When the aftershocks of Federal Reserve interest-rate hikes started rippling through financial markets nearly a year ago, who would have thought that the Mexican peso would eventually become one of the biggest victims of the turbulence? Even after the currency lost more than a third of its value over four brutal December days, many people were still scratching their heads in disbelief. "The reaction of the market has been excessive," International Monetary Fund Managing Director Michel Camdessus insisted to reporters on Jan. 3.
Maybe so. But while the peso collapse is grabbing most of the headlines now, Mexico is hardly the only country whose currency has become vulnerable to attack. In fact, many economists think 1995 could see debt and currency crises that will make the 1992 European Monetary System blowup look tame by comparison. It's just the latest sign that as global investors become increasingly able to switch from economy to economy at the tap of a computer key, some countries may find themselves getting a drubbing they never anticipated.
What did Mexico in was a mushrooming trade deficit, financed by billions in short-term foreign debt at a time of heavy competition from rising U.S. rates. With an untested President in office for less than a month, all it took was a new flare-up of tensions in Chiapas for foreign investors to start dumping Mexican assets.
COMEDOWN. Now, some other Latin American countries are facing rough going in the wake of Mexico's comedown. Argentina, for example, is grappling with trade deficits of its own. President Carlos SaPound l Menem will probably have to enforce a strict austerity program--and maybe even set off a politically unpopular recession--if he wants to continue pegging the Argentine peso to the dollar at a ratio of 1 to 1. One sign of investor concern: Since Mexico's peso troubles began on Dec. 20, the Buenos Aires stock market is off 9%.
But several industrialized countries may also find themselves in the same boat as Argentina. Take Italy. Worries over the collapse of Silvio Berlusconi's government and a national debt exceeding 100% of the gross domestic product are pushing the lira down against the dollar and German mark. Some traders worry that Italy may even default on its $1.2 trillion debt. That could send investors running for the safety of U.S. and German government debt and touch off a chain reaction of interest-rate increases, bond defaults, and currency crises among such other debt-laden countries as Belgium, Canada, Sweden, and Spain, where the central bank raised interest rates Jan. 4 to defend the sagging peseta.
But the risk of financial meltdown in Canada may even be worse. Like Italy, Canada is burdened by debt and severe political ills--in this case Quebec separatism. As a result, notes Martin H. Barnes, managing editor of Montreal's Bank Credit Analyst, "investors are demanding a huge risk premium to hold Canadian debt."
VICTIMS? Yields on long-term government bonds have risen to 9%, despite an inflation rate of 2% or less. But not even that, or recovery, has stopped the Canadian dollar from slipping 5% against the greenback since fall. "Foreign investors will buy Canadian debt, but at an interest rate that keeps getting worse and worse," warns Barnes. "It's killing us."
France also may fall victim to the currency vigilantes. The Organization for Economic Cooperation & Development expects the French economy to expand by 3.1% this year. But it wouldn't take much to wreck that, especially if Germany's Bundesbank raises interest rates in coming months.
Such a move could force Banque de France Governor Jean-Claude Trichet into making an unpleasant choice. To keep the franc in lockstep with the German mark, Trichet would then have to raise French rates as well. That could imperil France's recovery, worsen joblessness--which now is a painful 13%--and swell a budget deficit that is already too large by many investors' reckoning. But refusing to follow any Bundesbank rate move would likely end France's efforts to keep the franc in line with the mark. With upcoming presidential elections setting traders' nerves on edge, the franc has slipped to a 13-month low against the mark. "And it's going to get a lot worse," predicts Mark Turner, managing director of Boston-based Putnam Investment Management.
It costs a lot these days to maintain a sound currency--one that keeps inflation at bay, reassures investors, and buys a flow of imported machine tools and designer duds. To keep its currency from tanking, a country has to have a gilt-edged economy and huge reserves of hard cash. With more than $1 trillion looking for a home in the foreign exchange market every day, even a slight deviation from the straight and narrow can invite a savaging. Mexico discovered this in December. Now, other countries may find out how bad things can get when they don't get everything exactly right.