Editor’s Introductory Note: Part 1 of this article on the Mexico currency devaluation was posted on Tuesday, January 29, 2019. Today, Part 2 concludes this article.
In Part 1, I described how, while I was living and teaching in Mexico in 1982, there was a nearly 50% devaluation of the Mexican Peso, resulting in major economic hardship for the average citizen. In this installment, I would like to share a few lessons I learned from experiencing a currency devaluation –essentially an economic collapse– and how these lessons can help us prepare for a similar, or much worse collapse in the future.
I would like to start by re-visiting my Lesson #1: Rules can be broken. I thought I was safe by having my money deposited in a Mexican bank in Dollars instead of Pesos. Wrong. As I mentioned in Part 1, I was shocked to learn that in order to withdraw my dollars, according to the new rules, those dollars first had to be converted to pesos at the new exchange rate and then, I would get my Dollars. So, figuring I might as well get something instead of possibly seeing the bank closing and getting nothing, I went ahead and withdrew my money.
The Shocks Will Come in Waves
Before the Mexico currency devaluation, the exchange rate was 27 Pesos to the Dollar. After the first of two devaluations, the rate skyrocketed to 45 Pesos to the Dollar. Six months later, there was a SECOND devaluation, sending the rate to 69 pesos to the dollar. So, suppose you have $1,000 in the bank. Pre-devaluation, those dollars are equal to 27,000 Pesos. (Yes, it was common back then to carry 500 or 1,000 Peso bills around). So, in that initial devaluation, we all lost nearly 50% or our buying power, and in the later devaluation, another 20% or so. So, since rules can be, and in fact, have been broken, who do we really believe? If you have your money deposited in a bank, remember, even though you have been told your money is safe, is it really? From past experience, I would say “no.” But what about certificates of deposit (CDs) for example? So what if you can earn 2.8% interest on a six month CD? If the bank closes down, or institutes capital controls, how “safe” are you then?
Now, regarding capital controls, or limits banks place on withdrawals: Did you know that banks, including banks in the U.S., already have capital controls in place? A few years ago, my wife and I wanted to buy a used recreational vehicle (RV) from a private party. I went to my local credit union, and needed to withdraw around $9,500. The teller told me, “I’m sorry, sir, we’re going to need some time to complete this withdrawal.” I replied, “How much time?” She said they would need an extra day to transfer the cash from one of their other branches to complete the full amount. So, I waited and got my cash. But the point is, banks and credit unions don’t have all that much cash laying around at any given time. I’m sure this is in part to reduce their liability in case of a robbery, but it’s also due to the practice known as fractional reserve banking, a system in which only a fraction of bank deposits are backed by actual cash on hand and are available for withdrawal. The rest of the money is tied up in loans, and risky investments, such as derivatives (more on that later).
A Mexico currency devaluation Redux?
Imagine what things will be like in a run on the banks, which I experienced in the Mexico currency devaluation in 1982. For a while, the banks will either impose a limit on withdrawals, or will charge depositors to withdraw their money. As I mentioned in the previous article, in the Cyprus “Bail-In” crisis of 2013, depositors with more than $130,000 lost 9.9% of their money. A surcharge. Depositors with amounts less than $130,000 were clipped for 6.75% of their deposits, even if they were insured. Remember, rules can be broken, and new rules can be written at will. And you can bet the new rules won’t benefit you and me.
Do you think you’re safe with your gold and jewels in a safety deposit box? Think again. In Greece, there are plans raid bank safety deposit boxes to confiscate cash, bonds and even works of art just to pay off government debt. In Italy in 2016 and 2017, when a few key Italian banks, Veneto Banca and Banca Populare di Vicenza, were on the verge of failure, the solution was an “investor bail-in.” This is when bank stockholders and bondholders are forced to pay large amounts just to keep the bank afloat. So much for a safe and profitable investment.
Also, it’s not just your bank account that is at risk. In Greece, pension funds have been cut at least 10 times in the past few years. In California, the California Public Employees Retirement System (CalPers), one of the nation’s largest, has lost $100 BILLION dollars dating back to the 2007-08 recession. Only about 2/3 of current and future retirees are covered by current reserves. In fact, governments in several states are already reducing their previously-agreed-upon contributions for government pension funds. In Illinois in 2013, pension benefits were slashed for employees to avert failure of the fund which was facing a $100 billion shortfall. And there are many other examples. My point in describing the Mexico currency devaluation is: Rules Can be Broken. And in many cases, the rules for our government, banks, credit unions, financial institutions and pensions are already being broken and rewritten as we speak.
Time To Make Some Changes
So, you may ask, what can I do? I can understand not wanting to do anything to jeopardize your retirement contributions. However, what about your savings, and any other investments you may have? For example, if you have an annuity, you can cash it in under certain circumstances. If you have a 401K, if you are younger than 59½ years old, you can withdraw it with a 10% penalty, plus any taxes on it. To avoid penalties, some investment funds will allow you to take out a “loan” on your investment, without taxes and penalties, as long as you make minimum payments to repay it. If you have CDs, you can either wait until they mature to withdraw your funds, or pay a penalty and at least get your cash. Most CD early withdrawals will only charge a certain portion of your interest and not the principal, but check with your broker for details on this.
Now, what about stocks and bonds? We have seen some wild swings in the stock market lately. The Dow Jones hit an all-time high of 26,828 in October last year, then fell 4% the following week. The market has since gone up and down, but the key concern here is volatility. Even though the economy has mostly recovered in the past year or so, there is so much uncertainty, especially with the government shutdown, immigration, and the 800-lb. twin gorillas of the current $21.6 trillion government debt, and $1.2 QUADRILLION derivative exposure worldwide. Now, when some of those derivative deals the banks and other institutions have made start going sour, guess who will be asked to bail them out before they close their doors? That’s right! You and me!
Now, some of you might ask, do I think a future collapse will be partial and/or gradual, or complete and sudden? The answer is, I have no idea. However, I have had enough experience in at least a partial collapse in the Mexico currency devaluation to have a strong desire to take action ahead of time, instead of waiting for fate to close in on me, whether gradually or suddenly. I have had enough experience from the past to know that I should take action now, buy those essentials now, before their prices skyrocket or when they become totally unavailable.
What should you buy? Buy land, buy non-perishable food, buy gold and/or silver, buy anything but keeping your money locked up in a bank or investment house where the future rules are bound to be broken, and you end up paying for it. When it comes to the government, banks and other institutions, trust no one! Take care of yourself and your family now, instead of kicking yourself later on for not taking action sooner!