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1994 Mexican Peso Crisis - Essay Example

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The 1994 Mexican Peso crisis was a monetary disaster that reverberated throughout the world.Brought on by Mexico's "Tequila Crisis" ,the peso's fixed exchange rate against the dollar "plunged by around 50% within six months…
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1994 Mexican Peso Crisis

Download file to see previous pages... The 1994 Mexican Peso crisis was a monetary disaster that reverberated throughout the world.Brought on by Mexico's "Tequila Crisis" ,the peso's fixed exchange rate against the dollar "plunged by around 50% within six months..This in turn caused the local-currency value of the government's large dollar-linked debts to swell enormously and sent Mexico into a deep recession". Through the help of the United States and others, Mexico's economy has since rebounded nicely, but is not growing at a rate that many experts would consider desirable. To be sure, the scars of the 1994 crisis will be apparent in Mexico for years to come.The impact of the currency crisis on Mexico's financial sector was especially severe. "Stacks of bad, even fraudulent, loans by the recently privatised banks were exposed. Many banks went bust. Thousands of Mexicans, particularly in the new middle class, defaulted on loans as interest rates rocketed, and had their homes repossessed. In 1995 GDP shrank by 6.2%". The devastation of this collapse had an impact that reverberated throughout the region, and was amplified by Mexico's recent ascension to the North American Free Trade Agreement.The new free trade block in North America demonstrated the ripple effect that a financial crisis in one country can have with its main trading partners.
The existence of NAFTA, while a hazard to the United States due to this vulnerability to problems plaguing another country, constituted a life raft for Mexico because it ensured that the United States would need to make a greater effort than it otherwise might to assist Mexico. "President Bill Clinton reasoned that Mexico, then America's third-largest trading partner, must be helped because of its importance to American jobs and investment. His administration arranged a $40-billion standby loan--in the words of Robert Rubin, then the treasury secretary, not so much 'for the sake of Mexico, despite our special relationship, but to protect ourselves'" (par. 3).
Nevertheless, it has been argued that NAFTA was one of the primary contributing factors to the currency crisis. Maskooki asserts that "Mexico's joining NAFTA, and ensuing trade liberalization and deregulation of capital market and banking stimulated large capital flows in the form of portfolio investment. Banks and the capital account transactions were liberalized before adequate regulation and supervision measures were in place. The result was an excessive accumulation of external credit and an unprecedented lending boom driven mostly by moral hazard. The availability of foreign capital promoted excessive borrowing by both the public and private sectors. As Mexican economic fundamentals deteriorated and the peso became overvalued, foreign portfolio funds reversed direction leading to the peso devaluation" (par. 12). Indeed, it is no accident that the currency collapse occurred within a few months of Mexico's ascension to NAFTA.
Maskooki also notes that NAFTA ignored the need to coordinate economic cooperation among its members in light of Mexico's relatively primitive economic situation. "NAFTA did not effectively address issues concerning macroeconomic coordination and monetary cooperation amongst the trading partners or provide an adequate safety net while Mexico was undergoing rapid deregulation and liberalization of its economy. There was a lack of coordination of economic policies among NAFTA partners. Most notably, the impact of the US monetary policy, and its ramification for Mexico's small and debtridden, archaic economy were little understood, and mostly ignored" (para. 10). Much more needed to be done to prepare Mexico for exposure to free trade such an advanced economy as that of the United States.
The deregulation of the banking sector that was called for by NAFTA made Mexico's lack of preparedness quite evident. "NAFTA did not provide Mexican ...Download file to see next pagesRead More
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