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Mexico's Peso Becoming Stronger, Fostering Fears of High Inflation

By Chris Kraul
Los Angeles Times

Is the Mexican economic recovery, especially the strengthening peso, too much of a good thing? That, ironically, is the subject of much debate these days in Mexico, where the stronger peso has some economists fingering their worry beads.

They point to the peso's rising value against the dollar on currency exchanges, despite Mexican inflation totaling 30 percent over the last 18 months. They fear that could reignite a Mexican frenzy for imported goods similar to one that helped torpedo the economy in 1994.

Fueling those fears was the news last week that Mexico ran a monthly trade deficit in July, the first since January 1995. Although a mere $20 million, the imbalance showed that for the first time since the crisis, Mexican consumers and businesses are buying more foreign goods and services than the economy is exporting.

The peso closed Tuesday at 7.77 to the dollar, virtually the same level it was at in December of 1995.

For the peso to be in perfect sync with the dollar, it would have weakened at a rate roughly equal to Mexico's inflation, leaving the exchange rate at more than nine to the dollar by now. That's the exchange rate that some economists, including MIT's Rudy Dornbusch, were predicting last year.

"Mexico is gradually coming back to a situation where you have a significantly overvalued peso," warned Gary Hufbauer, director of studies at the Council on Foreign Relations in New York.

Also concerned about the peso is Bank of America Chairman David Coulter, who on a visit here Monday said the peso is too strong and that the government should take steps over the next 18 months to ensure that the overvaluation doesn't continue.

"I used to run the bank's currency trading room, and it was always tough to determine what a fair value of any currency is," Coulter said. "But I'd say the peso is slightly overvalued."

But the peso's defenders say its strength merely reflects growing international confidence in Mexico's economy, especially since the orderly July 6 elections. The upshot: stronger foreign demand for Mexican currency to build factories, open stores and buy Mexican stocks and bonds.

The strength of Mexico's recovery was highlighted by second-quarter figures released last week showing the economy had grown a startling 8.8 percent compare with last year, a rebound boosted by renewed consumer spending.

"The peso is much stronger than what anyone expected, but there are good reasons," said Oscar Vera, chief economist at Deutsche Morgan Grenfell in Mexico City. "We're in a virtuous cycle in which a stable economy attracts more capital, which reinforces the peso's strength," he said.