“Everyone got used to playing with free, easy money. Now it’s going to cost us.”
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
On July 1, the Financial Times wondered just how low the Mexican peso could go, likening the ill-fated currency to a limbo dance: “Every month, it gets just that little bit lower.”
In the 20 trading days since, the peso has experienced eight record daily lows, in itself a record, even for Mexico. Not since the peso-dollar floating exchange rate system was established, on December 21, 1994, at the height of Mexico’s Tequila Crisis, has the currency notched up so many new lows in one single month. And there are still three days left to go!
At 16.25 pesos to the dollar currently, the peso has lost roughly 20% of its value against the dollar within a year. In December last year, with the exchange rate dropping to 14 pesos to the dollar, the country’s Exchange Rate Commission launched a currency intervention program in a bid to prop up the peso, or at least stymie its slide.
Like so many central bank interventions these days, it failed: by March, it took 15 pesos to buy a dollar. The Commission upped the ante, announcing it would conduct daily auctions of $52 million, without setting a minimum price requirement. That was four months ago. Since then, the peso’s value has continued to slide against the dollar, and the pain is beginning to show.
As El Financiero reports, although inflation, at around 3% , remains at historically low levels, pressures are beginning to rise. Some imported goods, including medical appliances, plastics and petrochemicals have registered price increases of between 10% and 15% over the last couple of months. With external trade accounting for 63% of the national economy, the impact is unavoidable. Particularly hard hit are companies with heavy debt loads denominated in dollars.
The worse the situation gets, the more likely it is that Mexico’s Central Bank will intervene with its own mini bazookas. There are two problems, however: first, after intervening with daily auctions for the last four months, the Bank of Mexico’s foreign currency reserves are at their lowest point since October last year; and second, the likelihood is that central bank intervention will have limited, if any, effect, for the simple reason that the current downward trend is a result of forces far beyond Mexico’s borders.
At the beginning of 2014, the IMF warned in an uncharacteristically prescient forecast that things could turn ugly in emerging markets. For once, they were right. And nowhere is this truer than in Latin America. Five years ago it was one of the world’s fastest growing regions, with 6.1% GDP growth; this year, the way things are going, not so much.
The main cause of the pain has been the collapse of the global commodity complex, owed in large part to China’s less-than-smooth landing.
“It’s hard to say anything positive,” Win Thin, global chief of emerging markets strategy for Brown Brothers Harriman, said about Latin America. The countries that rode the wave of rising commodity prices “are now seeing the other side,” he said. One result is that traders on the $5.3-trillion-a-day Forex exchange are fast losing faith in the region’s currencies. Indeed, in a July 15 report, Morgan Stanley strategists warned clients that they could not identify a single Latin American currency worth recommending.
The Brazilian real has lost close to a fifth of its value so far this year. Venezuela’s Bolivar is collapsing. Argentina continues to languish neck-deep in stagflation. Even the continent’s more aligned economies, Chile, Mexico, Peru, and Colombia, are slowing down as a result of declining demand for commodities, in particular from China, as well as a strengthening dollar.
With Friends Like These…
It doesn’t help when your own national investors and corporations are offloading the domestic currency as fast as they can. As Jorge Gordillo, chief analyst at Grupo Finaniero CI Banco, told the Mexican daily El Excelsior, as confidence in Mexico’s economic fortunes wanes, more and more Mexican banks and businesses are exchanging their pesos for dollars, fueling further demand for the world’s reserve currency.
It is the worst of vicious circles: the stronger the dollar gets, the more the locals want it. The more the locals want it, the weaker the peso becomes. Rinse and repeat:
We are talking about large Mexican investors, banks and businesses. Whenever there’s uncertainty they turn their backs on the peso…
(The) Financial Times recently ran an article on the peso, citing a study done by a Citigroup representative that tracked currency flows… What it found was that it was not the normal transactions that were going against the peso, nor normal deposits… it was primarily the institutional movements within the banking sector itself that were moving out of pesos and into dollars…
In other words, Mexico’s biggest banks and institutional investors are betting en masse against the country’s currency. According to some estimates, 75% of transactions of pesos into dollars are being executed by big institutions and banks, mainly Mexican. Gordillo estimates that the pressure against the peso will continue to rise because the driving force behind the phenomenon is a shift – or at least an expected or feared shift – in the Fed’s monetary policy. And he added: “Everyone got used to playing with free, easy money. Now it’s going to cost us.” As free, easy money always does. By Don Quijones, Raging Bull-Shit.
The autopsy has already begun. Read… Is Mexico Ready For Life Without Its Sugar Daddy?
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