In Defiance of the Bond Vigilantes, Bank of Mexico Slashes Interest Rates

The current actions of Mexico’s central bank is an example of what I call as policy shaped and driven by the philosophical ideology of the “euthanasia or the rentier”, or of the entrenched creed that economic growth can only be spurred by abolishing interest rates which have been seen as obstacles of “scarcity value of capital” through unlimited ‘free lunch’ credit expansion.

From the Wall Street Journal Economics Blog:

The Bank of Mexico surprised the market and most analysts Friday with a quarter-percentage-point interest rate cut, and in the process set central bank watchers squarely into two camps: those who see it as a one-off event and those who expect further easing if the economy continues to struggle.

The central bank, led by Governor Agustín Carstens, was clear in its reasons for cutting the overnight rate target to 3.75%: the economic downturn in the second quarter was “faster and deeper” than expected, and the slack in the economy is likely to remain for a prolonged period.

The bank acknowledged that economic growth this year will be well below the 2%-3% estimate it gave in August, about a week before the National Statistics Institute released the bad news about second-quarter gross domestic product, which contracted 0.7% from the first quarter and was up just 1.5% from a year earlier.

Never mind if the current woes have been created by the same solutions policymakers earlier applied to artificially bolster the economy.

Since the 2008 US crisis, Mexico’s monetary policies via official rates had been zero bound.

The consequence has been to balloon or more than double private sector debt.

And the other ramification has been to expand government spending financed by external debt.

Low interest has enabled the Mexican government to indulge in a spending spree.

But through the period where zero bound rates prompted for a debt financed growth, Mexico’s annual GDP growth rate has been in a conspicuous decline where quarter on quarter GDP growth has even turned contractionary or negative during the second quarter

And part of the negative 2nd quarter growth can be traced to a spike in Mexico’s 10 year bond yields. 

Domestic credit markets which rates have been tied to such bond benchmark has extrapolated to higher interest rates. Higher rates have thus became a drag on a debt finance statistical growth.

And coincidentally the arrival of the bond vigilantes has only unmasked the diminishing returns of a credit driven statistical boom.

And another symptom of the damage from the bond vigilantes has been the falling Mexican peso.

USD-MXN has been on the rise over the same period.

Aside from Peso and bonds, the Mexican benchmark the Bolsa plunged towards the bear market, over the same period. The Bolsa bounced back strongly from June lows, but have showed renewed signs of infirmity.

It remains to be seen who will be proven right and who will look like a fool, the bond vigilantes or the Bank of Mexico.

Bottom line: The contemporary central banker know only of one solution to economic woes: to permanently blow quasi-booms via zero bound rates and by adding asset purchasing programs for the same goals. Never mind if such policies has ever been effective. The policy recourse as if shaped by intuition has been the same.

Someone previously noted that doing the same things over and over again and expecting different results is called insanity. Insanity via permanent boom bust cycles have become the dominant governing monetary policies of the global economy.