James Carville, Bill Clinton’s political advisor, famously said that if he were reincarnated, he would want to come back as the bond market: Then you can intimidate everybody. By this, he meant that the markets have immense power over governments. By giving the thumbs down to a government’s economic policy, markets could force the government to change course. This was a painful lesson that Mr. Carville learnt when the so-called bond market vigilantes expressed in no uncertain terms their disapproval of the high budget deficit during the Clinton presidency. 

Judging by his radical comments following last week’s landslide election victory for his Moreno party, Mexican President Lopez Obrador (AMLO) is yet to learn Mr. Carville’s lesson. Otherwise, he would not have invited the exchange market’s wrath with the provocative remarks he made after that election that he intended to press ahead with economic reforms and policies that he must have known were anathema to the markets. 

During his term in office, AMLO had been thwarted from making the radical institutional economic reforms he desired by a judiciary that insisted on upholding the Mexican constitution. However, now that his party has won more than a two thirds Congressional majority and has control of the senate, AMLO is in a position to push through judicial reform that would effectively clip the judiciary’s wings and allow him to do as he pleases with the economy. 

This explains why the bond markets took fright last week when AMLO intimated that he would push ahead with judicial reform and a swath of economic reforms before he is scheduled to leave office in October. These changes would allow him to both weaken Mexico’s economic institutions and to increase public spending on social programs. It would do so even at a time when Mexico’s budget deficit is already running at a worrying six percent of GDP. Little wonder then that last week the Mexican peso slumped against the US dollar by eight percent to reach an eight-month low of 18.40. 

Among the reasons that AMLO is playing with fire when he makes ill-considered remarks about the currency is that Mexico is no stranger to currency crises. Indeed, it had major currency crises in 1982 and again in 1994-95 with the Tequila crisis. Mexico also has an open capital account that allows for the free movement of capital both into and out of the country. This creates the conditions for a downward spiral in the currency should investors lose confidence in the direction of the currency. Something like this recently occurred in Turkey when President Recep Erdogan stuck to a policy of inappropriately low interest rates on the basis of the harebrained idea that high interest rates were the cause rather than the cure for inflation. 

Another reason that Mexico would be ill advised to talk down the currency is that it has a very open economy. According to the World Bank, Mexican exports and imports each amount to around 40 percent of the country’s GDP. That implies that should the currency depreciate by 10 percent on a sustained basis that could over the longer term add around four percentage points to the headline inflation rate. This is hardly something the country needs as the Bank of Mexico battles to get inflation down to its three percent inflation target. 

It would be particularly unfortunate if Mexico went down the wrong economic path at this juncture. If it did so, it would be squandering the opportunity to take advantage of the strong desire of US companies to re-source their production away from China to friendlier and geographically closer countries to the United States. That could jumpstart an economy that has experienced disappointingly slow economic growth during the AMLO presidency. 

Based on the experience of other countries that have been punished by the markets for their wayward economic policies, it would seem to be only a matter of time before market pressure forces a Mexican policy U-turn. We have to hope that AMLO has the wisdom to make such a policy U-turn early before his ill-advised policy course causes real damage to the Mexican economy.

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