What’s The Deal On The Peso Slide?

And how low can it go?

The Mexican peso has declined to an alarming 16.48 exchange rate against the U.S. dollar. The reasons are very complicated but most analysts agree that several factors are involved.

Mexico’s economy is tied very closely to that of the U.S. because nearly 85% of its exports are to the United States. Its greatest export and its most valuable national resource is oil. The easiest reserves to exploit have already long been tapped by Mexico and in fact the government has taken the drastic step of allowing other countries, and very large exploration companies, one of them Russian, to enter its oil production business and help Mexico get their deep water oil out. But, Mexico has finally asked for help just as fracking for natural gas has come of age, glutting the market with energy, and the Gulf oil cartel, led by Saudi Arabia, has declined to cut back on production. This has had a dasastras effect on Mexico’s balance of payments.

peso.jpgIn addition, the volatility of the Euro by the mess in Greece has contributed to this, because the Mexican peso is by far the most active currency traded in EM (emerging markets) countries. The peso is very liquid and consequently events world-wide can quickly impact Mexican trade balances and currency reserves when large investors move vast sums (in the billions of dollars) within a few days in or out of the country.

Also the prospect of an international deal with Iran by world powers has affected investors by making them believe that Iran will soon be welcome to sell their oil on the international market. They have the fourth largest oil reserves in the world.

Uncertainty also comes from the fact that the current president has increased the foreign debt about 35%. It is nothing like the Greek debt at about 170% of Gross Domestic Product. The Mexican debt is more like 50% of Gross Domestic Product, which is manageable, but the debt pressure is upward at this time.

The last time a crisis like this was brewing, Mexico was using its central bank to maintain an artificial exchange rate within a certain range. That did not work. Today the peso floats on the open market but it alarms government managers when the decline against the dollar is rapid or too sharp. In July they took steps to improve their currency by selling 200 million U.S.dollars per day – up from the previous policy of 52 million per day. At the same tlme they lowered the threshold for emergency intervention from a drop of 1.5 percent in value in any one day to only a drop of 1 percent a day. These activities have helped to improve the exchange rate but it is still at over 16 pesos to the dollar as of this writing.

The Mexican government has traditionally been slower to move to protect its peso valuation than other Central or South American governments which are most sensitive to hyperinflation. That reluctance to quickly intervene resulted in the massive devaluation of the peso in 1994. At that point the MXN, the new Mexican peso, came into effect which required Mexican people to turn in 1,000 old pesos to receive one new peso. The country was a very long time in recovering from that mess. Nobody expects a devaluation like that again, but people who went through that are still hesitant to trust the banks in Mexico. Over night, many people lost their life savings. Unfortunately, as is universally the case, the local people are only marginally aware of the implications of these events on a global or international scale.

 Of course there are implications for Americans living. One of those is whether they should purchase their goods and services with pesos or with dollars.

One restaurant owner told us he is not concerned and actually has benefitted from the peso’s loss of value. He buys almost all his supplies locally or at least in Mexico but he has a wide range of clientele, including many Americans, who often pay in dollars. He maintains an exchange rate of 14 to the dollar so he benefits by about 15% there. He gets 16 pesos to the dollar for goods he buys but he only gives 14 pesos for each dollar when his customers pay him in dollars. This is in addition to tips in dollars. So his customers would be far better off to pay him in pesos, which some of them actually do. He has to buy some of his liquor from the U.S. but that’s okay because as we all know, liquor sales are very lucrative.

It’s good wherever the merchant can buy his suppliesin pesosand is then able to sell them to Americans who pay in dollars. So in general these business owners are not worried about their survival, although they are concerned for the health of the Mexican economy..

However, it is a far different scenario if the business owner buys most of his inventory from the U.S. and most of his customers are Mexican or his American customers pay solely in pesos. This is the situation for instance at The Metal Corral, which produces replicas of large animals like horses, elephants, dragons, and metal wall decorations. They buy their iron, copper and bronze locally but their buyers are 80% Americaa business people who are smart enough to pay only in pesos. The exchange rate works a hardship on the Mexican merchant in that case.

The small grocery owner is not concerned at all because she mostly serves Mexicans but she buys her goods here as well. The few Americans who ventured in and paid in dollars got an exchange rate of 14.5 and usually didn’t notice because she paid them back only in pesos.  They don’t even examine the change.

Some businesses, like Z The Bodega Express, which supplies propane to both commercial and residential customers, are charging an outrageous rate if you pay in dollars. Currently their exchange rate is only 12 to the dollar. That gives them a premium of 33% on the exchange rate alone not to mention their established profit margin for the propane. We suggest you to only do business with them in pesos. Or not at all.

Gigabyte Computers provides a wide variety of services related to virus protection, software and hardware fixes, and auxiliary items such as storage devices and mouse pads. They charge their American customers a fixed exchange rate of 15 pesos to the dollar. They do not attempt to do a daily update on the rate. Their rate is pretty fair, at about a 7% premium (16 divided by 15 gives you 1.066).  Most businesses are charging a premium on the the current daily exchange rate of somewhere between 14 and 15.9 vs. the official rate of 16.11. We found 15.9 at the Pemex and 7-11 store on the south end of Rosarito.

The people who really get the shittty end of the stick are the laborers or employees who are getting paid in pesos and buying in dollars. They have actually received about a 23% pay reduction since the rate started falling in the summer of last year. They are sometimes aware of this and sometimes not. The guard who works at Corona Del Mar Condominiums is a deportee who owned his own business in the States. He is fully aware of the devastating loses the peso has undergone in the last year because he gets paid in pesos. There just is nothing much that he can do about it except try to get a better job.

Perhaps the Mexican government will be successful in managing this crisis this time. But so much of this is out of their hands that their most careful managment of Mexico’s situation isn’t going to save them.: They can only hope that the world economy and the exchange rate rights itself.