Mexico as a Major Power

BY GEORGE FRIEDMAN MARCH 14, 2016

Mexico has the 11th-highest GDP in the world based on purchasing power parity, according to the International Monetary Fund. As Europe weakens, it will be in the top 10 in the not-too-distant future. Yet, this country is regarded by many Americans as a Third World nation, dominated by drug cartels and impoverished people desperate to get into the United States.

While it is true that organized crime exists in Mexico and that many Mexicans want to immigrate to the US, a roughly equal number are leaving the US and returning to Mexico… drawn by economic opportunities in their home country. The largest auto plant in the Western Hemisphere is in Mexico, and Bombardier builds major components for aircraft there. Mexico has many problems, of course, but so does the U.K. (the 10th-largest economy) and Italy (12th).

No one would be surprised by the U.K. or Italy rankings, but many people would be stunned to find that Mexico is ranked right up with them. Obviously, Mexico is not as developed as Britain is. Like most nations transitioning from underdevelopment to greater development, Mexico suffers from substantial class and regional inequality, and the emergence of a dominant middle class is still unfolding.

At the same time, Italy also has substantial regional inequality. Mexico can't aspire to British standards, but Italy is a reasonable model. Inequality diminishes the significance of being 11th in some ways, but it doesn't change the basic reality of Mexico’s relative strength.

Mexico is commonly perceived, far too simplistically, as a Third World country with a general breakdown of law and a population seeking to flee north. That perception is also common among many Mexicans, who seem to have internalized the contempt in which they are held.

Mexicans know that their country’s economy grew 2.5 percent last year and is forecast to grow between 2 percent and 3 percent in 2016—roughly equal to the growth projection for the US economy. But, oddly, they tend to discount the significance of Mexico’s competitive growth numbers in a sluggish global economy.

Here, therefore, we have an interesting phenomenon. Mexico is, in fact, one of the leading economies of the world, yet most people don’t recognize it as such and tend to dismiss its importance.

This week, I spoke at the annual meeting of the Mexican Association of Banks in Acapulco. It was a major event, with the Mexican president and the head of the central Bank speaking, along with Americans such as Larry Fink, chairman of BlackRock. The contrast between what Fink and I had to say about Mexico, and what the Mexicans had to say, is interesting. The Mexicans were cautious, frequently dwelling on the challenges facing Mexico and not focusing very much on the country’s achievements.

Fink and I were effusive about Mexico. Given the condition of the rest of the world, we argued, North America is an island of tranquility and opportunity—with Mexico as the most promising region economically. The contrast between our views, the views of many Mexicans, and the views of most Americans is so vast that it feels as if we dwell on different planets. I know of few places on earth that are viewed so differently by different observers.

Let me summarize the argument I made. First, the Eastern Hemisphere (Eurasia in particular) is moving toward systemic failure. The EU is struggling to manage a host of problems. Russia is contending with strategic and economic challenges, particularly the collapse in oil prices. China is trying to find a stable new normal and maintain social stability. As for the Middle East, no summary will suffice. The rest of the Eastern Hemisphere is experiencing what I might call “normal instability.”

Compared to other parts of the world, North America is not only remarkably stable but is also doing well economically. One of the main views of the Geopolitical Futures model is that, following the collapse of the Soviet Union, there was no longer any European global power. The center of gravity of the international system had shifted away from Europe, to North America. This argument rests heavily on the inherent military and economic power of the United States. The US Navy controls the oceans, and the United States produces 22% of the world’s GDP. Just as important, the United States is an inefficient exporter, a factor that cushions the US from the Eastern Hemisphere’s crisis.

While roughly 30% of GDP comes from exports in Russia, 46% in Germany, and 23% in China, US exports account for only 13% of GDP with over a third of that total sold to Canada and Mexico. Thus, while Eastern Hemisphere powers teeter on the edge of an economic volcano or tumble in, the United States finds itself relatively insulated from declines in global import demand, and the US insulates the countries on its northern and southern borders to a great extent.

The contrast between the European Union and NAFTA is critical. There are institutional differences between the attempt by the EU to integrate heterogeneous countries and NAFTA’s limits on integration. But the most important difference is that Germany, the foundation of the European system, is a massive exporter, while the United States is a net importer. Given the vastness of the US economic base, the net negative flow has little impact. However, it has an important twist in terms of Mexico. Exports, more than 80% of which go to the United States, constitute 32% of Mexico’s GDP. Thus Mexican exports to the United States amount to about a quarter of Mexico’s economy.

US GDP is about $17 trillion, and imports from Mexico’s are about 0.2 percent of the US economy, so they have very limited impact. But their impact is further mitigated because Mexican-manufactured exports contain a substantial quantity of components made in the United States. For example, Mexico is one of the top exporters of automobiles to the United States. These cars are not sold under a Mexican label, since Mexico manufactures them for foreign companies. But unlike Japanese or Chinese exports to the United States, cars manufactured in Mexico contain about 40% of their parts purchased from the United States. This means that US manufacturers contribute to the total value of Mexican exports.

Synergies have driven Mexico into dependence on the United States. The US has had the option of shifting its imports away from China and sourcing from Mexico instead. This shift has had a huge impact on Mexico’s growth. It is also one of the reasons why the Mexicans are less than positive about their economic position.

There is much history between Mexico and the United States, with the pivotal event being the American conquest of northern Mexico—from present-day California to Texas—in the 1830s and 1840s. This conquest created a complex view of the United States, informed by both anger and envy. The tragedy of Mexico, from its point of view, is that it is still so tied to the United States.

NAFTA, much debated in the US, had an even greater effect on Mexico. Access to the American market reshaped the Mexican economy, strengthening it immeasurably. It also created an enormous imbalance—economically in Mexico’s favor, politically in the United States’ favor. When you send 80% of your exports to one country, that country has tremendous power over you. This is not only a political fact, in the sense that some politician could try to shut down trade, it is also distinctly macroeconomic: If the American economy catches a cold, Mexico catches pneumonia. As other exporting countries have discovered, their well-being is in the hands of their customers. So long as the US–Mexico imbalance is there, the Mexicans will and ought to feel uneasy.

The American conquest of Northern Mexico implanted an image in American minds. The Mexicans ought to have defeated the Texans. The Mexicans had the larger army, better equipment, and, in many ways, better commanders. But the Mexicans also had the defect of a class-ridden society. The army General Santa Anna brought north into Texas had well-trained French generals and good artillery, but it was an army drawn from Chiapas, composed of indigenous people without shoes or training. It was a Napoleonic army of the impoverished led by the nobility, fighting as a mass rather than with individual skill.

When Santa Anna crossed the northern deserts, his army found itself facing the coldest winter in years, with ice and even snow. The soldiers suffered terribly, and by the time they reached the Alamo, they were exhausted. Their commanders didn’t care about the troops and made their way east to San Jacinto… where the Texans defeated them.

It is important to understand the vast chasm that existed between the officers and soldiers in Mexico's army. There are always such differences, and they sometimes run very deep. But the chasm in the Mexican army resembled the divide in the British army so apparent at Waterloo, when the commander, Wellington, called his men “scum.” The Mexicans adopted the European model, in which the soldiers were induced by money or simply pressed into service. This was the lot of Mexican soldiers; it was their lives. But when they confronted the Americans, where the gap between enlisted men and officers was substantially smaller, an army that was inert (unless pressed) confronted an army that encouraged initiative at all levels. The latter army won.

The model of European colonialism defined the Mexican forces… but not the Americans. And for the next century and a half, the Mexican legacy of colonialism continued to define the difference between the two countries’ armies.

The experience of the Mexican-American War also defined American perceptions, and perceptions turn into habits, and habits become truths. The Mexican soldiers were seen as typical Mexicans and held in contempt, while the generals were seen as fools.

Further, the border that was created shielded Americans from a real understanding of Mexico. The border was arid and mountainous—hard to penetrate. As in many borderlands, it was a brutal place of criminals and desperate men. Certain commodities are always worth more on one side of the border than on the other. Sometimes it is cattle; sometimes it is drugs. Sometimes the goods are rightfully owned, and sometimes they are stolen.

The area north of the US–Mexico border is not like the rest of the United States, and the area south of the border is not like the rest of Mexico. But the borderland is a shield, and the shield is all that most people on either side tend to see.

The American view of Mexico was formed at San Jacinto and confirmed by endless images of Mexican revolutionary Pancho Villa raiding US border towns. He was depicted as ignorant, brutal, and dangerous. Today, Mexico is seen as a land of drug dealers, the descendants of Villa, far more dangerous than he was to American security. This perception is like viewing the United States today as if it were Chicago in the 1920s and 1930s and as if Al Capone were the typical American.

The Mexican fear of the United States is not unreasonable. Nor is the American fear of Mexico. It is easy to construct a tale of Mexico that is heavy on cartels and illegal aliens seeking to plunder and terrify the country. There is a deep history between our nations, a history that regenerates in different ways at different times.

The bankers I met at the conference in Mexico were cautious. They have been disappointed many times before by their own country. The Americans were enthusiastic. Americans tend to forego history in favor of the future… especially where money is concerned. But everyone there knew what Donald Trump has been saying during his campaign and resented the way he preys on American fears. There is no denying these fears, and there is no denying that Trump understands them. There is also no denying that, like most fears, there is some truth to them. There are cartels, and there are illegal immigrants, if fewer than before. But it is the distance between the Mexico that these fears conjure and the reality of what Mexico has become that is startling. The Mexicans themselves don’t trust the transformation of their country that has happened. They expect success to be snatched from them—probably by the United States.

But the fact is that Mexico is the 11th-largest economy in the world, with free access to the largest economy in the world and vast amounts of American investment pouring in. It may still have to contend with the challenges of sharing a border with Central America, but with China in decline, even the poor of the south might be mobilized by the low-level industries that made China successful and that now seek a new home.

The borderland and the smugglers who live there do not represent Mexico. Mexico will be one of the top 10 economies in the world shortly, and since North America is now what Europe once was, the prospect of two great powers on one continent is worrisome.

Of course, most of us cannot imagine Mexico as a great power. Nor could most people have foreseen the emergence of China or the resurrection of Japan—or even the United States itself—as a great power. This is a failure of imagination masquerading as common sense. I always doubt the ability of humanity to manage its future. The inevitable rolls over us. But here is a moment when an understanding of what Mexico has become might just have some real value, if only for our grandchildren.

There is an old Mexican saying: “Poor Mexico. So far from God, so close to the United States.” I don’t know about Mexico’s proximity to God, but it is clear to me that Mexico is no longer paying a price for its closeness to the United States, and neither is the United States. But now Mexico, as the junior partner, must manage this relationship.

George Friedman

Condé Nast Traveler magazine's top 10 cities for Americans to retire to

By Gary Peterson, gpeterson@bayareanewsgroup.com

1. Coronado, Panama: "Pacific Coast beaches and perfect sunsets"

2. Penang, Malaysia: "Historic architecture, a thriving art scene"

3. Cascais, Portugal: "10 major golf courses, a castle, miles of cobblestone streets"

4. San Miguel de Allende, Mexico: "Art scene, colonial charm, and affordable living"

5. Killarney, Ireland: "Ranked high for safety, cleanliness, and overall charm"

6. Corozal, Belize: "A gateway to world-class snorkeling and scuba diving"

7. Concord, CA: "Excellent health care facilities, and free community activities throughout the year"

8. Grand Haven, MI: "A lakefront star with a boardwalk, 90,000-gallon musical fountain"

9. Santa Fe, NM: "A friendly community of all ages, and warm days with low humidity"

10. Louisville KY: "Appealing for retirees for its pace of life, climate, and culture"

Emergency Number in Mexico

911 will be new emergency number starting next year. 

I experienced a little chest pain last night. It could have come from the bad diet I brought back from our trip from NOB: Cheetos which I can only get here with bacon added, and those little candy hearts with sayings like "CRAZY 4U", "LOVE YOU", and "MISS YOU", all in delicious pastels.

As I tried to get comfortable, back, side, and other side, I thought about emergency numbers to call. Does 9-1-1 work in San Miguel?

Mexico News Daily cleared things up for me.

"The number for a new national emergency phone line will be 911, the Federal Telecommunications Institute (IFT) announced this week.

Last April the federal Chamber of Deputies approved legislation to make 066 the official number.calls was announced last November by President Enrique Peña Nieto as one of a series of measures in response to the Iguala-Ayotzinapa events of September 26 and 27. At the time it was to be 911.

Now 911 is back, and existing emergency numbers will be required to migrate to it. Those include 060 for local police, 061 for state and Federal District judicial police, 065 for the Red Cross, 066 for the national system for citizen emergencies, 068 for fire emergencies and 080 for security and emergency calls.

The new number, for both fixed line and mobile telephones, is to begin operating early ( in 2016).

Puebla’s Tunnels Will Open Soon to Public

From Mexico News Daily, "Five months after the discovery of ancient tunnels beneath the city of Puebla, the centuries-old passageways are being opened as part of the Secretos de Puebla, or Secrets of Puebla, project.

Believed to be as many as 500 years old, the tunnels were originally constructed within the foundations of the city, possibly to provide underground passage between monasteries, or to function as a drainage system.

The tunnels are also rumored to have aided Mexican soldiers in their celebrated fight against French troops, which they won on May 5, 1862.

Located in Puebla’s historical center as well as on the fringe of the area known as Las Fuertes, the tunnels reach seven meters in height and 3.5 meters in width and extend for an estimated total of 10 kilometers in length.

The president of the State School of Civil Engineers, Ricardo Olea Ayala, believes that the tunnels were used as secret passageways between a network of monasteries, including Santo Domingo, San Agustín, La Merced and San Javier.

Sergio Vergara Bermejo, manager of the Historical and Heritage Center of Puebla, remarked that the discovery of Puebla’s tunnel network was the confirmation of a popular urban legend. He said, “We talked of the tunnels of Puebla, but nobody had seen them.”

Specialists from the National Institute of Anthropology and History will assist in the recovery of the remaining tunnels, but on February 17 the first recovered sections will be opened to the public. Secretos de Puebla will introduce about 2.5 kilometers of uncovered tunnels in addition to its other catalogued historical sites, including the Puente Bubos.

They are calling on visitors to create videos to recount their personal experience with the tunnels, stories of which have been passed down through generations.

Total restoration of the subterranean passageways, whose existence was confirmed last September, is expected to take 10 years.

Sources: El Economista (sp), Puebla Capital (sp), Union Puebla (sp)

Peso Hits New Low of 18.8 Against Dollar

Mexico News Daily | Thursday, January 21, 2016

The Mexican peso dropped to a new record low against the dollar yesterday and did the same again today.

The peso slid to 18.8 to the dollar today after dropping to 18.71 yesterday.

Some banks were selling the U.S. currency for more than 19 pesos today.

The peso has lost nearly 8% in the past three weeks. Last year it dropped by nearly 17% against the dollar.

Finance Secretary Luis Videgaray told El Financiero during an interview today that the peso is “clearly undervalued” and that its decline in value is the result of overreaction by the market.

But when markets calm down, he said, the peso will regain strength.

Ongoing dollar auctions to support the currency will continue, said the Finance Secretary, who is attending the World Economic Forum in Davos, Switzerland, but there will be no further budget cuts.

He said there was “definitely” no risk of a financial crisis.

Source: El Financiero (sp)

Medical & Dental Care

I am impressed with the Medical & Dental care here in San Miguel. Women here can have face lifts done by the revered Dr. Barrera and his beautiful doctor assistant for $6600. Included is a pick up and delivery to and from the hospital, four day stay in the hospital, personal home visit by the doctor to remove stitches, and all sorts of hand holding before and after. Compare that to the U.S. at three or four times the price and a one day stay in the hospital.

For me, I had a tooth that was bothering me. Turns out I had developed a cavity under the crown. The dentist examined me, took an x-ray, and sat down with me in his office. I will have to have a root canal and a new crown, he said It would cost me 8,500  pesos. That's about $480 to $500. I would imagine the same thing in the states to be as much as $3,000.

Did I hear medical tourism?

Impossible Trinity

What is the Impossible Trinity?

It’s a theory that says a country cannot have all three of the following at once: an open capital account, a pegged exchange rate, and an independent monetary policy. That’s all there is to it.

You can have one or two of those three conditions, but not all three at once. If you try, you’ll fail. It’s those impending failures that make the Impossible Trinity so useful for predictive analytics.

Jim Rickards, Editor, Currency Wars Alert, says Mexico is experiencing the Impossible Trinity now and predicts a coming devaluation of the Peso.

What can Mexico do to escape the Impossible Trinity?

It has three choices: close the capital account, give up its monetary independence, or devalue the peso. There are no other ways out for Mexico.

It is almost inconceivable that Mexico will close its capital account. Mexico is dependent on U.S. trade and an IMF backstop lending facility. Both the U.S. and the IMF would strongly oppose closing the capital account. Mexico is highly unlikely to move in opposition to its two largest sources of financial support.

As a short-run expedient, Mexico has abandoned its independent monetary policy. The chart below shows how Mexico raised interest rates 0.25% two weeks ago, exactly one day after the Fed raised rates by 0.25%.

If Mexico had not raised its interest rate, capital would have flowed from Mexico to the U.S. in search of higher yields. These capital outflows would have drained Mexican reserves. This rate hike illustrates the constraints imposed by the Impossible Trinity.

Outsourcing its monetary policy to the Fed bought a little time for Mexico, but it’s not a long-term solution. The Fed will likely raise rates next March, and again in June. The Mexican economy is already slowing down because of declining growth in its major trading partners, China and the U.S. Raising interest rates only make the Mexican slowdown worse.

If Mexico will not close its capital account, and cannot raise interest rates to follow the Fed, there’s only one thing left for Mexico to do — devalue the peso. Not only can we see this coming with our IMPACT system, but we have a good sense of the timing.

The Mexican Currency Commission (the official body that sets the Mexican exchange rate to the dollar) will meet later this month to decide on whether to extend the peso support program. The Fed is unlikely to back off its rate hike rhetoric before then, so that’s an opportune time to devalue the peso.

All of this analysis is probabilistic, but none of it is certain. Still, our analytic tools, including the Impossible Trinity and my IMPACT trading system, give us fairly good visibility on a coming peso devaluation. U.S. dollar investors in Mexican stocks will suffer when the peso value of those stocks declines.

The ideal way for investors to play this is to short a major Mexican company with dollar-based securities and weak fundamentals. That way, an investor can be positioned to win on a declining stock and a declining currency.