A slow motion devaluation...

One British view of the choice confronting Germany...

Martin Wolf of the The Financial Times concludes that Germany's choices are these...

"Germany must choose between a eurozone disturbingly different from the larger Germany it expected, or no eurozone at all. I recognise how much its leaders and people must hate this choice. But it is the one they face. Chancellor Angela Merkel must dare to make that choice, clearly and openly."


For his analysis, see 
http://www.ft.com/intl/cms/s/0/c3085eb4-202d-11e1-9878-00144feabdc0.html#axzz1gXTdpMke

Paul Volker's analysis of how we got where we are...

Excerpts from his Taylor lecture:

"Now, we know all the seeming mathematic precision brought to task, epitomized by calculations of Value at Risk, complicated new structured products, the explosion of derivatives, all intended to diffuse and minimize risk, did not bear out the hopes. Instead the vaunted efficiency

helped justify exceedingly narrow credit spreads and exceedingly large compensation. By now it is pretty clear that it was faith in the techniques of modern finance, stoked in part by the apparent huge financial rewards, that enabled the extremes of leverage, the economic imbalances, and the pretenses of the credit rating agencies to persist so long. A relaxed approach of regulators and important legislative liberalization reflected the new financial Zeitgeist.

If those remarks sound critical – and they are meant to inspire caution - let me emphasize that the breakdown in financial markets and the “Great Recession” are the culmination of years of growing, and ultimately unsustainable, imbalances between and within national economies. These are matters of national policy failures and the absence of a disciplined international monetary system."

"..the build-up in leverage, the failure of credit discipline, and the opaqueness of securitization -- all the complexity implicit in the growth of so-called “shadow banking” -- helped facilitate accommodation to the underlying imbalances and to the eventual bubbles to a truly dangerous extent. In the end, the consequence was to intensify the financial crisis and to severely wound the real world economy."

Fasten your seat belts...

The European crisis is snowballing. If the question were just whether European governments can act in time to prevent a full-fledged run on Italy and Spain, it would be be bad enough. That the Europeans don't agree on what needs to be done to prevent a re-run of the post-Lehman crisis makes these days much more frightening. An already ugly situation is getting uglier by the day.

Mexico is feeling the fallout. At the beginning of August, the fix rate was a peso lower than it was today, Monday, September 12. The IPC (Mexican stock index) has dropped 2,000 points. Expectations about interest rates have changed dramatically: if the Banco de Mexico moves the Mexican reference rate before the end of next year, odds are that it will lower it, not raise it. It's not just the financial markets that have been hit. With US growth projections being cut, Mexico's projected growth rate has been reduced. Growth should still receive a boost next year from the presidential election but it won't be enough to counteract the dampening effect coming from the US.

Yet another trade surplus for Mexico...

For the sixth consecutive month, Mexico ran a surplus in its trade account. At US$107.9 million, June's surplus was the smallest of this year, but the fact that the trade account was in surplus while the economy is growing is striking. The 44.3% increase in oil revenues through June (compared to the first six months of 2010) was complemented by the 19.9% growth of non-oil exports.

In the first half of this year, the trade surplus totaled US$3.34 billion, 1,058.1% higher than in the first half of 2010. In the first half of 2009, the trade account was in deficit to the tune of US$1.84 billion. However, if oil is excluded from the calculation, the trade account showed a US$3.69 billion deficit through June; that was 21.0% less than in the first six months of 2010.

Investment

The gross fixed investment (GFI) figures for December were published today, ten weeks after the year ended. GFI rose a less than impressive 2.3% last year. While GDP (in current pesos) might have recovered its 2008 by the final quarter of 2100, GFI certainly wasn't driving the recovery: GFI dropped 10.1% in 2009.

GFI in machinery and equipment rose 4.3% last year, After plunging 18.7% in 2009, GFI in nationally-produced machinery and equipment climbed 13.3%, its fastest growth rate in seven years. Imported machinery and equipment inched up a mere 0.8% in 2010 after plummeting 22.0% in 2009. It will be interesting to see if this is a one-time effect or presages a switch in sourcing. Construction

Will the Fed put an end to monetary stimulus this year?

The Mexican government doesn't think so, if the wording in the statement issued on June 23 by the Council on Financial Stability (CESF, comprised of Hacienda, Banco de Mexico, the CNBV, the Insurance Commission, the Consar and the IPAB -- in short, the financial regulators) is any guide. The CESF does not expect the Fed to "retire the monetary stimulus before the beginning of 2012".

The consequences are interesting: "therefore, the risk that capital flows to emerging markets will revert when US monetary policy is normalized has diminished. Nonetheless, risk persists due to the financing needs or renewed volatility caused by the fiscal problems of developed countries." In other words, we're not out of the woods yet.

Risks to Mexico's banking sector

When the official body charged with assessing the stability of Mexico's financial system (Consejo de Estabilidad del Sistema Financiero) issued its first report yesterday, it gave Mexico's financial system a clean bill of health. The Council (CESF) is presided over by Hacienda and its members include Banco de Mexico, the CNBV (National Banking and Securities Commission), the CNSF (National Insurance and Bond Commission), the Consar (National Commission for Retirement Savings), and the IPAB (Institute for the Protection of Savings in Banks).

The CESF, the latest in the string of anacronyms overseeing the financial system, did observe that "an abrupt reversion of capital flows toward Mexico" could have have "unfavorable impact" but that it would be limited, thanks to actions taken by the government in recent years. The CESF also stated that "the Mexican economy has been capable of absorbing in an orderly manner the elevated capital inflows it has received recently and without generating distortions in the principal financial variables". The CESF goes on to assure us that "(T)he underlying conditions of the Mexican economy are solid and growth perspectives, favorable."

Finally, the CESF concludes that although "the indebtedness of states and municipalities does not presently represent an important problem for Mexico's financial system, it is necessary to generate adequate incentives to improve transparency and promote prudent fiscal policies by states and municipalities." Amen.

Investment

The gross fixed investment (GFI) figures for December were published today, ten weeks after the year ended. GFI rose a less than impressive 2.3% last year. While GDP (in current pesos) might have recovered its 2008 by the final quarter of 2100, GFI certainly wasn't driving the recovery: GFI dropped 10.1% in 2009.

GFI in machinery and equipment began to recover from its 21.0% plunge in 2009, rising 4.3% last year. Construction, the other main component of GFI, gained 1.2% in 2010, after falling 2.3% in 2009.

GFI in nationally-produced machinery and equipment climbed 13.3% in 2010, its fastest growth rate in seven years; in 2009, it dropped 18.7%. Imported machinery and equipment inched up a mere 0.8% in 2010 after plummeting 22.0% in 2009. It will be interesting to see if this is a one-time effect or presages a switch in sourcing.

Interview with Ambassador Davidow

On Tuesday I gave a "Tequila Talk" at the Institute of the Americas. (Yes, they did serve tequila.) To see the interview, just click on the following link:

http://www.iamericas.org/en/ioa-videos/Tequila-Talk-with-Deborah-Riner/0/35/1

Food for thought on the strength of the peso...

Foreign investment in peso-denominated money market obligations jumped US$12.23 billion in the first nine months of this year. Those volatile capital inflows were the equivalent of ¾ of remittances in the same period, 85% of direct foreign investment, and 55% of crude oil export revenues. Portfolio investment can leave as easily as it comes into a country. If the European authorities do not succeed in containing the Europe-centered financial crisis and there were to be a resurgence of risk aversion on the scale of the six months between October 2008 and March 2009…

Where the elderly in the US get their income...

The numbers speak for themselves... (Source: http://krugman.blogs.nytimes.com/?nl=todaysheadlines&emc=a212)

Portfolio investment inflows welcomed in Mexico

The interest rate premium (between peso and dollar investments) creates an attractive “carry trade” opportunity, especially when coupled with a stable or appreciating exchange rate. Investors who can borrow in dollars or other currencies where interest rates are low can invest in higher yielding peso instruments, reaping the interest rate differential and generating handsome profits. Obviously, if the peso devalues, profits can disappear. The Fed's QE2 (the second round of quantitative easing) adds fuel to the carry trade fire.

Mexico is only one of many countries in which investors are playing the carry trade game. The peso has appreciated less than the exchange rates of some other “emerging countries”, whose governments are quite concerned about the impact of a strengthening currency on trade flows and the creation of stock and property bubbles.

Governments ranging from Chile and Brazil to Thailand and Malaysia have imposed measures ranging from taxes to limits on investments in short-term money market instruments to try to dampen the negative effects of an appreciating exchange rate based on portfolio investment flows. Mexico has not.

Mexico’s policy was summed up by Banxico Deputy Governor Manuel Sanchez in a November 18, 2010 speech delivered at a Cato Institute symposium: “…capital controls may lessen investor confidence in these economies [countries that impose capital inflows], generate black markets, and inhibit the entry of capital necessary for innovation and productivity improvements. Currency interventions, in turn, are hardly effective and tend to impose financial losses on the central bank. Furthermore, the most important threat generated by these actions is a widespread movement toward protectionism that could hamper the sustained recovery of the world economy. Thus, it is preferable to completely avoid these measures.”

Glass half empty or glass half full?

Mexico's GDP grew 5.3% (year over year) in the third quarter, well below the second quarter's 7.6% rate but above expectations. The second quarter rate benefitted from the "base effect": the economy was in such bad shape in the second quarter of 2009 (-9.6% versus the second quarter of 2008) that the year over year comparison looked good with any growth. In the third quarter of last year, GDP contracted "only" 5.5%. So, is the glass half empty or half full? It looks fuller to me.

If, as seems quite feasible, GDP grows 3.0% year over year in the fourth quarter, the growth rate for the year will be 5.1%. The flip side of this year's good news is that next year's growth rate will be lower -- we'll be measuring it against a higher base.

What comes in can go out...

Today's jump in the fix rate put the peso at its highest level of the last 17 trading days. It's no coincidence that the cost of a dollar climbed $0.18 between last Friday and today, the first working day of this week: the concern over Ireland is rocking world equity markets as well.

X-Box for planners!

Making the INEGI an autonomous entity has paid off big for those of us who use their information. Check out the nifty new "growth cycle" indicator (see the following link).

http://www.inegi.org.mx/sistemas/reloj_cicloseco/default.aspx

INEGI has also developed a tool that will be of great help in business planning. For those of you who are interested in seeing it, I'll invite someone from the INEGI to the December Economex meetings to demonstrate how it works.

Ireland: damned if you do and damned if you don't

In spite of being lauded for the rapidity with which it implemented draconian measures to deal with its banking crisis and government debt levels, Ireland once again finds that the premiums investors demand to buy its debt have climbed. Fortunately for the country, it has already funded its borrowing needs through the middle of next year so it can opt not to place debt at these rates.

Why do Ireland's problems matter to Mexico? For several reasons... First, if the Europe-centered financial crisis were to erupt again, the dollar would strengthen and the peso along with it. In the worst of cases, we could see financial markets freeze up again. Second, Ireland's position now is a vivid reminder that markets can be fickle: portfolio investment that comes in can go out in as long as it takes for someone to press the "enter" key. Being the markets' poster child -- slashing government spending, saving its banks, and sticking to its austerity program -- doesn't guarantee that the premium for issuing debt later won't soar.

Pleasant surprises on the growth front in Mexico

Fortunately, we don’t have to clean the tomb of the economy here in Mexico on the Day of the Dead (Día de los Muertos). The IGAE, a monthly indicador of growth, is a precursor of the quarterly GDP figures. The September IGAE reading makes it all but certain that the Mexican economy will grow 5% (year-over-year) in the third quarter, putting the growth rate in the first nine months of 2010 at 5.6%. Even if the economy grows only 3% (year-over-year) in the fourth quarter, the annual growth rate would be 5%.

The economy’s surprisingly strong rebound from the 2009 plunge will combine with the portfolio investment-strengthened peso to put Mexico’s GDP in dollars back above a trillion dollars. This year’s GDP should fall short of 2008’s by less than US$50 billion.

The domestic economy...

The growth rate Hacienda is projecting for 2011 (3.8%; now, thanks to the Chamber of Deputies, 3.9%) is higher than the 3.6% consensus projection of the economists surveyed by the Banco de Mexico each month and the 3.5% I'm projecting. Why? Hacienda is assuming the domestic market will play a more important role in driving growth next year. How likely is it that the domestic market will step up to the plate?

Three factors are critical: 1) job creation; 2) real wage growth; and 3) the growth rate of bank lending to consumers. I'm not overly optimistic on any count. Job creation will continue to be inadequate. Real wage gains will be small. Bank lending to consumers will grow but at modest rates.

We'd better hope that US exports do well and American consumers become more animated.

An excellent review of recent publications on narco violence in Mexico

In "The Murders of Mexico", Alma Guillermoprieto reviews two recently published articles (in Spanish) and one book (in English) examining the narco-violence that's afflicted Mexico. You can find her article in the most recent issue of the New York Review of Books. Here's the link. It's well worth reading.

http://www.nybooks.com/articles/archives/2010/oct/28/murderers-mexico/