A perspective from our CEO

Inflation matters. The famous economist John Maynard Keynes has described it as a “method for governments to secretly confiscate citizen wealth.” Warren Buffett called it a “tax more devastating than any legislative action.” Milton Friedman labeled it “taxation without legislation.” And former U.S. President Ronald Reagan compared its impact on society to “that of a violent criminal.”

Inflation reduces the value of money, makes planning and investment harder and can destabilize an economy if it is high or unpredictable for long. The central banks of governments often set “target inflation rates.” The United States has a target inflation rate of 2%; Mexico‘s is 3%. These targets help individuals, businesses and investors plan accordingly based on the expected inflation rates in each country.

Inflation falls to 3.37%, just above Banxico’s target

Over the past 50+ years, Mexico has always had higher inflation than the U.S., except for a period of several months in 2022 during the COVID-19 post-pandemic period when inflation rapidly increased in both countries.

For a few months in 2022, the U.S. had inflation of 8.0% compared to Mexico‘s 7.9%. Other than that, inflation has never been lower in Mexico. Until now. The most recent inflation data from each country, published just this past week, has Mexican inflation at 3.37% and U.S. inflation at 4.2%. Interestingly enough, Mexico’s inflation rate is currently trending down, while in the U.S., it is trending up.

For added context, in the decades before the early 2000’s, Mexico always had much higher inflation than the U.S., oftentimes at least 10% higher. During the decade of the 2000’s, this gap lowered to about Mexico being 5% higher on average each year. In the 2010’s, it lowered further to Mexico being about 3% higher on average each year. Since the pandemic, the gap has narrowed even further to the situation today in which Mexico actually has lower inflation than the U.S. by almost a full percentage point.

So why should we care? And what could this mean? When one country runs persistently higher inflation than another (as Mexico has done for decades versus the U.S. until now), it tends to end up with a weaker currency, higher interest rates, more volatility and a long-run loss of competitiveness and real incomes relative to the lower-inflation country. It is worth re-reading the previous sentence and thinking about it in the context of Mexico and the U.S. over the past decades.

Mexico has, in fact, almost always had a weaker currency than the U.S. (which made Americans feel “relatively wealthier” in Mexico and made Mexicans feel “relatively poorer” in the U.S.). Mexico has always had higher interest rates and more interest rate volatility (making individuals and businesses less likely to invest due to higher risk factors). And in part due to this difference in inflation rates, Mexico has continually had a long-run loss of real incomes relative to the U.S. The per-capita GDP in Mexico is still only about 1/7th of what it is in the U.S. and in fact, it has not improved from what it was decades ago! The relatively higher inflation in Mexico decade after decade, along with factors like lower productivity and lower rates of fixed investment, is in large part what is responsible for Mexicans’ inability to increase their wealth.

To illustrate, let me provide a very simple example. Imagine that inflation is 6% and wage growth is 5%. In that case, the average worker actually has lost purchasing power, and in effect is 1% poorer than they were a year earlier. Now imagine a scenario where inflation is 3% and wage growth is 4%. In that case, the average worker has gained purchasing power and, in effect, is 1% richer than they were a year earlier. The first example is almost always what has happened in Mexico year after year. The second example is almost always what has happened in the U.S. year after year. Until now. The U.S. right now is experiencing a decline in purchasing power (inflation is higher than wage growth), while Mexico right now is experiencing an increase in purchasing power (wage growth is higher than inflation).

So what’s the big picture and what could be expected for Mexico and Mexicans if this trend continues?

1. In the near term, there is limited pressure on the Mexican peso to devalue further against the USD. It might actually gain in strength.
2. Lower inflation will bring lower interest rates in Mexico, which could be a boost to the economy if more individuals use credit and more businesses are willing to invest in a more stable interest rate environment.
3. Mexicans will likely see their purchasing power begin to improve.
4. Even though inflation has moderated, foreigners and foreign companies in Mexico will likely feel that Mexico is getting more expensive (a dramatic change from the decades during which Mexico “always felt like it was getting cheaper” to foreigners).
5. Relatively speaking, this hurts those in Mexico who depend on international tourism, but is good for those who depend on domestic tourism.
6. For home buyers in Mexico, mortgage and loan instruments will likely become more affordable and accessible.
7. Investment products in Mexico might become more readily available and more attractive to international investors.

It’s important to note that there are many, many factors that go into exchange rates, interest rates and economic data. Oil prices, war and policy changes can all quickly change economic outlooks and reverse trends. That being said, I think it is worth noting that Mexico has achieved lower inflation in spite of the Trump tariffs and the oil and other commodity price increases as a result of the Iranian and Ukrainian wars.

Mexico right now is in fact demonstrating impressive fiscal discipline. The country’s latest level of government debt to GDP is 45% and trending down. In the United States, it is 123% and trending up. Said differently, Mexico’s debt burden is relatively low and decreasing, while in the U.S., it is relatively high and increasing. The U.S. currently has a debt ratio that is almost 3 times higher than that of Mexico.

What does this mean for the two countries in the future? No one knows for sure, but it will certainly be fascinating to watch. The team at MND will help you make sense of it all every step of the way!