1994 economic crisis in Mexico
Encyclopedia
The 1994 Economic Crisis in Mexico, widely known as the Mexican peso crisis, was caused by the sudden devaluation
of the Mexican peso
in December 1994.
The impact of the Mexican economic crisis on the Southern Cone
and Brazil
was labeled the "Tequila Effect" .
The root causes of the crisis are usually attributed to Salinas de Gortari's policy decisions while in office, which ultimately strained the nation's finances. 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 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, a period of hyperinflation from 1985 to 1993, 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) from the Institute for International Economics
have commented on the macroeconomic policy mistakes that precipitated the crisis:
Macroeconomics 5th Edition by N. Gregory Mankiw
explains the country-risk issues precipitating the crisis:
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 five months of Salinas' administration. Some critics affirm this maintained Salinas' popularity, as he was seeking international support to become director general of the World Trade Organization
. 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.
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.
stabilized some time after the US
President Clinton
, in concert with international organizations, granted a loan to the Mexican government.
Loans and guarantees to Mexico totaled almost $50 billion, with the following contributions:
The Mexican "bailout" attracted criticism in the US Congress and the press for the central role of the former Co-Chairman of Goldman Sachs, U.S. Treasury Secretary Robert Rubin
. Rubin used a Treasury Department account under his personal control to distribute $20 billion to bail out Mexican bonds, of which Goldman was a key distributor. In late 1995, Patrick Buchanan wrote "[n]ewly installed President Ernesto Zedillo said he needed the cash to pay off bonds held by Citibank and Goldman Sachs, lest the New World Order come crashing down around the ears of its panicked acolytes." According to Hannibal Travis, the "former manager of $5 billion in Mexican investments at Goldman Sachs became U.S.
Secretary of the Treasury and lobbied for legislation that forced U.S. taxpayers to contribute in excess of $20 billion to bail out investors in Mexican securities, in a form of 'corporate socialism'".
The United States' assistance was provided via the treasury
's Exchange Stabilization Fund
. This was slightly controversial, as President Bill 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 $500 million profit on the loans.
Devaluation
Devaluation is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged....
of the Mexican peso
Mexican peso
The peso is the currency of Mexico. Modern peso and dollar currencies have a common origin in the 15th–19th century Spanish dollar, most continuing to use its sign, "$". The Mexican peso is the 12th most traded currency in the world, the third most traded in the Americas, and by far the most...
in December 1994.
The impact of the Mexican economic crisis on the Southern Cone
Southern Cone
Southern Cone is a geographic region composed of the southernmost areas of South America, south of the Tropic of Capricorn. Although geographically this includes part of Southern and Southeast of Brazil, in terms of political geography the Southern cone has traditionally comprised Argentina,...
and Brazil
Brazil
Brazil , officially the Federative Republic of Brazil , is the largest country in South America. It is the world's fifth largest country, both by geographical area and by population with over 192 million people...
was labeled the "Tequila Effect" .
Causes
The crisis is also known in Spanish as el error de diciembre — The December Mistake — a term coined by outgoing president Carlos Salinas de Gortari in reference to president Zedillo's sudden reversal of the former administration's policy of tight currency controls. While most analysts agree that devaluation was necessary for economic reasons, Salinas supporters argue that the process was mishandled on the political level.The root causes of the crisis are usually attributed to Salinas de Gortari's policy decisions while in office, which ultimately strained the nation's finances. 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 affected by an armed rebellion in Chiapas
Chiapas
Chiapas officially Estado Libre y Soberano de Chiapas is one of the 31 states that, with the Federal District, comprise the 32 Federal Entities of Mexico. It is divided in 118 municipalities and its capital city is Tuxtla Gutierrez. Other important cites in Chiapas include San Cristóbal de las...
, 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, a period of hyperinflation from 1985 to 1993, 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) from the Institute for International Economics
Institute for International Economics
The Peter G. Peterson Institute for International Economics , formerly the Institute for International Economics, is a private, non-profit, and nonpartisan think tank focused on international economics, based in Washington, D.C. It was founded by C...
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.
- 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.
Macroeconomics 5th Edition by N. Gregory Mankiw
N. Gregory Mankiw
Nicholas Gregory "Greg" Mankiw is an American macroeconomist and Professor of Economics at Harvard University. Mankiw is known in academia for his work on New Keynesian economics....
explains the country-risk issues precipitating the crisis:
- The EZLN's violent uprising in Chiapas in 1994 along with the assassination of presidential candidate Luis Donaldo ColosioLuis Donaldo ColosioLuis Donaldo Colosio Murrieta was a Mexican politician, and PRI presidential candidate, who was assassinated at a campaign rally in Tijuana during the Mexican Presidential campaign of 1994.-Political history:...
made the nation's political future look less certain to investors, who then started placing a larger risk premium on Mexican assets. - Mexico had a fixed exchange rateFixed exchange rateA fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.A fixed exchange rate is usually used to...
system that accepted pesos during the reaction of investors to a higher perceived country risk premium and paid out dollars. However, Mexico lacked sufficient foreign reserves to maintain the fixed exchange rate and was running out of dollars at the end of 1994. The peso then had to be allowed to devalue despite the government's previous assurances to the contrary, thereby scaring investors away and further raising its risk profile. - When the government tried to roll over some of its debt that was coming due, investors were unwilling to buy the debt and default became one of few options.
- A crisis of confidence damaged the banking system, which in turn fed a vicious cycle further affecting investor confidence.
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 five months of Salinas' administration. Some critics affirm this maintained Salinas' popularity, as he was seeking international support to become director general of the World Trade Organization
World Trade Organization
The World Trade Organization is an organization that intends to supervise and liberalize international trade. The organization officially commenced on January 1, 1995 under the Marrakech Agreement, replacing the General Agreement on Tariffs and Trade , which commenced in 1948...
. 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
United States dollar
The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....
), 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.
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.
Financial assistance package
A week of intense currency crisisCurrency crisis
A currency crisis, which is also called a balance-of-payments crisis, is a sudden devaluation of a currency caused by chronic balance-of-payments deficits which usually ends in a speculative attack in the foreign exchange market. It occurs when the value of a currency changes quickly, undermining...
stabilized some time after the US
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
President Clinton
Bill Clinton
William Jefferson "Bill" Clinton is an American politician who served as the 42nd President of the United States from 1993 to 2001. Inaugurated at age 46, he was the third-youngest president. He took office at the end of the Cold War, and was the first president of the baby boomer generation...
, in concert with international organizations, granted a loan to the Mexican government.
Loans and guarantees to Mexico totaled almost $50 billion, with the following contributions:
- The United StatesUnited StatesThe United States of America is a federal constitutional republic comprising fifty states and a federal district...
arranged currency swapCurrency swapA currency swap is a foreign-exchange agreement between two parties to exchange aspects of a loan in one currency for equivalent aspects of an equal in net present value loan in another currency; see foreign exchange derivative. Currency swaps are motivated by comparative advantage...
s and loan guarantees with a $20 billion total value. - The International Monetary FundInternational Monetary FundThe International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
promised an 18 month Stand-by Credit Agreement of around US$17.7 billion. - The Bank for International SettlementsBank for International SettlementsThe Bank for International Settlements is an intergovernmental organization of central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks." It is not accountable to any national government...
offered a $10 billion line of credit. - The Bank of CanadaBank of CanadaThe Bank of Canada is Canada's central bank and "lender of last resort". The Bank was created by an Act of Parliament on July 3, 1934 as a privately owned corporation. In 1938, the Bank became a Crown corporation belonging to the Government of Canada...
offered short term swaps of around US$1 billion.
The Mexican "bailout" attracted criticism in the US Congress and the press for the central role of the former Co-Chairman of Goldman Sachs, U.S. Treasury Secretary Robert Rubin
Robert Rubin
Robert Edward Rubin served as the 70th United States Secretary of the Treasury during both the first and second Clinton administrations. Before his government service, he spent 26 years at Goldman Sachs eventually serving as a member of the Board, and Co-Chairman from 1990-1992...
. Rubin used a Treasury Department account under his personal control to distribute $20 billion to bail out Mexican bonds, of which Goldman was a key distributor. In late 1995, Patrick Buchanan wrote "[n]ewly installed President Ernesto Zedillo said he needed the cash to pay off bonds held by Citibank and Goldman Sachs, lest the New World Order come crashing down around the ears of its panicked acolytes." According to Hannibal Travis, the "former manager of $5 billion in Mexican investments at Goldman Sachs became U.S.
Secretary of the Treasury and lobbied for legislation that forced U.S. taxpayers to contribute in excess of $20 billion to bail out investors in Mexican securities, in a form of 'corporate socialism'".
The United States' assistance was provided via the treasury
United States Department of the Treasury
The Department of the Treasury is an executive department and the treasury of the United States federal government. It was established by an Act of Congress in 1789 to manage government revenue...
's Exchange Stabilization Fund
Exchange Stabilization Fund
The Exchange Stabilization Fund is an emergency reserve fund of the United States Treasury Department, normally used for foreign exchange intervention...
. This was slightly controversial, as President Bill Clinton
Bill Clinton
William Jefferson "Bill" Clinton is an American politician who served as the 42nd President of the United States from 1993 to 2001. Inaugurated at age 46, he was the third-youngest president. He took office at the end of the Cold War, and was the first president of the baby boomer generation...
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 profit on the loans.
See also
- Economy of MexicoEconomy of MexicoThe economy of Mexico is the 13th largest in the world in nominal terms and the 11th by purchasing power parity, according to the World Bank.Since the 1994 crisis, administrations have improved the country's macroeconomic fundamentals...
- Late 2000s recessionLate 2000s recessionThe late-2000s recession, sometimes referred to as the Great Recession or Lesser Depression or Long Recession, is a severe ongoing global economic problem that began in December 2007 and took a particularly sharp downward turn in September 2008. The Great Recession has affected the entire world...
- 1998 Russian financial crisis
- MexicoMexicoThe United Mexican States , commonly known as Mexico , is a federal constitutional republic in North America. It is bordered on the north by the United States; on the south and west by the Pacific Ocean; on the southeast by Guatemala, Belize, and the Caribbean Sea; and on the east by the Gulf of...
- North American Free Trade AgreementNorth American Free Trade AgreementThe North American Free Trade Agreement or NAFTA is an agreement signed by the governments of Canada, Mexico, and the United States, creating a trilateral trade bloc in North America. The agreement came into force on January 1, 1994. It superseded the Canada – United States Free Trade Agreement...
- Sudden stop (economics)Sudden stop (economics)A sudden stop in capital flows is defined as a sudden slowdown in private capital inflows into emerging market economies, and a corresponding sharp reversal from large current account deficits into smaller deficits or small surpluses. Sudden stops are usually followed by a sharp decrease in output,...
External links
- The Mexican Economy 1996: Financial Assistance Package - Annual report of the Banco de MéxicoBanco de MéxicoThe Bank of Mexico , abbreviated BdeM or Banxico, is Mexico's central bank and lender of last resort. The Bank of Mexico is autonomous in exercising its functions, and its main objective is to achieve stability in the purchasing power of the national currency.On December 15, 2009, Agustín Carstens...
- The Post-Nafta Mexican Peso Crisis: Bailout or Aid? Isolationism or Globalization? by Brett M. Humphrey
- Mindmapping for Economic Crisis of Mexico