The Importance of Nominal Exchange Stability Within the Context of Financial
Financial liberalization, free capital movements and
consequent capital markets’ liberalization, have increased the importance of
the exchange rate management, due to its significance in determining capitals’
value, as well as the constant impact that financial transactions originate upon
the relation of currencies’ exchange. Financial investment realized in
emergent countries loses in terms of dollars with currency devaluation of such
countries, and it earns with nominal stability and the exchange rate value,
because this allows it to increase earnings in terms of dollar.
In the face of the importance that exchange rate has within
the framework of capital markets’ internalization, it makes that its
determination is sub-ordinate to international financial capital demands.
Emergent countries’ governments and central banks are
pushed to operate with low inflation and to homologate it with developed
countries to avoid nominal exchange parity anxiety, to save international
financial capital’s profitability conditions, so that capital flows are
positive in their countries. Also, exchange rate stability is necessary within
financial liberalization in order to avoid speculative practices that might
provoke financial markets instability.
Policies to Achieve Exchange Stability
Latin American economies have no domestic macroeconomic,
productive and financial conditions to reduce inflation in order to achieve
nominal exchange rate stability. Countries with low productivity and heavy
pressure over their macroeconomic fundamentals, have been able to reduce
inflation through promoting capital inflows. This allows to cover current
account deficit and to increase international reserves to face attacks coming
from international financial markets’ fluctuations, to guarantee exchange
nominal stability and free convertibility.
Hencefore, policies are directed to expand foreign capital
influence within the national atmosphere, among which liberalization’s
acceleration and economic deregulation are significant, as well as privatization
and domestic assets’ foreignism, the establishment of profitability
conditions, and reliance demanded by such capital. UNCTAD’s Report says that
“ it is very difficult for a country to resist a strong tendency towards
capital movements liberalization if links with the international markets are
closed through Direct Foreign Investment (DFI) and trade flows”. (UNCTAD,
2001, chapter V).
Latin American governments privilege restrictive monetary and
fiscal policies considering that these ones would avoid demand’s pressure over
prices, the foreign sector, and public finances, to reach economic performance
that guarantees exchange stability. Fiscal discipline, supported by investment
decrease and public expense, as in the privatization process of public assets,
expands investment frontiers to national and foreign private capital, promoting
its entrance, and domestic currency value. To this process, there is central
bank’s autonomy, to privilege only restrictive policies that rely on high
interest rates aimed at increasing financial profitability to attract capitals.
So, defending such postures, there is Carsten Hefeker’s position stating that
“to achieve credibility, monetary policy regulations are required to prevent
inconsistent policies. Fixed exchange rates are seen as an obliged compromise”.
(Hefeker, 2000, p. 162).
Exchange Value Policy and Foreign Financing
Exchange rate anchorage policy, high interest rates, fiscal
discipline and growing national assets’ foreignism, being fundamental for the
promotion of capital inflows, conform the financing pattern that allows our
insertion into globalization, as well as exchange stability and inflation’s
decrease. In relation to this, María Concepcíon Tavares says that “exchange
rate over-valuation is a characteristic sign of a financing model of a monetary
pattern through foreign indebtedness” (Tavares, 21/06/98).
Inflation’s decrease and exchange nominal stability are not
sustained over domestic financial and productive basis, but on capital inflows.
Factors concurrence, ad the so called structural reforms of market’s
orientation (that have expanded profitability and the international capital
influence frontier), have made possible financing that facilitates inflation’s
decrease at the Latin American economies.
United States’ economic dynamics during the nineties played
a significant role in currency flows to Mexico, through exports growth of this
one, as well as through greater capital inflows due to growth expectations
compliance, which worked in favor of the nominal exchange rate stability.
When an economy presents fixed or stable exchange rate, and
growth expectations, it attracts capitals, these ones generate stock exchange
boom that stimulate more capital inflows to such markets. This increases
currency supply, which values national currencies and reduces inflation.
When external factors perform an essential role in the
nominal exchange stability, this one is highly vulnerable in front of such
At the beginning, the exchange rate is dissociated from
purchasing power’s parity and from foreign trade balance’s adjustment.
The economic policy is circumscribed to perform the objective
of inflation’s decrease through nominal stability or exchange (valuation) so
active exchange policy stops (flexible around domestic prices’ differential
versus foreign ones) to adjust trade balance.
Free capital movements, capital markets’
internationalization and growing demands for capital inflows that require Latin
American countries, prevent exchange rate’s active use, so they conduct it to
dissociate it from the principle of the purchasing power’s parity, because it
does not align with the exchange rate in relation to prices’ differentials,
which is required to guarantee the law of unique price, necessary for commercial
goods to sustain the same price in both countries, so it may counteract
productivity differentials, both, to protect and to develop the national
productive plant in front of imports, to improve national enterprises’
accumulation dynamics, and to diminish foreign trade deficit and the growing
capital inflows dependence.
The law of unique price stops to operate within the context
of financial liberalization, because it would touch profitability levels that
financial capital demands, so the exchange rate stops being an adjustment
variable of foreign trade deficit, and of industrial policy, to constitute
itself into a financial instrument.
Nominal and Real Exchange Rate*
(December 1996 = 100)
Nominal Exchange Rate
Real Exchange Rate
Exchange Value (%)
*December each year
** May 2001
Real Exchange Rate = Nominal E. R.* (Prices Mexico/Prices US)
Real Exchange Rate = [(Real E. R./Nominal E. R.)- 1]
Source: Bank of Mexico, Economic Indicators; U.S. Department of Labor, Bureau of
Government of Mexico has defended nominal exchange rate’s
stability in spite of facing pressure over the foreign trade balance. In the
figure above we can observe exchange rate value of about 31% accumulated from
1996 up to half year 2001. On the other hand, foreign trade balance went from a
superavit of 6831 million dollars in 1996, to a deficit of 8049 million dollars
in the year 2000. Settlement balance’s capital account superavit went from
4069 million dollars to 17920 million dollars in the period.
Current globalization scheme, foreign trade deficit, and the
settlement balance’s current account stop determining the exchange rate (at
least temporarily, while there is enough capital inflows), so that such deficit
might be adjusted. Capital inflows and the consequent settlement balance’s
capital account superavit, makes the exchange rate to stop being determined
temporarily by the settlement balance’s current account position.
When facing current account deficit through the settlement
balance’s capital account superavit, nominal exchange stability and high
interest rate policy are essential for the financial market’s development and
for capital inflows. Besides, there is the fact that exchange undervalue does
not realize the enough adjustment at the foreign trade balance to be able to
reach trade superavit needed to finance foreign debt’s service settlements.
(In Mexico, at the end of 1994 and the beginning of 1995, the exchange rate was
devaluated to be able to adjust foreign deficit, and the achieved trade
superavit –about 7 billion dollars- was not enough to finance debt service’s
burden that was about 14 billion dollars). (Huerta, A., 1997).
Flexible Exchange Rate and Value
After fixed exchange rate led Mexico and other countries to
exchange crises, a flexible exchange rate was taken, for it was considered as a
better alternative to adjust foreign sector, to face international financial
markets fluctuations, and to avoid financial and exchange crises. Exchange
regime’s supporters point out that it allows larger margins for the economic
policy flexibility to reduce interest rates as well as to increase monetary
supply, and public expenditure for growth.
Nonetheless, fluctuating exchange rates within the context of
financial liberalization is not realized by domestic prices differential versus
foreign one, necessary (in principle) to avoid foreign sector’s distortion.
This free flotation does not operate, even if the Mexican government is pointing
out that it is working with flexible exchange rates.
Exchange rate flexibility is due according to currency’s
demand and supply, so the government establishes economic policies aimed at
increasing supply and decreasing currencies’ demand, as well as to have enough
settlement balance’s capital account superavit to sustain nominal exchange
stability and value. This is why financial liberalization is accompanied by
fiscal discipline policies (supported by expenditure cut and enterprises sales),
by rational and moderate monetary supply, by high interest rates and by
permanent privatization and foreignness of enterprises. These policies diminish
pressure over prices’ demand and the foreign sector, as well as currencies’
demand, and on the other hand, they stimulate capital inflows, increasing
In spite of the fact that the government takes the flexible
exchange rate, the same economic policies that predominated within the fixed
exchange rate regime are still operating, so there are no free margins within
the economic policy management that flexible exchange rate offers. Besides,
there is constant IMF’s support for financial resources’ transference for
foreign debt’s settlement, as well as from World Bank, the United States
Federal Reserve to Mexico and other Latin American countries, which allows to
support national currencies.
When capital flows are guaranteed, monetary and finance
authorities do not adjust exchange rate in relation to domestic prices
differential versus foreign prices to adjust foreign trade deficit, so a valued
exchange rate is composed, which maintains latent pressures over deficit.
Exchange value is set under competitive disadvantage of
national production in front of exports, so it attempts against the enterprises’
accumulation dynamics. It de-capitalizes them, it increases unemployment,
domestic and foreign indebtedness levels, bank insolvency and instability, as
well as foreign trade deficit, so, soon it will generate national currency’s
devaluation. Cardim de Carvalho, et. al. say that “fixed exchange
rates...instead of producing convergence among the region’s economies they
produce divergence.” (Cardim, et. al., 2001, p. 451), because such policies
stress upon competitive differences against the countries that establish them,
affecting their accumulation dynamics, and therefore their investment growth.
This makes evident the high cost that it implies to realize foreign sector’s
adjustment through capital inflows.
Flexible exchange rate does not exempt Mexico from possible
crises, because such a policy does not protect the productive plant, or the
foreign trade balance, so the productive sphere’s de-capitalization goes on,
as well as bank instability, and macroeconomic imbalances, placing the country
within a context of high fragility and vulnerability, due to incapacity to
generate endogenous growth conditions to be able to face up foreign shock.
Prices Stability and Interest Rate
The objective of inflation’s decrease is introduced by
monetary authorities, believing that with this step, interest rates will
decrease, pushing investment and economic dynamics. Nonetheless, such a
situation does not occur.
Predominant exchange regime has not allowed domestic interest
rate’s discretional management in favor of growth, because exchange
flexibility has been achieved through currencies demand and supply’s behavior,
and, with this, the interest rate realizes an active role. Besides, high
interest rates predominance is due to the predominant capital’s short-term
financial character that flows to the country. In spite of the fact that Mexican
interest rate has significantly decreased during the second semester in the year
2001, in contrast to previous year (from 18% at the end of the year 2000 to 7%
at the beginning of November 2001), it is still keeping an attractive real
margin in contrast to the United Sates’ interest rate (that in real terms it
is below 1% in November 2001), to be able to continue attracting capitals.
Predominant exchange policy keeps latent pressure over
foreign deficit, obliging to establish real high interest rates to avoid
capitals’ flight and to continue attracting them to finance such deficit. It
is a pernicious cycle that leads to larger foreign indebtedness levels, and to
greater international financial capital’s presence in all national markets.
So, exchange value is not translated into lower real interest
rates, for it demands growing capital inflows. The problem is that interest
rates’ increase, which obliges nominal exchange stability, impacts upon public
finance and upon the productive sector, the bank system and the foreign sector,
which goes on demanding high interest rates to attract capitals in order to
finance such imbalances. High interest rates make more expensive and hold
productive investment and productivity’s growth, putting national production
into grater competitive disadvantage in front of imports.
Exchange value and high domestic interest rates, take
enterprises to look for foreign financing, because this one is cheaper, so the
private sector has been significantly increasing its domestic debt. Private
sector’s foreign debt in Argentine during the decade of the nineties,
increased 10 times, and in the case of Mexico, it did six times.
The interrelation between the interest rate and the exchange
rate within the context of financial liberalization, lead governments to not
having monetary, credit, fiscal and exchange policies to be able to push
productive investment. Interest rates and the exchange rate cannot respond to
domestic financial and growth needs, but on the contrary they are established
according to capital inflow needs. Basil Moore says that “high and low limits
– of the domestic interest rate- will depend on the interest rate level
worldwide, on the domestic exchange rate level, and on the size of the domestic
economy’s opening, where the interest rate’s differentials induce
international capital flows to exchange markets”. (Moore, 1988, p. 380).
Likewise, María Concepción Tavares says that “we are prisoners of the high
interest rate and of the exchange rate, and we are more dependent on financial
markets oscillations” (Tavares, 12/10/97).
When profitability is jeopardized by exchange parity’s
modification expectations, the government increases the interest rate to
counteract (through earnings at the money market) loss that the exchange rate
modifications might provoke, in order to keep capital at the domestic market.
When the interest rate does not accompany inflation’s reduction, it makes
possible capital inflows, so the nominal exchange rate adjusts less to the
domestic prices’ differential versus foreign prices, so low accumulation and
insolvency go on, as well as pressure over foreign trade balance and the growing
requirements of capital inflows, consequently, exchange risk continues.
It is Intended to Homologue Inflation to the Developed
Mexico is pretending to homologue its inflation to United
Sates’ inflation to avoid competitiveness loss. The problem is that it is
trying to do so through stabilizing the exchange rate in nominal terms. With
such exchange parity, it is important low United States’ inflation, who is its
main commercial associate, specially on trading goods, but domestic growth of
non-trading goods’ prices goes on, which are the ones that explain the
domestic prices’ differential versus foreign prices. Such a way of reducing
inflation is very expensive and self-defeating for the country. Even if it
achieves to reduce inflation through such exchange policy, it will never improve
competitiveness in relation to United Sates, resulting in greater foreign trade
deficit, lower capital accumulation dynamics, and greater foreign vulnerability.
International Reserves and Exchange Stability
Mexico is compelled to guarantee large amounts of
international reserves to be able to comply with currency’s demand and to
consolidate nominal exchange stability. In order to achieve large reserves, it
privileges monetary, credit, and fiscal policies to avoid foreign deficit to
increase and to push reserves. High interest rates are important to guarantee
permanent capital inflows to finance current account deficit. It is high
interest rates, economic activity contraction, and to keep latent iliquidity and
insolvency problems as well as to alien the country, that makes international
reserves to increase, making evident the high cost that exchange stability
implies. This is also emphasized on the UNCTAD’s Report when it points out
that “to keep a high reserves level for these purposes would be a very
expensive way to prevent financial panic”. (UNCTAD, 2001).
Within the context of globalization, the monetary policy
links monetary supply to the international reserves’ amount in order to
guarantee convertibility and the exchange stability’s reliance. Such policy
belongs to the theory that relates the settlement balance with the monetary
supply, which explains the settlement balance’s problems with the expanding
behavior of the monetary supply. Hence, the intention to reduce pressure over
the foreign sector and over the international reserves through restrictive
(monetary and fiscal) policies.
When central bank purchases foreign currency to increase
international reserves, monetary supply increases. In order of not lowering the
interest rate, to stimulate the economy, and to generate pressure over the
prices, over the foreign sector and the exchange rate, public debt is issued to
take out of circulation the same money that is issued when purchasing currency
from capital inflows. Capital inflow’s sterilization process realized by the
central bank implies foreign debt increment. So, the international reserves’
increment, through interest rates increase, goes together with the domestic
public debt increment, which makes pressure over public finance.
Even if Latin American governments are preoccupied for
maintaining high international reserves to be able to face foreign shock and to
guarantee nominal exchange stability, this is not completely guaranteed because
stability depends not only on the reserves’ amount but, to a great extent, on
its composition. It is different if reserves are constituted by resources
derived from the settlement balance’s current account superavit, or if they
come from capitals account superavit. At the same time, it is different if
capital inflows are long-term resources, or if they are conformed by short-term
highly speculative capital reserves. Besides, it is not international reserves
amount what determines exchange stability, but, as it is pointed out by Tavares,
“viability to resist against currency depends on the capacity to guarantee
uninterrupted and large enough flows which are congruent to our cash needs”.
(Tavares, 09/11/97). The problem in Mexico and in the rest of Latin America is
that these countries are not sure of having permanent capital flows, because of
their domestic problems (high foreign sector deficit, and indebtedness’
levels) that do not encourage their flow, as well as for the same economies and
international markets’ instability.
When there is low capital inflow and growing currency’s
demand, central bank has to sell to satisfy such demand, so reserves diminish,
and in the process, it is taking money out of circulation or reducing its
domestic debt. This allows it to maintain the relation between reserves and the
monetary supply to avoid pressure upon the exchange parity. When international
reserves are restricted, the authorities increase interest rates and/or they
diminish public expenditure to restrict the economic activity, adjusting money’s
supply and demand to diminish availability of reserves in order to avoid
pressure over prices, over the foreign sector, and over the exchange rate.
When international reserves are not enough to ease
speculative currency’s demand, nominal exchange stability ends, giving way to
the real exchange rate increase, and to the capital market’s drop (stock
exchange crack), constituting a context of assets devaluation, insolvency, bank
instability, and financial crisis.
Nominal Exchange Stability and Restrictive Policies
When the economy is left to free movements of goods and
capitals, and exchange value predominates, pressure over the foreign sector
deficit increases, and, in order of not aggravating this one and not originating
exchange fluctuations that propitiate speculative actions, monetary authorities
privilege permanent monetary, credit, fiscal, and wages restrictive adjustments,
in order to reduce domestic demand’s pressure making the economy to depend on
Fiscal policy has been subordinated to play a significant
role within the nominal exchange rate stabilization and in promoting free
capital inflows. Therefore, fiscal cuts are realized and public enterprises are
privatized to diminish public debt amount in order to reach fiscal discipline
and to grant trust in prices’ stability and the exchange rate to be able to
attract capitals to finance existing deficit.
Capital inflows and policies that promote them, value the
currency, decreasing inflation through affecting the accumulation dynamics,
restricting investment and deepening productive setback problems, as well as
through increasing pressure over trade deficit. Therefore, it demands more
capital inflows to keep exchange stability, therefore it falls into a vicious
Latin American governments, specially the Mexican government,
prefer these policies in spite of their recessive effects, instead of
devaluating and reintroducing the predominant economic policy. They consider
that real interest rate differential’s reduction, and monetary and exchange
policies’ expansion, would create greater iniquity to the economy, because
capital markets would destabilize, with the subsequent invested capital’s
devaluation, which would propitiate hard capital outflows that would
de-capitalize the economy, taking it to moratorium problems, and to a greater
international financial system’s vulnerability.
Nonetheless, predominant policies do not achieve the desired
monetary stability. What it is achieved is nominal exchange rate stability,
which is very far from monetary stability. If this one was reached, monetary,
credit and fiscal restrictions would not predominate, neither would be allocated
governmental titles at very high interest rates to attract capitals to increase
reserves to be able to finance nominal exchange stability.
If currency stability is not achieved, it is not because
there is lack of discipline within the policies taken up, but it is the
consequence of such policies’ contradictions, which attempt against
productive, financial and macroeconomic conditions. Tavares says that “the
anti-inflationary policy is destined to defeat inflation, but not to guarantee
macroeconomic stability. Abrupt opening, exchange over-valuation, and high
interest rates look to guarantee prices at any cost, but they destabilize the
other macroeconomic variables (activity, consumption, investment, and settlement
balance levels), and they dismantle part of the industry and the agriculture
without making them more competitive”. (Tavares, 08/97).
Anyway, such situation jeopardizes trust and the exchange
stability conditions demanded by financial liberalization, generating negative
expectations that hinder capital inflows and propitiate their outflow, provoking
Therefore, exchange rate fluctuations are so harmful for the
economic activity (within the context of free capital movements) that they do
not adjust settlement balances’ inequity, and they do not finance deficit
through capital inflows without altering the nominal exchange rate, because it
obliges to establish high interest rates, severe monetary, credit and fiscal
restrictive policies, which go against accumulation, the economy’s sustained
growth, and it sets a situation of high foreign vulnerability when it strongly
depends on exports and capital inflows.
Economic Policy for Growth Stops
Within the context of globalization, monetary and fiscal
policies cannot dissociate from the objective of nominal exchange stability.
Depending on the growing capital inflows to guarantee nominal exchange rate
stability, the economic policy stops to be able to face national productive
problems, to increase domestic market, productivity, imports substitution and
national exports component. Exchange stability policy, Tavares says, creates a
“progressive loss of freedom and spaces to manage the closing of our foreign
account which pushes us to more severe monetary regimes each time”. (Tavares,
The Exchange Rate is a Macro-price, So its Distortion Has
The exchange rate reflects the relation domestic prices
versus foreign prices, so in a context of an open economy, it represents the
main economy’s price, for to a great extent, on this it depends production’s
protection, and national employment in front of foreign employment, as well as
accumulation dynamics and capitalization levels within the productive sphere.
Eatwell and Taylor say that “a change at the exchange rate will affect all
domestic prices of all trading goods, in that way, the exchange rate is a
macro-price”. (Eatwell and Taylor, 2000, p. 70).
Such variables are crucial for the foreign sector’s
adjustment, as well as the assets value (productive as well as financial) and
liabilities, and for the bank’s sector stability, so its determination and
management cannot be left in hands of the market’s free force, that are
commanded by the international financial capital, but it has to respond to the
macroeconomic needs for sustained growth.
Nominal exchange rate’s stability, and its consequent
value, has been used to decrease inflation. The fact that national currency’s
parity in contrast to dollar moves below inflation and of domestic inflation’s
differential versus the foreign one (United States, our main commercial
associate), determines the relative prices’ distortion that acts in favor of
imported products and in detriment of national products, that have a higher cost
structure in contrast to the imported ones, due to lower productivity levels in
contrast to the imported ones. National producers are compelled to fix their
prices according to imported products, which are cheaper because of the exchange
value. That is to say, they come to be price- takers, giving up earning margins
and jeopardizing their capitalization levels (and consequently those who cannot
face competence are displaced by imports), therefore, productive accumulation
decreases, as well as national production growth and employment. Productive
chains are broken, and indebtedness levels increase, as well as foreign trade
deficit, which leads to depend even more on capital inflows, therefore it is
necessary to maintain high real interest rates.
Exchange value, high interest rates, and fiscal discipline,
create revenues distortion, which alter the economic structure. They affect the
productive sphere in favor of capital and money markets. This provokes that a
large part of capital inflows move towards the non-productive sector reproducing
financial and speculative actions against sustained growth.
Exchange Value and Manufacturing Exports
Exchange rate valued in favor of capital inflows affects
national exports’ growth (specially enterprises that are not integrated to the
United Sates’ economy), and it reduces exports national component. It acts in
favor of exports realized by transnational enterprises in Mexico, for it allows
them to cheapen input costs (specially Asia) in order to improve competitiveness
to export with low national aggregate value to United States. Likewise, exchange
value in Mexico favors United Sates exports towards this country, for its
product’s competitiveness increases in contrast to Mexican products.
Nominal Exchange Value and Inflation’s Decrease Does Not
Promote Investment and Growth
Commonly, inflation is blamed for competitiveness loss and
for consequent foreign trade deficit, as well as for the countries’ financial
instability. Nonetheless, these problems present nowadays within a context of
low inflation, because it has rested on restrictive policies, and on exchange
value, which attempt upon the productive plant’s competitiveness and
capitalization levels, they increase foreign commercial deficit, insolvency
problems, the bank sector’s instability, and upon public finance pressure.
So it contradicts the conventional theory’s position, which
points out that the exchange rate stability and the inflation’s decrease are
the best option to promote investment and growth, in contrast to the exchange
rate devaluation’s management, because it creates exchange uncertainty, where
there is no certainty upon the future exchange rate, so stockbrokers postpone
their investment decisions and they are led to speculation. Nevertheless, fiscal
restriction policies, high interest rates and nominal exchange rate, in spite of
being directed to guarantee financial capital stability and profitability, they
do not represent a better option to stimulate the productive sphere stockbroker’s
investment decisions, because they are the ones that provoke the domestic market’s
contraction, low accumulation, greater levels of domestic and foreign
over-indebtedness, as well as insolvency and credit restriction, and the foreign
sector’s deficit, which regress into monetary stability and economic growth
Therefore, they are “healthy” policies that have
predominated in favor of the international financial capital, not in favor of
the fiscal and monetary expansion and in low interest rates, as it has
traditionally been said by the conventional theory, they are the cause of the
economic contraction problems and high foreign vulnerability that Mexico and the
rest of the Latin American countries are suffering. These countries have
deepened their underdeveloped structural problems (breaking productive chains,
credit restrictions, foreign deficit), jeopardizing endogenous growth capacity,
making them dependent on foreign financing and making them vulnerable within the
world economy’s behavior.
The Exchange Rate Expectations
The expected exchange rate is determined by capital flows,
which finance foreign gap and increase international reserves amount. Their
behavior lies upon economic growth expectations and upon economic fundamentals
behavior, within the perspective that these ones will guarantee, or not, the
exchange rate stability and capital revenues. This depends on the expectation
that the government will influence upon the economic policy’s efficiency to
guarantee economic growth, but mainly, upon the fundamentals required for
nominal exchange stability. Another significant element of capital flows are the
privatization process and the capital market’s behavior. So, financial assets
value that are quoted within an emergent economy, as well as the macroeconomic
indicators, are the ones that greatly influence upon capital flows, therefore
the exchange parity determination.
When expectations are favorable for the economy, whether it
its because of fiscal or foreign adjustments, or because of economic growth and
greater economic liberalization or privatization, they attract capital, which
values the exchange rate and increases stock and price’s demand in the face of
the expected larger dividends. The stock market’s boom makes more attractive
capital inflows, so the currency is more valued, contributing to the inflation’s
reduction, to greater credit availability (if capital inflows are enough to
generate growth expectations). Nonetheless, these elements are before all
financial, exchange and bank crises within the underdeveloped countries.
Exchange value, on one hand, increases the foreign sector deficit, and on the
other hand, it affects the accumulation dynamics, increasing the enterprises’
over-indebtedness levels, and generating insolvency problems that disestablish
the bank sector, restricting credit and originating pressure upon public
finance, ending in the stockbrokers’ expectations change. Capital outflows
creates the stock market’s crack, accompanied by the exchange rate
devaluation. Both crises deepen the bank sector’s instability, due to capital’s
under-valuation and to high interest rates that are established to hinder
capital outflows, due to the economic activity’s contraction and to income
that it originates, creating insolvency problems.
The economic policy put into practice may not be successful
to guarantee macroeconomic balance. Nonetheless, capitals may still be moving
towards the economies, if they put into practice high interest rates, budgetary
cuts and taxes increase in order to decrease fiscal deficit and foreign trade
deficit, and if, besides, they accelerate the privatization process and
attractive assets’ foreignism. These ones are aimed at influencing upon the
economic agent’s expectations, and as these ones believe that such policies
get rid of inflation and pressure upon the fundamentals, the capital still flows
to the country and it keeps within it.
In spite of foreign imbalance, such a situation makes the
economy to operate with valued exchange rate, because of capital inflows that
finances it and that increments international reserves, which conforms exchange
stability expectations, which may change when there are no stability or
reimbursement conditions. J. Pinto de Andrade and M. L. Falcao Silva, say that
“domestic currency ex-post devaluation by the government depends on the
private agents’ expectations, and that this last one depends on credibility
associated to the government’s policies”. (Andrade y Silva, 1999, p. 317).
When the economy does not offer macroeconomic stability
conditions, (in public finance, and foreign sector), and therefore, it fails to
pay capital revenues, or when it has difficulties to deepen the privatization
process and strategic assets foreignism to guarantee larger capital flows and
settlement conditions, or when it fails to offer or grant them as guarantee to
the international capital, this one changes the country’s expectations. In
front of assets devaluation, whether it is because of policies’ inefficiency
to preserve nominal exchange rate stability, or because there are no
opportunities of larger profitable assets’ appropriation, or due to contagious
of problems that other economies are experiencing, they look for more secure and
profitable markets. On the other hand, financial liberalization facilitates fast
capital movements, which are difficult to control in the face of domestic and
foreign expectations’ change. Mario Presser says that “even though the need
to reduce the exchange rate volatility is recognized, instruments’
insufficiency to attend conflict are discovered within a framework of high
capitals movement.” (Presser, 2000, p. 38).
Quickness with which financial capital acts at the
international level in front of changes contrary to its interest, makes it
impossible to hold for a long time inflation’s decrease with exchange
anchorage, through the financing pattern that capital inflows represent, due to
uncertainty and volatility, in the face of domestic and foreign problems.
Exchange Stability Cost
Financial liberalization, nominal exchange stability and
currency’s convertibility are being very expensive for Mexico, for nowadays
there are no monetary, credit or fiscal policies for sustained and generalized
growth. There is less industry, less agricultural sector and a bank that does
not grant credit. There are less national assets, larger domestic and foreign
debt, and we are more vulnerable to international fluctuations.
When exchange stability and currency’s convertibility is
sustained on capital inflows, it represents a high cost for the country. When
capital inflows are significant as a financing pattern, they impose high
interest rates to the country, as well as restrictive policies, and exchange
rate valued parities, with the consequent loss of national production
competitiveness, and other effects already mentioned, as well as the national
patrimony’s permanent sacrifice because they expand profitability and the
foreign capital’s influence sphere.
When pressure is harder over economic fundamentals, the
government finds it difficult to sustain nominal exchange value, for concessions
and assets that it has to grant or to transfer to international capital have to
National enterprises have had to look for international
associates to be able to reach liquidity levels and capitalization in order to
sustain within the market. In this process, large enterprises that offer better
profitability expectations have participated. So, the exchange stability policy
generates a patrimonial adjustment in favor of international capital. The
enterprises and assets foreignism process has a high cost, for it implies to
finance the economic liberalization policy and the nominal exchange stability,
that do not generate endogenous growth conditions, but larger delay and
Currency’s Value and the Enterprises and Families Income
Eatwell and Taylor point out that “a weak currency tends to
decrease real income flows and the families and enterprises’ real wealth” (Eatwell
and Taylor, 2000, p. 74). It is worth mentioning that this operates if the
enterprises and the families have financial assets, because these ones cheapen
with currency’s devaluation, and if wages are not adjusted in relation to
inflation. On the contrary, if the currency is strong, (valued), it affects
income and the enterprises and the families’ wealth within the productive
sphere, because it originates lack of competitiveness, as well as negative
consequences derived from restrictive policies and high interest rates that go
together with exchange value.
Anti-inflationary policies diminish enterprises and
individual’s income, no matter if the acquisition power increases in contrast
to dollar, if the enterprises and the individuals’ income diminish to acquire
goods consumption, affecting above all, national goods.
Also, in the face of the impossibility of using the exchange
policy to improve national production competitiveness, and to adjust foreign
trade balance, Mexican governmental authorities have pointed out to the
entrepreneurs that if they want to improve competitiveness, they have to adjust
salaries. Through decreasing real wages it is expected to counteract earning
problems that exchange value generates, as well as to decrease more domestic
inflation to avoid greater exchange value and greater competitiveness loss.
Nevertheless, real wages’ drop allows the country to continue with exchange
value, but without counteracting negative effects that such exchange parity
originates. It only delays exchange adjustment at the expense of greater
impoverishment of the population.
Productivity differentials between United States and Mexico
are so great in favor of the first one, that in spite of low salaries that
Mexico has, its competitiveness and its foreign sector’s situation do not
improve. Therefore, real salaries decrease does not propitiate greater economic
dynamics, but on the contrary, it places Mexican economy into a vicious cycle,
because it restricts more the domestic market’s growth, and makes it to depend
more on exports, and on the dynamics that United States shows, where more than
85% of total exports are channeled, placing itself within a context of high
vulnerability in relation to the behavior of such economy.
Capital Inflows Do Not Counteract Negative Effects that the
Economy that Generates it Stimulates it.
Problems that are derived from the policy aimed at promoting
capital inflows, such as domestic market’s contraction, the productive sphere’s
de-capitalization, and insolvency that restricts credit availability, are not
counteracted by such capital inflows, which generally flow to the financial
sphere, or is associated to exports.
Capital inflows have not improved the productive sphere, or
the bank sector’s solvency, or public finance’s position of the foreign
sector. On the contrary, the policy established in favor of such capital has
acted in detriment of the sectors, which places us into greater foreign
vulnerability that hinders the economic policy’s management for sustained
Economic Liberalization Does not Guarantee Macroeconomic
Conditions to Hold the Required Exchange Stability.
To be able to work with stable nominal exchange rate foreign
trade superavit is required, and/or larger capital inflows and international
reserves, which allows to face foreign shock that are present at the
international markets. Nonetheless, the economic liberalization context that
operates in Mexico and in the rest of the Latin American economies, does not
conform foreign trade superavit to reimburse foreign financial obligations, and
besides, it does not guarantee confidence conditions for permanent capital flows
to allow foreign imbalance financing and nominal exchange stability.
Even if economic fundamentals are looked for to be able to
sustain exchange stability, these fundamentals are weakened by the currency’s
value and the accompanying policy, so not only it is not possible to make
compatible exchange stability and economic growth, but nominal exchange
stability is also weakened.
The way inflation is reduced affects public finance because
of accumulation problems that currency’s value originates. This one, together
with the domestic market’s contraction, that derives from contraction
policies, reduces taxes collection. Also, the enterprises’ over-indebtedness
levels increase, they recreate the bank sector’s insolvency and instability
problems, demanding the government to transfer resources to such sector,
increasing public debt and pressure over public finance. At the same time, these
ones are also affected because of domestic debt’s increase that derives from
capital inflows’ sterilization. High interest rates that are established to
guarantee capital inflows for exchange stability affect public finance, and
recreate national bank sector’s problems, contracting investment growth.
Foreign sector faces pressure as consequence of the exchange
policy and commercial opening, as well as anti-inflationary restriction policies
(monetary, credit and fiscal). Current account deficit is not the result of
monetary and fiscal expansion as it is pointed out by the conventional theory,
but on the contrary, monetary and fiscal restrictive policies that have been
predominating, together with high interest rates, act in favor of capital
inflows that values the exchange rate. This diminishes competitiveness and
affects the productive sphere (breaking productive chains and lower
productivity), so supply pressure over trade balance increases.
Pressure upon public finance, the foreign sector, and the
bank system, as a result of dominant economic policies, together with the
dominant international financing vulnerable character, weaken nominal exchange
stabilization and the achieved inflation’s decrease, and it underestimates
capital inflows, jeopardizing exchange stabilization and growth.
Exchange Value for a Weak Economy that Questions It
Exchange value does not imply currency’s strength or the
economy’s strength. The economy is weakened, as consequence of effects
originated by the same value and the policies that originate them. This problems
is present in Mexico as well as in the rest of Latin America. So, for the case
of Brazil, Sampaio and Naretto say that “exchange combination valued with high
interest rates are adverse to the economic activity. The exchange rate
stimulates imports and underestimates domestic production and exports. High
interest rates benefited rentier sectors in detriment of domestic producers.”
(Sampaio and Naretto, 2000, p. 121).
When inflation’s decrease rested on capital inflows to be
able to finance current account deficit and to maintain nominal exchange
stability, it comes to be unsustainable. It only postpones a greater crisis
manifestation, for such capital inflows and the economic policy that accompanies
it, keeps exchange value and also pressure over foreign trade, and, besides,
financial obligations increase derived from capital inflows. This places the
economy into insolvency, that hinders capital inflows, outflows, currency
devaluation, and financial crisis. R. Blecker says that “debt positions
created because of inflows with time are unsustainable, provoking abrupt
outflows of speculative capital, which in fact, precipitates settlement balance’s
crisis and Draconian adjustment policies that reduce growth and create massive
unemployment.” (Blecker, 1998).
History has put into evidence temporality of exchange
anchorage, whether it sustains upon capital inflows, prices control, or severe
monetary and fiscal control, demonstrating that the market, sooner or later,
corrects the prolonged exchange distortions, at a high devaluatory,
inflationary, recessive and highly subordinated cost for international creditors
Exchange Value and Current Recession
Contraction that United States has been presenting since the
second semester of the year 2000, has affected exports growth towards that
country, which had constituted into it growth motor. This increases foreign
trade deficit, as well as capital inflows requirements to be able to cover the
gap and to guarantee nominal exchange stabilization. International context
change and domestic problems’ intensification, as well as settlement problems,
tend to hinder capital inflows and to jeopardize nominal exchange stabilization.
There are no endogenous perspectives to face foreign
adversity, to diminish foreign trade deficit, and to keep nominal exchange
stabilization. The same predominant exchange value policy, as well as the
productive plant’s destruction and productivity’s drop, do not allow to
improve competitiveness and to develop imports substitution to have trade
superavit and to cover foreign financial obligations.
In front of this, Mexico keeps relative high real interest
rates (higher than in United Sates), as well as credit and fiscal restrictions
and exchange value, to avoid capital outflows and to keep on promoting inflows.
This places the country into greater competitive and productive disadvantage to
be able to face exports contraction, besides such policies are pro-cyclic.
Instead of increasing public expense and credit availability, or diminishing
real interest rate to be able to improve domestic liquidity and increasing
domestic market, and to make the exchange rate flexible in order to counteract
exports drop in order to reactivate the economy, it still favors exchange
flexibility to avoid capital outflows and a financial crisis. The problem is
that nominal exchange stabilization cannot be kept in a context of low
accumulation dynamics, greater depression over foreign trade deficit, of high
levels of domestic and foreign indebtedness, and of credit restriction, because
this places us into a context of high foreign vulnerability that will propitiate
the financial crisis that it wants to avoid. International context, as we have
already said, is accentuating pressure over the national sector, and it is
increasing the private sector’s insolvency problems highly indebted in
dollars, which separate us from international financial markets, so financing
for growth and exchange stability is limited.
Up to Where Can Monetary and Exchange Policy Management be
Taken Within the Financial Liberalization?
Latin American monetary authorities cannot make flexible
their monetary policy and cannot decrease their real interest rate at the level
of the developed countries, to be able to make the exchange rate more flexible,
because both variables are key pieces to guarantee the needed capital inflows to
finance current account deficit and to avoid speculative practices that provoke
financial crisis. Therefore, monetary and fiscal policies subordinate to
accomplish nominal exchange stabilization, a condition that financial capital
demands to be able to flow to these economies.
Emergent economies’ exchange rate cannot be flexible to
promote exports and to adjust foreign trade deficit, because the exchange rate
devaluation does not meet financial liberalization, because it devalues
financial capital that operates in such economies.
Devaluation would originate severe problems within the
capital markets and would propitiate their outflow and would hinder their
inflow, which would jeopardize foreign deficit financing, such as foreign debt
settlement. It would aggravate financial problems of the highly indebted sectors
in dollars, whether it is the public sector or the private sector, which would
hinder to increase investment to profit from the new exchange parity and to
realize productive investment. Interest rates would increase to hinder capital
outflows, which would accentuate insolvency problems and bank instability.
Only to adjust relative prices would not guarantee the
productive plant’s protection or the better competitive position to improve
the accumulation dynamics and foreign trade balance. The economic liberalization
context has increased imported coefficients and it has destroyed productive
chains, so imports show a strong inflexible price, which would hinder
devaluation to decrease significantly to be able to adjust foreign trade
deficit. Besides, manufacturing exports would not grow significantly, because of
high imported coefficients, as well as because of low dynamisms within the
economy worldwide, and the strong investment required to increase productive
capacity, which demands credit availability that does not exist due to the bank
problems, and that would deepen in front of devaluation.
Devaluation would affect inflation because of productive and
financial costs, so the initial effect of relative prices’ correction would
nullify to improve competitiveness, imports substitution and to increase
exports, so investment flows would not be possible in that direction, or the
foreign sector, and the economic impulse adjustment would not operate.
How Can Economic Policy Management be Taken?
To avoid permanent pressure over the exchange rate and the
interest rate, as well as to take the sovereign management of the economic
policy in favor of the productive sphere, and of the generalized and sustained
growth in the Latin American economies, it is necessary capital movements
control to stop being stuck to the commitment of nominal exchange rates and
monetary and fiscal restrictive policies, that separate us from macroeconomic
and productive problems attention. At the same time, foreign debt servicing
settlement must be reorganized to be able to decrease foreign sector’s
pressure and capital inflows requirements, not to establish a policy in favor of
It is necessary to reorganize economic relations with the
developed countries to be able to reach better credit flows and investment in
the long-run, as well as to achieve better commercial and technological deals,
to overcome productive delays, to increase production, and to reconstruct
domestic productive chains to be able to improve employment, income and solvency
conditions. It is only this way that we may decrease pressure over the foreign
sector, reach bank stability, and retake monetary, credit and fiscal policies
To be able recover sovereign management of the economic
policy to fulfill national demands, capital movements have to be regulated as
well as capital inflows requirements have to decrease.