Election Year and Economic Collapse
Carlos Salinas's popularity and credibility at the time was high. The economic bubble gave Mexico a prosperity not seen in a generation. This period of rapid growth coupled with low inflation prompted some political thinkers and the media to state that Mexico was on the verge of becoming a "First World nation". In fact, it was the first of the "newly industrialized nations" to be admitted into the Organisation for Economic Co-operation and Development (OECD) in May 1994. It was a known fact that the peso was overvalued, but the extent of the Mexican economy's vulnerability was either not well known or downplayed by both the Salinas de Gortari administration and the media. This vulnerability was further aggravated by several unexpected events and macroeconomic mistakes made in the last year of his administration.
Several economists and historians, amongst them Hufbauer and Schoot (2005), have analyzed some of the events and policy mistakes that precipitated the crisis of December 1994. In keeping with the PRI election-year tradition, Salinas launched a spending spree to finance popular projects, which translated into a historically high deficit. This budget deficit was coupled with a current account deficit, fueled by excessive consumer spending as allowed by the overvalued peso. In order to finance this deficit, the Salinas administration issued tesobonos, an attractive type of debt instrument that insured payment in dollars instead of pesos. This may have been a response to three important events that had shaken investor confidence in the stability of the country: the aforementioned Zapatista uprising, the assassination of PRI presidential candidate Luis Donaldo Colosio, and the assassination of José Francisco Ruiz Massieu, Salinas' former brother-in-law who was also the Secretary General of the PRI, and whose murder was never solved during Salinas' presidency, even when Mario Ruiz Massieu (Francisco's brother) was the attorney general in charge of the investigation.
These events, together with the increasing current account deficit fostered by government spending, caused alarm amongst Mexican and foreign T-bill (tesobono) investors, who sold them rapidly, thereby depleting the already low central bank reserves (which eventually hit a record low of $9 billion). The economically orthodox thing to do, in order to maintain the fixed exchange rate functioning (at 3.3 pesos per dollar, within a variation band), would have been to sharply increase interest rates by allowing the monetary base to shrink, as dollars were being withdrawn from the reserves (Hufbauer & Schott, 2005). Given the fact that it was an election year, whose outcome might have changed as a result of a pre-election-day economic downturn, the Bank of Mexico decided to buy Mexican Treasury Securities in order to maintain the monetary base, and thus prevent the interest rates from rising. This, in turn, caused an even more dramatic decline in the dollar reserves. These decisions aggravated the already delicate situation, to a point in which the crisis became inevitable and devaluation was only one of many necessary adjustments. Nonetheless, nothing was done during the last five months of Salinas’s administration even after the elections were held in July of that year. Ernesto Zedillo took office on December 1, 1994.
Read more about this topic: Carlos Salinas De Gortari
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