Since Sunday night in Mexico, the Asian stock markets have been falling. On Monday morning we woke up to the news that the Japanese market had suffered its worst fall in 37 years. Today, the Japanese stock market, measured by the Nikkei 225 index, had a robust recovery (10.23 percent yesterday Tuesday). The American market, measured by the S&P 500 and the Nasdaq, had a slight recovery (around one percent).
Many analysts pointed to Japan’s low-interest rate policy as the cause of Monday’s instability. But given the strong recovery in the Japanese market, and the weak recovery in the American market, it is possible that the carry trade (leveraging yen to buy risky assets in dollars or other currencies) is not the main source of this crisis. In fact, the exchange rate correction between the yen and the dollar is not significant. Rather, there are concerns around the US labor market data (which actually does not seem to be that bad). The VIX index, which measures the emotions that cause volatility in the market, peaked on Monday on the fear side (as opposed to greed).
Concerns about a recession in the United States are real. The New York Fed predicts recessions based on the difference between the rate on a 10-year bond and a three-month bond. By June 2025 (one year from now), the probability of the American economy falling into recession, according to them, is 55.8 percent.
Forecasting is tricky. No economist can really predict when a recession, or a severe correction in international relative prices, will occur. What we can say is that the US economy has been jumping around the probability of a recession for quite some time now. At the end of 2022, many analysts were painting a picture of 2023 being a recession year, with a probability of almost 100 percent, which did not happen. The question is at what point does the resilience of the US economy end, and if it falls into recession, whether there is room for fiscal policies to boost growth given the high public deficit, estimated at two trillion dollars. That’s a deficit close to 7 percent of nominal GDP for 2024. The Congressional Budget Office (CBO) estimates U.S. public debt at 99 percent of GDP in 2024. Consumer confidence is also on the decline, as measured by the University of Michigan, it’s at 66.4 today, down from 71.5 points a year ago.
The jitters in the United States may be related to the presidential election there. Voters, Stephen Roach wrote in a Project Syndicate editorial last June, are angry with the Biden administration because of the overall price level, not so much the inflation rate. Roach says that since January 2021, price levels remain high in categories such as energy (41 percent), transportation (40 percent), housing (22 percent) and food (21 percent). That is why the American public is so pessimistic about the economic outlook.
All of this is bad news for Mexico. Our country’s economic growth depends on the growth of the United States. We can forecast Mexican growth using only the growth of the United States as an explanatory variable, with a one or two quarter lag.
Mexico has its own problems with deficits and public debt. Our deficit is 6 percent of GDP, and our recognized public debt is around 48 percent of GDP. We were already under pressure on public finances due to pensions. Our excesses from the Echeverrista era, accompanied by poor pension designs in state and municipal institutions, and public universities, further complicate the scenario that reduces the State’s spending capacity.
The Mexican State will be constrained in its ability to provide health services, education, public security, and infrastructure. With an American recession, our growth will not be able to finance State expansions in all that Claudia Sheinbaum has promised. The only solution is to make strong cuts to public spending, and move towards a government that is much more efficient in the use of resources. If continuity is the hallmark of this government, we are going to have a very difficult time in the coming years.
