Wednesday, May 10, 2006

Buying Mexico: Not As Hard As You'd Think!

Yesterday I reviewed some of the reasons why it is in the best interests of Mexico and the United States for our country to purchase our southern neighbor. We could discuss the reasons at length, but there is no more compelling justification for why this must be done than a simple trip across that very border.

Moving south into Mexico one is struck with how quickly prosperity turns to poverty. Although no real geographic advantage is afforded to the U.S border states of Texas, New Mexico, Arizona or California, one could be excused if they were to think there was some awful disadvantage to Mexico’s location in North America. The reality, of course, is the exact opposite. By virtually any measure Mexico has the happy advantage of bordering the world’s most successful country, and this fact alone should provide outsized advantage to Mexico relative to other locations. Just as real though, is the sad truth of how one country’s government can so utterly fail its own people.

We must buy Mexico.

Before we go further, I should mention that the inspiration for this series posts (beyond the idiotic demonstrations of the preceding week), is an article by Mr. Walter Mead that appeared in Esquire Magazine somewhere in the early ‘90’s titled, “Let’s Buy Siberia!” I’ve Googled high and low for a copy and have been unable to find it, but I do believe that the model described by Mr. Mead serves as a decent proxy for what I am talking about here. If you can locate it, it’s a worthy read and I sure would appreciate a copy.

As I said in yesterday’s preview to today’s post, buying Mexico seems to be a difficult proposition, but I suspect that from a financial point of view it really is not that daunting of a challenge. True, there are cultural concerns on both sides; fear of the unknown for both sets of citizens and a general preference for the status quo, but I think these can be overcome if we get the numbers right.

The numbers, of course are daunting. Mexico’s current GNP of $700 billion would command a hefty price tag. To come up with a price (attention Mexico this is for illustrative purposes only and not an offer to purchase. Mr. Pursuit, Pursuit Worldwide Inc., and its employees shall not be held responsible for any offer implied or otherwise) I’ve employed some basic present value analysis. My assumptions are as follows:

Our investment horizon is 20 years (value after that is the result of new owners’ efforts)

Mexico GNP remains flat at $700B during this period

Discount Rate: 6%; admittedly high, but this is buy no means a risk free deal

Popping these numbers into my handy Excel spreadsheet I’m coming up with a value for Mexico of approximately $8Trillion. Whew! That’s pretty rich for an underperforming country, but don’t go all weak kneed on me and suffer the vapors – lets think this one through. Yes, I admit this would require an extraordinary expansion in our public debt but we must remember that unlike so much of our existing publicly held debt this issuance would actually be paying for value producing assets! In fact, our payback on existing GNP alone would only be a little over 11 years, not so bad.

Of course, I have not factored in any negotiation on this deal and I’d recommend that we low ball these guys because my guess is that Mexico is a buyers’ market. Think about it; how many countries out there would have an interest in purchasing Mexico? Certainly the U.S. is one and others might be Spain and Brazil, after which interest falls off pretty fast. Given that group, Spain is really the only other country that might be able to pull off such a deal, but the truth is that this is extremely unlikely.

In other words, it’s good to be the deep pockets guy when you’re on offense and the happy result is that I think we can negotiate this baby down to $5trillion, which still represents a fine deal for the sellers since the benefits for Mexico would be profound:

We would pay off all of the country’s externally held debt of $174B

A majority of the remaining purchase price would be used to upgrade public infrastructure

A cash rebate would be paid to Mexico’s 105 million citizens.

The legal system would be brought up to par with America’s system

The government would be reformed into a two party system with American style checks and balances

The U.S. greenback would provide a stable currency, controlled by the Fed

This is just the beginning; the economic benefits that would accrue to ordinary Mexicans would change life as they know it today. To estimate the impact we only have to look at NAFTA’s impact to see what complete removal of the border might accomplish from an economic point of view.

Since NAFTA passed over 10 years ago the economic landscape of Mexico and the U.S. has changed substantially. Trade between the two countries has tripled to an annual number of $252B. Over the past ten years American manufacturing output has increased 41% as compared 34% during the ten years preceding NAFTA. Worker productivity has been positively impacted in both countries and Mexico’s economy has become more market based than it was prior to NAFTA.

Still, more can be done, and by purchasing Mexico we’d accomplish this feat with one simple act. Annual U.S. investment in Mexican manufacturing now stands at $1.9B. This compares unfavorably to both the $230B we invest annually in our domestic manufacturing base, and that which we invest in other countries. Eliminating the border between the two countries, and establishing greater legal standing to private property rights for both Mexican and U.S. entities would have the affect of multiplying this investment substantially. U.S. companies and private individuals would be encouraged to allocate their capital as efficiently as possible in both locations of the newly expanded U.S. providing real jobs and opportunity for all. As we all know, while it may be truth that sets you free, access to capital and efficient investment are what make that freedom a beautiful thing.

The question is how much opportunity can we create and how do we measure the impact this change would have on Mexico? For the answer I suggest that we look north to Canada. While not a perfect analogy Canada does have the benefit (for analogy purposes) of sharing a border with the U.S., and having an economy that is based on both natural resources production and manufacturing. It does have a modern financial and service sector as well, which represents the future of how Mexico would develop as the economy grew and became more sophisticated.

There can be no question that Canadians have done marvelous job of taking advantage of their co-location with the U.S. and the fact is that over 90% of the Canadian population lives within 100 miles of the U.S. border! Our businesses trade easily, our cultures mix, and investment in goods and services is efficiently allocated between the two countries. Sadly, for a variety of reasons, Mexico hasn’t faired so well and the results are found in some startling GDP numbers.

Compared to Mexico, Canada’s GDP per capita is approximately three times that of Mexico’s; $31,000 annually compared to $6,700. Canada has achieved this mark and become the worlds 7th largest economy because of its solid support of private property, its stable currency and predictable governance. With the purchase of Mexico it is not unreasonable to expect that the U.S. would implement the same reforms with similar results over the course of our 20 year investment horizon.

And the results would be astounding. Were Mexico to simply move into line on a per capita basis with Canada – ignoring “normal” growth and population expansion, Mexico’s GDP would increase to $2.3T annually making it by today’s numbers the fifth largest economy in the world ahead of countries such as the U.K., France, Italy, and yes, Canada itself. Remember though, that we would be making Mexico a full member of the U.S. with all the benefits of our legal system, currency, and stable government; something Canada does not have access to. Is it therefore reasonable to think that Mexico might do better than Canada under these relative advantages? It certainly is possible.

Now I’m on to you folks, because I know what you’re thinking: “Well yah, but that growth would just come out of America’s hide and net, net we’d be worse off and they’d be better off. No difference in total”. Shame on you people! Take two Milton Friedmans and call me in the morning! Everyone knows, or at least those with a modicum of sense know, that global economies are not zero sum games. That is, we all know that just because someone wins doesn’t mean that someone else will lose.

Growth is growth baby, and what we would be accomplishing with our Mexican buyout would be providing the Mexican people with an opportunity to realize their full potential. We would be investing capital, making the allocation of that capital more efficient, with the resulting benefit being that Mexican growth would come from their adding increased value to the global economy! The idea that they somehow would be stealing this growth from the U.S. or any other country for that matter is contrary to everything we know about modern economic theory. In fact, given the increased allocation of capital and the addition of a new, fast growing segment of the domestic U.S. market, it is quite likely that we’d see growth rates in the U.S. expand as well.

The beauty part is summed up in two words people: Value Creation. Gosh, I’m almost weepy just thinking about it. Say it with me: Value Creation. Why is that so beautiful? Well yes we would be making the lives of each and every Mexican better but as wonderful as that is that isn’t really it. No, the beauty part is that Mexico, since it would now be part of the U.S., would be increasing in value as part of the United States of Blessed America! In other words, all that new value would be taxable and serve as a source of debt repayment on the five trillion that we borrowed to do the deal!

In other words, we didn’t just buy Mexico; we accomplished a leveraged buyout deal utilizing the lowest cost of capital in the history of mankind! We’d be friggin’ geniuses! Future generations would marvel at our skill and foresight.

And it just gets better. Anybody want to guess the demographics of the Mexican population? That’s right, they’re skewed towards youth. 30% of the population is under 14 and a full 94% are under 65. This matters because we need young workers with long lives ahead of them to help support our baby boom generation in retirement.

Gracias Amigos!

There was a time in America when we thought about expansion. Thomas Jefferson took advantage of Napoleon’s financial problems and executed the Louisiana Purchase and Americans everywhere talked excitedly about our “Manifest Destiny”. The purchase of Mexico could be every bit as important as Jefferson’s coup, and perhaps more so. We just need to summon the courage and determination to make it happen.

Tomorrow: Yes, but what about all of those voters?

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