Dollarising Mexico

A major reason for Mexico's lack of economic growth recently is monetary policy, says economist Steve Hanke. Mexico's central bank has maintained the value of the peso and reduced inflation, but at the cost of economic growth. In the process, it has accumulated large reserves of dollars. Net foreign reserves have increased dramatically to $53.7 billion from $149 million in 1996.

But it pays for the dollars by issuing peso-denominated bonds that carry a higher interest rate than the interest it earns on foreign reserve holdings.

The effect has been deflationary – annual real gross domestic product growth slumped to -0.2 percent and 0.9 percent in 2001 and 2002, respectively, and is expected to be only 3 percent this year.

Consumer price inflation has come down to a tame 5 percent from 34.4 percent per year in 1996, and interest rates on 28-day Cetes – or treasury bills – have fallen to less than 5 percent from 31.4 percent on average in 1996.

The peso has held its own in the foreign-exchange market over the same time period, depreciating to around 10.3 against the dollar from 7.86.

The cure he recommends is formal dollarisation – retiring the peso and using U.S. dollars instead. Dollarisation would free capital for investment and further the integration of Mexico's economy with that of the United States – something that is already happening informally.

In fact, almost a quarter of Mexico's labour force is now employed in the United States. And since 1996, remittances of dollars to Mexico have totalled $51.6 billion, while the dollar value of the peso supply has only increased by $12.8 billion.

Source: Steve H. Hanke, It's Time for Mexico to Dollarise, The Americas, Wall Street Journal, May 30, 2003.

For WSJ text (requires subscription) http://online.wsj.com/article/0,,SB105425398319945100,00.html

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FMF Policy Bulletins/3 June 2003