Tequila Effect

If we were to ask country artist Joe Nichols to describe the “Tequila effect,” he’d tell us that it makes his wife’s clothes fall off. Which is interesting, to be sure...but it’s not quite the “tequila effect” we were thinking of.

In the world of economics, the “Tequila Effect”—it’s capitalized because it’s important—is a name for the South American after-effects of the Mexican peso freefall in 1994. It didn’t quite make anyone’s clothes fall off, but it did make a bunch of other currencies shed a bunch of their value, which isn’t good.

In 1994, the Mexican peso was overvalued. Everyone knew this, but no one knew how overvalued until the Mexican government devalued it and then subsequently raised interest rates to ease the devaluation blow. Within a few months, the peso dropped like a sack of tamales, losing half of its remaining value and sending the South American economy—especially Argentina and Brazil—into a tizzy. Eventually, the U.S. and the IMF got together and sent a $50 million bailout care package to Mexico. The money was nice, but it came with strings attached: Mexico had to promise not to do any of the shady stuff it had done in the past that had led to the overvalued peso problem in the first place.