Found Items - April 9, 2006
Mexican Peso Bills from 1969 and 1988
Can the U.S.A. have a "Peso Problem"?
Pesos = US$1.00
|My family lived in
Guadalajara, Mexico in the late 1960s. Above is one of several
bank notes I saved from that time. A peso was then worth about
US$0.10. The Mexican Peso had been a stable currency for over a
century and a half, so much so that it was used as a currency by other
nations, including China, much as the American dollar is today.
In fact, the Mexican Peso was the basis for the U.S. dollar.
a decree adopted by the
United States on 6 July 1785, the peso became the official currency of
most of North America; it also became the foundation for the U.S.
monetary system, at a rate of one peso to one dollar. The US dollar was
not issued until 2 April 1792, but the peso continued to be officially
recognized and used until 21 February 1857. In Canada, it remained a
legal medium of payment until 1858.
most of the 20th century, the Mexican peso remained one of the most
stable currencies in Latin
America, since the economy did not experience periods of
hyperinflation common to other countries in the region.
Pesos = US$10.00
|I returned to Mexico
with my soon-to-be wife in 1988 to show her around. Here's a
20,000 peso note like ones we were using on our trip at the time to buy
a couple of sandwiches and a beer. A long term trend in the
of the Mexican Peso had come to an unseemly end. What happened?
the Mexican economy maintained its rapid growth during most of the
1970s, it was progressively undermined by fiscal mismanagement and a
resulting sharp deterioration of the investment climate. The GDP
more than 6 percent annually during the administration of President
Luis Echeverría Álvarez (1970-76), and at about a 6
percent rate during
that of his successor, José López Portillo y Pacheco
economic activity fluctuated wildly during the decade, with spurts of
rapid growth followed by sharp depressions in 1976 and 1982.
Fiscal profligacy combined with the 1973 oil shock to exacerbate
inflation and upset the balance of payments... The balance of
disequilibrium became unmanageable as capital flight intensified,
forcing the government in 1976 to devalue the peso by 45 percent.
action ended Mexico's twenty-year fixed exchange rate.
Although significant oil discoveries in 1976 allowed a temporary
recovery, the windfall from petroleum sales also allowed continuation
of Echeverría's destructive fiscal policies. In the
went from being a net importer of oil and petroleum products to a
significant exporter. Oil and petrochemicals became the economy's most
dynamic growth sector. Rising oil income allowed the government
continue its expansionary fiscal policy, partially financed by higher
foreign borrowing. Between 1978 and 1981, the economy grew more
percent annually, as the government spent heavily on energy,
transportation, and basic industries. Manufacturing output expanded
modestly during these years, growing by 9 percent in 1978, 9 percent in
1979, and 6 percent in 1980.
This renewed growth rested on shaky foundations. Mexico's external
indebtedness mounted, and the peso became increasingly overvalued,
hurting nonoil exports in the late 1970s and forcing a second peso
devaluation in 1980. Production of basic food crops stagnated,
Mexico in the early 1980s to become a net importer of foodstuffs.
portion of import categories subject to controls rose from 20 percent
of the total in 1977 to 24 percent in 1979. The government raised
tariffs concurrently to shield domestic producers from foreign
competition, further hampering the modernization and competitiveness of
The macroeconomic policies of the 1970s left Mexico's economy highly
vulnerable to external conditions. These turned sharply against
in the early 1980s, and caused the worst recession since the
mid-1981, Mexico was beset by falling oil prices, higher world interest
rates, rising inflation, a chronically overvalued peso, and a
deteriorating balance of payments that spurred massive capital
This disequilibrium, along with the virtual disappearance of Mexico's
international reserves--by the end of 1982 they were insufficient to
cover three weeks' imports--forced the government to devalue the peso
three times during 1982. The devaluation further fueled inflation and
prevented short-term recovery. The devaluations depressed real
and increased the private sector's burden in servicing its
dollar-denominated debt. Interest payments on long-term debt
were equal to 28 percent of export revenue. Cut off from
credit, the government declared an involuntary moratorium on debt
payments in August 1982, and the following month it announced the
nationalization of Mexico's private banking system.
|A sad turn of events for a great
currency, with a moral for those of us in the U.S. who understand that Oh
yes, it can happen here.
Let's fast forward to 2013 and imagine a possible future Country
Data.com report on the U.S. dollar.
|Although the U.S.
economy maintained its rapid growth during most of the 1990s and 2000s,
it was progressively undermined by fiscal mismanagement and a resulting
sharp deterioration of the investment climate. The GDP grew about
4 percent annually during the administrations of President Bill Clinton
(1993-2001) and during that of his successor, President George W. Bush
(2001-2009), except for a brief recession following the collapse of the
stock market bubble in 2000. But asset prices fluctuated wildly
during the decade, with booms and busts in the stock, bond and real
Fiscal profligacy combined with the 2008 oil shock exacerbated
inflation and upset the balance of payments. The balance of
payments disequilibrium became unmanageable as capital flight
intensified, forcing the government in 2008 to devalue the dollar by 30
Although a bubble in bond and real estate prices from 2001 to 2006
allowed a temporary recovery, the windfall from sales of financial
assets to foreign central banks also allowed continuation of the Bush
destructive fiscal policies. In the mid-1980s, the U.S. went from
being a net exporter of goods and to a significant importer. Sales
of financial assets became the economy's most dynamic growth
sector. Net foreign purchases of U.S. financial assets grew
from 50% of issuance in 1996 to nearly 80% in 2005. Rising foreign borrowing allowed the government to
continue its expansionary fiscal policy. Between 2001 and 2006,
the economy grew more than 4 percent annually, as the government spent
heavily on the military and the real estate and financial sectors provided more than 50% of private sector
This renewed growth rested on shaky foundations. The United
States' external indebtedness mounted, and the dollar became
increasingly overvalued, hurting exports in the late 2000s and forcing
a second dollar devaluation in 2010. The action effectively ended the
U.S. dollar's status as a reserve
currency. The portion of import
to controls rose from 10 percent of the total in 2008 to 24 percent in
2010. The government raised tariffs concurrently to shield
domestic producers from foreign competition, further hampering the
modernization and competitiveness of U.S. industry. As
unemployment rose to more than 20%, government policies to limit
immigration fueled further increases in wage rates and inflation.
The macroeconomic policies of the 2000s left the U.S. economy highly
vulnerable to external conditions. These turned sharply against
the U.S. in the late 2000s, and caused the worst recession since the
1930s. By mid-2010, the U.S. was beset by rising oil prices,
higher world interest rates, rising inflation, a chronically overvalued
dollar, and a deteriorating balance of payments that spurred massive
capital flight. This disequilibrium, along with the virtual
disappearance of the U.S. international reserves--by the end of 2010
they were insufficient to cover three weeks' imports--forced the
government to devalue the dollar three times during 2012. The
devaluation further fueled inflation and prevented short-term
recovery. The devaluations depressed real wages and increased the
private sector's burden in servicing its dollar-denominated
debt. Interest payments on long-term debt alone were equal to 28
export revenue. Cut off from additional credit, the government
declared an involuntary moratorium on debt payments in August 2013, and
the following month it announced the nationalization of the U.S.
private banking system.
Peso = US$1.00
|Returning to the
present, there is a happy ending for the Mexican Peso. In the
1990s, new political regimes
returned the peso to its former glory, at least for now.
government economic strategy called the "Stability and Economic Growth
Pact" (Pacto de estabilidad y crecimiento económico, PECE)
was adopted under President Carlos Salinas. On 1
the Bank of Mexico introduced a new currency,
the nuevo peso
("new peso", or MXN), written "N$" followed by the numerical amount.
One new peso, or N$1.00, was equal to 1,000 of the obsolete MXP pesos.
1 January 1996, the
was dropped from the name and new coins and banknotes – identical in
every respect to the 1993 issue, with the exception of the now absent
word "nuevo" – were put into circulation. The ISO 4217 code, however,
remained unchanged as MXN.
due to the stability of the Mexican economy, and the
growth in foreign investment, the Mexican peso is among the 15 most
traded currency units in the world, and the most traded in Latin
America. It has been fairly stable for the last few years; since the
late 1990s the peso has traded at about 10 to 1 to the U.S. dollar, and
is currently about $10.85 per dollar. This makes it relatively easy to
convert from dollars to pesos and back; the 50¢ coin (tostón)
is worth about the same as a U.S. nickel, and a 200 peso note about USD
|Moral #1: A nation
can go through a severe inflation and come out ahead. Inflations
are bad, yes. End of the world, no. A major inflation is a
severe economic error but by no means a fatal error. Under severe
circumstances, inflation can even be an optimal policy choice.
The benefit: foreign and internal debts are erased; the nation starts
again with a clean slate. The tarnished image does not last
long. Markets tend toward nearly pathological forgiveness because
market participants focus not on the money that was lost in the past --
that's gone -- but on the money to be made in the future.
Moral #2: In the past 70 years or so since the world monetary system
went off the gold standard, inflation has been the policy option of
choice for governments of nations with a significant balance of
payments disequilibrium; when an external shock causes the
disequilibrium to assert itself as a unmanageable demand by creditors
to pay, the government is faced with the choice between high inflation
and high unemployment. Invariably, governments chose the former over
the latter. The U.S. did so after the collapse of the stock
market bubble in 2000, creating asset inflation in bonds and real
estate that generated employment in the financial services and housing
industries. The Bernanke Fed has broadcast loud and clear its
intention to provide ample liquidity once the current asset bubbles
collapse as a result of continued rate hikes aimed at an inflation
target of 2% to 3%, while inflation is today between
6% and 7%. I believe that the path of collapse
is likely to be chaotic and the results of the subsequent reflation
program via the promised liquidity injection will be unpredictable and
undesirable to holders of dollar denominated assets.
During the inflationary period in Mexico, if you lived there at the
time it was a good idea to have your assets in U.S. dollars or a bunch
of the above.
|As interest rates
rise in countries that are major lenders to the U.S., especially
Japan and the UK, the American
dollar may experience a "peso problem." Without co-dependent
support from China, Japan
and the UK, the dollar will begin to truly "float" against the yuan RMB,
the yen and British Pound.
If U.S. dollar
depreciates in the manner of the once stable Mexican Peso,
then what currency should one hold during such a dollar
depreciation? Mexicans in the 1970s could store their wealth in
dollars to ride out the peso inflation. But what currency can
North Americans rely on to ride out a dollar inflation?
Peso Problem: "No one knows the precise origin of the term peso
problem, but it is often attributed to Nobel laureate Milton Friedman
in comments he made about the Mexican peso market of the early
1970s. At that time, the exchange rate between the U.S. dollar
and Mexican peso was fixed, as it had been since 1954. At the
same time, the interest rate on Mexican bank deposits exceeded the
interest rate on comparable U.S. bank deposits. This situation
might seem like a flaw in the financial markets, since investors could
borrow at the low interest rate in the United States, convert dollars
into pesos, deposit the money in Mexico and earn a higher interest
rate, then convert the proceeds back into dollars at the same exchange
rate and pay off their borrowings, making a tidy profit. Friedman
noted that the interest rate differential between Mexico and the United
States must have reflected financial market concerns that the peso
would be devalued. Otherwise, the interest-rate differential
would soon disappear as investors increasingly took advantage of
it. In August 1976, those concerns were justified when the peso
was allowed to float against the dollar and its value fell 46
percent." -- FEDERAL RESERVE BANK
OF PHILADELPHIA BUSINESS REVIEW SEPTEMBER/OCTOBER 2000: Understanding
Asset Values: Stock Prices, Exchange Rates, And the "Peso Problem" (PDF)