Tequila and tonight’s state dinner

May 19, 2010

Mexican President Filipe Calderon is in Washington, DC tonight for an official state dinner at the White House. While much of the focus will be on keeping the Salahis out and what will be served, the dinner will hopefully generate a good discussion of policy. Besides the major issues expected to be discussed (immigration and the drug war), the state dinner would be a good opportunity to reflect on Mexico’s fiscal crisis in 1994 and the lessons it can provide for overspending today.

We highlighted Mexico’s crisis and the ensuing “Tequila Effect” earlier this month:

Following two decades of overspending, Mexico faced a debt problem that was serious, but, at the time, manageable. However, violent uprisings in the country and political uncertainty led investors to question the riskiness of investing in Mexico’s debt. This led to a panicked sell-off of the debt holdings and, through a series of issues related to monetary policy, a rapid devaluation of the Peso. The crisis’s negative impact on the currencies of other South American economies was called the “Tequila Effect.”

The real lesson here is that countries shouldn’t act as if they are immune from fiscal crises by borrowing and spending, and borrowing and spending even more. The U.S. – as we have noted numerous times — is in a similarly precarious position and needs to immediately put itself on a sustainable course by cutting spending to manageable levels. Otherwise, we all could be facing the “Bourbon Effect” in the coming years.

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