The Surprising Peso

In the United States, most of us don’t worry about currency crises. Politicians rarely talk about the stability of the dollar because it is a world currency. Global demand keeps its value relatively stable and allows us to focus on other topics.

Mexican policy makers, on the other hand, continually keep an eye on the movement of their currency because the peso has endured a number of rapid freefalls throughout its modern history. The cause is often a sudden drop in exports, which causes businesses to exchange fewer dollars for pesos. This puts a downward pressure on the value of the peso and generates unease amongst investors. Afraid of a rapid drop, these investors pull their money out of the country, consequently exacerbating the very drop they were afraid of.

In the fall of 2008, as the US financial crises was causing severe loses at the New York Stock Exchange, Stephen Jen, the chief currency strategist at Morgan Stanley, predicted that nations like Mexico would soon face currency and financial shocks. He said, “the US financial sector has been the epicenter of the global crisis. I fear that a hard landing in emerging market assets and economies will become the second epicenter in the coming months.” If you look at the history of developing economies this was a pretty safe prediction.

But in Mexico, Jen’s forecast has proven incorrect. Despite an adjustment in the price of the peso in early 2009, there was never a freefall. Why is this? Why has the Peso shown resilience in the face of a severe recession? Why hadn’t investors pulled their money out of the country at the first sign of turbulence like they had in the past? I had been asking myself these questions since I arrived in Mexico in November, and I presented them to just about anyone that wanted to listen. I also searched the web to see if anyone else was discussing it.

The best answer I found was in an academic paper covering this very topic, written by American University professor of economics Arturo C. Porzecanski. I encourage everyone to read it. Porzecanski stated that a number of factors contributed to Mexico’s – and most of Latin America’s – hardiness during this crisis. He also contrasted Latin America with Eastern Europe, which have suffered considerably during the crisis.

One factor is the debt that Mexico incurred prior to the crisis was primarily denominated in pesos, as opposed dollars. This was the result of a growth in the domestic bond markets for both the Mexican government and large Mexican corporations. In the past, Mexico’s credit channels were typically in dollars, which meant that if the peso dropped Mexican debt grew proportionally.

Porzecanski also explained that the current banking system is more locally self-sufficient than in the past. In other words, money for loans was earned in the same markets where these loans were distributed. Finally, he stated that at the beginning of the crisis, the level of both public and private debt in Mexico was relatively low. This added a layer of credibility to finances and kept investors fears at bay.

I think Mexico has taken a crucial step over the past 10 years and, perhaps, the peso is no longer a particularly volatile currency. This story, however, isn’t over. Recent troubles in Venezuela and Argentina can spill into Mexico despite the improvements in its financial stability. Also there are still real problems in the Mexican government, from corruption to economic policies that hinder productivity.

These problems can slow growth and with the recession not over yet, investors may still get scared away. In emerging economies, policy makers really have two sets of constituents – their citizens, and international investors. If they don’t keep both confident and happy, they will face problems.

Options in the Car Market

Let’s say you’re in the market for a new car. You’re looking for a reliable and fuel-efficient sedan but you don’t have $25,000 for a new Prius or diesel Jetta. You also shy away from those second-rate car companies, like Hyundai or Saturn. If this is you, I would recommend the 2010 Nissan Tsuru. It has a sticker price of $8700 and gets 39-47 miles per gallon.

Or maybe you’re looking for a small utility truck. You need a vehicle that will fit into the cramped curbside parking spots outside your house but still be able to haul those bags of concrete for your backyard projects. Again, you are looking for fuel-efficiency, a carmaker with a proven track record, and you have a budget of about $10,000.

The Ford Courier would be a good choice. With a regular Ford truck suspension, this 95 horsepower vehicle can carry 1500 pounds. And for a price of $10,680 it is accessible for many.

However there’s just one problem. If you live in the United States you won’t be able to find either of these cars at the dealership. They are just two examples of car models that I have seen in Mexico that do not exist in the US.

And from what I’ve observed, those cars that are absent in the US are generally fuel-efficient and inexpensive. A combination that is difficult to find in the second biggest car market in the world. The Tsuru, for example, is similar to the Sentra from the 1990’s but with some simpler components such as manual steering and non anti-lock brakes. The Ford Courier is one of various “mini” trucks found throughout much of the world.

It is a common practice for car companies to target certain markets with particular models that they believe will be profitable. However, in a time when money is tight and gas prices are expected to rise, I'm puzzled why we don't see cars like the Tsuru in the US. Perhaps Nissan is afraid the Tsuru would crowd out their more expensive cars and the higher profit margins that come with them. But, nevertheless, I think there is a golden opportunity for a car company to capitalize on this niche market of fuel-efficient $10,000 cars.

In Mexico you can find anything from the Hummer H2 to the diminutive Ford Ka, and perhaps, in the automobile sector, the US's southern neighbor is the land where freedom of choice reigns.

Small Businesses and the Informal Economy

With my first entry I going to jump right into it and talk about the informal economy here in Mexico. But first, a definition: The informal economy generally refers to individually owned and operated small businesses that exist outside of the tax system and lack reliable access to credit. These businesses are usually run out of a home, on the street, or in an open air market, and can include just about any consumer good or service imaginable, from homemade tamales to t-shirts made in China.

During an economic crisis, as workers are laid off and jobs become scarce, this sector grows. When a worker loses their job in the United States they apply for unemployment insurance. In Mexico, the recently unemployed often start a business. This spirit of entrepreneurship is inspiring but it also shows the disenfranchisement of a significant amount of the community. By some estimates, 40% of the goods sold in Mexico are from the informal economy.

For many, days are long and there is little chance of seeing their business grow because they lack the necessary credit. I was at a cafe the other day in the center of Mexico City when an older man with a bucket of soap and water walked in and approached the barista. With my struggling comprehension of Spanish, I thought I overheard him ask if they needed their door cleaned. The barista nodded "yes" and the man went to work. It turns out he asked if they needed the tracks on their main garage-type sliding door cleaned. He worked for about a half an hour cleaning out the dirt and rust from these tracks and when he finished I watched the barista hand him 10 pesos (85 cents). The man then went on his way to find his next customer.

Not all people working informally, however, receive such little compensation. In some cases, they may be doing better than those with "regular" jobs. A friend of mine in Guadalajara, for example, is a French teacher. She has a bachelor's degree and worked as a teacher in France for a year. Her salary, however, is quite modest. In contrast, her sister, who did not go to college, works in a market selling pirated DVD's. With the money from her job she drives a nice car, wears fashionable clothes and has an apartment in her city of Atlacomulco.

The informal economy appears to function as both a safety net for those out of work and as an alternative for those who do not want the constraints of a formal sector job. It seems to me, however, that the Mexican government should try to "formalize" these businesses by opening up channels for credit and also taxing their profits. This is certainly a tall order and it would be difficult to construct an accurate and fair tax regime. But, by allowing these businesses to plug in, I believe it will create a more fertile atmosphere for innovations to prosper. Consequently, this would create more home grown jobs in Mexico and generally make the people better off.



Also, here's an interesting podcast from NPR's Planet Money, which talks about the benefits of legitimizing Jamaica's informal businesses. http://www.npr.org/blogs/money/2010/04/the_friday_podcast_fear_and_ta.html