Making history is not comfortable.  And that’s what Ben Bernanke, the head of the Federal Reserve, and U.S. Treasury Secretary Paulsen, along with central bankers and finance ministers around the world have been doing on what seems like a daily basis since early September.  In spite of unprecedented action after unprecedented action, policy-makers around the world haven’t yet been able to stop the meltdown in the financial markets.  Concerns about solvency have spread from banks to insurance companies, to automotive finance companies, to conglomerates with financial operations.  At the moment, the question is the viability of hedge funds.  Are there guarantees that can stop the contagion?

Recession looms, if it hasn’t already started.  The violent swings in stock markets reflect answers to the question of how long, how severe and how extensive the recession will be.  The graph below charting the daily percentage change in the Dow Jones Industrial index in 2008 conveys the extent of uncertainty about the future.  The second graph charts the evolution of the Dow this year and last.  It leaves no doubt that the question is “how bad,” not “if.”

Graph One

Mexico is not exempt from the meltdown felt around the world.  In welcome contrast to 1995 and previous crises, this one is not self-imposed.  The macro-economic fundamentals are much sounder. Neither inflation nor interest rates should multiply as they did in 1995.  In fact, both are likely to be a bit lower in 2009 (respectively, 4.65% and 7.34% at year-end) than this year.  Growth will also be lower in 2009, but not just a little lower.  Mexico’s growth rate will suffer from reduced demand from manufactured exports, a reduction in remittances and tourism income, and a dramatic fall in oil revenues, which will be hit on both the price and volume fronts.  In the best of cases, the economy will grow, barely (0.2%).

The immediate fallout from the crisis, the epicenter of which is the U.S. financial markets, has sown up in the exchange rate and the financial markets.  Liquidity dried up in the financial markets and the government stepped in.  Nafinsa and Bancomext are guaranteeing corporate and non-bank financial sector commercial paper for up to Ps$50 billion as well as providing Ps$35 billion in debt and guarantees to PyMes (small and medium-sized companies).  The government’s Federal Housing Society (SHF, Sociedad Hipotecaria Federal) is supporting the housing market through medium-term credit lines (Ps$20 billion) and providing liquidity and credit to the housing sector by guaranteeing up to Ps$20 billion more in debt issued by financial intermediaries.  And that’s not all: the SHF is also supporting the housing bond market by buying and selling debt issues.  For its part, the central bank is providing liquidity to the banking system.

The performance of the Mexican stock markets has been no different than that of the Dow or other stock markets around the world — like a popped balloon.  The IPC on October 24 was back down to its November 2005 levels but in dollar terms, it was 20.4% lower.

Bets in the derivatives markets that went bad sparked the peso’s dramatic plunge.  Those corporate positions, estimated at US$ 15 billion, have been mostly unwound (estimates are that only US$ 1-2 billion is still outstanding), but the peso hasn’t bounced back (see graph three).  “Deleveraging” is taking its toll: cash-strapped investors are selling liquid assets, wherever they are, including in Mexico. It has nothing to do with Mexico and everything to do with the urgent need for cash.  Substantial inflows of portfolio investment last year and in the first six months of this kept the peso very strong; when those inflows become outflows, there are consequences for the exchange rate.  Next year, the peso will feel the effects of a substantial jump in the size of the current account deficit, the product of lower oil revenues and lower remittances, as well as the evaporation of portfolio investment, the product of world-wide allergy to risk.  Don’t look for the peso to recover to its summertime levels.
The average exchange rate in 2009 is unlikely to fall below Ps$13.

Graph Three

The world economy has entered a new phase.  The boom times are behind us and won’t be back any time soon.  Debt won’t be as easy to come by and it will be more expensive.  Growth will be slower and the big risk of stagflation exists.  Now, more than ever, it’s critical to address the obstacles to competitiveness.