Mexico Should Ditch The Peso For The DollarRudi Dornbusch
If Mexico wants to change, it should give up the peso and adopt the dollar as its currency. If that is done, an economic boom will result within the year, with 6% growth almost guaranteed.
Why give up the peso? Because each time Mexico makes economic progress, a currency crisis destroys it. Mexico's economy runs on a political cycle, with presidential elections coming every six years. By the third or fourth year, the economy is almost always growing, as it is now. Then election-year spending and borrowing lead to a peso crisis. This is the third year of the current political cycle, and Mexico has successfully emerged from the 1994-95 peso crisis. Unless Mexico changes its currency system, a replay of the crisis-collapse-recovery cycle will occur in 2000, the year of the next presidential election.
The seeds for trouble are already planted. There are grave political uncertainties as democracy catches up with a bankrupt official party and its hold on power. The congressional elections in July, when the National Action Party and the Revolutionary Democratic Party may increase their clout, will indicate what is to come. The financial system is in trouble, too. It continues to limp along with dilapidated balance sheets and daily infusions of government support.
Nations like to have their own money for many reasons. First and most prominent is nationalism. A country has its flag, its airline, and its money. They are part of its culture and identity. Printing money is also a source of funding for governments. They can pay out more to their political constituencies by letting the printing presses run. Monetary policy, exercised through adjustments in interest and exchange rates, can also be valuable by providing flexibility to offset shocks to the economy.
ABUSED POLICY. It is immediately clear that these traditional arguments are not compelling when it comes to Mexico. Every six years, Mexican government officials have abused just this flexibility, causing peso crises. They have overvalued the currency and printed money, even in the face of capital flight.
A dollar plan for Mexico could not be more simple. The country declares that the dollar is legal tender. The central bank uses its dollar reserves to retire large bills from circulation and replaces them with real dollar bills. Coins and small change in pesos can be left without risk. The banking system makes loans and takes deposits only in dollars.
The net effect would be to end currency volatility and inflation in Mexico. Prices and wages would no longer reflect the uncertainty that comes with regular peso crises and soaring inflation every six years. Wage growth would be limited to productivity increases. Prices would probably decline as people no longer worried about currency depreciation or inflation.
ARGENTINA PREVAILED. Can a plan like that work? Is it really that simple? Argentina has already declared parity with the dollar. No week passes without all of Argentina applauding that dramatic day in 1992 when the country made an irreversible commitment to the dollar. Growth has averaged an unprecedented 5% and now is running at near 7%. Stability was tested when capital flight after the last peso crisis threatened the Argentine economy. The dollar standard prevailed.
To avoid offending nationalist sensibilities, it would be better for Mexico to take the Argentine route and create a currency board that would manage a dollar-pegged peso. But Mexican presidential politicians have a record of manipulating the peso during election seasons. They simply can't be trusted not to interfere with a currency board. So the Mexican economy must become dollarized.
In the past, managing monetary and currency policy has led to disasters. It won't be any different in the future. The same people are in charge. They are well-intentioned, well-trained--and overwhelmed by the politics of the day. That costly insistence on trying to outsmart markets has destroyed progress for decades. The lesson surely is to ask whether it is worth retaining the peso as a national currency, and the answer is no.
Mexico has made extraordinary efforts in restructuring its economy and recognizing that integration with the world is a source of growth. NAFTA was a huge gamble and is now paying off. However, currency stability is an essential underpinning for flows of direct investment to Mexico. It is critical for obtaining low-risk interest rates on loans. These in turn are essential for a revival of investment and high growth. If Mexico wants social progress and political stability, the country must follow up the bold NAFTA move with one more downpayment for prosperity. It must move irreversibly on the dollar.