Mexican Peso

http://econ161.berkeley.edu/Econ_Articles/themexicanpesocrisis.html

It is one thing to liberate an economy or a market; it is another to lift all regulations on such market. Economic liberalization should be done in an appropriate, intelligent manner. The lack of proper regulation can lead to a snowballing effect where a seemingly trivial matter can lead up to a terrible outcome. This was the case of Mexico in 1994 where birth was given to the “Tequila Effect”. What were the conditions in the country that gave way to this crisis? Could the crisis have been avoided? Perhaps under a more strictly regulated economy Mexico’s financial crisis could have been prevented, and if not, it could have been toned down in severity. The government’s decision to liberalize the country intended well, but was poorly engineered and therefore became an uncontrollable Leviathan that took its toll on the country as a whole.

Leading up to 1994 Mexico seemed to be miraculously rising from its crippled past of inflation and instability, to become a shinning beacon for the rest of Latin America. It was the example to be followed and the cause for much excitement among the players in the financial markets. This phenomenon was known as the “Mexican miracle” and had been led by President Carlos Salinas de Gortari; a firm believer in neo-liberalization policies, and also the man who tackled inflation through a rigid fiscal and monetary policy, while strongly holding the exchange rate pegged at an average of 3.1 pesos to the dollar[1]. The new conditions of the Mexican economy were looked upon favorably by potential investment, and the stability it provided at home was very popular among the domestic population.

[1] Froot, K and Mathew McBrady, “The 1994-95 Mexican Peso Crisis”, HBS Case No. 9-296-056 (Boston: Harvard Business School Publishing, 1996), 3

However the reforms did not stop there. It is questionable whether it was appropriate or not to go ahead with so many changes in the economic structure all at once. Privatization of state-owned firms, including the bank sector, took place, and plus the country opened up to investment from abroad both in the form of direct as well as portfolio investment [1]. For the first time in history, foreigners were allowed to hold Mexican government bonds and shares in private companies. Suddenly, Mexico became the recipient of massive capital inflows[2]. Between 1990 and 1993 Mexico received a total of $91 billion in overall investment; of that total 67% was in the form of short-term portfolio investment while the rest was in the form of foreign direct investment[3].

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[1] Froot, K, “The 1994-95 Mexican Peso Crisis,” 2

[2] Froot, K, “The 1994-95 Mexican Peso Crisis,” 8

[3] Froot, K, “The 1994-95 Mexican Peso Crisis,” 2

But all was not well. A series