Idea of Peso-Dollar Link Gains in Mexico

The idea was floated as an improbable trial balloon: Why not end Mexico’s long-suffering experience with the peso and move closer to North American monetary union by “dollarizing” the Mexican economy?

Conventional wisdom had it that proud Mexicans would never tolerate the sacrifice of their currency, yet another surrender of sovereignty to the “gringos.”

Yet when news reports surfaced that the peso’s latest pounding had encouraged Mexican central bank authorities to consider linking the peso to the dollar, the public reaction was startling.

In a poll of more than 1,500 radio talk show listeners, 87% were in favor and only 13% against. Newspaper columnists began touting the notion as the best hope for financial stability and discipline. A major right-wing presidential candidate even came out in support of the concept.

Suddenly the dollarization of the Mexican economy didn’t seem so far-fetched after all, especially against the backdrop of Europe’s looming monetary union.

Inevitably, of course, the political parties began to crank up their nationalistic volume and express their outrage at the notion. And the Finance Ministry sniffed that changing course from the current floating peso exchange rate is not even under consideration.

And the polls were taken before this week’s unprecedented volatility in the dollar, which acted more like a peso by losing some 17% of its value against the Japanese yen.

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But the debate is very much alive, particularly as 2000 approaches and with it the end of another six-year presidential term, a traditional trigger for economic crises and financial instability.

“The performance of the peso over the last 22 years has been more a cause of pain than of pride,” wrote columnist Salvador Kalifa in the newspaper Reforma. “It is time that we put aside false nationalism and study truly the costs and benefits of the various options to achieve stability of prices. One of those options is the dollarization of the economy.”

A Reforma survey last weekend underscored public support for the idea. In Mexico City, 59% favored a common currency for Mexico, the United States and Canada within the North American Free Trade Agreement region, while 36% were opposed. In Monterrey, a city nearer to the Texas border, the percentage in favor hit 70%. By similar majorities, people favored receiving their wages in dollars and having dollar savings accounts.

But when the question was asked this way: “Are you in agreement or disagreement that the peso should disappear and the country should go without its own money,” the answer in Mexico City was 71% against, 27% in favor. That shows the potential for nationalist opposition to dollarization.

Vicente Fox, governor of Guanajuato and a former Coca-Cola executive who is seeking the presidential nomination for the conservative National Action Party, was among the first political leaders to respond favorably to the idea. He said a policy of dollar-peso convertibility “could give us complete stability in the financial markets.”

The governing Institutional Revolutionary Party and left-wing Party of the Democratic Revolution both pounced on Fox. The PRI’s Economic Policy Commission said Fox was guilty of “lack of historical awareness” and added: “The Mexican economy would depend on the ups and downs of the U.S. economic cycles and would lose its capacity to confront economic shocks caused by difficulties in the United States.”

After Mexico’s brutal peso devaluation of December 1994, which set off the country’s worst recession in 50 years, financial authorities abandoned the fixed exchange rate and adopted a floating currency regime. They didn’t have much choice: They had used up virtually all their international currency reserves in a failed attempt to defend the peso’s fixed value.

Since 1995, the floating peso has been widely hailed as a successful policy tool that contributed to Mexico’s remarkable recovery, culminating in 7% economic growth last year. A floating peso moves against other currencies based on market demand, forcing fiscal and monetary authorities to exercise tight discipline over spending and money supply.

This year, though, the worldwide financial crisis has pummeled all emerging markets, and the peso has paid an especially heavy price. At the end of last year, a U.S. dollar bought 8.05 pesos. Now a dollar buys 10.10 pesos, a depreciation of more than 20%--a greater fall than in any other Latin country.

And that fall came despite a huge jump in interest rates, from about 20% to more than 50% briefly, as the Bank of Mexico sought to keep the peso from falling too abruptly and inflation from soaring. Still, inflation estimates are creeping back up above 15% for the year compared with an original target of 12%.

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So in the face of yet another roller-coaster ride for interest and exchange rates, it’s no wonder ordinary Mexicans are tempted by the stability of the dollar.

Neither the U.S. government nor the Mexican political establishment is ready for such a change. But economists say intermediate steps such as permitting Mexicans to hold dollar bank accounts and to make contracts in dollars could be useful first steps.

Economist Carlos Elizondo Mayer-Serra says Mexico would need to boost its foreign reserves, strengthen its sickly banking sector, improve its tax collection and make its labor laws more flexible in order for convertibility to succeed.

But monetary union in North America is not only desirable but inevitable, writes Mexican financial commentator Arturo Damm Arnal in the daily Universal.

“In matters of money, what is important? That it is ours and is managed by our monetary authorities, or that the money maintains its buying power and contributes to price stability?” he wrote. “And if from Alaska to Yucatan, one single market is forming for goods as well as capital, then sooner or later one single currency will circulate between these two peninsulas.”