The Tequila Effect is a colloquial name given to the fallout of the 1994 Economic Crisis in Mexico, also known as the Mexican peso crisis. In Mexico it is often referred to as the December Mistake (el error de diciembre), a name introduced by Carlos Salinas de Gortari. The Tequila Effect is more precisely used to describe the domino effect that triggered economic crises in Argentina, Brazil, and other neighboring regions in Latin America.
Leading up to the economic crisis which triggered the Tequila Effect was President Carlos Salinas de Gortari’s administration. His government was notoriously corrupt, with members of the government receiving graft and skimming funds from the country. At the same time, entering an election year, Gortari underwent a program of large-scale spending, building up a large national deficit.
A conflict also broke out around the same time in Chiapas, causing a decrease in foreign investment, as investors waited for the country to stabilize somewhat. One of the candidates for president, Luis Donaldo Colosio, was also assassinated, leading to concerns among foreign investors that Mexico’s government was about to destabilize in a mode similar to other Latin American countries.
This lack of confidence from foreign investors meant that when the government needed to update their debt, which they had grown considerably through massive spending, they couldn’t find buyers. This left defaulting on their loans as one of the only options. This in turn led to investors losing more confidence in the government, triggering a minor failure of the banks, which in turn fed back and lessened investor confidence even more.
The Tequila Effect is complicated in part because of how many small things added up to a considerable collapse. The impending election played a large part in setting off the Tequila Effect, and not only because of the increased spending. In order to stop the investor confidence from causing a national economic downturn, which could have cost Salinas the election, the government bought large amounts of Treasury Securities, reducing its dollar asset reserves considerably.
After Salinas left office, a new president, Ernesto Zedillo, took office. Zedillo immediately tried to devalue the peso a bit, to get things stable again. Critics charge Zedillo handled this devaluation poorly, however, and foreign investment was withdrawn on a massive scale. Within a week, the peso fell in value from four to the dollar to more than seven to the dollar. This level of devaluation, which led to the Tequila Effect in neighboring countries, could have been catastrophic, but the United States intervened with a massive loan, helping to staunch the hemorrhaging of value somewhat.
The Tequila Effect spread before it was reversed, however, with the decline in the peso spreading to other countries. Brazil saw its currency devalue enormously over a very short period of time. Argentina was also hit hard by the Tequila Effect, with a decline in domestic spending and a credit crunch coming in 1995.