Mexico’s Central Bank Just Broke with the War on Cash

Motivated by inflation?

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

A strange thing just happened in Mexico. The Bank of Mexico (Banxico), announced that it is considering launching a 2,000 peso note (ca. $105), double the highest denomination note currently in circulation. It’s also considering doing away with Mexico’s lowest denomination 20 peso bill (ca. $1.05), which will be replaced by a coin with the same face value.

Not everyone’s happy about the proposal, which forms part of a range of measures aimed at updating Mexico’s currency notes. Miguel González Ibarra, director of the Center for Financial Studies and Public Finance of the National Autonomous University of Mexico, said that introducing a higher denomination bill flies in the face of the broad trend among advanced economies to weed out such notes.

In 2016 Peter Sands, the former CEO of the British bank Standard Chartered, set the tone of the debate when he published a report for Harvard Kennedy School of Government imploring central banks around the world to stop issuing high-denomination notes and bills. They include the €500 note, the $100 bill, the CHF1,000 note and the £50 note. This is the first rule of the war on cash: make high-denomination notes taboo in law-abiding circles.

“Such notes are the preferred payment mechanism of those pursuing illicit activities, given the anonymity and lack of transaction record they offer, and the relative ease with which they can be transported and moved,” the report warned. In other words, only criminals use cash. High-denomination notes, the report added, “play little role in the functioning of the legitimate economy, yet a crucial role in the underground economy.”

Since the publication of the report, the ECB has decided to stop producing €500 banknotes as of the end of 2018. Although the Eurozone’s highest-denomination note will remain in circulation for some time, its phasing out has already had the desired effect: most consumers today associate it with criminal activities, such as corruption, drug trafficking, or the financing of terrorism, and dealing with it is now more trouble than it’s worth.

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In Mexico the highest denomination bill currently in circulation, the 1,000 peso note, was introduced in April 2008. But even today the bill is still rejected by many retail establishments due to the inconvenience of providing so much change or out of fear that it could be forged, which begs the question: why the sudden need for an even higher denomination note? The most likely answer? To keep up with inflation.

In the last 10 years the Mexican currency has lost much of its value despite the fact that inflation during that time has been relatively tame by Mexican standards! The accumulated inflation rate of the last 10 years of so-called “moderate” inflation is 51%. The result has been a 34% fall in purchasing power.

It’s a stark reminder of how even “moderate” inflation can, over an extended period of time, obliterate the value of the money people earn, spend and save. Inflation may be good for companies and landlords because it means they can hike prices and rents, and can report higher revenues without having sold a single extra thing. But for workers whose salaries do not keep up with the rising prices, it can be brutal. In Mexico, a country that has become a paradise for low-cost production, most salaries have been left in the dust.

In 2017 the National Council for the Evaluation of Social Development (CONEVAL), an independent government organization, calculated that the percentage of the population with daily earnings lower than the basic daily food basket — just 92 pesos ($4.96) — was over 41%. This relentless increase in prices, which is really a mirror reflection of the unending loss of purchasing power of the currency, may explain why the face value of Mexico’s highest denomination bill is no longer deemed high enough by the country’s central bank.

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And that has many people spooked. While annual inflation, at 4.8%, remains more or less under control by Mexican standards — and certainly compared to what’s happening in places like Argentina and Turkey — Banxico’s proposal to introduce a 2,000 peso note has set off alarm bells among older members of the populace who can still recall the devastating effects of Mexico’s last bout of hyperinflation, in the late eighties, when average annual price rises reached a peak of 180%.

“A 2,000 peso bill would send a negative psychological message concerning the loss of purchasing power of our currency,” says Raymundo Tenorio, director of Economics course at the Monterrey Institute of Technology and Higher Education. González Ibarra agrees, noting that the main reason for issuing a higher denomination note would be as a vain attempt to keep up with the peso’s ongoing loss of purchasing power.

Another reason is the slow uptake of electronic and mobile payment methods. Due to the rampant hacking of personal data and cloning of cards, many people in Mexico prefer to continue making payments in cash rather than risk using electronic methods. Also, Mexico, like many other countries in Latin America, has a very large informal economy that shows little sign of going away. As a result, cash is still very much king.

In its latest press release, Banxico said it would issue the new bill only if it deemed that “such a bill is required to satisfy user’s needs.”

But many users are fearful that the real reason behind Banxico’s apparent interest in issuing a higher denomination bill is that the old bugbear of rampant inflation is about to rear its ugly face once again. With the US dollar rising, emerging market currencies swooning, and hot money getting cold feet in higher-risk markets, you can’t exactly blame them. By Don Quijones.