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.