Mexican Silver Lining: Weakening Peso And The Drug Trade Will Bring Country Out Of Recession

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Mexico is one of the world's geopolitical disasters waiting to happen.

There's a brutal, costly and ineffective war on drug cartels; big government deficits (debt is nearly 40% of GDP); and less and less oil (Mexico could be a major energy importer within 10 years).

Peter Zeihan, VP of Strategic Analysis at Stratfor, a global intelligence company, recently put the looming oil crisis this way to us: "What happens when all of a sudden its primary source of income disappears? Mexico is flirting with failed state status now."

Dire stuff. But two unlikely silver linings to Mexico's financial crisis may help turn the country around.

Stratfor summarizes:

Standard & Poor’s on Dec. 14 cut Mexico’s credit rating to BBB, the second-lowest investment grade. Faced with declining oil profits and an increased budget deficit, Mexico will be at risk of underinvestment in the years to come, which may force the government to ramp up borrowing. This is not an unfamiliar situation for Mexico: Capital shortages are built into its geography. However, there are two possible silver linings for the Mexican economy: the weakening peso and the drug trade.

How does that work? First, the weakening peso may have a positive effect on trade and may dampen negative effects of declining remittances.

Again, Stratfor:

Despite the decline in the value of the peso — 17 percent since January 2008 — the depreciation is not really a problem for Mexico compared to past bouts of peso devaluation. This time around, Mexico’s government debt is a relatively manageable 39.3 percent of GDP. Private sector debt is at 30.9 percent of GDP, but it is mostly peso-denominated, with only around 30 percent of all private sector debt denominated in foreign currency...The peso’s loss in value, therefore, will not have a devastating effect on the economy due to sudden appreciation of foreign currency loans that were denominated in U.S. dollars.
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Furthermore, peso depreciation helps with two other key economic factors for Mexico: remittances and exports...Even though fewer U.S. dollars are going back to Mexico in absolute terms, they have a greater purchasing power.

Also, an influx of money from Mexico’s lucrative drug trade into local banks may have helped them weather the worst of the recession.

Stratfor: Ironically, the solution to Mexico’s revenue problem may be the drug trade. Trafficking in drugs brings Mexico’s drug cartels more than $40 billion of estimated annual revenue. That is equivalent to around 5 percent of Mexico’s GDP and is double what Mexican migrants send back as remittances. Most importantly, it constitutes an indigenously produced source of foreign capital, a boon that every emerging/developing economy would want access to. This capital has to go somewhere: the mattress of a local sicario (essentially cartel enforcers), investments in the entertainment and tourism industry or offshore bank accounts.

Feliz Navidad.

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