The peso crisis was the Mexican government’s near DEFAULT on its international debt obligations in 1994–95. The frightening but largely unreported aspect of the Mexican peso crisis was how dangerously close Mexico came to defaulting on all its debt. The unprecedented U.S.-IMF (INTERNATIONAL MONETARY FUND) financial support package was the largest international aid response since the MARSHALL PLAN in 1948. While the peso crisis was a Mexican economic problem, it is included in an encyclopedia of American business for three reasons. First, Mexico is the United States’ secondlargest trading partner (after Canada). Second, the U.S. government was heavily involved in Mexico’s bailout during the crisis. Third, the peso crisis is instructive of the risks associated with international business in EMERGING MARKETS. In 1994 Mexico was widely heralded as one of the success stories of ECONOMIC GROWTH through export expansion. For decades the nation had pursued import-substitutionindustrialization (ISI), by which economic growth is attained through substituting domestic production for foreign IMPORTS. The logical limit of ISI economic development is the size of the domestic economy. At the time, the Mexican economy was about one-twentieth the size of the U.S. economy. When the Mexican economy stagnated in the 1970s and again in the 1980s, Mexican economists and later political leaders began to reduce TRADE BARRIERS and support export expansion. However, Mexico had a long history of financial crises coinciding with changes in political leadership every six years. In 1994 the outgoing Mexican president, Carlos Salinas, who was lobbying hard to become the first president of the WORLD TRADE ORGANIZATION, chose to ignore a growing liquidity crisis. (A liquidity crisis occurs when currency reserves are insufficient to offset trade deficits.) Early that same year, international investors led by U.S.-based banks began reducing their holdings of Mexican peso debt securities. In an effort to maintain CAPITAL inflow, the Mexican government expanded the use of tesebonos, short-term peso-denominated securities convertible to U.S. dollars. In effect, the Mexican government assumed the RISK of currency devaluation by guaranteeing payment in dollars. In early 1994, the expanded use of tesebonos combined with an overvalued Mexican peso, which stimulated greater imports and reduced exports, increased the currentaccount deficit. This further reduced Bank of Mexico currency reserves. At the time, Mexican exchange-rate policy was a “crawling peg”—that is, the peso was being devalued on steady rate within a prescribed range or band. But Mexican INFLATION was greater than the rate of devaluation of the currency. Thus, the peso became overvalued. In December 1994, when the new government took office, it quickly became evident that peso devaluation was needed. Finance Minister Dr. Guillermo Ortiz, hoping to gradually reduce the imbalance, announced an expansion of the band of peso/dollar devaluation. While the new Mexican leadership hoped this would be seen as a minor adjustment and not panic in the financial markets, it was seen as a radical step and became front-page news. Investors rapidly pulled funds out of Mexico, and the peso immediately fell by 35 percent. Because of the tesebonos guarantees, the Mexican government now owed billions more in dollars while the peso was worth significantly less. The U.S. government stepped in with a $6 billion currency swap credit, but that was only the beginning. By the end of January 1995, President Bill Clinton had orchestrated a $52 billion bailout plan, including funds support through the Exchange Stabilization Fund (U.S.), the International Monetary Fund (IMF), the BANK OF INTERNATIONAL SETTLEMENTS (Switzerland), and lesser amounts from commercial banks and other countries. One Mexican commentator called the plan “at least the greatest event in Mexico since the arrival of Cortes.” Two unique features of the plan were the requirement for Mexican finance managers to report weekly to the U.S. Treasury and a provision tying the revenue from Mexican oil sales as collateral for the loan. In Mexico, oil is a public resource that is controlled by the government through Petroleos Mexicanos (PEMEX). The 1917 Mexican Constitution prohibits foreign exploration for oil in the country, but the constitution does not say what the government can do with the proceeds from the sale of oil. The bailout required deposit of payments by foreign customers for Mexican oil to be made into an account with a U.S. bank that would be under “irrevocable instructions” to transfer funds to the Banco of Mexico account at the Federal Reserve Bank of New York. The U.S. Treasury was entitled to file claims against these funds if Mexico failed to repay the loan. In addition to the financial guarantees, the Mexican government was forced to implement a series of IMFdictated economic reforms to increase government revenues and reduce government spending. Unlike past Mexican financial crises, when recovery often took a decade or longer, this time the Mexican economy recovered quickly with the growth of the MAQUILADORAS program, the signing of the NORTH AMERICAN FREE TRADE AGREEMENT (NAFTA), and other new export-directed trade policies. By the late 1990s, the government had paid off its peso-crisis bailout.
See also EXCHANGE RATES.