Back in March when the US Government felt compelled to bail out out Citigroup, Tracy Alloway over at FT Alphaville noticed a curious thing – Citigroup had effectively been nationalized.

No, they were not seized by government, but Citi was controlled by government.  The Feds had 36% of shares outstanding, which in many cases is considered to be a controlling interest for a government (for instance, until the Open Skies Treaty pushed the level to 49%, foreign carriers could not take more than a 25% stake in any airline as this is considered a threat to national security).  That matters because of Banamex.

From Alphaville on 2 Mar:

Does the US government’s 36 per cent stake in Citi violate Mexican ownership laws? Have we got our countries confused? No.

Citi owns Banamex, a Mexican bank with circa 1,200 branches and 2.6m checking accounts. And Latin American finance blog Inca Kola sees a fight brewing over the Southern subsidiary:

The nub of the issue revolves around Mexican law, which states in crystalline manner that foreign governments cannot own more than 10% of any bank that operates inside Mexico. It’s as clear as a bell and on the statute. So as Banamex is a wholly owned subsidiary of Citigroup (C paid $12.1Bn or so back in 2001 for the bank) if the US Gov’t takes its 36% stake in Citigroup then it will be a larger-than-10% shareholder of Banamex, something against Mexican law. Won’t it?

Mexico’s National Banking and Securities Commission is therefore investigating, while Banamex is saying that the North American Free Trade Agreement will (somehow) protect it.

The next day Bloomberg reported that Mexican law makers had decided to pursue a bill to force Citi to disgorge itself of Banamex because of it was a government –controlled entity.  Then this story disappeared from the mainstream press. 

Now, as background, after the recession of 1991, Citicorp was bailed out by Prince Waleed of Saudi Arabia because it was in danger of failing. Low interest rates and the money from Prince Waleed did the trick and Citi experienced a remarkable recovery – and eventually the broader economy did as well. In fact, recovery was enough that Alan Greenspan attempted to raise rates fairly rapidly (this was before policy asymmetry at the Fed because the norm). The result was the Tequila Crisis and the near bankruptcy of Mexico (see my post “1995” for more.)

Banamex , the 2nd largest Mexican bank, was made insolvent due to the Tequila crisis. And what do you know, Citi swooped in to buy it lock, stock and barrel. Spain’s BBVA later took over the re-privatized Bancomer that had been nationalized after the Latin American Debt crisis in 1982 (also induced by rising rates in the US).

These incursions into Mexico have caused outrage. Why should foreigners own the two largest banks in the country? So, the topic of Nationalized Citibank has been percolating for a while in Mexico. And it has just resurfaced.

From Breakingview.com:

Mexico’s high court is set to decide this week whether to hear a case brought by a contingent of Mexican senators that Citi must offload Banamex because a foreign government owns more than 10 percent of its stock. They want the court to decide whether the finance ministry had the constitutional right to decree in March that the United States government’s 34 percent slice of Citi was acceptable because it was intended to be short term.

So Citi is hardly up against a wall just yet — and it reckons any decision to force a sale would breach the North American Free Trade Agreement anyway. But if push comes to shove, the bank should be prepared to put up more of a fight than it did for Phibro.

Quite frankly, America is used to treating Mexico – all of Latin America, really – like its poor cousin. This displays a lack of respect that many there find galling.  If Citi is forced to disgorge itself of Banamex, it will be interesting to see not how Citi reacts, but how the Obama Administration reacts since he wants to present a new American image on the world stage.

By the way, below is a hilarious video of ‘Nationalized Citibank’ that captured the mood in America back in March when the bailout happened.

Related posts:

• Does Obama have the legal authority to take over Citi?
• Citi: looking for as much as a 40% stake from the government
• Will Mexico suffer contagion?
• Citigroup and Redecard: shedding international assets
• Is Mexico imploding?

The following is the currency outlook released today by the Brown Brothers Harriman Currency Strategy team:

Swine flu and concerns about US banks may be hitting the headlines but, the European banking sector remains a threat for the euro zone. Indeed, ECB President Trichet, speaking in NY yesterday, highlighted the fact that the European banking sector is significantly important in the euro area compared to the US although Trichet noted signs that liquidity was moving away from the ECB balance sheet to the money markets was an indication of improving confidence. The President held back from making any strong hints about policy, merely stating that any non-standard measures would be announced at the next meeting May 7. He attempted to address the criticism that the ECB’s refi rate is higher than the Fed rate by pointing out the importance of the 0.25% deposit rate in Europe, and the rough parity of euro and dollar money market rates. The President also defended the ECB’s stance on policy indicating the ECB had been the first to introduce non-traditional policy measures. The ECB’s balance sheet did expand in late 2008 although overall assets have slipped by more than 10% since their January highs. While the Fed’s balance sheet also slipped as some programs such as the commercial paper program began to take affect, the Federal Reserve have continued to adopt additional policy measures including the purchase of US Treasuries and expanded its MBS program to address other financial concerns. The ECB President and some ECB members including Weber and Hurley appear to be continuing with a cautious approach to policy. That’s in contrast to other ECB members such as Austrian Council member Ewald Nowotny whose dovish comments yesterday coincided with the euro’s tumble by over a big figure to around $1.30 yesterday. Nowotny said the central bank ‘stands ready to use unconventional measures of quantitative easing to assure European firms and consumers access to credit at appropriate conditions.’

The Japanese yen is the top performer against the major currencies today; the US dollar has now given up 38.2% of this year’s gains against the yen (JPY95.98) while the euro cross has now lost half its gains (124.76). That isn’t a reflection of the Japanese economy. While there have been some signs that the decline in exports may be easing, today’s retail sales point to ongoing weakness in the consumer sector. Retail sales fell for a seventh month in March. Sales were down 3.9% from a year ago compared with February’s 5.7% slump. Though better than the 4.7% drop expected, this is still a sharp decline, and just one month’s data. Meanwhile, the April business confidence index showed a slightly better monthly outcome, up to 30.8 from 30.4, though not as much as expected. Note that the BoJ is holding its regular meeting on Thursday: rates will most likely stay on hold (at 0.1%) and the central bank already on a program of quantitative easing.

The Mexican peso has lost further ground overnight amidst concern about the escalation of the swine flu scare. The World Health Organization said the flu outbreak is no longer containable, upgrading its global pandemic alert level to four from three. The current outbreak of flu in Mexico is a cause for concern for both the people of Mexico and the economy, but is also raising concerns about the possible effects on economies worldwide. Level five signals a pandemic is imminent while level six signals it is under way. However, it remains too early to make any material changes to our Mexico forecasts just yet, but the situation bears close watching. There was further news that could increase risk concerns for investors with the Wall Street Journal reporting that US regulators have told Bank of America and Citigroup that they need to raise more capital based on the stress tests. The two banks are expected to respond, denying the assessment, according to the report.

Related posts:

• U.S. Dollar: Cliff Diving Again
• The dollar is rising against floating currencies
• U.S. Dollar: Cliff Diving
• Japanese defend dollar’s status while China tears it down
• Chart of the day: Japanese Yen

After a good run-up in the last month, the Mexican Peso is getting crushed in the currency markets today.  How much of the pullback is a result of the news regarding Swine Flu and how much is technical, due to the prior run up, is hard to identify.  Nevertheless, the outbreak will have a negative effect on the Mexican economy and trade, making the recent IMF package Mexico has received a good buffer in case things get worse. Russia and China have already banned U.S. pork imports as well (Sounds like a political move if you ask me).

The Currency Strategy Team at Brown Brothers Harriman notes that the U.S. Dollar and the Japanese Yen are benefiting against a wide swathe of Emerging market currencies, not just the Peso.  And airline stocks are getting hammered as well.

The US dollar and yen are up against the major and emerging currencies. Concerns Mexican swine flu could become pandemic after Pres Obama declared it a public health emergency helped drive the dollar and the yen higher with the Mexican peso the hardest hit, falling over 2% against the US dollar. While the outbreak has potential to create additional problems for the global economic slowdown, so far officials have responded quickly and decisively to the outbreak, something that did not happen during the SARS outbreak. The euro is already overextended on the downside and is likely to trade higher as the focus turns to other event risks this week, the FOMC meeting, the release of further bank earnings reports and the stress test.

The global equity markets are being hit by concern about swine flu adding to existing concerns about US banks amidst talk 3 of the 19 US banks that underwent Federal stress tests have been asked to raise capital. Still, airlines have been amongst the hardest hit today while health care related equities are benefiting. In Asia, China’s Shanghai Composite, down 3.2%, and the Hang Seng, down 2.7%, were amongst the hardest hit in Asia but not just due to memories of China’s slow response to the SARs epidemic. China’s largest bank, ICBC fell over 5% on reports Amex and Allianze planned to sell shares. Japan’s Nikkei bucked the trend, adding just 0.2% as M&A related news supported the market. European bourses are lower, erasing some of last week’s gains while early indications suggest US markets will open sharply lower. On a positive note, Chrysler reached a tentative agreement with UAW that boost the odds it can avoid bankruptcy. Most commodities are lower including gold and oil. Grains are also lower on concern demand for animal feed grains could fall.

While the crisis has not hit epidemic proportions (see Paul Kedrosky’s bubonic plague map), an epidemic outbreak is clearly on everyone’s minds as more than 100 people in Mexico have died.

If you are looking to get a read on epidemics, try John Barry’s The Great Influenza about the Spanish Flu epidemic of 1918-1920.

Below is a CNBC video of how Swine Flu spreads in humans.

Related posts:

• Does the Swine Flu really have the makings of an epidemic? Yes.
• Swine Flu Tempature Rises, Dollar and Yen Remain Firm
• WHO: Swine Flu Pandemic is imminent
• Swine Flu video primer from the Wall Street Journal
• First Swine Flu death in Texas (video)

This comes from Win Thin, a senior currency strategist at Brown Brothers Harriman:

Mexico President Calderon is now saying that Mexico stands ready to take a $30-40 bln IMF credit line. This was a surprise to us, and we view this as a negative for Mexico since no country until now has gone to the IMF for any sort of precautionary program due the stigma that’s still attached to such a move. There have been no further details, but we assume that Mexico is talking about the Short-Term Liquidity Facility (SLF). This was established back in Oct as a quick disbursement mechanism for countries with strong economic policies that are facing temporary liquidity problems in the global capital markets. While there has been a surge in traditional IMF programs in recent months, there has been zero demand for the SLF so far. We also note that after the Asian crisis, then-Managing Director Michel Camdessus set up the “Contingent Credit Line” that was intended to be precautionary credit for “good” members. The program was introduced in 1999 and expired in March 2003 after no borrowers came forward.

We do note that Mexico really isn’t that vulnerable compared to Eastern Europe. External debt/GDP is around 20%, while short-term debt/reserves ratio is about 42% and the current account gap this year is expected at around 3% of GDP. However, there are concerns that the corporate sector is facing a large-scale currency mismatch, which would help explain the potential IMF deal. Central bank Governor Ortiz said recently that Mexico may activate its USD swap line with the Fed soon. Still, it’s a bit surprising to hear about a possible IMF program even as the peso is having its best month since the Tequila crisis of the 1990s. In our view, though, investor confidence is likely to take a hit from Calderon’s remarks. USD/MXN tested the 14 level but failed to break it today, and so we look for a bounce higher for the buck after this news. USD/MXN earlier this week broke the 38% retracement level of the Mar drop at 14.434, which targets the 50% level at 14.6532 and the 62% at 14.8725.

Related posts:

• Is Mexico imploding?
• Will Mexico suffer contagion?
• Mexico: Central bank to cut today
• Hungary cut to a notch above junk by S&P
• Regional banks: Zions falls

The political realities of solving a financial crisis have often meant circumventing legislative approval to meet the exigencies of a particular situation. This was certainly the case in 1995 during the so-called Tequila Crisis in Mexico. And I believe it is the case again today in 2009. Before I go into how this applies to what is presently happening in the Obama Administration, I thought an example from 1995 would be illustrative.

This comes from a recent article in the New Republic called “Free Larry Summers.”

In December of 1994, the Mexican finance ministry alerted Summers’s assistant secretary, Jeff Shafer, that the country was nearing a currency crisis. During the early ’90s, Mexico had started down two paths that, together, proved unsustainable. First, the country ran large trade deficits. To pay for all the goods it was importing, Mexico needed dollars, which meant it had to sell government bonds. This led to the second problem: To appease all the foreign investors who worried the peso would lose value, Mexico issued certain short-term bonds–called “Tesobonos”–that were linked to the dollar.

This worked fine for a while. Foreign money flooded in as investors snatched up the Tesobonos. But, as the years passed, creditors began doubting that the government would pay off its bonds at the fixed exchange rate. Many began withdrawing their money, forcing the Mexicans to redeem the bonds for dollars. By the time Treasury tuned in, in late 1994, the dollars had almost run out and the government could no longer defend the peso-dollar exchange rate. The imminent decline of the peso would make Mexico’s foreign debt more expensive and raise the risk of a default.

Worse, Treasury itself was in limbo. Then-Secretary Lloyd Bentsen had announced his retirement, but Bob Rubin, his successor, had yet to replace him. It fell to Summers–whose team included Shafer and a young deputy assistant secretary named Tim Geithner–to figure out the consequences of a Mexican collapse. By January 10, 1995, the Summers group had a tentative answer: The fallout could be several hundred thousand U.S. jobs and a 30 percent spike in illegal immigration. If Mexico infected other emerging markets, it could wind up shaving a point off U.S. GDP growth.

That same day, Summers accompanied Rubin to his Oval Office swearing in. Once President Clinton administered the oath, Rubin recalls in his memoir, the new Treasury secretary turned to the president and urged a massive loan package. He then gave the floor to Summers, who briefed the president and concluded that something on the order of $25 billion would be necessary. Surely he meant twenty-five million, George Stephanopoulos interjected. No, Summers said, “billion with a ‘B.’” Clinton swallowed hard and, after weighing every angle, signed on.

The initial response from congressional leaders was also favorable. But the rank and file was hostile. Vermont’s then-congressman, the socialist Bernie Sanders, told Rubin to “go back to your Wall Street friends [and] tell them to take the risk and not ask the American taxpayers.” A freshman Republican named Steve Stockman accused Rubin of arranging a bailout to protect the investments he’d made while a partner at Goldman Sachs. Soon, even the once-supportive leaders were either quietly backtracking (Senate Majority Leader Bob Dole) or railing against the package outright (Banking Committee Chairman Alfonse D’Amato). It was what High Noon might have looked like if Gary Cooper had played a policy wonk.

As it became obvious that cooperation from Congress wouldn’t be forthcoming, Rubin and Summers began to consider plan B. Back in 1934, Congress had given Treasury a pool of money called the “Exchange Stabilization Fund” (or ESF) to help smooth out exchange rates. Sixty years later, the fund stood at about $35 billion, and Treasury lawyers believed they had the authority to draw on it. And so, on January 30, with no congressional help in sight, Summers, Rubin, and Clinton’s top White House aides decided to tap the ESF to the tune of $20 billion.

Still, even this amount was unlikely to restore confidence in Mexico. The only other source of money was the International Monetary Fund, and here’s where Summers’s occasional bullying actually served him (and the country) well. To help cajole what eventually became a $17.8 billion contribution out of managing director Michel Camdessus, Summers pushed and prodded relentlessly. “I remember late the night that this unfolded, in the early morning, Larry was in an adjoining office in rather strong terms telling the IMF they had to step up to the table here in a major way,” recalls one former colleague.

By early March, the first U.S. installment of the nearly $40 billion package was flowing. By mid-May, there were signs it was working. By early ‘97, the Mexican government had completely paid off the loan–three years ahead of schedule.

What should be clear from the preceding article is the fact that Congress was in no mood to fund the bailout of Mexico in 1995. Nevertheless, the Clinton Administration was able to cobble together a bailout package of $40 billion that did not require any Congressional approval.

Fast forward to 2009 and you can see similar themes emerging. There is zero chance that the Obama Administration will get more funds for bailouts of the likes of AIG, Citigroup or Bank of America.

Enter the Federal Reserve and the FDIC.

The US authorities have no money to fulfil their ambition of stopping large US banks from failing without taking them into public ownership. The $300 bn left in the TARP kitty is all that is available for recapitalising banks, purchasing toxic assets and providing other financial support. Congress has thrown its toys out of the pram and is unwilling to appropriate more funds for the rescue of the banking sector.

As an aside: it is astonishing that Congress and much of the US populace are apoplectic about $165 mn (perhaps $182 mn) of bonuses paid to AIG executives and employees, when $170 billion or so of public money is at risk (and tens of billions probably already gone out of the window) in the rescue of this most undeserving of companies. Perhaps you can only get indignant about what you can comprehend… .

The US authorities are reduced to begging, stealing and borrowing the rest of the funds they believe they will need. The two main proximate sources of funds are the FDIC and the Fed. The ultimate sources of funds will be (1) the US tax payer and the beneficiaries of future US spending programs that will have to be cut, (2) the holders of nominally denominated liabilities of the US state, including the monetary liabilities of the Fed and US Treasury bills and bonds.

Owners of dollar-denominated debt instruments will see the real value of their claims on the government eroded by future inflation if, as I expect, the recent and prospective future increases in the US monetary base (driven by credit easing and, in the future also be quantitative easing) cannot be reversed in the future. The main obstacle to such a reversal will be the US fiscal authorities, who are unlikely to let the Fed dump large amounts of US Treasury debt, acquired by the Fed as part of its quantitative easing program, into the markets.

I believe that the raids by the US Treasury on the FDIC and on the Fed are illegitimate and, in the case of the FDIC, quite possibly illegal.

These are the words of Willem Buiter in a recent piece he has written on his site at the Financial Times. While the language he uses is more colourful than what I would say, I agree with him that what we are now seeing is an end-run around on the Congress. The Obama Administration know full well that they have to work with the money and institutions now available to them because Congress won’t stand for more bailouts and because populist sentiment in the American electorate is in a critical state.

But, more worrying for me are the changes to the TALF program now operated by the Federal Reserve. It was originally created to increase lending by increasing liquid in the marketplace for new asset-backed securities. Not any more, according to the press release by the Treasury for The Public-Private Investment Program for Legacy Assets, it will fund legacy assets.

“To address the challenge of legacy assets, Treasury – in conjunction with the Federal Deposit Insurance Corporation and the Federal Reserve – is announcing the Public-Private Investment Program as part of its efforts to repair balance sheets throughout our financial system and ensure that credit is available to the households and businesses, large and small, that will help drive us toward recovery.”

Willem Buiter has a word or two to say about this in a previous missive of his:

The legacy assets to be purchased by the two legs of the PPIP are legacy securities and legacy loans. The legacy securities are toxic assets. Toxic assets are assets whose value cannot be established with any reasonable degree of accuracy, because there are no liquid markets for them and because their complexity prevents too much faith being put in mark-to-model valuations.

The legacy loans, however, are just bad assets. They are plain vanilla household and commercial loans that have become impaired. Their value can be calculated quite readily by any reasonably competent banker. It is likely to be low relative to the notional or face value of the loan. That’s sad and too bad, but not a reason for getting the state involved through the PPIP.

By bundling toxic assets and bad assets, the Treasury muddles up price discovery issues and the recapitalisation of or subsidies to loss-making banks.

The long and short here?

1. None of this requires Congressional approval.  The executive branch and the Fed are working in concert in ways that exclude the legislative branch entirely.
2. Changes in the TALF program demonstrate that the true purpose of TALF has now expanded from increasing liquidity to make new loans to helping banks get rid of so-called toxic assets.
3. The assets in question do NOT all suffer from poor market liquidity.  For example, loans are held to maturity on bank balance sheets and are NOT marked to market.  They present no writedown risk until the loans actually sour. So, they have not been a writedown problem to date.  Clearly, the PPIP is helping banks by taking these assets off their hands.

I find all of this quite troubling.

Sources
More on robbing the US tax payer and debauching the FDIC and the Fed  - Willem Buiter
The new toxic and bad legacy assets programs of the US Treasury: surreptitiously squeezing the tax payer and the Fed until the PPIPs squeak – Willem Buiter
Free Larry Summers – New Republic

Related posts:

• AIG: worst damage yet to come
• FDIC Chairman Sheila C. Bair Statement on the Legacy Loans Program
• Geithner’s Plan: one of the most regressive wealth transfers of all time
• Crony capitalism in U.S. banking bailout should end
• Bush Administration turns the TARP over to Obama

This analysis comes via Brown Brothers Harriman (I have bolded a few lines):

Mexico’s central bank is widely expected to cut its overnight rate by 25 bp today. That would bring it to 7.25%. Last month it delivered a 25 bp rate cut too. The market had expected a 50 bp cut and punished the peso in disappointment. However, the peso has strengthened sharply in recent days-up until yesterday–and this has renewed some speculation of a 50 bp move today. This seems unlikely. Consumer inflation remains stubborn. It was 6.2% in Feb, having peaked at 6.53% at the end of last year.

Mexico’s economy is contracting. Domestic demand is weak and of course foreign demand (primarily the US) is poor. The main sources of capital inflows into Mexico–exports, worker remittances and tourism are drying up. Oil prices are roughly a third of where they were 9 months ago.

Mexico has spent some $20 bln to slow the peso’s descent or roughly 5% of its reserves. Central Banker Ortiz is unlikely to risk the new found stability in the currency may cutting rates more aggressively. Given the pass through of a weaker peso on imported inflation and then domestic inflation, means that policy makers think that the stability of the peso is the key to capping inflation.

Mark Twain once said that history doesn’t repeat itself but that sometimes it rhymes. In this context, it would suggest that the peso may not sell-off on a 25 bp rate cut like last month. On the other hand, K Marx said that history repeats itself–the first time as tragedy the second time as farce. That would suggest that the peso might in fact sell-off again. Technicals are more aligned with the latter scenario. Hourly technical indicators suggest the overnight recovery in the peso has left it over-extended. Look for the dollar to bounce back from a test on MXN14.10.

Clearly there is downside risk here.  Remittances are down.  Oil revenue is down. Tourism is down.

Apropos tourism, the Mexican travel industry is extremely worried about the bad press the country has been receiving in the U.S. about the drug trade and murders of late.  I am going on holiday in Mexico next month and my resort sent me the following e-mail two days ago:

Dear Customer,

While millions of U.S. and Canadian citizens safely visit Mexico each year, including thousands who cross the land border every day for study, tourism or business, the display of travel warnings as well as details of unexpected events has increased recently.

That being so, we would like to clarify as well as to reassure that our company has strict security measures such as 24 hour security surveillance and guards. Additionally, access to the hotel is strictly controlled and limited to guests only. We must stress that our priority is to ensure that all of our members will be provided with the highest safety and security while visiting our Resorts.

Please be advised that the majority of the news of violence refer to the drug war, an unfortunate situation occurring mostly in the northern border states of Mexico, and does not significantly affect any tourist destinations.

Furthermore, our concierge and hotel manager will be more than happy to answer any questions you may have prior or during your arrival. Please keep in mind that we are working hard to ensure that you and your family have a safe and pleasant vacation.

If you need further assistance, please do not hesitate to call us at any of the numbers listed below.

I have never been worried about safety at this resort – it is a lovely place. But, this message actually had the perverse effet of making me think twice.

Update 1120ET: The Mexicans went super-aggressive and cut 75 beeps. Obviously, they do not want a repeat of last go round. Perhaps they are taking cues from Ben Bernanke on how to get this downturn sorted? Anyway, BBH has this to say after the fact:

The Mexican central bank surprised the market by delivering a larger than expected rate cut. The 75 bp cut brings the overnight rate to 6.75%. Last month the central bank disappointed expectations and the peso fell. This time it surpassed expectations and the peso rallied. The central bank justified the rate cut on grounds that inflation expectations have been anchored and the downside risks to the economy are growing. The official concern is more about the growth trajectory than price pressures, which it thinks has been easing in recent months. The dollar fell to about MXN14.00 on the news from near MXN14.20. The greenback has recovered quickly back to MXN14.10. With the finance ministry making it clear that it is not oppposed to the peso being weaker than MXN14.00 and news the Cemex has postponed their earnings until late next month should see the peso weaken as the impact of the unexpectedly large rate cut wears off quickly.

Related posts:

• Mexico goes hat in hand to the IMF
• What’s a central bank to do?
• Is Mexico imploding?
• U.K. central bank does not follow Fed to ZIRP
• Will Mexico suffer contagion?

I plan to visit Mexico early next month as I do at least one or twice every year. This year I question what awaits me as evidence that Mexico’s economy and civil order is imploding mount. The latest strike against Mexico comes in its now escalating trade war with the United States.

The Mexican government said Monday it would slap tariffs on 90 U.S. industrial and agricultural products, in a trade dispute that underscored the difficulties facing President Barack Obama as he tries to assure business and global allies that he favors free trade.

Mexico said the tariffs were in retaliation for the cancellation of a pilot program allowing Mexican trucks to transport cargo throughout the U.S.

Unions have for years fought to keep Mexican trucks off U.S. highways, despite longstanding agreements by the two countries to eventually allow their passage. Legislation killing the pilot program was included in a $410 billion spending bill Mr. Obama signed last week.

The White House responded Monday to the tariff threat with assurances that Mr. Obama would work with Congress to create a new cross-border trucking program that addresses safety concerns.

White House spokesman Robert Gibbs said U.S. and Mexican officials would work on legislation for a new plan “that will meet the legitimate concerns of Congress and our [North American Free Trade Agreement] commitments.”

Mexico’s Economy Minister Gerardo Ruiz Mateos said Monday the legislation signed by Mr. Obama was “wrong, protectionist, and clearly violates” the free- trade treaty signed by the U.S., Mexico and Canada in 1994. Mr. Ruiz Mateos said the ban protected U.S. truckers while hurting Mexico’s ability to compete.

The Mexican government wouldn’t say Monday exactly which products would be hit with tariffs but that the total value of the products was $2.4 billion in 2007 and originated in 40 states. A detailed list was expected to be published this week.

Republican members of the House suggested such commodities as wheat, beans, beef and rice would likely be targeted.

Certainly, I fully anticipate protectionism to increase globally in the months ahead. However, this is not Mexico’s only problem. Mexico’s largest oil field has peaked, oil prices are way down, remittance income has shrunk, and drugs are a big concern.

Concern about a potential failed state — not Pakistan, not Somalia, but California’s neighbor Mexico – is mounting in Washington as an all-out war involving 45,000 Mexican military personnel fails to quell rising drug violence that is spilling from such Mexican cities as Tijuana into the United States.

An estimated 6,290 drug-related murders occurred in Mexico last year, six times the standard definition of a civil war, said Vanda Felbab-Brown, a leading scholar on the issue at the Brookings Institution.

All of this has had a very negative impact on Mexico’s currency as the chart below reveals. Last year just after the Lehman crisis, the Mexican Peso was trading at just over 10.50 to the dollar, today it trades over 14 pesos to the dollar. It has been over 15.

While recent reports from the likes of Morgan Stanley have been largely positive about Mexico’s economy, the backdrop is clearly deteriorating and the growing trade war with the U.S. is but one sign. If Mexico and its workforce come under pressure economically, the impact will surely be felt in the United States as well.

Update 430PM ET: A good video over at Bloomberg Television adds a bit more color to the situation. Enjoy.

Sources
Mexico Strikes Back in Trade Spat – WSJ
Migrant Workers Sending Less Money to Latin America – WSJ
Mexican Banks ‘Party’ May End as Economy Shrinks: Week Ahead – Bloomberg.com
Concern Grows in the U.S. That the Drug War Is Destablizing Mexico – AlterNet
Currency Charts – FXStreet.com

Related posts:

• Mexico: Central bank to cut today
• ‘Buy American’ will translate into a 21st century Smoot-Hawley
• Will Mexico suffer contagion?
• Tariffs: Other industries may line up for sanctions against China
• The dollar is rising against floating currencies

On Wednesday I posted an article that pointed out a largely positive review by Morgan Stanley of Mexico and their economy. Having noticed a negative bias in the article, I amended it to reflect the tone originally given in the Morgan Stanley piece. That said, I would like to point out a Bloomberg video clip and another from the Wall Street Journal, which illuminate some of the pitfalls of investment there. Below are some additional links that should shed more light as well.

Related articles
Mexico emerges as concern for U.S. – Politico
Mexican ‘drug lord’ on rich list – BBC News

Related posts:

• Will Mexico suffer contagion?
• Is Mexico imploding?
• Mexico goes hat in hand to the IMF
• Mexico: Central bank to cut today
• World Economic Forum: Experts voice their views on the economy

Morgan Stanley put out a post today pointing out that Mexico’s banking system is under stress and may well and probably will not have difficulty rolling over its debt obligations this year even if the credit crunch continues. Below are excerpts with my highlighting (Update 12 Mar 2009  - I also struck through parts of this intro paragraph I found revealed a bias in re-reading this post):

With the peso reaching historically weak levels in early March, Mexico watchers are increasingly wondering if the sell-off is overdone or reflects Mexico’s greater vulnerability to the US and global downturn. The list of concerns is a long one, starting with the strong link on the industrial front between the Mexican and the US economies and the impact of lower crude prices on the fiscal accounts, which derive nearly 40% of revenues from oil (see “Mexico: No Oil, No Problem?” EM Economist, February 27, 2009). And more recently, with exports collapsing, capital flows under pressure and remittances declining at double-digit rates, concerns about the sustainability of Mexico’s balance of payments have resurfaced.

Market concerns about the sustainability of Mexico’s balance of payments appear to be overblown, in our view. Indeed, Mexico’s external accounts during 2009 appear to be quite manageable based on our stress-test exercise. On the current account front, plunging demand for Mexico’s manufacturing exports is almost fully offset by lower imports of intermediate goods. Meanwhile, the deterioration due to the collapse in crude prices on the current account front is largely compensated by an inflow in the capital account from the government’s oil hedge. Remittances will be a major drag, but the services deficit is unlikely to deteriorate. Indeed, we estimate that the deterioration in Mexico’s trade account is more than offset by the combination of declines in capital and consumer goods imports (on the current account front) and the inflows from the oil hedge (on the capital account front).

So, on this score, we do not seem likely to have another Tequila crisis just yet.  But what about Mexican banks?  Aren’t companies having difficulties as a result of the lower oil revenues, the lost remittances and the reduced trade with the U.S.?  You should note that the 2nd biggest bank in Mexico, Banamex, is a part of Citigroup – now partially owned by the U.S. government (Is this a takeover target for BBVA, which owns the largest bank there?). Morgan Stanley does not think so and this could mean the weak Mexican Peso is oversold.

The greatest risk likely lies in external private sector debt. According to Finance Ministry data, there is US$27.7 billion in non-financial private sector and an additional US$7.7 billion in financial sector foreign currency obligations coming due this year. Of the non-financial private sector obligations, US$10 billion are in trade financing, which we expect to be fully rolled over. Indeed, there have been no significant problems with trade financing so far; moreover, the US$30 billion Fed swap line more than covers trade financing lines and is ideally suited to support any trade financing difficulties. Although the Fed swap line currently expires in October, we expect that the line will be renewed (or substituted with another instrument) for as long as the current turmoil represents a potential balance of payments threat to Mexico. The remaining US$17.7 billion is split between US$2.1 billion in bonded debt, US$11.8 billion in bank debt and US$3.8 billion in other debt obligations. So far, however, nearly US$6 billion of the bank debt has already been rolled over. As a conservative assumption, we assume no further rollover for the bonded debt or the rest of the bank debt. We further assume that 50% of other non-financial debt is rolled over and there is a 75% rollover of the US$7.7 billion in financial sector obligations, given the relative strength of Mexican banks. The net impact is that the private sector generates an outflow of US$11.7 billion.

Even under very conservative assumptions for net foreign investment, the potential stress on the capital account remains limited…

Bottom Line
Mexico faces a series of long-term structural challenges that need to be addressed. The near-term cyclical challenges in 2009 and into 2010, however, are unlikely to be as severe as they might appear at first glance. Mexico is a small, open economy and relies heavily on trade with the US for manufacturing employment. A prolonged downturn in the US is likely to pose significant risks to Mexico’s labor markets and, in turn, the growth dynamic for the economy. But the narrower question of a balance of payments shortfall that could have an impact on currency markets appears to be limited. Neither Mexico’s balance of payments challenge nor its fiscal challenge appear to justify a significant weakening of the Mexican peso from here. Of course, our fundamental analysis provides little guidance as to how the Mexican peso will trade in the near term. It does suggest, however, that the extreme stress being experienced by the Mexican peso today likely represents an opportunity for reversal, rather than a step to a permanently weaker level.

My take on this is: while everyone seems to be shedding assets, Citigroup included, BBVA seems to be doing relatively well. If they are as strong financially as they indicate despite Spain’s crashing economy, antitrust concerns aside, Banamex would be a good target for increasing their North American footprint.

Source
Stress-Testing the Balance of Payments – Morgan Stanley

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Tariffs and price controls? Apparently, Latin America thinks it can stop the growing tide of inflation and end the riots on their streets by just imposing tariffs and imposing price controls. They better get ready for a blind date with Econ 101. But, I guarantee you this date won’t end well either.

The Financial Times reported yesterday “Mexico’s centre-right government on Wednesday announced the widest range of price controls in more than a decade in an attempt to curb rising food prices.” Inflation is spiraling viciously out of control around the world. Meanwhile, ordinary citizens are rioting in the streets because of the state of affairs.

Over in Argentina, they are using tariffs to deal with the problem. They are actually raising tarrifs on their own grain exporters to increase the money collected by the government as grain prices soar. The Financial Times says:

“A bitter conflict over the tariff regime, lasting nearly 100 days, has opened up deep divisions within the ruling Peronist party. Members of Congress from northern and central farm-based provinces will come under intense pressure from their constituencies to seek tariff changes.”
-The FT, 18 Jun 2008

In both cases, the government is trying to control the price and availability of basic foodstocks in the domestic market, insulating the population from the rising inflation around the world.

The experiment in Argentina has already led to food shortages and rising inflation, despite the official doctored inflation numbers. Obviously, this is the opposite effect of what policy makers are hoping to have.

In Mexico, I reckon the outcome will be the same, a food shortage. Price controls don’t repeal supply and demand; they artificially hold prices below the level at which sufficient supply can be met. This results in demand outstripping supply and food shortages.

Ultimately, these are two desperate attempts by emerging market governments to stem the tide of food inflation. If we don’t get this thing under control soon, we may be headed for trouble. I’m beginning to think rate hikes in the UK, US, Europe and Asia are inevitable.

Sources
Mexico imposes price controls on food, The Financial Times, 18 Jun 2008
Argentina tariff bill calms farming crisis, The Financial Times, 18 Jun 2008
Argentine inflation index under fire, The Financial Times, 11 Jun 2008
Argentina’s conflict over tariffs intensifies, The Financial Times, 23 May 2008
El conflicto del campo argentino se atasca, El Pais 3 Jun 2008

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• Morgan Stanley warns of a new inflationary period
• George Soros warns UK on economy, oil and inflation
• U.S. CPI: Lowest since 1954 – deflation here we come
• Chart of the day: Inflation
• The inflation – deflation debate redux