Often, political relations between two countries also shape their trading partnerships. The United States has long depended on China for rapid and affordable production of goods.

However, as China’s and the United States’ political relationship has become more tense, so have trade tariffs. Specifically, under the Trump administration, steep tariffs were implemented on imported Chinese goods. Since Chinese goods became more expensive for purchase, individuals have begun looking towards Mexico as an alternative to goods produced in China.

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Mexico as the new choice?

The primary reason for the emerging preference for Mexico is the two countries’ geographical proximity to one another. It is much cheaper for the United States to import goods from Mexico than from China, which requires a voyage across the Pacific Ocean. Additionally, after the impact of Coronavirus on backlogging products, United States officials and businesses have recognized it is not in their best interest to rely so heavily on China. Making new trade routes to Mexico to accommodate increased trading is much easier to manage.

Raine Madhdi, the founder of Zipfox, a San Diego-based company that links factories in Mexico with American companies seeking alternatives to Asia, explained that “everybody who sources from China understands that there’s no way to get around that Pacific Ocean.” He says there “always” is “this push from customers: “can you get it here faster?””

Another benefit of increased trade with Mexico is that the United States and Mexico operate within an expansive trade zone, meaning that their supply chains are often intertwined. Therefore, businesses in both countries can supply raw materials and other parts of production that are used in the final goods of products made in the other country. And as American companies have begun shifting to Mexico to source their products, Mexico has increased staffing and factories for production.

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Impact on the foreign exchange market

Naturally, this newly strong trading relationship with Mexico and the United States will impact the foreign exchange market. Increased export of Mexican products will benefit Mexico. In the short run, as the demand for Mexican products increases, so will the demand for pesos (because individuals need it to purchase Mexican products). This means that demand for pesos will increase in Mexico’s foreign exchange market. As demand for pesos in Mexico’s trade market increases, so will the price of pesos in dollars. At the same time, the quantity of pesos will increase.

In the United States foreign exchange market, the supply of US dollars will increase as consumerism increases for Mexican goods. This will depreciate the price of dollars in pesos and increase the quantity of US dollars. Due to this increase in spending on imports, the aggregate demand will decrease in the United States.

As the price level within the American economy decreases, so will its gross domestic product (because fewer American goods will be produced and bought), and unemployment will rise. Mexico, on the other hand, which has growing exports and employment, will therefore have increasing aggregate demand, so, Mexico’s price level and GDP will also increase.

The long run

In the long run, the immediate short-run impacts of the increased demand for Mexican products will level out and likely return near the countries’ respective ‘start positions’ before the short-run shocks. A higher price level in Mexico will cause higher inflation. This will lead foreign importers to feel as though there is not a greater benefit to buying as much Mexican goods. Thus, the demand for pesos in Mexico’s foreign exchange market will decrease, lowering the prices of pesos in dollars and the quantity of pesos. Likewise, Mexico’s price level and GDP will lower in its aggregate supply and demand market. Eventually, the United States’ supply of dollars in its foreign exchange market will shift back, therefore increasing the price of dollars in pesos while decreasing the quantity of US dollars. The aggregate supply and demand market for the United States will increase GDP, and its price level aggregate demand increases with less consumption of imports.

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