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The largest denomination banknote ever officially issued for circulation was in 1946 by the
Hungarian National Bank for the amount of 100 quintillion pengő
(100,000,000,000,000,000,000, or 1020; 100 trillion on the long scale). image (There was even a
banknote worth 10 times more, i.e. 1021 pengő, printed, but not issued image.) The banknotes
however did not depict the numbers, "hundred million b.-pengő" ("hundred million billion
pengő") and "one milliard b.-pengő" were spelled out instead. This makes the
100,000,000,000,000 Zimbabwean dollar banknotes the notes with the greatest number of zeros
shown.
In 1946 Hungary issued a 100 Million B-Pengo, which was the the largest circulated banknote at
the time, unfortunately it was worth only about $0.20 USD in 1946.
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A
Graphical Look at the Peso Collapse
As shown in Figure 7-IV.1, the peso was fixed in
value in relation to the dollar in the early 1990s. The
graph shows the peso pegged to the dollar at a
exchange rate of one peso to $0.28 (which equals 3.5
pesos to $1). Note that we show the quantity of pesos
in world foreign exchange markets on the horizontal
axis and the $/peso exchange rate on the vertical
axis. In the beginning of 1994, it took $0.28 to buy a
peso's worth of Mexican goods.
After nearly a decade of nonexistent economic growth, the Salinas-led surge in the Mexican
economy occurred in the early 1990s. Economic growth averaged 3.1% annually, a respectable
rate, although slow in comparison to other developing economies. Increasing rates of economic
growth, coupled with the strong exchange rate of the peso (which kept U.S. imports relatively
cheap and Mexican exports relatively expensive) caused a significant current account trade
deficit. With over 70% of Mexico's imports coming from the United States, the supply of pesos
was much greater than the corresponding demand in the current account.
As Figure 7-IV.2 displays, the Mexican current
account trade deficit of the early 1990s led to a net
increase in the supply of pesos in foreign currency
markets. By itself, the current account deficit puts
downward pressure on the peso's value. Offsetting
effects occurred in the capital market, where the
demand for pesos remained strong in early 1994.
As mentioned earlier, there was a substantial demand for pesos from foreign savers looking for
higher rates of return in Mexico's equity markets and an increase in direct investment by
businesses in Mexico seeking access to the growing Latin American consumer markets. The
capital account had a surplus due to the scorching rates of return being earned on Mexican
financial assets in the early 1990s. Consider 1993, when investors who purchased Mexican
stocks earned nearly a 100% rate of return, doubling their money in one year.
Figure 7-IV.3 shows the balance of the supply and demand for pesos in foreign exchange
markets in early 1994. Despite the significant supply of pesos resulting from the current account
deficit, demand in the capital account remained strong. The Salinas government had little trouble
maintaining a stable value of the peso in relation to the dollar.
The Mexican current account deficit was roughly balanced out by the capital account surplus. As
noted, the Mexican government had a large surplus of dollars to use in foreign exchange markets
to purchase pesos when the demand faltered. When there was downward pressure on the peso,
the Mexican government could use its ample dollar reserves (nearly $29 billion) to buy pesos in
foreign currency markets.
The United States Federal Reserve Fights Potential Inflation
After the recession of 1991 and the near catastrophe in the U.S. banking system resulting from
the Savings and Loan fallout, the Federal Reserve Board engaged in expansionary monetary
policies, eventually reducing U.S. interest rates. Falling interest rates helped to revitalize a
comatose banking system while preventing the extinction of the U.S. savings and loan industry.
A reduction in the federal budget deficit in 1993 resulted in significant reductions in long-term
interest rates, stimulating consumption and investment. By 1994 the U.S. economic growth rate
was soaring. Capacity Utilization and other inflationary indicators were reaching a danger zone
of potentially resurgent inflation. As a result the Fed slammed on the monetary brakes, raising
the U.S. Fed Funds interest rate seven times over the course of a year.
Rising U.S. interest rates increase the attractiveness of U.S. assets, such as bonds, to savers. The
higher U.S. rate of return coupled with the political uncertainty present in Mexico in 1994
initially caused Mexican savers to flee Mexican markets in favor of U.S. assets. U.S. money fund
managers quickly followed. True to form, money managers who controlled huge amounts of
U.S. savings held in Mexican assets, overreacted and raced each other to flee the Mexican
market. As the greed of 1993 turned to the panic of 1994, the value of Mexican stocks and bonds
plunged.
As savers left Mexican asset markets, the demand for
pesos in international currency markets dried up. In
addition, by December 1994 President Zedillo's
finance minister had nearly depleted the reserve of
dollars used to buy pesos in order to maintain its
fixed value. As shown on the graph to the left
(Figure 7-IV.4), the continued increase in the supply
of pesos due to the current account trade deficit,
coupled with the reduction in demand for pesos,
swamped the currency markets and President Zedillo
had no choice but to float the peso, allowing it to
depreciate.
Consequences of the Peso Depreciation
By the fall of 1995, the peso had depreciated to roughly 8 pesos to the dollar ($0.12). Economic
theory tells us several outcomes are likely when a country's currency falls as far as the peso in so
short a time period. This is especially true for a country like Mexico where international trade
represents an important part of GDP.



The peso depreciation will lead to a significant increase in the prices of imported
goods. This will result in a large spike in the prices of consumer goods and prices
paid by businesses for materials used in the production of goods. Higher input
prices raise production costs, further contributing to increases in the prices of final
goods. The net effect is the potential for a significant jump in the inflation rate.
The peso depreciation lowers the relative price of Mexican exports in world
markets, especially in the United States. The Mexican current account deficit will
fall as exports rise and more costly imports decrease.
The peso depreciation leaves the Mexican government no favorable choices. The
government can choose to use fiscal and monetary restraint to prevent inflation
and thus cause a severe recession. Or it can continue positive economic growth in
order to avoid higher unemployment rates and to mitigate social unrest, but at the
cost of ever-increasing inflation rates.
The statistics confirm Mexico's situation.
1. Inflation is exceeded 50% in 1995.
2. As a result of the cheaper peso, Mexican exports increased by 33% during the
first eight months of 1995 in comparison to a similar period during 1994. Overall,
the current account deficit became a surplus by the end of 1995. The effect of the
peso devaluation is especially pronounced in trade with the U.S. where Mexico
engages in almost three-fourths of its international trade.
3. The Mexican government chose to put on the economic brakes to prevent a
further inflationary spiral. 1995 GDP growth is expected to fell by -6% as a result,
and the total number of unemployed has doubled within the past year.
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Zedillo landed on his feet after leaving office in late 2000, however, and eventually scored a
cushy job in the states, as a professor of economics at Yale University, where he oversees the
Yale Center for the Study of Globalization. (An example of you screw up, you teach others how
to do the same.)
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Pictures for powerpoints:
Dharavi: