Currency Wars: “Beggar Thy Neighbor” Policy
February 12, 2025
Formula Price to Sales Ratio = Current Market Price / Reported Sales Revenue Many companies state their revenue after removing the effects of onetime events whereas others continue to state the revenue without any adjustments. Meaning The price to sales ratio tells an investor how many dollars they are paying for every dollar that the […]
Asset-backed securities have become famous all over the world in the past few years. The largest market for asset-backed securities was in the United States of America. The sub-prime mortgage exposed the flaws inherent in the process of issuance of asset-backed securities. The world had been looking for an alternative to asset-backed securities. This is […]
The Icelandic budget airline “Wow airline” became the latest airline to go bankrupt in Europe. Of late, Europe has seen a lot of airlines go bankrupt due to multiple reasons. No less than eight airlines have suspended their operations in Europe in the past year. Price wars, rise in fuel prices, and overcapacity have been […]
The term short selling is often seen in the news. This tactic is regularly used by well-known investors. They are also very public about the shares they have shorted. This prompts many retail investors to follow suit. While, it may be true that many funds and high net worth investors make a lot of money […]
The banking system is an integral part of the financial system of many countries. In fact, as we have discussed in the previous articles, many countries base their entire financial system on the banking system. The central bank plays a very important role in the financial system of any country. This is the reason why […]
The Mexican peso crisis, which is also known as the tequila crisis was one of the first major currency crisis in the South American continent. The Mexican peso almost collapsed as a result of this crisis. The government was close to default on its national debt. The level of foreign reserves was dwindling to dangerously low levels and in the end the Mexican government required a bailout to stay afloat financially. Also, foreign investors that had invested in Mexican bonds ended up losing 15% of the value of their investments in a single day and over 40% of the value in the long term. These rates are catastrophic considering that bonds are fixed income investments and losing money on bonds is considered to be a very distant possibility.
Ideally, a government can swap the pesos for dollars on the market and pay off their debt. However, the Mexican government was maintaining a currency rate peg with the United States. This meant that the Mexican Central Bank would conduct foreign market operations to keep the value of their debt stable as compared to the United States. Hence, they needed dollar reserves to conduct these operations and therefore did not have the dollars to pay up on their loans.
A currency peg can be dangerous if there is runaway inflation in any country. This was the case with Mexico where the government was creating credit in huge quantities driving inflation through the roof. If the peso were a freely floating currency, it would have undergone a serious devaluation. However, since the peso was pegged, its value remained stable to the dollar. Hence it was extremely overvalued which could have been observed by the rising imports and the dwindling exports.
Therefore, the American government somehow managed a $51 billion bailout for easing the situation in Mexico. In return, Mexico had to pledge their oil reserves as collateral. Also, Mexico was bound by investors to follow stringent monetary and credit expansion policies till their debt was paid off.
The Mexican debt crisis is therefore a case in point of what can go wrong when countries try to maintain artificially high Forex rates with the help of open market operations of their Central Banks.
Your email address will not be published. Required fields are marked *