Hyperinflation in US, how will it affect Mexico?

by Mark Benson on March 18, 2009

Is Mexico too close to the US?

Is Mexico too close to the US?

As the worldwide economy continues to weaken there has been significant comment regarding economies around the world with particular interest in a thread on the Expat Forum which covers the US recession, hyperinflation in the US and how this may affect Mexico. The thread is entitled “Hyperinflation in US……….. how will it affect Mexico?” although for those of a nervous disposition it could make very uncomfortable reading!

While the thread is initially aimed at the relationship between the US and Mexico, and the potential impact of “hyperinflation” in the US, this has brought a number of interesting comments into the open. We will cover a number of the important points discussed on the thread below:-

The US recession

Historically there has always been a very close relationship between South America and the United States of America. While over the last few years this close relationship has loosened a little, there is no doubt that the direction and strength of the US economy still impacts heavily on economies such as Mexico.

There are a number of comments regarding the policy of “quantitative easing” (one which has also been adopted in the UK) whereby the central bank “prints money” to buy back various financial assets and introduce fiscal stimulus packages with the intention of increasing liquidity levels in the US economy. Aside from the many general comments that the government and a whole host of business leaders who have literally brought the worldwide economy to its knees there is much discussion about inflation, hyperinflation and potential deflation.

Inflation, hyperinflation and deflation

Inflation

These three scenarios are discussed in great detail as are their differing impacts upon the US economy and for example Mexico. Inflation, in moderate terms, is required to keep an economy growing and allows businesses to expand and reinvest for the future. This is pretty much taken for granted and as long as governments are able to keep inflation under control there should be no real problems.

Deflation

Deflation is one of the most hard-hitting and potentially dangerous economic scenarios you could ever imagine. In effect in a deflationary environment the cost of goods and services spirals downwards as consumers hold off on spending, which then leads to significant cost-cutting in the business arena and eventually redundancies. As consumers see their income falling they hold back further on purchases under the impression they will be cheaper “tomorrow” which then forces prices lower, further cost savings in the business arena, more redundancies and less income for consumers and there we have the downward spiral of deflation.

Hyperinflation

While traditionally many people assume that hyperinflation is the figures we have seen in places such as Zimbabwe where the dollar in your pocket will be worth substantially less tomorrow, this is probably an extreme example of hyperinflation. It is widely known that in the current economic environment, where businesses are suffering and prices are falling, the continued rescue packages and fiscal stimulus programs introduced by government around the world have the potential to turn economies around in the short to medium term. As suggested by the Bank of England recently there is a substantial risk of hyperinflation (or possibly just high inflation) as and when an economy turns and consumers suddenly move back into buying mode.

To this end it seems almost inevitable that as and when worldwide economies improve we will see interest rates rocket upwards to try and offset consumer demand (making debt more expensive) and “hyperinflation” although this will be a very difficult and potentially painful situation to control.

Currencies

There is much debate about the US dollar, Mexican peso, Euro and the pound for example with a number of people suggesting that investments such as gold, silver and diamonds are possibly safer in the short to medium term. As a number of posters have mentioned, the exchange rate of any particular currency is dictated by the confidence in the underlying government, the underlying economy and the prospects for the country as a whole.

The US dollar has fallen dramatically on the worldwide currency exchanges, as has the pound, as investors jump ship amid concerns that the economy is in freefall and the substantial rescue packages and financial stimulus programs are not working. The policy of “quantitative easing” also has a detrimental impact on the exchange rate in the short term as investors fear more and more debt will be brought on board to try and turn around the economy.

The future of the worldwide economy

Even though the connection between the US economy and the Mexican economy is fairly evident in the past, there is no doubt that the US economy has and continues to have a significant impact on all economies around the world. The US is a massive business machine importing and exporting significant amounts of goods and services all around the world. When the US economy is under pressure this automatically places further pressure on other economies around the world as businesses and consumers reduce their spending thereby having a knock-on effect to the strength of other economies.

While the credit crunch and worldwide economic slowdown began in the US it has spread to every corner of the globe and despite the short-term currency movements which may be beneficial to some, very significant concern has been expressed about the impact upon places such as Mexico and the potential for currencies across the world to be dragged down in due course. The ongoing recession has brought into focus comparisons between the cost of living across the world and the potential impact which currency movements can and do have in the short to medium term.

Currently we are seeing all major governments of the world acting together to try and refloat the worldwide economy although in truth there has been little impact as of yet. Serious concerns still persist that the worldwide economy is headed for a depression which could last for decades in a worst-case scenario. The previous boom time in places such as the US and the UK was fuelled by debt and it is these record debt levels which are holding back any potential recovery and have led to substantial write-offs from banking institutions around the world.

Conclusion

While the suggestion that a weakened the US economy will impact upon the Mexican economy and the Mexican currency is correct, the wider picture is a little more serious with concerns that the worldwide economy is headed for a depression. Quantitative easing has begun in the US and the UK and while there are hopes this will impact upon economies in the short to medium term in many ways we have never been in this scenario and nobody quite knows what to expect.

Despite the attention of many governments around the world there is a need to go through the process of rebuilding economies which will be painful, will be expensive and ultimately see taxpayers around the world paying back substantial government borrowings for many years to come. Those who expect a short-term turnaround in the worldwide economy may be very disappointed and those who predicted a doomsday scenario of a depression, deflation and then hyperinflation may well get their day in the sun.

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