When foreign currencies fall against the dollar, it becomes clear not all countries are created equal.
Japan and the Eurozone relish the times when the yen or euro drops 50 percent against the dollar. Russia, Turkey, and Mexico, however, are trying everything in their power to prevent their rubles, liras, and pesos from losing against the dollar.
The Bank of Mexico, for example, recently blew through $1 billion in foreign exchange reserves to defend the value of the peso, only to see gains evaporate in a matter of days. Since the beginning of the year, the peso has lost 5 percent, to a value of 21.65 to the dollar, a level not seen since the last Mexican financial crisis in the early 1990s.
So what is the difference between Japan, where the yen has dropped 50 percent against the dollar since early 2012, with global financial markets cheering for it to go lower, and Mexico, where the peso dropped 58 percent over the same period and pundits are talking about a real financial crisis?
There are, of course, many differences, and the two most important ones are interconnected: deficits and debt.
Although Japan is not the export bellwether it used to be, it is still running a current account surplus, not a deficit. That means it exports more than it imports. So even if it has to pay more for its imports because of a cheaper yen, the cheaper currency makes exports more competitive. Effectively, Japan keeps paying for its imports by exporting more and even generates a small return.
This dynamic and other domestic factors contribute to low inflation in Japan, which is good for consumers because their incomes buy them more goods, even if growth is stagnant and they have to pay more for imported goods.
Mexico, on the other hand, doesn’t have that luxury. Despite $18.5 billion worth of oil exports in 2015 and a current account surplus with the United States, Mexico had a deficit of $7.6 billion with the world in the third quarter of 2016. The lower peso didn’t bring Mexico a net export gain in international markets, and a lower oil price resulted in less hard currency flowing into the country.
Because Mexico’s exports don’t pay for its imports, a depreciating currency means Mexican consumers and companies pay more for imported products. Higher import prices feed through the economy and lead to higher inflation. Indeed, inflation rose from 2.54 percent in June 2016 to 3.36 percent in December 2016.
Higher inflation means investors demand a higher premium for lending money, which leads to higher interest rates. Higher interest rates usually have an adverse effect on the economy, which prompts international investors to withdraw money—a vicious cycle, similar to what Russia went through at the end of 2014 when the ruble lost 50 percent of its value against the dollar.
With respect to lending money, Mexico has another problem that Japan doesn’t have: a high proportion of foreign currency debt. Out of $421.2 billion borrowed from foreigners, only $103.8 billion is in the local currency, according to the latest IMF report on Mexico. The country has to service and repay this debt in dollars, yen, and euros.
This would be OK if Mexico generated enough income to service international debt through the current account. It doesn’t, and a falling peso makes the ultimate repayment of foreign currency denominated debt more difficult.
This is why Mexico is more like Russia and Turkey and not like Japan and the Eurozone. And this is why President-elect Donald Trump’s proposal to squeeze and reduce the Mexican current account would make the peso fall further, rendering intervention by the central bank an exercise in futility.