reluctant to disclose the exact situation of the Mexican economy, including the accelerated depletion of foreign exchange reserves and massive trade deficits, which subsequently led to the crisis (p. 50). Therefore, transparency regarding the real state of the economy would have mitigated the country’s balance of payments problems. Another vital policy action is the establishment of a multinational safety net to protect the world financial system from such peso-collapse crisis. Eun and Resnick (2015) observe that political processes alone are inadequate and cannot prevent balance of payments problems. Presence of a multinational safety net, such as the G-7 countries that endorsed $50 billion bailout fund to be administered by the IMF to a country in financial distress, will be critical in preventing currency collapse (Eun and Resnick, 2015, p.50). A fast response by the United States and its allies would have prevented the peso collapse. Another policy action would have been reducing the influx of foreign capital into the economy. Eun and Resnick (2015) note that Mexico depended extensively on foreign capital to finance the country’s economic development projects. As a policy response, Mexico should have promoted domestic saving and relied more on long-term as opposed to short-term foreign capital investments. Additionally, the influx of foreign capital contributed to the increased domestic inflation as well as the overvaluation of the local currency, thus the challenges with the country’s trade balances (Eun and Resnick, 2015, p.50). Implementation of these policies would have mitigated the balance of payments challenges and the subsequent collapse of the peso. Lessons that can be derived from the Mexican experience  An important lesson that can be derived from the peso collapse is that countries should save more domestically and depend more on the long-term foreign capital for economic development. This lesson is derived from Mexico’s over-reliance on short-term foreign capital for the country’s growth (Eun and Resnick, 2015, p.50). Another important lesson is th...