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The 1994 economic crisis in Mexico, widely known as the Mexican peso crisis, was triggered by the sudden devaluation of the Mexican peso in the early days of Ernesto Zedillo's presidency. A week of intense currency crisis was stabilized when US President Bill Clinton, in concert with international organizations, granted a $50 billion loan to Mexico.
The crisis is known in Spanish as el error de diciembre — The December Mistake— a term coined by the then ex-president Carlos Salinas de Gortari. The impact of the Mexican economic crisis on Southern Cone and Brazil was labeled the Tequila Effect (Spanish: Efecto Tequila).
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Causes of the economic crisis of 1994
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While the crisis took place under President Zedillo, the causes are usually attributed to Carlos Salinas de Gortari's outgoing administration. Salinas de Gortari partially coined the term "December Mistake" when he referred to Zedillo's sudden reversal of the former administrative policies of tight currency controls, "a mistake." His government's currency policy put a strain on the nation's finances, despite some saying the economic bubble gave Mexico prosperity.
As in prior election cycles, a pre-election disposition to stimulate the economy, temporarily and unsustainably, led to post-election economic instability. There were concerns about the level and quality of credit extended by banks during the preceding low-interest rate period, as well as the standards for extending credit. The country's risk premium was also affected by an armed rebellion in Chiapas, causing investors to be wary of investing their money in an unstable region. The Mexican government's finances and cash availability were further hampered by two decades of increasing spending, debt loads, and low oil prices. Its ability to absorb shocks was hampered by its commitments to finance past spending.
Economists Hufbauer and Schott (2005) have commented on the macroeconomic policy mistakes that precipitated the crisis:
- 1994 was the last year of the sexenio, or 6-year administration of Carlos Salinas de Gortari who, following the PRI tradition on an election year, launched a high spending splurge and a high deficit.
- In order to finance the deficit (7% of GDP current account deficit), Salinas issued the Tesobonos, a type of debt instrument denominated in pesos but indexed to dollars.
- Mexico experienced lax banking or corrupt practices; moreover, some members of the Salinas family collected enormous illicit payoffs
- The EZLN, an insurgent rebellion, officially declared war on the government on January 1; even though the armed conflict ended two weeks later, the grievances and petitions remained a cause of concern, especially amongst some investors.
All of the above concerns, along with increasing current account deficit fostered by consumer binding and government spending, caused alarm among those who bought the tesobonos. The investors sold the tesobonos rapidly, depleting the already low central bank reserves. Given the fact that it was an election year, whose outcome might have changed as a result of a pre-election-day economic downturn, Banco de México decided to buy Mexican Treasury Securities to maintain the monetary base, thus keeping the interest rates from rising. This caused an even bigger decline in the dollar reserves. However, nothing was done during the last 5 months of Salinas' administration. Some critics affirm this maintained Salinas' popularity, as he was seeking international support to become director general of the WTO. Zedillo took office on December 1, 1994.
A few days after a private meeting with major Mexican entrepreneurs, in which his administration asked them for their opinion of a planned devaluation; Zedillo announced his government would let the fixed rate band increase to 15 percent (up to 4 pesos per US dollar), by stopping the previous administration's measures to keep it at the previous fixed level. The government, being unable even to hold this line, decided to let it float.
While critics agree a devaluation was necessary, some critics of Zedillo's incumbent 22-day-old administration, argue that although economically coherent, the way it was handled was politically incorrect. They argue that many foreigners withdrew their investments, aggravating the situation. The peso crashed under a floating regime from four pesos to the dollar to 7.2 to the dollar in the space of a week. The United States intervened rapidly, first by buying pesos in the open market, and then by granting assistance in the form of $50 billion in loan guarantees. The dollar stabilized at the rate of 6 pesos per dollar. By 1996, the economy was growing (peaked at 7% growth in 1999). In 1997, Mexico repaid, ahead of schedule, all US Treasury loans.
By extending loans to the Mexican government the Clinton administration stopped US banks collapsing as a result of the Mexican default. Thus US banks were protected form the effects of giving excessive loans to a poor creditor while the Mexican economy was saddled with further debt[1]
Financial assistance package
Loans and guarantees to Mexico totaled almost $50 billion, with the following contributions:
- The United States arranged currency swaps and loan guarantees with a $20 billion total value.
- The IMF promised an 18 month Stand-by Credit Agreement of around US $17.7 billion.
- The Bank for International Settlements offered a $10 billion line of credit.
- The Bank of Canada offered short term swaps with a US dollar value of around one billion.
The United States' assistance was provided via the treasury's Exchange Stabilization Fund. This was slightly controversial, as President Clinton tried and failed to pass the Mexican Stabilization Act through Congress. However, use of the ESF allowed the provision of funds without the approval of the legislative branch. At the end of the crisis, the U.S. actually made a 500 million dollar profit on the loans.[2]
See also
References
- ^ David Harvey, A Brief History of Neoliberalism p.67
- ^ Alan Greenspan (September 17, 2007). The Age of Turbulence. The Penguin Press, p. 159. ISBN 1594201315.
- HUFBAUER GC, J Schott, NAFTA Revisited: Achievements and Challenges, Institute for International Economics, Washington DC, October, 2005
External links
- The Mexican Economy 1996: Financial Assistance Package - Annual report of the Banco de México
- The Post-Nafta Mexican Peso Crisis: Bailout or Aid? Isolationism or Globalization? by Brett M. Humphrey
