Mexico Beyond NAFTA

Martin Puchet Anyul, Lionello F Punzo, Martin Puchet Anyul, Lionello F Punzo

• Publisher: Routledge
• Year: 2001
• ISBN:
  9781134543588
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Business allgemein

With European Monetary Union well underway, Europe is starting to look at nearby countries and culturally closer continents to define its strategies for the future. In this book, chapters by leading Mexican economists are matched with reactions from European colleagues. They offer a novel viewpoint on the critical assessment of the North American F

Part I
Paths to convergence and monetary union(s)

1 Currency boards and monetary unions

The road ahead or a cul de sac for Mexico’s exchange rate policy?¹

David Ibarra and Juan Carlos

Moreno-Brid

The world, now that commercial frontiers have been erased, is en route to the elimination of monetary divisions. The process is already underway and it seems that, once again, it will catch us unprepared. The reason for this lies in the innate, or imposed, global instability which burdens governments and economic agents operating in the markets of Mexico and Latin America, overwhelming them with uncertainty. These uncertainties have become more acute in recent years, as a result of the rapid and unrestricted movement of global financial capital in amounts which exceed, many times over, the international reserves of the majority of countries in this region. Confronted by unsatisfactory, contradictory or utopian solutions proposed by economists and other experts, there have been lapses of behavior that border on the irrational or that clutch at elusive miraculous cures.

Under present circumstances, to fix the nominal exchange rate by decree tends to mirror an ideological posture: displaying complete distrust in the abilities and goodwill of governments, together with a blind faith in the markets’ self-correcting and optimizing mechanisms. Both extremes are false. Some state interventions and regulations are indispensable, and dangerous market disarrays can exist, as exemplified by the multiple financial crises occurring today and in the past.

The apologists of a world without frontiers regard the formation of a zone of monetary integration among members of the North American Free Trade Agreement as imminent. In their view, the creation of a currency board – eliminating, once and for all, any variation between the peso and the dollar – would be even simpler. The cost of surrendering monetary sovereignty is deemed to be of little account. This course of action, they affirm, would wipe out inflation at a stroke, interest rates would fall to levels comparable to those of the First World, the uncertainty surrounding the exchange rate would stop blurring investment decisions, foreign trade transaction costs would be substantially reduced and the fragile banking system would, at last, be put back on a healthy track.

The cases of the single European currency, the West African Monetary Union,² and the currency boards in Bosnia, Brunei, Djibouti, Hong Kong, Estonia, Lithuania or Argentina³ are promoted as irrefutable proof of the viability of proposals for monetary reform, without any reference to the specific nature of each case. What is overlooked, due to candor, ignorance or convenience, are the conditions that must be fulfilled and the price that must be paid to ensure even the minimal success of such proposals.

The purpose of this paper is to examine these questions as they apply to the Mexican economy. The work is organized in three sections. Following this introduction, section 1.1 analyses the viability and the necessary requirements to establish a currency board, with particular reference to crucial characteristics of Mexico’s productive and financial structure. Section 1.2, after a brief review of the progress made in the commercial integration between Mexico and the United States, analyzes the extent to which a monetary union between them would boost, or perhaps hinder, Mexico’s economic development. There are two main aspects to this analysis. The first is a study of the intermediate goals established by European countries, long before their monetary union was formalized, with respect to harmonizing macroeconomic strategies and creating institutional means to supervise and regulate their labor and capital markets. The second aspect is to reveal certain elements of Mexico’s institutional organization and the operational dynamics of its labor, goods, and services markets, as well as its banking system, which are far from fulfiling essential requirements to establish a viable monetary union with the United States. The work closes (section 1.3) with a series of final considerations. Here, based on the foregoing analysis and emphasizing the profound asymmetries between the Mexican and the United States’ economies, it is concluded that for Mexico, at present and in the near future, the best option is a floating exchange rate. The alternatives of fixing the nominal exchange rate of the peso against the dollar, via a currency board or monetary union, will end up critically deteriorating Mexico’s international competitiveness and, more seriously, making domestic output and employment more vulnerable to the impact of future external shocks. Such negative effects, besides hindering Mexico’s insertion into a path of rapid and sustained economic growth, could damage its internal social cohesion and may even threaten its political stability.

1.1 Advantages and limitations of currency boards: an overview

The defining characteristic of a currency board is the legal obligation on the part of the monetary authority to maintain international reserves in excess of the total amount of coins and bills in circulation. Thus, it is a system that displaces and narrows down the traditional functions of the central bank, transforming it into a mere convertibility window forced to redeem, without limit, all monetary liabilities at the stipulated exchange rate, dispensing with any attributes of being lender of last resort beyond the limits imposed by the amount of foreign reserves. In effect, it is a radical, extreme means of returning to the gold standard; that is, of freezing the nominal exchange rate and eliminating its use as an instrument to adjust to external disequilibria.⁴ Such redirection of exchange rate policy towards the single-minded achievement of the goal of price stabilization has proved, without doubt, to be effective in reducing inflation. But this success is invariably accompanied by the progressive loss of international competitiveness which, sooner rather than later, erupts into a balance of payments crisis.

The Mexican economy has experimented on several occasions with fixed nominal exchange rates. Indeed, its evolution over the past 40 years has been marked by episodes during which macroeconomic policy has had as its primary – and, on occasion, unique – objective to eliminate inflation. In this quest the peso–dollar nominal exchange rate was fixed at levels that gradually undermined the growth potential of the tradable sector and, therefore, effectively slowed down the overall rate of economic expansion. During these episodes the goal of economic growth was perennially subordinated to the goal of reducing annual inflation to a single digit; price stabilization that, it may be added, was at most achieved in a transitory manner. The results have proved disastrous. The existence of severe structural imbalances was overlooked and, rather than being resolved, they became more acute, thereby making it more difficult for the Mexican economy to achieve a strong and persistent expansion.

The first necessary condition to create and sustain a currency board is to have sufficient foreign reserves to fulfill convertibility requirements, as well as to gain the requisite internal and external credibility.⁵ This condition is not easily fulfilled if, in addition to M-1, other closely linked monetary substitutes are included.⁶ However, of greater importance is its implicit obligation, not only to surrender monetary autonomy, but also to subordinate fiscal policy to sustain the fixed exchange rate; an economic objective that would have the utmost priority.⁷ In other words, everything would be subject to the fixing of the exchange rate. This was possible during the first years of the gold standard only due to the political alienation of a great part of the population at the time, as well as a lack of a clear understanding of the relationship between monetary regulations and economic activity.⁸ Once these conditions began to disappear, the gold standard collapsed in the face of pressures from structural imbalances in foreign trade and from domestic social upheaval.

Within such a system, external shocks would force the government to expand – or to reduce – its expenditure or taxes in order to modify the level of economic activity in accordance with the goal of maintaining unaltered the nominal exchange rate. Simultaneously, it is likely that the strategy of outward-oriented growth and the satisfaction of long-time postponed popular demands would enter in contradiction with the obligations assumed in establishing the currency board.

1.1.1 Economic policy, produc...