Mexican Eco Crisis Essay, Research Paper

Mexico has grown to be known as part of North America, rather than Central America, due to its borders and close ties with the U.S. Westward lies the Pacific Ocean and to the east and north, the Gulf of Mexico. It is the third-largest North American country with the second highest population, of more than 100 million people, and its territory spreads over 756,000 square miles. The government is a liberated and unstable federal republic, which is composed of 31 states and a federal district, with Mexico City as the nation’s capital. Mexico City is comprised of the world’s largest network of urban communities and is the most polluted city on earth. The dominant language is Spanish, although Mayan dialects are also spoken. Mexico is a sub-tropical climate, with a mixed terrain of coastal jungles, and a central plateau, which is surrounded by mountain ranges and deserts (jainschigg, 12).

In the period surrounding 1994-5, Mexico suffered from unstable economic conditions. Several factors were catalysts to this Mexican financial crisis. Although there are many contributing factors, there are three main factors that can be attributed to the blame; political turmoil, the devaluation of the peso and the health of the private banking sector (Worldbank.org, n.p). This financial crisis also had an extreme impact on the U.S. and the world. In recent years, many developing countries have experienced financial crises; the Mexican crisis of 1994-5 represents one of the most dramatic ones. The world’s reliance on, and opinion of Mexico, changed in a short period of time.

Towards the end of 1993, after signing the North American Free Trade Agreement, Mexico seemed strong, stable, and poised to enter the developed world. However, in two short years the country would suffer the deepest depression of its history, and the political system would appear to be in shambles.

The Mexican financial system was young and vulnerable, wild swings in expectations and investor confidence, in the reigning political party was common. The deciding factor for investors was panic due to political turmoil, which created concern among foreign lenders, about the safety of their investments. In 1994, investors pulled out due to a host of political shocks that dominated the news wire. The assassination of Luis Donaldo Colosio, the ruling party’s presidential candidate and an uprising in the southern state of Chiapas, hit hard (Jainschigg, 31).

Carlos Salinas de Gortari, president of Mexico between 1987 -93, adopted an economic policy which left Mexico seemingly developed. There were signs of an emerging middle class that were importing automobiles, televisions and other luxury goods. Salinas was also able to reduce the foreign debt payment down to a fraction of the annual budget, and performed the ultimate miracle of lowering Mexico’s inflation rate from 157% to less than 10%. The years between 1987 and 1993 were marked by outstanding growth in exports, which grew by over 100%, while imports quadrupled. Meanwhile, the poor people of Mexico, which account for an estimated 40% of the population, were still waiting for the benefits of this growth (Worldbank.org, n.p.).

This caused unrest, an exploited feeling, and left a sour taste in the mouth of a poor right wing terrorist group known as the “Zapastitas.” On January 1st, 1994, the same day the NAFTA went into effect, this impoverished group of terrorists began a twelve-day uprising in the remote southern high lands of Chiapas. It was in response to the government’s approval of NAFTA. The “zapatistas” did not understand why Mexico wanted to be part of NAFTA, when half of its population was poor. The reality was, the poor were to be exploited while the top 50% benefited from their hard labor. The result of this uprising was 100 dead, and the government at a shaky peace with the zapatistas. The start of a year, that made investors further question Mexico’s stability (Worldbank.org, n.p.).

The nail in the coffin occurred in March, with the assassination of Luis Donaldo Colosio, the presidential candidate of the Institutional Revolutionary Party. He was Salinas’ handpicked successor, and to some, thought of as a strong willed puppet. The PRI, a political party, had ruled Mexico for more than 65 years, and were responsible for the signing of NAFTA and their recent economic reformation. Colosio, along with Salinas, were part of a new generation of PRI leaders, who felt Mexico was ready to move out of the ranks of their third world stigmatism. Their goals were to attract foreign investment, modernize Mexico’s economy, and to some extent its political system (Worldbank.org, n.p.).

Colosio agreed with Salinas on many issues including the unconditional support of NAFTA, which ended tariffs and most trade restrictions between Mexico, the United States, and Canada. They believed this would be a tremendous boost to the Mexican economy, and distinguish it as a developed nation. Obviously, their views and recent success, did not occur without a few toes being stepped upon. The rumor is, the radical views they shared angered powerful people somewhere in the shadow world of PRI politics.

As a replacement of Colosio, Salinas pressed the Party’s old Guard to choose his Education Minister, and Colosio’s campaign manager, Zedillo, a Yale educated technocrat. Zedillo was weak, scared and colorless as a campaigner, but he was committed to Salinas’ reform (Worldbank.org, n.p.).

The final political blow came to Mexico in September, Zedillo’s main political adviser, Jose Francisco Ruiz Massieu was assassinated. Investors jumped ship.

Investors have a natural tendency to withhold and or withdraw funds in response to turmoil, and Mexico was in turmoil. Most of Mexico’s foreign debts were short-term in nature, which caused severe problems for private borrowers and lenders.

By the third and fourth quarter, the Mexican Peso had begun to come under attack. To combat this, the Mexican Central Bank raised interest rates sharply, however it was unable to stem the attack and was forced to devalue the peso 14%, on December 20, 1994. This shocked the financial markets and the so-called Mexican peso crisis was drastically to unfold during the upcoming week. The devaluation came after more

than three years of strong fiscal policy, during which Mexico, followed an exchange

rate policy of maintaining the peso within a well-defined band against the U.S.

dollar (Worldbank, n.p.).

After a strong devaluation on December 20, the government and the Mexican central bank stepped in. The following two days were a nightmare of phony press releases and six billion in expenditures from Mexican reserves, to defend the peso, which only made it worse. Mexican authorities were forced to allow the peso to float freely on December 22, and its external value plummeted.

In response, monetary and fiscal policies were tightened significantly, and Mexico received an unprecedented package of external financial support from the International Monetary Fund, the Exchange Stabilization Fund of the U.S. Department of the Treasury, the Federal Reserve, the Bank of Canada, and the Bank for International Settlements. The institutional structure of debt markets in Mexico interacted with the peso devaluation to propel the economy into a full-fledged financial crisis. The peso had lost half its value by March 1995. In pursuit, actual and expected inflation rose dramatically, and interest rates on debt denominated in pesos went to sky-high levels exceeding one hundred percent a year. The Peso’s rapid devaluation created fear, and investor expectations of further devaluations, that would greatly reduce the dollar value of their assets.

Unfortunately, the Mexican banking system was in no position to help due to the recent deterioration in the Mexican banks. Trouble had begun to plague their balance sheets, due to an increase in the amount of bad loan losses. This was occurring as a result of the Mexican banks being privatized in the early 1990s, and financial market intermediaries being deregulated. As a result, a lack of supervision in the private banking sector, and an overall decrease in screening, and monitoring of borrowing patterns, by regulators ensured doom. A lending boom ensued in which bank credit to the private non-financial sector, as a fraction of G.D.P accelerated dramatically, went from 10% of G.D.P in 1988 to over 40% of G.D.P in 1994 (Worldbank.org, n.p.). Losses on loans began to mount, causing Mexico’s banks net worth (capital) to erode. This decline in bank capital would mean that the banks would have fewer resources to lend, and this lack of lending would eventually lead to contraction in economic activity.

These problems produced what is known as the “tequila effect” throughout Mexico. Rampant inflation caused prices of products and services to increase, therefore depriving the average worker of about 60% of his spending power. This led to dramatic depression, and as a result an increase in crime rates and drug trafficking filtered through out the society. Store owners would no longer accept there homeland currency, demanding America dollars instead (Gould, 14). Mexican morale was at an all time low.

Perhaps the biggest blow occurred to the Mexican education system. The University of Mexico’s budget was cut in half, which meant they could no longer afford resources to accommodate their student population. Students were cut, in an effort to downsize, and they no longer accepted any more students at the University level (Gould, 17). This caused many of the applicants to protest, leaving them angry with nowhere else to attend.

A snowball effect could be seen as it plowed its way through the economy and the lives of its citizens. The government was forced to raise interest rates to safeguard the peso. Mexican borrowers could not make payments on their loans, causing repayment problems and foreclosures. The ratio of bad debts doubled, which resulted in a huge increase in interest payments. Due to the short-term nature of the Mexican debt, cash flow dropped dramatically, leading to a further deterioration in the banks. Many firms who had its debts denominated in dollars, before the depreciation of the peso, were slaughtered, and in many cases resulted in bankruptcy.

In 1994, the numbers spoke for themselves. The Mexican current account deficit rose to about $29 billion (greater than 8 percent of Mexican G.D.P) while Mexico’s international reserves declined about two-thirds. In response, the Mexican government issued more than $25 billion in peso denominated short-term debt, whose face value was indexed to the U.S. dollar. Mexico’s increase in borrowing led to a capital account surplus of US$15 billion in 1995. The peso continued to weaken and in early 1996 the exchange rate stood at 7.4 pesos per dollar (Gould, 20)

Foreign trade was also affected by the peso devaluation, starting in 1994, Mexico’s imports decreased by nine percent a year for the next two years because the increasing value of the dollar versus the peso, which made American products more expensive. The U.S took advantage of this and as a result Mexican exports rose from U.S $43 billion in 1991, to U.S $80 billion in 1995. A bright spot could be seen as Mexico’s current account deficit began to decline in 1995, due to an improvement in its amount of exporting.

The Mexican crisis had an affect on many countries, including its neighbor the U.S. The most noticeable impact is the bailout package, which gave Mexico an unmentioned amount of long-term funds, which will most likely not be repaid on time. NAFTA, North American Federal Trade Agreement, was also considered to be an expensive failure because it was initiated prematurely. The Mexican economy had evolved too quickly and did not have a strong enough foundation for a close merging with the United States’, and Canada’s established financial structures.

Labor costs were now lower than ever, which meant, labor-intensive goods could be produced extremely cheap in Mexico compared to its neighboring American companies. American jobs and products were lost to Mexican manufacturers, as we took advantage of their downfall. As a result, it was estimated that half a million Americans lost their jobs and about a fifth of a percentage point was knocked off the U.S.’s GDP in 1995. U.S. shipments to Mexico suffered, due to the weakness of the peso, causing the United States to experience a trade deficit with Mexico (Quicklink, n.p.). These related factors caused the United States to raise interest rates and there was a possibility that the U.S. dollar would be weakened in International markets as a result of our bumbling neighbor.

Mexico’s problem’s weighed heavily in Texas and the other big border-states. This could be seen in the huge decrease in the purchasing of U.S. goods, especially their technology and heavy equipment exports. The borders themselves were also under attack as a wave of cheap labor swept across. Illegal immigrants poured into the U.S by the thousands forcing a new form of cowboy to dominate the west. The border patrol consisted of U.S. officials and ranchers who took up arms to protect their country and local economy. The combined job loss in these states in 1995 was estimated to be 190,000.

The peso continued to weaken and in early 1996 the exchange rate stood at 7.4 pesos per dollar The U.S stock market was also hit by the collapse of the peso, causing temporary panic and a sizable short-term loss of approximately 5-7% on most indices

The majority of U.S. citizens wanted to turn their heads, and protect their own necks as a strong anti-Mexican, ethnocentric wave took hold in the west. The fact is Mexico wasn’t going to go away and neither was their problem without some help from the US and NAFTA. The U.S.’s objective, “Economic Engagement”, was to help Mexico economically, democratically, and attract U.S investment, with the intent of securing a future U.S market that would eventually be a strong ally. Through the help of NAFTA, this could be accomplished. NAFTA offered Mexico a great deal of future security and a significant increase in free access to the U.S. market (quicklink, n.p.).

Mexican businesses and investors were reassured that their companies and industries would not be bankrupted by a sudden wave of U.S. protectionism. Perhaps most important to the U.S. and Mexico was an agreement to a continuation of market-friendly reforms that the treaty placed on future Mexican governments. As was previously mentioned, it was in the U.S.’s best interest to help Mexico, until recently they were the second largest buyer of U.S. goods and services. It is critical to have monetary cooperation among all three partners in a trade agreement because exchange rate fluctuations can disrupt trade flows and create further problems (Newnation.org, n.p.). This is even seen today with the devaluation of the Euro, and its effect on the major Blue Chip companies, regarding overseas profit.

With the help of NAFTA and a strong U.S. economy around the end of1995, Mexico began to show good signs of economic recovery and was now on its way to a better financial standing. The first signs could be seen in the Mexican trade balance, which had increased from an $18.5 billion deficit in 1994, to a $7.1 billion surplus, in 1995 only one year after the peso devaluation. At the end of 1996, confidence began to trickle back into Mexico as shown with an increase of about 5.1% in Gross Domestic Profit and a drastic 10.7% increase in industrial production (quicklink, n.p.). This only could mean one thing, a rise in employment as Mexico continued to pull itself out of the recession.

In a little over two years a tragedy had turned into success as domestic interest rates fell and stability returned as inflows of foreign capital increased. The help of NAFTA allowed for the Zedillo Administration to flourish, which will in turn allow Mexico to once again import U.S. goods.

After a devaluation of more than 50 percent in less than three months, and a huge drop in the Gross Domestic Product in 1995, Mexico has made a huge comeback and in some cases large improvements. In order to reach their goal of full economic recovery, the Mexican government has had to define some goals and build a solid foundation for the future. The government’s major focuses were to reduce the current account deficit to a level that is easier to finance, restore international reserves, restructure short-term debts and initiate a financial support program for the Mexican banking system. The government has had to strengthen monetary and fiscal policy, which has included budget cuts, and changes in governmental expenditures, which would be viewed positively by foreign money.

It was a good thing that Mexico joined NAFTA; little did they know that exporting would soon be their only chance at survival. However, it did little to jump-start economic growth, it really just widened the gap between the rich and the poor. The U.S.’s liquidity was now in place and the support and guidance of Mexico’s long run goals looked stable. This sparked the determination of various international banking systems, as they raced in to invest in Mexico and become the first to capitalize on this emerging market. By 1997, the government had begun to achieve its goals and was solving many of its economic problems.

There were many events that led up to the Mexican Economic Crisis of 1994-5, however today these are all considered part of the Mexican Heritage. Mexico is now almost fully recovered with a few war stories and lessons under its belt. It is said that Gross Domestic Product will grow 2.7% by the year 2000and 3.2% by the year 2002 (quicklink, n.p.). NAFTA will now have a second chance to prove itself in the eyes of the world, as the U.S. will now have another ally and avenue of export. Hopefully, the country will learn that a tower is only as good as its foundation.