No change in interest rates

As expected, both the US Federal Reserve and the Banco de Mexico did not move interest rates when they met last week (on September 21 and 24, respectively). It is surprising, though, when in the monetary policy communique issued at the conclusion of its meeting, one of those central banks, the Fed, effectively says it thinks inflation is too low.

That's not an issue in Mexico, where the central bank, Banco de Mexico, cautioned that although recent inflation rates have been lower than expected, inflation will rise "towards the end of the year" before declining again in 2011.

What adjusting to global imbalances could mean for Mexico

Last month in Economex we talked about different explanations for the global imbalances that helped produce the US and European financial crises that sparked the "Great Recession". Here are some thoughts on how the eventual adjustment to those imbalances might affect Mexico.

If the weight of the adjustment to global imbalances falls on a deficit country like the US, "adjustment" will mean slower growth in the US, obviously bad for Mexico. If the dollar follows the usual adjustment pattern and devalues, US exports will be more competitive. The peso will follow the dollar and Mexican manufactured exports will become more competitive. If other countries do not allow their currencies to revalue against the dollar, though, it will mean: 1) deflation in the US; 2) positive real interest rates in the US, boosting the government deficit and the cost of servicing debt for businesses, households and the government; and 3) a cutback in US imports. Under this scenario, we would not see deflation in Mexico, where the quasi-monopolies in key sectors of the economy would ensure that prices don't fall. Real interest rates would have to rise to keep money in Mexico, with a similar impact on the government's finances and everyone's debt servicing costs. If the growth of Mexico's manufactured exports slows, unless the growth rate of the import bill slowed by as much or more, Mexico could conceivably face difficulties financing its current account deficit, triggering a classic balance of payments crisis.

If the surplus companies (like China) participate in the adjustment, US growth would not be as hard hit. A weaker dollar would allow exports to become the driver of US growth. All that would be good news for Mexico. As the revaluing renminbi pushes costs up in China, Mexico would become relatively more attractive to direct foreign investment.

The US recession ended 15 months ago; is another in the works?

The National Bureau of Economic Research, the body responsible for dating recessions, announced that the US recession that started in December 2007 ended in June 2009. The 18 month recession is the longest since World War II. The prior post-war record was 16 months (the 1973-1975 and 1981-1982 recessions). The NBER committee "did not conclude that economic conditions since that month [June 2009] have been favorable or that the economy has returned to operating at normal capacity."

That the recession ended over a year ago doesn't guarantee sustained growth: the danger now is that the US recovery could turn into a double dip recession.

The US recovery has driven growth in Mexico this year. If US growth slows or turns negative, Mexico will fell the fallout -- through its manufactured exports, remittances, and incoming tourism.

"The Slump Goes on: Why?"

An answer is to be found in the September 30, 2010 issue of the New York Review of Books. The article, by Paul Krugman and Robin Wells, summarizes four different explanations of the 2008 crisis and the policy prescriptions for responding to the crisis and its aftermath. It's a thought-provoking article, one well worth reading. Here's the link.

http://www.nybooks.com/articles/archives/2010/sep/30/slump-goes-why/

How much has the renminbi devalued?

Remember back on June 19, just before the G-20 summit meeting, when China announced it was going to allow the renminbi to revalue against the dollar? It has -- all of 1%. Interestingly, most of that 1% revaluation occurred in the last few days, just prior to the congressional hearings on China's currency policies starting Wednesday.

Treasury Secretary Geithner, who is scheduled to testify on Thursday, has told the Wall Street Journal that the Chinese have "done very, very little".