Matthew Reid
“Mexico’s Crisis, The World’s Peril.” Foreign Policy, #49, Winter 1982-83
Main Point: The Mexican Crisis had such a large impact globally because it was a period of global recession and many other countries were running large debts and financially vulnerable. The Mexican experience weakened bank and investor confidence overall and decreased the amount of funds available to many middle-income countries who were at the time in desperate need of capital. The crisis highlighted the weaknesses of the international financial system.
The Path to Crisis:
External Factors: 1) weak world oil markets
2) higher world interest rates
Oil made up 3/4 of Mexican exports so as oil prices fell so to did the government’s revenues. Plus, with high interest rates, the interest burden climbed from $5.4 billion in 1980 to $8.2 billion in 1981.
Internal Factors: 1) Between 1978-81, the government pursued expansionary fiscal policy that created an average of 8.2% real economic growth. This was very inflationary and not sustainable with the international economy in recession.
2) Huge budget deficits. Mexico borrowed 44% of the nine largest U.S. banks’ capital in 1981. If Mexico was unable to pay this back than over 1/3 of the banks’ annual profits would have been wiped out.
3) Overvalued exchange rate. This caused non-oil exports to stagnate while the demand for imports climbed well over exports.
What Sparked the Financial Panic?:
In July 1982, the PRI won the election and immediately imposed austerity measures to reduce the budget deficit. Prices of bread rose by 100% and gasoline by 50%. These changes are inflationary in the short-run, and already suffering from 60% inflation, the public exchanged their pesos for dollars. With foreign exchange reserves declining, the government was forced to close the exchange market. But when it opened back up the peso experienced immediate and enormous devaluation––it went from 70 to 120 pesos per dollar.
International Response:
America, deeply concerned about Mexico’s economic stability, immediately arranged billions of dollars in aid. Foreign banks postponed debt repayments for 3 months and the IMF began to negotiate a deal.
Austerity:
Although Mexico seemed to be making progress in 1982 with imports falling, exports rising, and a devalued currency, a recession was coming. It seemed Mexico would have to reschedule its debt from short to long-term and the resultant damage to its credit would limit its ability to borrow. The IMF instructed Mexico to enact more stringent austerity measures.
International Repercussions :
Mexico’s crisis hurt banks’ confidence in lending to Latin America in general. This was extremely harmful as many countries, especially Brazil, were in need of capital. Other countries besides Brazil, like Costa Rica, Ecuador, Bolivia, and Chile were all running major deficits and the cutting off of funds would only lead to insolvency and more economic downturn.
IMF:
The IMF got to demonstrate its importance not only to low-income countries but to Newly Industrialized Countries as well. They not only supplied funds from their own coffers but the recovery plans they set forth gave confidence to other nations and private institutes to do so too.
Change in Supply of International Capital:
In the 1970’s, the lending responsibilities to mid-income countries were taken over by private institutes. This was at first seen as praise worthy but now it is recognized that such funds are easily stopped and reversed so now the structure of capital flows is under fire.
If capital flows are significantly reduced to many mid-income countries with large debts, then the countries can no longer afford to pay their loans and the banks are then under serious threat. The problem is that banks no longer want to risk loaning to Latin America but they rely too heavily as a dumping ground for loans. Plus, they need the area to recover in order for them to recover and to be able to pay their debts.
Symbiotic Economies:
It has become increasingly apparent that the U.S. and Mexico need to cooperate and that what hurts one hurts another. U.S. banks, U.S. border towns, and U.S. citizens with dollar deposits in Mexican banks all depend on a healthy Mexican economy. Also, illegal immigration increases into the U.S. when Mexico is in economic trouble.