The Origins of Mexico's Financial Reality
The Silver Standard, Hyperinflation, Porfiriato Era, Banking System, Financial Investments, Home Ownership, Nationalism, Land Distribution and Today's Economy.
I firmly believe that if you want to be prepared for the present and the future, you must know history. Every concept of today’s reality can be understood by looking at its origins since they’re just a combination of the consequences of yesterday’s actions. I also believe that history repeats itself through Social Cycle Theory.
If you haven’t yet, I invite you to read the first article of this triple series, in which I share a Few Personal Stories about Mexico’s Social Class System. In this post, I will answer the following two questions :
What are the origins of Mexico’s Financial Reality? What’s the present outlook?
I will do so by first looking into the History of Money in Mexico, from the Silver Standard to today’s conservative monetary policy strategy under President AMLO. Then, I’ll look at the financial sector, once again, presenting its historical background first and the present behavior of Mexican households. We’ll then go through the economic models this country has employed, swinging from Protectionism to a Free Trade Economy with a strong touch of wealth distribution.
The History of Money in Mexico
Throughout my passage in Canada’s education system, there always was a gap in the financial and monetary lessons. It almost seems as if it’s on purpose that those topics aren’t touched. Then I jumped into Bitcoin’s rabbit hole and caught up on how the world works, mainly through an America First lens. I’ll be explaining money through the Mexican lens.
The Silver Standard
The Spanish invasion of the Aztec Empire by Hernan Cortez was ingeniously executed. Without any previous military experience, only a couple hundred men, and while disobeying orders from the crown, he took Mexico City within only two years by kidnapping and personally executing their Kings. This conquest and a further won war against Portugal made Spain the most powerful Empire of the early modern period.
Why was Mexico so vital to establishing Spain’s hegemony? The abundance of silver, New Spain’s main economical product for centuries, was a match made in heaven with Spain’s Almadén, the largest reserve of liquid mercury in the world, an essential resource for silver refinement. The Spanish Real / Dollar, minted in Mexico, became the first global standard currency used for international trade in Europe, the Americas, and Asia until the 19th Century.
The Mexican Peso, a direct descendant of the Real, was also recognized globally due to its similar silver weight. It was legal tender in the United States until 1857 and, surprisingly, in China, until 1935. It kept the same value from independence until 1918, when it was first debased, with further debasements in the 1940s and 1950s.
When Fiat Money Collapses
The US got off the Gold Standard with the Nixon Shock in 1971, and suddenly the world changed. Mexico had gone through an economic miracle for the past three decades, and politicians thought it would be a great idea to increase social spending by leveraging the newly found oil reserves, so they indebted the country in the late 70s with foreign credit. For the first few years, the strategy worked, and Mexico maintained high levels of growth but with weak foundations. When the price of oil went back to normal in the 80s after a decade of high growth, Mexico went bankrupt, having bet prices would stay high to maintain their debt.
The Lost Decade, formally known as the Latin American Debt Crisis, brought a decade of government mismanagement, recession, massive depreciation of exchange rates, and, ultimately, hyperinflation. The Peso collapsed from its rate of 12.50 MXP / USD (1957-1976) to over 300 MXP / USD until it had to be replaced by the New Peso in 1993. The exchange rate from the old to the new Peso was 1000:1.
Mexico’s problems weren’t over, and the country was still facing a debt default, so they, once again, debased the currency by 50% overnight (3.5 to 7) in December 1994. The US and the IMF bailed out Mexico soon after, but the Peso continued its depreciation for the next two decades. The country sold many public assets for pennies on the dollar, such as its railroad network and telecommunications infrastructure. It was the beginning of Neoliberalism in Mexico, fully turning the country into an export-based economy with NAFTA and further free trade agreements.
2023 for the Peso
Over the last few years, the Peso has proven relatively stable compared to the USD and more robust than its Latin American counterparts.
The reasons vary from growing energy independence, historically high foreign investments (due to Western countries divesting from China), and conservative monetary policy (higher rates than the US) from the Central Bank and President AMLO. This trend is expected to continue as the President’s party remains popular and set to win the next elections.
Mexico’s Central Bank, Banxico, was founded on August 25th, 1925 (only a few years after the first monetary debasement) and works similarly to other central banks. However, unlike the Federal Reserve, which has Commercial Banks as private shareholders, Banxico is fully publicly owned by the country’s Federal Government, in a similar fashion as Canada’s Central Bank.
Interest rates are currently set at 10.5% as of February 7th, 2023, but a hike of 0.25% is expected at the next Banxico meeting on February 9th. Rates in Mexico have been going up since June 2021, when they were at a 5-year low of 4%, which means they started hiking rates about a year before the Federal Reserve.
I hope this gives you an idea about how money works and has worked in this country. We’re now ready to move forward to the complementary financial system.
The Financial System of Mexico
In this section, I’ll cover the origins of Credit and Finance in Mexico during the years following the independence, the Civil War, and the French rule that led to the Portfiriato, Mexico’s first industrial era in which the banking system was initially set up.
Then, I’ll address the changes of the second half of the 20th century that have led us to today’s financial system. Finally, we’ll go through many statistics describing Mexicans' financial reality.
The Origins of Credit and Finance in Mexico
Soon after Mexico’s independence, the Spanish mercury supply was cut to the country. Immediately, silver production, which remained the main economic driver for the complete existence of New Spain, collapsed and only recovered at the end of the century.
During the 1800s, the Mexican State was extremely weak and barely influenced the economy. No property rights or judicial system framework also blocked developments on the private banking front.
On the other end, the Mexican Catholic Church was at its peak of power: it owned tremendous amounts of land, imposed a 10% tax on agriculture across the country, and was the top creditor, exclusively reserved for agriculture investments. Thus, the culture of investment during this era for wealthy Mexicans was to borrow from the church and invest in barely profitable commercial land.
The Civil War and the French Rule
Mexico experienced two wars, one after the other, in the second half of the 19th century; the first was a Civil War between the Conservatives and the Liberals for control of the country. The Liberals won, but the country was destroyed and bankrupt, so Benito Juarez, the first indigenous President and one of the best of all time, suspended debt payments to European countries.
Europe wanted to force Mexico to pay back its debts and collectively invaded Mexico. Upon realizing the French had a conquest plan rather than a simple financial disagreement, the United Kingdom and Spain withdrew. The Conservatives betrayed the country and helped France conquer Mexico, thus forming the Second Mexican Empire under Emperor Maximilian I, an Austrian archduke.
When the American Civil War ended, American troops helped Juarez retake control of the country and reestablish the Republic. Due to their betrayal, the Conservatives were politically decimated and thus began decades of Liberal rule, with a few additional years of Juarez but decades of Diaz Porfirio. The Porfiriato, the first stable period of modern Mexican history, was born.
The Porfiriato
The late 1800s was the first period of industrialization in Mexico. Militia forces (rurales) were set under the army's control to maintain security throughout the country's rural regions. A property rights framework was established for the first time in the history of the country, thus allowing foreign investment to enter the country.
The first private banks to form the country were almost exclusively foreign banks. The leading banks were the National Bank of Mexico, the International Bank of Paris national subsidiary, and the London Bank of Mexico and South America. You can read more about the Mexican Banking System during the Porfiriato in the book The Banking System of Mexico, published in 1910.
At first, they all operated with different charters negotiated with the government, but they all came under the same regulation with the Banking Law of 1897. The new private banking system brought down rates from 12% to 8%, and new private notes appeared.
The mining industry was revitalized with silver production, but also copper was in high demand due to its usage in electricity networks. Oil was discovered in the country, and American investors secured the rights to those natural resources. Railroad networks were built connecting Mexico City to Veracruz and the US Border. Capital formation was finally a reality in Mexico, and foreign finance played a significant role.
The Collapse and Reformation of the Banking System
Although the country changed significantly during the first half of the 20th century, the private banking system was untouched. It did become more independent from foreign powers and nationally owned through time. The main changes were currency centralization and debasement under the mandate of Banxico, Mexico’s Central Bank.
It wasn’t until the Lost Decade (mentioned in the Money section) that a massive change was brought to the sector. In an unprecedented, historically sloppy move, Mexico nationalized its banking sector on September 1st, 1982. The government foolishly believed that it could take back control of the economy by doing so and controlling exchange rates, thus preventing a further devaluation of its currency.
This led to further distrust from the national private sector and foreign capital. It only took a decade before banking was reprivatized. Still, once again, it was done poorly because it was corruptly given to national entrepreneurs who drove those banks to the ground.
In 1995, banks were again restructured under foreign ownership, and today’s banking system is almost exclusively foreign-owned as subsidiaries of Spain’s BBVA and Santander, USA’s Citigroup, and Britain’s HSBC.
Today’s Financial Reality
Today, Mexico’s financial system has fully integrated with international standards, and there’s very little difference between it and its American counterpart.
Formal Finance
Retail products such as debit and credit cards, checking and savings accounts, home mortgages, insurance products, and pension accounts are widely available, with interest rates relative to the Central Bank’s policy. Sure, the poorer class doesn’t have access to this infrastructure, but most of the country does, with a 67.8% usage rate as of 2021.
Mexico has an obligatory private pension system that (obviously) only targets formal workers. In a 2019 government survey, it was estimated that of the 2.2 trillion pesos the country’s households have in financial assets, 78.5% of that amount was in pension funds. Only 17.2% of families save money in traditional checking or savings accounts, which amounts to 6.6% of households’ financial assets wealth.
It seems that only the Upper Classes use capitalized life insurance or invest in the investment products such as bonds, stocks, or mutual funds. That number only reaches 2.5% at best, which is nothing compared to 56% in the United States for direct investments in the stock market. It represents 5.8% of households’ financial assets’ wealth.
Cash Usage, Informal Savings, and Informal Work
Cash does remain the preferred method of payment in Mexico, being used for 41% of transactions, the highest in Latin America. This is particularly the case in Southern states which are often poorer and less modern.
Informal savings are very popular in Mexico, at a rate of 28% of households officially (probably way higher). This means cash under the mattress, at safes in friends’ or families’ houses, and at informal credit associations. However, this only equals 6.6% of households’ financial assets’ wealth (officially).
The size of the informal sector is unknown, but it’s estimated to be around 22% of the country’s GDP and generated by 56% of workers. The informal workers don’t pay taxes either. It was estimated that 54.7% of workers in 2014 didn’t pay taxes, which meant the State was short of HALF A TRILLION pesos in tax earnings for that year alone. That number has decreased in recent years but remains high.
Non-Financial Wealth
Rest assured that most Mexican households’ wealth isn’t in financial products; the vast majority is in non-financial assets such as real estate and businesses, elevating itself to 27.2 trillion pesos, 12 times higher than non-financial wealth.
It’s estimated that around 65% of Mexican households own their homes, with a median value of 450,000 pesos which is 23,762 USD as of February 7th, 2023. Car household ownership rates are 45%, compared to 91.5% for US households, as of 2021. This same survey tells us that 22.3% of Mexican households have business ownership, with a median value of only 20,000 pesos and an average value of 321,600 pesos.
I have to note that even though Mexico’s house ownership rates are on par with the U.S. and Canada, their household debt rate is also much lower, which translates to higher absolute house ownership rather than risky long-term mortgages one could default on. Household debt rates to income in the USA are 101%, in Canada 185%, and in Mexico only 27%.
Moving on to Wealth Creation
This section was meant to understand the financial reality of Mexicans, particularly in the context of financial product usage for payments and investments, but also the size of the informal sector and the non-financial wealth primarily found in home ownership.
The next section of this article will be about understanding Mexico’s wealth creation and distribution history and today’s economic outlook.
Wealth Creation and Distribution
The era of the Porfiriato brought tremendous wealth creation and growth to the country, but it was often reserved for very wealthy families and foreign powers. Under the shiny surface, the general population was not happy. They were working under terrible conditions, and when they rose up, they would get crushed by federal forces and American enforcers. The country wasn’t sovereign: it had been sold to foreigners, and the boiling point was near.
When Porfirio Diaz stepped down from office, the Mexican Revolution began. It was a socialist nationalist populist grassroots revolution that lasted a decade and fought on many fronts across the country. Millions died.
Ultimately, the revolutionaries won, and the 1917 Constitution was implemented. It recognized many labor rights that allowed businesses to continue operating smoothly. Also, land distribution and industry nationalization became crucial government efforts. Many efforts were made in the next two decades, but it wasn’t until the presidency of Lazaro Cardenas, which began in 1934, that structural changes were made to the economic model.
Nationalism: Nationalization and Unification
In the wake of the Great Depression, Cardenas took control of the country and made massive changes that are still relevant to today’s reality. One of Cardenas's core moves was nationalizing the oil and gas industry under the state-run corporation PEMEX. At the same time, he created the National Polytechnic Institute to educate engineers to run oil and gas facilities. PEMEX is widely considered a nationalization success due to its stable high production and profitability-generating capabilities for the Federal Government up until today.
Cardenas was also known for unifying a country that had gone through two wars in the previous decades, not only the Mexican Revolution but the Cristero Wars (a religious conflict). He repealed Calles Law as soon as his mandate began, which was an effort of his predecessor to reduce religious education. He won the support of the Catholic Church and many conservatives with that move.
Being a revolutionary military general himself, he won over the support of the junior officer corps by providing them with better housing, pensions, and schooling for their children. However, he armed the peasantry to balance out the power of the military establishment.
Land Distribution in Mexico
His most significant change was land distribution by dismantling the encomienda system. Ever since the creation of New Spain, the crown and later the Mexican State distributed almost all of the land to wealthy Spanish and then Mexicans, accompanied by slave indigenous workers. This system wasn’t even that effective since it was too concentrated in the hands of a few, providing little competition and too much-unused land.
Cardenas created an agrarian collective model called Ejidos and distributed 180,000 km² of land to peasants. Ejidos are divided into parcels, each corresponding to a family, but they’re a community managed as a whole. This land is neither public nor private property: peasants don’t own it but can stay there indefinitely if they follow the agricultural government framework. This was done so that the State remained in control of the process, and the newly organized armed peasantry became part of the enormous new political coalition. It provided uneven economic results, with some regions having tremendous success.
The Ejido system remains to this day, and it’s distributed in over 90% of the municipalities of this country. Over 5.6 million Mexicans live in those lands, which compromises 53% of the country's surface. All sorts of resources are produced in ejidos, ranging from agriculture, livestock, primary resources, construction materials, artisanry, and touristic services. The families live from the product, but most of it goes to the country and, in some cases, is exported to foreign markets. In 1991, land reform officially ended, and Ejidos could be privatized, or their rights could be transferred, ever since.
Import Substitution Industrialization
Cardenas's successors kept his radical changes and took inspiration from his nationalistic philosophy to adapt the country to an Import Substitution Industrialization. In the wake of the Great Depression, Mexico’s economy was still dependent on foreign powers to export primary resources and import consumer goods. Due to little export revenues from a weak global economy, Mexico could not make the payments necessary to import goods.
A new economic model had to be installed, and an inward-looking strategy was adopted. Thus began the Mexican Miracle, a thirty-year period in which GDP increased sixfold while the population only doubled. Industrial production averaged a growth of 8% during those years.
As previously mentioned, this period ended in the 1980s when government financial mismanagement collapsed the economy. To receive financing from the IMF and the United States, Mexico agreed to convert itself to an export-oriented neoliberalist economy in 1995.
Today’s Economic Outlook
Mexicans are incredibly hard-working; it’s estimated that the average worker here works 2,127 (USA: 1791 hours) hours per year, and over 27% of the population works more than 50 hours per week, which ranks at the top of OECD countries. Mexican labor is considered very cost-effective, making it very attractive for foreign capital to move their production capacity here.
Like developed countries, Mexico’s most prominent economic sector is the service one, covering 62% of the GDP. It employs about the same number of people. Agriculture has decreased from 25% in 1970 to only 5% of the GDP today. However, it uses 16% of the working force. The industry sector is responsible for about a third of the economy, with a focus on manufacturing automotive, aerospatial, electronics, beverages, and construction materials. Industry is responsible for 50% of exports.
Due to its macroeconomic environment, an export platform with free-trade access to 45 countries, a growing internal market with excellent demographics, and very competitive advanced manufacturing, Mexico is predicted to become the 5th largest economy by 2050 per Goldman Sachs, or 8th largest per HSBC.
Conclusion
This article was a monetary, financial, and economic lesson on the reality of my home country, Mexico, with a lot of historical background. I wrote it so I could share my latest research and studies and give an excellent presentation of this market before jumping into the final article of this series to answer the initial question :
How is Bitcoin Adoption going in Mexico?
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Article très enrichissant. Ça du prendre beaucoup de recherche à produire ?