March 16, 1995
"Peso's Plummeting Past"
San Jose Mercury News
By Timothy Taylor
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ANYONE WHO was deeply surprised at the devaluation of the Mexican peso these last few months doesn't pay much attention to the Mexican economy. Over the last 20 years, the peso has sunk like a stone.

Flashback to 1976. For several years, the exchange rate had been 12.5 pesos per U.S. dollar. In July, Jose Lopez Portillo was elected president, amid the usual criticism that the elections weren't open enough. On Sept. 1, 1976, in response to concerns over high levels of Mexican debt, he sharply devalued the peso, so that it took 20 pesos to purchase a dollar.

The New York Times wrote that the "result would be the devaluation of the savings of thousands of Americans," who had been enticed by high interest rates into buying Mexican bonds. Meanwhile, Lopez Portillo was pledging to strengthen the Mexican economy by nationalizing everything that breathed.

The peso exchange rate changed little from 1976 to 1981. But in the election year of 1982, the currency started collapsing. In July, Miguel de la Madrid Hurtado was elected president, amid the usual criticism that the elections weren't open enough. By December, the peso was trading at 148 to the dollar; that is, it took seven times as many pesos to buy a U.S. dollar as it had during the previous five years.

The New York Times reported, once again, that "Americans who invested in Mexican financial instruments, attracted by high interest rates and transactions confidentiality, may have lost hundreds of millions of dollars." The U.S. Border Patrol warned that the currency depreciation was causing an influx of illegal immigrants.

As the peso plummeted in 1982, California Gov. Jerry Brown asked President Reagan to have San Diego and Imperial counties declared economic disaster areas, because Mexican purchasing power across the border had dropped so sharply. Lopez Portillo, before leaving office, gave a speech at the United Nations explaining that Mexico's currency crisis threatened the stability of the world monetary system. He offered a plan to rescue the Mexican economy by nationalizing the banks.

Terrible years followed for the Mexican economy. High prices for Mexican oil had encouraged heavy spending and borrowing. When oil prices came down and interest rates stayed high in the 1980s, the debt crunch hit with a vengeance. The currency kept slumping, from 145 pesos to the dollar in 1983, to 371 pesos in 1985, to 923 pesos in 1986, to 2,209 pesos to the dollar in 1987.

Carlos Salinas de Gortari was elected president in July 1988, amid the usual criticism that the elections weren't open enough. The peso didn't devalue in 1988, for the simple reason that wage, price and exchange rate controls were imposed from March through December of that year.

When the controls were lifted, the peso kept falling. It sunk to 2,641 pesos to the dollar in 1989 and 2,945 pesos in 1990. Just 15 years earlier, the exchange rate had been 12.5 pesos/dollar!

But now, Mexico became an economic reformer. Salinas and others preached that Mexico needed to give up its knee-jerk desire to nationalize an industry every time there was bad economic news. They argued for more open markets and free trade, for reducing the amount of government borrowing and keeping the money supply under control.

From 1990 through 1993, the peso exchange rate barely budged. In fact, the government was so confident that in January 1993, it introduced the "new" peso, which traded for the old peso at a rate of 1,000 to 1. At a stroke, the exchange rate went from about 3,100 (old) pesos to the dollar to 3.1 (new) pesos per dollar.

But the peso began to slide again in 1994. Ernesto Zedillo was elected president in July, amid the usual criticism that the elections weren't open enough. By December, the exchange rate had fallen to 3.4 pesos/dollar.

The fall accelerated after the peso was officially devalued in late December, and the current exchange rate is about 7 (new) pesos per dollar. It now takes more than twice as many pesos to buy a dollar as it did from 1990 to early 1994.

The news coverage of this devaluation repeats stories that should be familiar, after 20 years of a declining peso. The devaluation will increase the number of U.S. immigrants from Mexico. U.S. investors in Mexico are losing money. The weaker currency will raise Mexican exports. U.S. border communities will be hurt by less purchasing power in Mexico. A collapsing Mexican peso could roil the world financial markets.

The stories all have an element of truth. This pocket history shows that predictions of utter disaster are overdone. In fact, the fundamental issues change surprisingly little over time.

It should be obvious to anyone with even a rudimentary historical background that the Mexican peso is not a stable currency. But many NAFTA critics immediately put their ignorance on display by claiming that NAFTA caused the devaluation. They are naive enough to believe that if the U.S. Congress hadn't passed NAFTA, the Mexican peso would have stayed unchanged. Some NAFTA critics have blithely gone further, and argued that Mexico secretly sought this devaluation to help its exporters. But Mexico is fully aware, based on its own miserable economic experience of these last two decades, that depreciating your currency is no way to become an economic powerhouse.

However, Mexico clearly does have ongoing problems with macroeconomic management, problems that show up in the plummeting peso.

For example, the Mexican government clearly has a habit of goosing the economy just before the election, by spending money and making additional credit available. This "political business cycle," as economists call it, creates an illusion of prosperity before the election, and leaves a legacy of inflation, devaluation, and painful adjustment afterward.

Thanks to last year's electioneering, Mexico's inflation rate may hit 70 percent this year. When a currency is being devoured by inflation, its value is sure to decline on foreign exchange markets, as well. Zedillo has blamed Salinas' last year in office for the present economic troubles. Opinion polls show that 95 percent of Mexicans agree.

At the deepest level, the shellshocked peso is a symptom of a global issue: With a trillion dollars a day being traded on the currency markets that determine exchange rates, can any nation assure a stable currency?

After all, the foreign exchange value of the U.S. dollar rose by 50 percent from 1980 to 1985, and then fell back to its previous level by 1987. The European Union tried to stabilize its exchange rates several years ago, but its system fell apart in 1992. In recent days, the Wall Street Journal reported that "the dollar went into a free fall against the mark and yen."

If economic leviathans like the United States and Europe can't shelter their currencies from the riptides of global currency markets, how is a tadpole like Mexico supposed to do it?

Investing in "emerging" markets of Latin America and Asia is a hot trend. Such countries attracted $460 billion in foreign investment from 1990 to 1994 -- more than triple what they had received in the previous five years.

But thanks to modern technology, this money can come and go at the flick of a finger on a computer key. When Mexico looked relatively stronger than other emerging markets in the early 1990s, foreign capital poured in. The instant Mexico looked a bit less attractive, the same capital fled elsewhere and the peso went down the drain.

No global mechanism exists for keeping exchange rates stable: not for the U.S. dollar, or the Japanese yen, or the German mark, and surely not for the Mexican peso. All a country can do is keep its own economic house in order, to avoid provoking currency speculation. The bailout of the peso by the International Monetary Fund and the United States has bought Mexico some time.

But Zedillo and his allies may be too weak to push through further economic reforms to bring down inflation, privatize state industries, and open markets. In that case, look for the Mexican peso to continue its ongoing decline.

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