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Sleight of hand

7 April 2009

Would you play poker with the Banco de Mexico Governors? From AFP:

Mexico’s central bank announced Friday that it would activate a credit swap with the US Federal Reserve in an auction of up to four billion dollars on April 21.

“The purpose of this credit is to provide financing to members of the private sector under pressure to obtain resources to meet dollar commitments,” a statement said.

The Federal Reserve agreed last October to swap dollars for the local currencies of Brazil, Mexico, South Korea and Singapore to unfreeze money markets in emerging market countries.

Mexico this week also requested a new International Monetary Fund mechanism granting a 47-billion-dollar line of credit, to add to foreign reserves of almost 80 billion dollars.

The request marked the first time in a decade that Latin America’s second biggest economy has sought IMF help and aimed to give a positive signal amid worsening predictions for the economy closely tied to the United States.

The request “should reduce the perception of risk from investors in relation to the Mexican economy,” central bank governor Guillermo Ortiz said Wednesday.

Mexican companies wanted to borrow money, but Mexican banks have very tight credit requirements, and make their loans in pesos.  So the Mexican businesses borrowed their money from U.S. lenders who loan dollars and expect to be repaid in dollars.

The U.S. lenders didn’t have the dollars to lend, but that didn’t bother them. The lenders gambled that the borrower would have enough dollars to pay the loan, so borrowed the dollars from other U.S. lenders who gambled that the money would be there to pay their loans.  In turn, these lenders borrowed from other guys who also were gambling that eventually the dollars would be there… and, in the end, everybody was wrong.  The dollars were never there.

And the peso — which is what the Mexican banks have — lost value because everyone assumed there would be enough dollars to cover the Mexican debts.  Game over… unless the dollars magically appear.

The Federal Reserve Bank has dollars, but not enough to cover all the gambling debts… some, but not all.  The Banco de Mexico also has dollars, and is gambling that IF the Federal Reserve has a few dollars more to cover some of the gambling debts of the U.S. lenders, then the peso will go up in value.

The Banco de Mexico is borrowing 47 billion dollars from the International Monetary Fund on this gamble.  That’s almost comprehensible.  What’s hard to fathom is that the BdeM is going to sell off 4 billion DOLLARS in IOUs… which will turn into pesos and give the Federal Reserve more dollars.

If they pull this off, the  Banco de Mexico governors belong in Vegas — not at the poker table, but on stage, performing magic tricks.

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