Reflections on 2013...

1) Congressional gridlock is not inevitable.

We've seen that congressional gridlock is not endemic to Mexican democracy: game-changing legislation can be passed even though the president’s party does not control Congress. Whatever your opinion of President Peña, it is undeniable that he is a skilled politician.

2) Reforms don’t work their magic overnight.

This year has taught us that reforms don’t boost the growth rate immediately. The time that elapses between passage of a law and its impact on growth depends on the type of reform and its scope. The energy reform is a case in point: it could be a decade before the expected new investments in oil production bear fruit.

3) Tweaking the economic model.

The Peña Administration has enlarged on prior governments’ commitment to sound macroeconomic policies. This Administration’s economic policy overlays the classical PRI strategy of government-provided social programs financed by deficit spending on a commitment to maintaining macro-economic stability. It can be a difficult balancing act, especially over the medium and long-term. Structural reform is the second piece of the policy puzzle. The Administration is betting on reform to boost the economy’s sustainable long-term growth rate.      

4) A changing external environment.

A consequence of the Fed's quantitative easing (QE) policy was that liquidity flooded world financial markets. Some of that liquidity found its way into emerging markets, strengthening their currencies. The Fed will, at some point, decrease and then eliminate its liquidity injections. When that happens, the countries that have received large inflows of portfolio investment should not be surprised if foreign investment in their fixed income and equity markets drops off.

The number and breadth of the economic reforms passed by Congress in the first year of the Peña sexenio is nothing less than breathtaking. The next five years will tell if the reforms live up to their billing.

The many ways one purchase affected direct foreign investment numbers...

Foreign direct investment (FDI) totaled US$28.2 billion in the first nine months of 2013, nearly doubling that of the first nine months of 2012. FDI should exceed US$30 billion this year and is likely to exceed annual portfolio investment for the first time since 2009.

Judging by the third quarter FDI figures, AB InBev’s purchase of the 50% of Grupo Modelo shares it didn’t yet own finally went through in the first half of the year. FDI in the third quarter of 2013 was just US$3.4 billion, just 12.0% of total FDI in the first nine months of 2013. Without the Modelo purchase, FDI this year won't be much more than last year's.

New investments were a minimal 2.3% of FDI in the third quarter. Increases in subsidiaries’ debt with their parent companies accounted for virtually half (49.7%) of FDI in the third quarter while reinvested profits, which appear as an outflow in the current account, accounted for 48.0%.

Reflecting the sale of Grupo Modelo, nearly half (47.0%) of FDI in the first nine months of this year came from Belgium. The US, traditionally Mexico’s principal source of FDI, was the second largest source, with a quarter (25.3%) of the total. The Netherlands contributed 6.6% of the total, followed by the U.K. and Japan, with, respectively, 4.4% and 4.2% of the total, and Germany, with 3.3%. The remaining 9.2% came from all other countries combined. 

Four-fifths (79.9%) of FDI in the first nine months of 2013 went into manufacturing, the sector in which the Modelo purchase falls. Typically, about half of FDI goes into manufacturing. Mining received 4.6% and commerce, 3.9% of the total. Information in mass media attracted 3.0% of the total and temporary lodging, 3.0%. The remaining 5.5% went into all other sectors.  

Assets held abroad rose US$28.0 billion through September, roughly in line with their US$29.3 billion increase in the same period of 2012. However, there were significant changes in their composition: Mexican FDI plunged while Mexican deposits in foreign bank accounts climbed.

Mexican deposits in foreign bank accounts soared US$26.1 billion in the first nine months of 2013.  In the same period of 2012, they rose US$4.2 billion. The tremendous jump in deposits in foreign bank account may well be explained, in part, by the sale of Grupo Modelo: Mexican shareholders may have chosen to place the proceeds of the sale in foreign bank accounts.

In the first nine months of 2013, Mexican FDI totaled US$6.5 billion, a third of its level in the first nine months of last year. Mexican FDI this year should be above its 2005-2009 annual average (US$6.3 billion) but far below its 2010-2012 annual average (US$17.0 billion).

If you see an FDI figure of US$1.2 billion reported for the third quarter, that's FDI using the new reporting methodology, which nets FDI in Mexico and FDI by Mexican companies. In the third quarter of 2012, that number was US$0.3 billion. For the first nine months of this year, thanks to the Modelo purchase and the drop off in Mexican FDI abroad,  FDI with the new reporting methodology was US$21.8 billion. Mexican FDI exceeded incoming FDI in the first nine months of 2012 to the tune of US$4.4 billion.

Portfolio investment is back but not like before...

Portfolio investment returned to Mexico in the third quarter: US$6.70 billion (net) came into the country in the form of investments in equities or fixed income instruments. This year's US$12.87 billion of portfolio investment through September is on a par with portfolio investment in the same period three years ago. But, it it is about half its level in the first nine months of 2011 and a third of its level in the first nine months of 2012. No wonder Mexico's central bankers are spreading the message that the monetary policy decisions by central banks in developed countries have consequences for emerging markets.

Remittances to Mexico are down but not so for the rest of Latin America...

Mexico received an average of US$25.9 billion in remittances between 2006 and 2008. The following four years, annual remittances dropped below their historical highs, averaging US$22.2 billion. This year, I estimate remittances will be around US$21 billion. The Pew Center's Hispanic Trends Project estimates remittances to Mexico will hit US$22 billion, still below 2012's level.

In other Spanish-speaking Latin American countries, the Pew Center estimates that remittances will total US$31.8 billion this year. That will be 1.7% more than last year and slightly above their 2007 peak.

The Pew Center estimates remittances to Spanish-speaking countries this year will total US$53.8 billion, 12.7% less than in 2007. Mexico's estimated share of the total this year is put at 40.9%, slightly down from 42.9% in 2007.

In 2012, three-quarters of remittances to the seventeen Latin American nations came from the US. The figure for Mexico was 98%.

Trade between Mexico and the US is concentrated...

More than three-fifths of Mexican exports went to just three states in 2012 -- Texas, California and Michigan. México exported US$99.9 billion to Texas in 2012, US$38.1 billion to Michigan, and US$36.0 billion to California. Mexico exported US$9.0 billion to Illinois, the fourth most important destination in the US for Mexican exports in 2012. México exported US$63.8 billion to another fourteen states last year.

Who's running things in Michoacan?

In the wee hours of Sunday morning, armed groups bombed and attacked 18 installations of the Federal Electricity Commission (CFE), including 8 substations, and set 6 gasoline stations and a convenience store on fire in Michoacan. Twelve of the state's 113 municipalities lost electricity.

Were the attacks, which appear to have been coordinated, the work of narcos fighting for control of territory? Of terrorists with an ideological agenda opposed to the government? Is the presence of the self-defense groups that started to pop up earlier this year related in any way? Are the attacks related to the three grenades thrown at marchers in Saturday's demonstration by self-defense groups in Apatzingan?

Serious health issues forced Michoacan's elected governor, Fausto Vallejo, to take a six-month medical leave of absence. Politicians in Mexico City believe that the tenure of the interim governor, Jesus Reyna, was a disaster. Mr. Vallejo announced last Wednesday that he was returning to office. Are the attacks related to his return?

Ten days after donning the sash of office in 2006, President Felipe Calderon sent 6,500 soldiers into Michoacan. The controversial decision to send the army into the state marked a watershed in the war against drugs, signaling that the challenge was too much for some state governments to handle on their own. Since then, violence ebbs and flows but never stops.

The weekend's molotov cocktails and the rise of the self-defense groups, some of which seem to be affiliated with different narcos, leave no doubt that the government has not yet been able to regain control of some areas of the state even with the intervention of the army. Let's hope that changes quickly.

The bloom is off the rose: not a fiscal reform dear to businesspeople

The income law passed at the end of last week by Mexico's Chamber of Deputies soured the business community's perceptions of the Peña Administration. Instead of a fiscal reform, the feeling is that the country got another "miscelanea fiscal", an assortment of measures designed to increase the government's tax take by going back to the same taxpayers as always.

There's a real concern that the new tax law will encourage, not discourage, the informal economy. Certainly the elimination of the IETU and the IDE control taxes (the former is effectively an alternative minimum tax and the latter, a tax on cash deposits over a certain monthly amount) takes away two important "sticks" in Hacienda's efforts to ensure, respectively, that all firms pay taxes and to rein in the informal economy. Time will tell whether the incentives the new law contains are sufficient to entice businesses operating informally to become formal. Unless we can see individual companies' tax returns, we'll never know if the elimination of the IETU redistributes the tax burden amongst companies or if those firms that have been paying IETU pay as much or more in income taxes going forward.

Even with an additional 1.0% of GDP in additional revenue next year, the "deficit creep" Mexico has experienced will accelerate sharply in 2014. The expanded social programs that are part of the 2014 budget raise the specter of new life being infused into the patron-client politics at which the "old PRI" excelled.

Meanwhile, it looks like the Administration is betting on public sector spending and exports to propel growth next year. The bet that the passage of President Peña's reform agenda would spur physical investment by private sector is not likely to pay off in 2014, unless it's investments in the energy sector. Portfolio investment is another story, of course: those flows will hinge on the Fed's tapering policy.

A government again...

The US Senate cobbled together a last minute deal to reopen the government and raise the debt ceiling last night, narrowly averting a default by the US Government. The yield on the one-month Treasury bill  plunged from 32 basis points (hundredths of a percentage point) on Tuesday to 14 basis points on Wednesday when a deal looked likely. Today, with the deal inked, the yield dropped to 1 basis point, its typical level prior to the latest edition of the budget/debt ceiling crisis.

The deal bought time. It is not a solution. Unless congressional committees have better luck negotiating budget packages than they've had in the past, we'll suffer a replay of what we've just been through early next year. It doesn't bode well for spending in the holiday season.

Here in Mexico the Chamber of Deputies approved the income half of the budget. The PRI found the votes it needed to pass its tax proposals with votes from the PRD.  It's not coincidental that a few days before the vote the federal government announced the creation of a special fund for the PRD-controlled capital city. The business community is not happy with the "tax reform", which increases the cost of being part of the formal economy.

The cost of shutting down the US government...

If you're in the tourism business or a small company for which the US government is an important client, you've felt the impact of shutting down the US government very directly. That the Congress has chosen to fund particular programs, program by program, leaves no doubt that the constituents served by those programs have made their voices and business cases heard. Unfortunately, if we have to rely on program by program approval to get a budget, we'll still be working on the 2014 fiscal year budget when the 2015 and 2016 budgets come along.

This is not the first occasion on which the US hasn't had a budget when the fiscal year began on October 1. It's happened twelve times since the 1970's. The average shutdown lasted 6-7 working days, according to research by Rabobank and the median reduction in growth during the quarter in which the government was shutdown was 0.9 percentage points of GDP. The last shutdown, during the Clinton Administration, was the longest, lasting 21 working days. We're already at eleven.

This time, the US is hitting the debt ceiling at the same time as the shutdown. The fallout from not raising the debt ceiling is much, much more serious than shutting down the government. If Congress doesn't raise the debt ceiling, authorizing the Treasury to pay for expenditures Congress already approved, default will be the outcome. When Treasury will run out of cash to pay all obligations falling due depends on how much more juggling of revenues and outflows Treasury's money managers can squeeze out of the system. But, that day is nearly upon us: Thursday in the worst of cases, the end of the month in the best.

Please, Speaker Boehner, call a vote. Save us from finding out whether default would be as devastating for the economy and financial system as the Lehman Brothers default in September 2008 was.

Markets focus on the US...

The US fiscal year runs from October 1 - September 30. Hours before the fiscal year is to end, the country still doesn't have a budget.

Tomorrow, October 1, parts of the US Government will shut down unless Congress approves a continuing resolution by midnight tonight. That could happen but, if it doesn't, it wouldn't be the first time the US has begun the fiscal year without a budget in place. We've danced this dance 18 times since 1977. The average shutdown last 6.5 days. The last shutdown took place nearly 18 years ago during the Clinton Administration. The longest ever, it lasted 21 days.

What's the impact of a government shutdown on the economy? Historical experience tells us the median reduction in the growth rate during the quarter the government was shutdown was 0.9 percentage points. That's rather significant in a year when the economy is expected to grow 1.6%. Naturally, the duration and implementation of the shutdown will influence how deep the hit to growth will be.

This time around, the shutdown is the least of markets' worries. Following hard on the heels of the looming shutdown is the prospect that the US may default on its debt payments. The last time it looked like Congress would not raise the debt ceiling - in August of 2011 - the US lost its AAA debt rating.

The shutdown and the debt ceiling are two discrete events. It's especially unfortunate that the two votes are happening so close together. The shutdown is what will happen if Congress doesn't approve a budget for fiscal year 2014. The vote to raise the debt ceiling is, effectively, voting to pay for what you've bought. By voting to raise the debt ceiling, Congress is authorizing the Treasury to borrow the money to pay for expenditures Congress has already authorized.

When Congress votes on the debt ceiling depends on when the US government exhausts its authorized borrowing capacity. This year, Treasury estimated that date to be October 15. However, juggling payments could win a few extra days or weeks.

Markets can live with a government shutdown. The real concern is whether Congress will raise the debt ceiling. If it doesn't and the Administration doesn't find a way to pay its bills, the US Government will default on its debt. No one wants to find out what the impact on the markets would be if the "full faith and credit" of the US Government were questioned.

Mexican migration to the US...

The Pew Hispanic Center estimates that 11.7 million unauthorized immigrants lived in the US in 2012, just over half of whom are Mexican. That's half a million fewer people than in 2007, the year before the "Great Recession" began, and the same estimate as for 2008. Although the number dropped to a low of 11.3 million in 2009, the increases in subsequent years aren't statistically significant. However, it does look like immigration is beginning to pick up.

A couple of points worth making....

1) Unauthorized immigrants accounted for 28% of the immigrant population in the US in 2012.

2) While the largest number of unauthorized immigrants -- 52% of the total -- were from Mexico in 2012, there have been some significant changes in that pattern.
     a) The unauthorized Mexican immigrant population was estimated at 6.0 million in 2012, well below 2007's peak of 6.9 million.
     b) That's not the case for unauthorized immigrants from other countries, estimated at 5.65 million in 2012 compared to 5.25 million in 2007.
     c) Annual apprehensions of Mexicans peaked at 1.64 million in fiscal year 2000. In fiscal year 2012, annual apprehensions were down to 266 thousand.

How do tax burdens compare?

Ever wonder how the direct tax income collected by the Mexican central government compares to what's collected in Brazil, Chile and Colombia? If you did, here's the answer for 2011, stated as a percentage of GDP.

• Mexico:     5.4%
• Brazil:       9.2%
• Chile         7.6%
• Colombia   6.9%

If you include direct taxes collected by all levels of government, the order remains the same:

• Mexico      6.0%
• Brazil       10.5%
• Chile          8.2%
• Colombia   7.5%

What's especially interesting is how direct taxes paid by individuals and companies (as a percentage of GDP) compares in Mexico, Brazil and Chile. (Colombia doesn't provide the breakdown.) Remember: these percentages of GDP are from 2011. If approved, Mexico's proposed fiscal reform will increase the percentage paid by individuals.

Companies

• Mexico   2.4%
• Brazil     3.7%
• Chile      3.9%

Individuals

• Mexico    2.7%
• Brazil      0.5%
• Chile       1.4%

US$38,000 a year...

Earning US$38,000 a year (Ps$500,000) a year in Mexico puts you in the top 1% of the population, according to Hacienda.

INEGI's income and expenditures survey says that in 2012 earning the equivalent of US$3,419 a month put a household in the top 10% of the household income distribution. (The average household was comprised of 3.7 members, 2.5 of whom are between 14 and 65 years old. The dollar figure was calculated using the 2012 average annual exchange rate.)

If earning just over US$3,000 a month makes someone part of the 1%, wonder what number it takes to be included in the top 0.5% or 0.1%?

Turning back the clock on decentralization....

Tucked away in Mr. Peña's fiscal reform is a move to re-centralize some functions that states had assumed when "decentralization" was one of the few concepts on which all political parties could agree.

During Ernesto Zedillo's presidency, the federal government  began transferring monies to the states so that the states, instead of the federal government, would pay teachers. The federal government also has been transferring monies to states so that states could buy the medicines used by public sector health facilities.

Secretary of Hacienda Videgaray has announced that the federal government will once again pay teachers and purchase medicines, which it will then distribute to the states. In other words, governors will no longer have access to massive amounts of money to use with little or no supervision or transparency, monies with the potential to be employed for political purposes or siphoned off.

Recentralization will effectively control some of the abuse of public funds by governors about which we've been reading so much. It will also give the president more power than his immediate predecessors had.  The PRI is back.

Fiscal reform unveiled...

The fiscal reform unveiled last night by President Peña leaves businesses and the middle class cold. No wonder, since they'll be footing the bill.

In macro terms, the government plans to collect additional tax revenues equal to 1.4% of GDP. Half of that will come from additional income taxes collected from companies. Another 0.6% of GDP will come from additional personal income tax collections and IVA (half from each concept). IEPS (excise taxes) on gasoline and other products will contribute, respectively, 0.4% of GDP and 0.2%. On a net basis, the expected loss of income from eliminating the IETU will cancel out the additional income taxes businesses are expected to pay. The question, of course, is whether the same businesses that benefit from eliminating IETU will pay the additional income taxes.

Exports will have to be the motor of next year's growth, along with public sector spending. Consumers will quite simply have less disposable income after the tax bite.

The fiscal package itself was a surprise. The government floated trial balloons but the package itself was very tightly held. One surprise was the decision to abandon levying value-added taxes (IVA) on foods and medicines. It's said that the President himself made the call, one that was very much influenced by political calculations.

The other surprise was the reappearance of public sector deficits, excluding investments by Pemex. Hacienda is asking for approval to increase this year's deficit from the approved 2.0% of GDP (0.0% excluding Pemex investments) to 2.4% (0.4% excluding Pemex investments). Next year's deficit is to be 3.5% of GDP (1.5%, excluding investments by Pemex). Mexico's debt to GDP ratio remains enviable but there hasn't been the same commitment to reducing deficits that we saw in earlier Administrations. The deficit began creeping higher as a percentage of GDP in the Calderon Administration. "Deficit creep" has transcended the change of sexenio.

While Mexico cuts its interest rate, BRICS agree to combat currency outflows...

The Fed announced in June that at some unspecified point in the future it will begin to taper back its monthly bond purchases. Following that statement of intentions, capital flows to emerging markets slowed to a trickle or, in some cases, even reversed. Consequently, currencies weakened.

The peso fared well in comparison to emerging market currencies. Between April 30 and August 30, the peso depreciated 9.8%. The Turkish lira lost 14.0% of its value in the four-month period. The Brazilian real dropped 19.5%. The Indian rupee lost 22.1% against the dollar. The Russian ruble fared well by those standards, declining just 7.2%.


Banco de Mexico, Mexico's central bank, surprised the markets this morning by cutting the Mexican Reference Rate 25 basis points, to 3.75%. It's the second reduction in six months. That follows a period of nearly four years in which the Reference Rate stayed at 4.50%. The Board of Governors explained their decision on the basis of economic conditions in Mexico and the world. The risks to growth have increased at the same time  inflation is not likely to pose a problem. In Mexico, financial markets, including the currency market, have had an "orderly" adjustment to the anticipated change in Fed policy. The Board concludes that in light of the expected weak demand and the expected "significant advances in strengthening public finances", it was appropriate to cut the Reference Rate.

The Mexican authorities are NOT intervening to to support the peso. By cutting the benchmark short-term interest rate Banco de Mexico sends a signal that monetary policy is not designed to attract carry trade flows. Of course, the increase in longer-term interest rates over the summer has steepened the peso yield curve, which means that portfolio investors can still reap an attractive yield differential in longer-term peso obligations.

The BRICs (Brazil, Russia, India and China) have had a different reaction to the hit to their currencies, judging by a paragraph tucked deep in e New York Times September 6 account of the G-20 meetings in Russia. According to the Times story, the BRICs intend to create a collective fund of US$100 billion to defend their currencies. When the fund will be in place and how it will operate remains to be seen.

Peso on the move...

Yesterday, the fix exchange rate was $13.34, close to the $13.40 a dollar cost on June 21. Leaving aside the last week of June, a dollar has cost more in the last few days than at any other time in a year. The previous high was on August 20, 2012 when the fix rate was $13.42.

Movements in the second quarter capital account suggest why the peso weakened so dramatically in June and the probable cause of its most recent fall.

Portfolio investment did not pour into Mexico in the second quarter as it had in prior quarters. In fact, it left: the US$3.20 billion outflow of portfolio investment in the second quarter cut portfolio investment in the first half of 2013 to US$6.17 billion. That the last quarter in which portfolio investment fell was in the final quarter of 2008 gives pause.

"Assets held abroad" declined US$1.50 billion in the second quarter, a sharp contrast to the US$18.91 billion increase registered in the first three months of 2013. Direct foreign investment (DFI) abroad by Mexican firms doesn’t explain the repatriation of funds to the country: Mexican DFI totaled just US$1.78 billion in the second quarter, a third of its level a year earlier. In fact, Mexican DFI has been quite restrained this year. At US$3.73 billion in six months, it is only 28.6% of its level in the first half of 2012.  

Neither do Mexican deposits in foreign bank accounts explain the repatriation of assets held abroad: those rose US$5.07 billion.

What does explain the inflow in the assets held abroad account is the repatriation of US$8.35 billion in its “other” component. It is the largest inflow we’ve seen in this account since the fourth quarter of 2008, when US$18.09 billion came back into Mexico. Governmental treasury management decisions are probably reflected in this account.

Here's some food for thought: both portfolio investment flows and the reason for the inflow of capital in the assets held abroad account in the second quarter of this year are similar in direction to what we saw in the last quarter of 2008.

Mexican growth: oops...

Whenever someone starts out by saying it will be next year when the economy really takes off, you can bet that this year's growth is disappointing. So it is with Mexico: the 1.0% registered in the first half of 2013 makes it a sure bet that the projections of 3%+ growth in 2013 made a year ago won't materialize. We'll be lucky to see 2% growth this year.

Mexico's GDP rose 1.5% in the second quarter (measured against the same quarter of 2012) - and that included the beneficial effect of Semana Santa having fallen in the second quarter last year. Measured using the US methodology (versus the prior quarter, annualized), Mexico's GDP contracted 3.0% in the second quarter. (US GDP rose 1.7% in the second quarter.) Using the US methodology, both the industrial (secondary)  and the services (tertiary) sectors contracted: the former dropped 4.3% while the latter fell 1.7%.

The base year against which growth is calculated was updated from 2003 to 2008. Prior years' growth figures were restated back to 1994. There were a few significant changes. Neither the 1995 nor the 2009 recessions were as steep as had been reported. Instead of plunging 6.2% in 1995, the drop was 5.7%. In 2009, the economy is now reported to have fallen 4.7% instead of the 6.1% we'd thought. The recovery in 1996 was stronger than we'd thought - 5.9% instead of the 5.2% reported using the 2003 base year - but the recovery in 2010 was weaker - only 5.1% instead of 5.5%. It also seems that growth was 0.4 - 1.3 percentage points weaker between 1999 and 2002.

The Peña Administration's ambitious reform agenda certainly has the potential to boost Mexico's growth rate. The economy's poor performance in the first half of 2013 reminds us that potential must be realized and that, of necessity, takes time.

Energy reform: is success dependent on its accounting treatment?

How accountants treat ownership of reserves could make the difference between success and failure for President Peña's energy reform, providing Congress approves it as proposed.

Oil companies want to tell their investors they've acquired reserves for future production. Depending on how agreements are negotiated, companies just might be allowed to record any oil and gas they find or produce in conjunction with Pemex as reserve holdings -- even though under Mexican law, the state will still own the reserves. (The argument is found in a Citibank report cited in the August 14, 2013 New York Times.) 

Will the US Securities and Exchange Commission (SEC) decide that  its accounting rules allow the reserves a firm finds or develops with Pemex to be included in the firm's financials? (The rule is that the reserves can be booked as such if the reserves equal the value of the cost recovery and revenue earned, per the above cited article.) If firms can report the reserves and the reform is approved,  "the results will be revolutionary for the country", according to the Citi report.

What's the income of the "average" Mexican household?

In 2012, monthly household income in Mexico averaged $12,708 in 2012 (US$980 a month using the average annual exchange rate). Half (51%) of income went to the top 20% of households. The bottom half of households had a fifth of income. Income ranged from $2,332 for the poorest tenth of households to $44,344 for the top tenth. 

The average Mexican household in 2012 had 3.7 members, 1.8 of whom were “economically active” and 2.4 of whom received income of some sort (perceptores por hogar). The head of the household was 48.6 years old and 2.5 people in the household were 14-65 years old. 

Focus on unemployment...

“Explicit state-contingent forward guidance” doesn't sound very radical but it is. With it, the UK's central bank quietly adopted the Fed's approach to setting interest rates. The Bank of England's Monetary Policy Committee (MPC) announced that, in effect, British monetary policy will depend on the unemployment rate. Until the unemployment rate falls below 7%, the Bank rate will stay at 0.50% and its quantitative easing (QE) program, at a minimum of 375 billion pounds sterling. Unemployment stood at 7.8% in the three months ending in May. Per the MPC, “unemployment is as likely to reach the 7% threshold beyond its three year forecast horizon as before”. There are three caveats, two of which have to do with inflation. The third is so long as the accommodative policy doesn't pose a significant threat to financial stability.

No central bank can afford to ignore growth, even banks with the sole mandate of controlling inflation. The decisions of the Fed and the Bank of England make it clear that unemployment comes under their umbrellas as well. Banco de Mexico has yet to be so explicit, but its statements and presentations leave no doubt that growth is very much on the minds of Mexico's central bankers. 

Inequality in the US...

Here's the link to a fascinating look at the likelihood that children starting life in families in the bottom fifth of the income distribution in the US will make it to the top fifth, along with an analysis as to why. In which city you live makes a big difference.

http://www.equality-of-opportunity.org/

It's not just demand that's sent commodity prices higher...

"Wall Street’s maneuverings in the commodities markets have added many billions to the coffers of investment banks like Goldman, JPMorgan Chase and Morgan Stanley, while forcing consumers to pay more for gasoline, electricity and a wide range of products, from cars to cellphones. In the last year, federal authorities have accused three banks, including JPMorgan, of rigging electricity prices, and on Monday JPMorgan was working to reach a settlement that could cost it $500 million." (New York Times print edition, July 23, 2013, page B1) 

Check out two articles on line:

http://www.nytimes.com/2013/07/21/business/a-shuffle-of-aluminum-but-to-banks-pure-gold.html?pagewanted=all

http://www.nytimes.com/2013/07/23/business/inquiry-possible-into-storage-of-commodities-by-big-banks.html?ref=business

Mexicans: the world's hardest workers

Check out CNN Money's lead article on line this morning:
http://money.cnn.com/gallery/news/economy/2013/07/16/10-hardest-working-countries/index.html?iid=Lead

Mexico

1 of 10

 

•  The four-day work week 

Average annual hours: 2,317

Average annual wages: $9,885

In Mexico, workers average 45 hours a week, the most of any industrialized nation. They work about 519 hours more than the typical American worker each year, only to earn less than a fifth of the pay.

When the OECD ranks industrialized nations by education and work-life balance, Mexico comes out on the bottom in both cases. Only about a third of adults -- ages 25 to 64 -- have earned the equivalent of a high school diploma.

There's also a huge gender gap in the job market. Whereas 78% of men have jobs, only about 43% of adult women work for pay.

Did you ever think of large investors as feral hogs?

Dallas Fed President, Richard Fisher, has. In comments on June 24, he remarked “I do believe that big money does organize itself somewhat like feral hogs. If they detect a weakness or a bad scent, they’ll go after it.”

There goes the peso...

The cost of a dollar soared following the Fed's announcement that it plans to begin reducing its asset purchases later this year. Did you wonder what investors' search for yield and the portfolio investment inflows that search produced had to do with the peso-dollar exchange rate? What's just happened in the markets in reaction to the Fed's announcement tells the story.

Not much of all that liquidity that the Fed, the European Central Bank and, now, the Bank of Japan, have been injecting into the markets ended up where policymakers wanted -- funding loans to the private sector. Lots of the liquidity sloshing around found its way into financial investments. Equities and emerging markets offered attractive opportunities to beef up returns. Mr. Bernanke made it clear yesterday that if the US economy continues on its present course, the Fed will reduce the size of its liquidity injections later this year. That was enough to send stock prices down and the cost of currencies other than the dollar higher. It's looks like an effective way to deflate bubbles...

The peso was unusually strong in early May when it took less than $12 pesos to buy a dollar. The peso is also unusually weak at today's $13.40 fix rate. It takes some time for the ups and downs provoked by portfolio capital flows to work through, but it's a good bet that in a few months it will take fewer pesos to buy a dollar than it does today. If you can hold off purchasing dollars for a while, it's a good idea to wait. 

Stay tuned for the FED...

The US Federal Reserve began its regularly scheduled two-day meeting today. Investors are on hold pending the Fed's announcement on what it's going to do with its asset purchase program. If the Fed starts to reduce the size of its monthly purchases, it's good news for the dollar and, conversely, bad news for the peso. If the Fed keeps things as they are, the peso could well strengthen.

The Mexican middle class...

If you randomly chose a household from Mexico's middle class, this is what you'd find, according to a just published study by INEGI.

The family has:

- a computer

- spends $1,460 (about US$115) monthly on food and beverages outside the home

- has a credit card

At least one family member is a salaried employee with a written contract with a private sector firm.

The head of household is married and has an education that, at a minimum, requires 2-4 years of schooling or training after completing secondary school (the equivalent of 9th grade in the US).

The children of the 4 member family attend public schools. 

INEGI cautions that its study is NOT definitive. It does conclude that 39.2% of Mexicans (42.4% of households) were "middle class" in 2010. That is up from 35.3% of the population (38.4% of households) ten years earlier.

For more, see: http://www.inegi.org.mx/inegi/contenidos/espanol/prensa/Boletines/Boletin/Comunicados/Especiales/2013/junio/comunica6.pdf

Mexican Bolsa underperforming US stocks...

The greater the risk, the higher the return... The Mexican stock index should outperform the three major U.S. stock market indices. It’s certainly been true in the last decade.  On May 31, 2013 (measured in dollars) the IPC was 399.9% above its May 2003 close. The Dow was up 70.8%, the S&P 500 had gained 69.2% and the Nasdaq, 116.6%.

However, the adage is either not necessarily true in the shorter-term. Since the end of 2009, the three major U.S. indices have all outperformed the IPC. Since December 31, 2007, the IPC has risen 32.1% in dollars. The Dow was 45.0% higher, the S&P 500, 46.2% higher, and the Nasdaq, 52.3% higher.

Of debt and investment...

Highlights of the 1st quarter balance of payments statistics...

-- Foreign direct investment (FDI) was US$4.99 billion, higher than any quarter of last year and 9% larger than in the 1st quarter of 2012.

-- Portfolio investment inflows of US$10.09 billion: 29% lower than last year's quarterly average but double 1st quarter FDI.

-- Debt: The US$18.09 billion of net new indebtedness was 25% greater than net new indebtedness in ALL of 2012. Commercial banks took on US$16.46 billion in net new debt in the 1st quarter. Last year, they repaid (net) US$3.21 billion.

--Mexican deposits in foreign bank accounts soared US$14.42 billion in the 1st quarter. The other major component of the "assets held abroad" account, Mexican FDI, was US$3.71 billion.

--Revisions to prior year statistics increased the current account deficit, typically by 0.1 percentage points of GDP. Revisions increased the 2012 current account deficit 23%, from 0.8% of GDP to 1.0% of GDP.

--The revised 2012 figures cut outflows in the errors and omissions account by US$2.05 billion. That is only marginally less than the increase in the current account deficit, suggesting that it is not easy to categorize flows.

Mexican immigration to the US

Research by Dr. Daniel Chiquiar of Banco de Mexico, Mexico's central bank, projects that about 260 thousand Mexicans will go to the US annually between 2011 and 2017. The heyday of migration was in the 1990's. It's not coming back.

His research divided the sectors of the US economy into three tiers, based on skill levels. In the 1990's all three skill tiers (low, medium and highly skilled) grew at roughly the same pace. Between 2000 and 2007, employment grew most rapidly for most skilled labor. Between 2007 and 2010, employment of the least skilled was hit hardest.

Mexicans have suffered from those trends. About seven of ten Mexican workers in the US fall in the "least skilled" tier. Only about 13% are in the "most skilled" tier.  

Security at any price?

Two of every five immigrants living illegally in the US have overstayed their visas, according to estimates quoted in the May 14, 2013 Washington Post. 

It seems there's been a law since 1996 that calls for the government to use biometric data to verify when visa holders enter and leave the US. It hasn't been implemented. Costs certainly played a role in the decision

The Senate committee pondering immigration reform today rejected an amendment that would have required Homeland Security to use biometric indicators to track visa holders' entries and exits. The bill does include a provision that would strengthen verification using biographic data like photographs.

If you're working in Mexico, odds are you're in the informal economy...

There are now two measures of the size of the labor force working in the informal economy in Mexico. The broader measure – 28.2 million people in the first quarter of this year - is the newer one, introduced in February with the publication of the fourth quarter 2012 unemployment statistics. The new methodology includes categories of workers who weren't counted in the existing measure of employment in the informal economy: household help, informal agricultural workers, and employees working in formal businesses, the government and institutions who weren't registered in the Social Security Institute (IMSS).

The traditional methodology, now called “employment in the informal sector”, put the number of people working in the informal sector at 13.7 million or 28.7% of the working population in the first quarter of this year. The new measure (the “informal labor rate 1”) more than doubled the number of people working in the informal economy, adding 14.5 million people to the informal economy. 

Almost three of every five (59.0%) Mexicans worked in the informal economy in the first quarter. Interestingly, the largest percentage of the 14.5 million people who are now counted as part of the informal economy are not maids or agricultural workers. People working informally in companies, the government (!) and institutions accounted for 23.2% of total workers in the informal economy. That's nearly half (45.4%) of the increment from the broader definition. Wouldn't it be interesting to see how many of those workers are in the government? Agricultural workers accounted for a fifth (20.6%) of the grand total (40.1% of the increment) and household help, 7.5% of the grand total (14.5% of the increment). 

The November elections and immigration reform in the US...

The perception that Republicans must broaden their base to attract Hispanic votes spurred the formation of the bipartisan "Gang of Eight" following the November US elections. Will the surprising information in a US Census Bureau report published today dampen interest in reforming US immigration policy?

It turns out that even though 1.4 million more Latinos voted in the presidential election in 2012 than four years earlier, not even half (48%) of the Hispanics who were eligible to vote in 2012 did. The number of Hispanics eligible to vote grew more -- 2.3 million more Hispanics were eligible to vote in 2012 than in 2008. That being said, time will ensure that Hispanics become a more important voting bloc in the future. Hispanics account for 24% of the under 18 population, compared to 17% of the total US population.

The turnout rate of Hispanics in last November's election was well below that of blacks (66.2%) or whites (64.1%). Hispanics' turnout rate last November was lower than in 2008, when 49.9% of those eligible to vote did, 1.9 percentage points higher than in the 2012 presidential election.

Fighting the drug lords: then and now

An excellent piece of reporting on the evolution of US-Mexico cooperation in Mexico's war against drugs is to be found in the Washington Post. Well worth reading.

http://www.washingtonpost.com/investigations/us-role-at-a-crossroads-in-mexicos-intelligence-war-on-the-cartels/2013/04/27/b578b3ba-a3b3-11e2-be47-b44febada3a8_print.html

Mexico's trade account in the first quarter...

What's striking about the first quarter trade account statistics is that automotive exports are the only major export category that grew. Oil export revenues were 10.6% less than in the first quarter of 2012; agricultural export revenues were 4.0% less; extractive, 15.7% less: and non-automotive manufactured exports, 2.0% less. In contrast, automotive export revenues were 6.9% higher - even though export sales in units were down 3.8%.

Imagine for a moment that automotive export revenues remained at the same level as in the first quarter of 2012. This year's US$1.11 billion trade account deficit in the first quarter would have more than doubled, to US$2.53 billion.

A few facts about Mexicans living in the US...

As Congress considers reforming US immigration laws, here are a few facts to bear in mind.

In 2011, there were 12.0 million Mexicans living in the US. Of those, 6.1 million (51%) were unauthorized. That means that 1 of every 2 Mexicans living in the US is legal.

Between 2007 and 2009, there were 12.6 million Mexicans living in the US. The largest number of Mexicans living in the US without documentation was nearly 7.0 million in 2007. Four years later, the number had fallen 12.9% .

Between 1995 and 2000, net migration to the US was 2.3 million, according to the Pew Hispanic Center. Between 2005 and 2010, net migration was flat. The number of Mexicans going to the US fell by more than half while the number of Mexicans returning to Mexico from the US more than doubled.

There are about 11.1 unauthorized immigrants in the US. Mexicans are the largest national group, constituting 58% of unauthorized immigrants. In the history of the US, no nation has ever seen as many of its people migrate to the US in absolute numbers. As a percentage of the immigrant population, however, the German and Irish immigration waves in the late 19th century were comparable.

Seven out of ten Mexican migrants live in five states: California (36.0% of the total), Texas (20.7%), Illinois (5.9%), Arizona (4.4%) and Georgia (2.4%).

Not too small to fail...

The Troika's agreement with Cyprus ended up respecting the 100% government guarantee on deposits of up to €100,000. Larger depositors and bondholders weren't so lucky: their losses will depend on the bank in which they have their money. Estimates put the losses at 60% if they were in Cyprus's second largest bank, Laiki.

The cost of the bailout to the Cypriot Government keep rising. When the terms of the deal to access €10 billion was agreed with the Troika, Cyprus's contribution was estimated at about €7 billion. Now, it's up to €13 billion. The cost of the rescue today (estimated at €23 billion) is larger than the Cypriot economy.

There are banks that are too big too fail, but they're not in Cyprus. Laiki Bank was a big player in Cyprus but not in the international financial system. Cyprus is a small country. Thus, for the first time in the history of the rescue packages cobbled together in the ongoing European crisis, "large" depositors and bondholders will share the cost of the bailout with taxpayers.

Will Cyprus start the dominos falling?

Greece didn't drop the Euro but there's a new threat to the common currency -- Cyprus. The country with a tiny economy (one about the size of Scranton, Pennsylvania) may abandon the Euro, thanks to the uproar caused by the "Troika's" (the European Central Bank, the European Union and the IMF) plan to force depositors to fork over a percentage of their fully guaranteed bank deposits to help finance the rescue of the country's banks.

The proposal, which isn't prospering, would have had savers take a haircut to pay bond holders 100 cents on the dollar. If implemented, it would toss aside the hitherto sacrosanct principle that a government guarantee of bank deposits is a hell or high water guarantee.

If ever there was an incentive to move money out of the banks of weaker countries (like Cyprus, Greece, Spain, Italy, etc.) into the banks of strong ones (like Germany), this is it. What a recipe for capital flight and for a death spiral for weak banks!

The problem is that there's still no other solution and Cyprus faces a March 25 deadline. Stay tuned for the result of the frantic negotiations that will undoubtedly be occurring over the weekend.

Quantitative easing: not without risk...

In his testimony before the Senate Banking Committee several week ago, Fed Chairman Ben Bernanke said as clearly as central bankers ever say anything that the Fed will NOT tighten monetary policy in the near future. He recognized that the Fed’s policy experiments carry risks but he deemed them manageable or worth taking. 

There are three broad risks associated with the Fed’s QE programs. One is the inflation risk, which the Fed is confident it can manage. The Governors believe the Fed has the tools to tighten monetary policy when necessary. In any case, inflation is not a problem now and inflationary expectations are low.

A less obvious risk is to the federal budget. The Fed earns interest on the assets it has purchased. Between 2009 and 2012, the Fed sent the Treasury on the order of US$290 billion, roughly triple its pre-QE remittances. When the Fed implements an “exit strategy” from its QE program, the interest earned and, consequently, the remittances to the Treasury will fall. Mr. Bernanke expects that even after the exit, the Fed’s remittances to the Treasury will be above pre-crisis levels. A recovering economy, a pre-condition of the exit, generates higher tax revenue, which would more than compensate for the decline in Fed remittances.

A third risk is to financial stability. With US interest rates so low and liquidity flooding the system, portfolio managers may “reach for yield” by taking on riskier credits, greater leverage or lengthening their exposure. The extraordinary inflow of portfolio investment directed to Mexico over the last three years exemplifies how low interest rates and ample liquidity in the US can affect other economies. Mr. Bernanke recognizes that investors may pile on risk in the search for higher returns but believes the benefits of stronger growth and job creation in the US justify the risk. 

The cost-benefit analysis for this last risk -- to financial stability -- may be different for the US and the recipients of massive portfolio inflows, like Mexico. Yes, Mexico will benefit from a stronger US economy. But, the vulnerability to the movements of foreign investment in fixed income obligations and equities is much greater for Mexico than for the US. Time will tell...