Warning: Capital Controls Are in Your Future

When Jim Rogers taught classes at Columbia, he liked to tell students that the US had a proud history of implementing capital controls, and warned them against going on the merry assumption that it would ever and always be easy to make cross-border investments. For instance, taxes on foreign securities transactins are a soft form of control and have been used to facilitate or restrict cross-border capital flows. The US lowered them when it abandoned Bretton Woods in 1971 to aid in adjustment of the price of the greenback.

Despite the hue and cry that we must keep trade and capital flows open, I have long believed that they would be restricted as financial reforms moved forward. The Carmen Reinhart-Kenneth Rogoff work shows convincingly that periods of high international capital mobility are associated with frequent banking crises. They do not assert that the relationship is causal, but I suspect it is. Capital that can move easily across borders is by nature difficult to regulate. It would require a considerable sacrifice of national sovereignity to devise rules and organizations that could do an adequate job of supervision. So a high level of international investment flows means lawless or seriously underregulated financial firms and activities. And we have just seen that this lawlessness eventually exacts unacceptably high costs to the real economy.

Thus, measures to increase stability that will be effective can only take place on a national level, and they further require at least some restriction of cross border flows. But how that would come about remained a mystery to me, hence my silence on this topic. Everyone seems wedded to the prevailing ideology of “fewer international restrictions are better.” Indeed, some have decried how awful it would be if the world were to revert to largely national pools of capital, depicting it as a financial Dark Ages. But would it be a Dark Ages for the economy, or merely for bankers?

Russell Napier in today’s Financial Times, describes how capital restrictions might come about, and his case is entirely plausible. The interest of high finance are increasingly opposed to those of governments. Capital will want to flee to havens which are not suffering from the need to work off enormous bank rescue costs. But those very same governments will find it necessary to keep funds at home to earn a return to work down those very same expenses. Hence capital controls.

From the Financial Times:

One consequence of the financial crisis is that fund managers are increasingly going to come into conflict with governments…

Developed world governments are desperate for finance; they will attempt to constrain private-sector credit growth and are likely to ease the economic pain with inflation and exchange-rate depreciation.

This differs from the environment of the past few decades when investors were happy to save in their own currencies, buy government debt and participate in credit-fuelled domestic asset booms. Will fund manager fiduciaries now be prepared to finance record fiscal deficits? Will they buy domestic assets in an era of sub-par credit growth? And will they buy shares in banks stuffed with government credit and loans aimed at securing employment rather than sound returns?

If they don’t, how much capital will they export? Indeed, might they consider it prudent to short government debt to protect their clients’ wealth? To protect against inflation, might they buy commodities?

This may all look necessary to fiduciaries, but governments will view it as speculating against their currencies and driving up the cost of government financing. Governments will not stand by and watch what they might come to term “capital behaving badly”.

Until 2008, capital colluded in maintaining the myth of prosperity, by providing the credit for excessive consumption. Capital supported the illusion of savings by pumping up equity valuations to ridiculous levels; and it supported the need to speculate, most notably in the housing market, by manufacturing savings that could not be earned. This support ended with a bang, and governments stepped in to prevent the deflation that would have brought poverty all too quickly.

The first emergency step was to partially nationalise commercial banks, but government interference with capital allocation will not end there. The need to bail out the banking system accelerated the public debt crisis that was coming anyway, due to the baby-boomers’ failure to save for their retirement. Once known as the ‘Grateful Dead’ generation, their demand for pensions and healthcare will mean they will increasingly be seen as the ungrateful undead. The political necessity of supporting their claims will drive government further into the capital allocation business.

Governments still need the support of capital to ensure that the myth of prosperity dies slowly. If that support is not provided willingly, history shows that governments can conscript capital to the cause. So what sort of “national service” can we expect ?

A transaction tax on financial instruments is very likely… A suitably high transaction tax would force investors to hold shares for much longer periods and to engage management to control risk. This would reduce the need for governments to police risk-taking in corporations. What could be more laudable than a tax that turned everybody into Warren Buffett?

Capital controls are also more likely than investors believe….There is an inherent conflict between western governments’ need for finance to sustain living standards and capital’s need to seek out the greater growth opportunities in emerging markets. Whatever the long-term benefits in boosting returns on savings, the short-term political necessity of public financing is likely to necessitate slowing capital outflows.

Capital controls seem impossible to many, but when a choice has to be made between economic principle and government bankruptcy, they are a likely political response

Japan is a case study in the cost of losing control of capital flows. The government made it easy for retail investors to buy foreign currency investment, with the logic being that yen-based returns were so low, savers needed to be allowed the opportunity to earn higher yields overseas. Unfortunately, a cadre of retail FX traders, every bit as manic as US day traders and holding even more funds in aggregate, now dominates yen trading. The government now has more impediments than it otherwise would have in influencing the level of the yen thanks to this self-inflicted wound (not that currencies are easy to manage even in the best of circumstances, but this policy has made a difficult task even more fraught).

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  1. Majia

    The article “capital controls are in your future” assumes that government represents the interests of the population over the interests of capital. Neoliberalism subordinates government to capital. So, it may not be the case after all that capital controls are in the future…

  2. Aki_Izayoi

    Roger’s analysis is correct, and I do count protectionism as a form of “capital controls” since it is a disincentive to move capital abroad.

  3. mmckinl

    Capital controls should be used.

    Capital is now being used as a weapon. Financial Transaction Taxes would accomplish at least two goals. They would deter damaging “casino capital” movements and help fill government coffers.

    We have seen companies driven to bankruptcy for no other reason than to collect on derivatives. We have seen the corrosive effect on the public good of threats and instances of “casino capital”.

    In the last analysis “casino capital” is being used as a weapon not as investment. Casino capital is driving resource
    destruction, pollution, labor abuse and tax washing …

  4. ComparedToWhat?

    Another angle is that countries with closed capital markets have come out of the crisis relatively better so far, while very open countries have done poorly. The distinction will become more dramatic over time as the extent to which financial institutions and public sector balance sheets are impaired becomes more obvious.

    Limited opening, only to the extent required to acquire skills and technologies from foreign partners, might be the preference of many potential destination countries.

    If so, and if Napier is correct which seems plausible, cross-border flows could be restricted from both sides in future.

    1. SidFinster

      I am just a tabby cat, not a neocon or a Randroid but Ukraine has very strict capital controls and it has suffered mightily under the crisis.

      On the other hand, the biggest economic success stories post WWII are Japan, Taiwan, South Korea, China, Singapore, etc.. None of these countries followed the Jeffery Sachs/World Bank neoliberalism model.

      Until fairly recently, by practicing merciless import substitution; respect for cats; state financing and currency devaluation; “national champions” and export promotion; active government support of favored industries, products, and sectors, and controls on both export and import of capital, these countries violated pretty much every neoliberal prescription.

      That’s right, in many cases foreign investment was either actively discouraged, restricted, or even banned, on the grounds that foreign investors were harder to regulate or could not be trusted to have national interests at heart.

  5. gordon

    Imposition of capital controls might make the idea of comparative advantage relevant again. I get so tired of people recycling this idea, which was developed in an era of far lower capital mobility than today, as though it were still applicable.

  6. dippy

    Here is a thought. As we decided what is real or not religion, economics, our cerebral chemistry, communism, socialism, fascism or democracy/republic we eat the very floor boards under our species for what, to be the last one standing.

    Oh DownSouth and Dave they wish to kill themselves just to prove a point of contention rather than learn to live together with difference of opinion.

    Dippy…how fkin hard is it really, when lead is zipping past your head it seems so foolish..eh.

    1. DownSouth


      It is undeniable that, as Daniel Yankelovich put it, that “anti-intellectualism runs like a thread through American history”. And it is also undeniable that this has in many ways worked to the advantage of the nation. As the theologian Reinhold Niebuhr wrote in The Irony of American History,: “Any modern community which establishes a tolerable justice is the beneficiary of the ironic triumph of the wisdom of common sense over the foolishness of its wise men.”

      But sometimes anti-intellectualism can go too far. As Yankelovich goes on to point out: “If the experts grow too bold, the electorate will express itself in populist fury and launch another episode of native know-nothingness.” (Coming to Public Judgment: Making Democracy Work in a Complex World) I think there is considerable fear of this now, especially since the discipline of economics “as a science” lies in complete shambles.

      But it is also possible that the US is now beginning to pay a price for its anti-intellectualism in a very different way. “I think this loss of an allegedly purely theoretical interest in political issues has not been the ‘genius’ of American history but, on the contrary, the chief reason the American Revolution has remained sterile in terms of world politics,” Hannah Arendt theorizes in On Revolution. “By the same token,” she continues, “I am inclined to think that it was precisely the great amount of theoretical concern and conceptual thought lavished upon the French Revolution by Europe’s thinkers and philosophers which contributed decisively to its world-wide success, despite its disastrous end.” The consequences of this may prove to be the end of the American republic as we know it, for, as Arendt goes on to explain, the spirit of the American Revolution, “where the exact opposite took place” as did in the French Revolution, has been smothered under all the attention heaped upon the latter.

      When viewed through the intellectual vacuum that exists in the US, the disastrous outcome of the French Revolution (combined with other revolutionary calamities such as the October Revolution and the Chinese Revolution) has resulted in the “triumphant success” of the American Revolution and its spirit of “public freedom, public happiness and public spirit” having all but been forgotten. Instead, Arendt concludes, what remains are, “in the main, outspokenly anti-revolutionary trends of political thought in America.”

      Lacking any intellectual framework to underpin and preserve the American revolutionary spirit, we may find that spirit ebbing away.

      1. Skippy

        Thanks for the pep talk_lol_affirmation.

        As some one who was using firearms, farm machinery, explosives, stomping around in the sticks, grandparents farm Franklin County MO or the 200K acres of desert my family had in geological rights in AZ on my own before puberty. It never ceased to amaze me when I opened my mouth in class reciting better knowledge on a subject than the teacher and fellow students, to be belittled by the hole room, expand that to almost all social situations.

        As someone who moved between two worlds ie: the commonality of farming community rural Midwest America to the wealthy upwardly mobile Maracopa County AZ community/South Bay Calif Beach/Brentwood/BelAir/Palo’s Verde/Pacific Palisades money movie-star cocaine make a buck bugaloo. I am always at a loss for words to describe our sociality’s condition_not…dumb/plain/outwardly focused = happiness, feel bad buy something, doubt your self seek a belief system, there are only winners and losers_don’t be a loser, life is to short be happy_so indulge your self regardless of consequences to others or future generations, its us or them, happiness is glossy advertising realized, humility/empathy/selfless acts/etc are character flaws, where self entitlement/greed/debasement of others/denial of actions, are character traits to be glorified.

        Skippy’s gone Dippy…Have friends that just came back from the states after vacation and now are thinking about moving to AZ for a few years…should I tell them or not ummm…dam the programing over there is soooo good…plethera of self indulgence awaits, if ya got the bucks.

        Disclaimer: yes its getting like that over here, but until recently we were about 20 years behind hence the old stinging phrase ‘wow its just like America was 20yr ago said the yank tourist’ Aussie politely gritting teeth whilst smiling. Never fear we are trying are best to catch up, for trade and military purposes, dam the consequences.

    1. Richard Kline

      And what major economy at present already _has_ fairly substantive cross-border capital controls? China; yes indeed, ‘those dirty Communists.’ So their experience throught this crisis may serve as a proof-of-concept.

      Controls aren’t perfect, and I personally dislike arguing counterfactuals. That said, consider where China would be at present without those controls over the last half dozen years, and the value of said controls kinda leaps out at a person. Not trusting capitalists beyond arms length has its virtues, what?

  7. Swedish Lex

    Thoughts not too dissimilar to these have been rumbling around my head too, although I come from a different perspective.

    The EU is debating a proposal to regulate managers of alternative investment vehicles (hedge funds, private equity, etc.). The Industry loathes the proposal and not only for the wrong reasons. The initial proposal was flawed in several ways which has pushed the financial industry into lobbying overdrive.

    The proposal contains provisions that would submit managers of funds from non-EU states to a passport requirement that would, from what I understand, take three years to obtain and be quite onerous (at least in comparison to existing requirements) and, furthermore, establish specific requirements triggered by the tax (haven) status of the third countries from which non-EU managers may operate. The Industry says these requirements in the draft are like death threats.

    This is clearly an attempt by the EC Commission to set up regulatory controls that would raise barriers to entry for managers who wish to operate out of or into the EU that, if enacted, to some degree would act as indirect controls of capital. By fast-tracking a rather radical proposal, the EC Commission in a way put the cart before the horse. It would have been better to first have had a broad intra-EU debate on the future shape of finance altogether and only then hammer out the various proposals that would be required. The outcome of such a debate may have been A) onerous requirements on providers of financial services in the EU and B) barriers to entry for providers operating out of third countries that permit e.g. anarchic leverage.

    1. DownSouth

      I agree NS, especially when Stiglitz’ paper is seen in juxtaposition to Nial Fergusons’s paper that Yves linked yesterday:

      Could it be that the more prescient neoliberals (or “neo-imperialists”, as Greg Grandin dubbed him) like Ferguson, seeing that they can no longer defend the unholy combination of 1) no regulation of the finance industry and 2) massive government subsidization of the finance industry, are falling back to a more defensible position, which is to try to defend only the no-regulation part?

      The Mexican writer Carlos Fuentes wrote in The Buried Mirror that the perception of Latin Americans of the United States “has been that of a democracy inside and an empire outside: Dr. Jekyll and Mr. Hyde.” And in A New Time for Mexico Fuentes gives a blow by blow description of the devastating economic, social and political consequences wrecked upon a nation by the vagaries of free capital flows.

      And Richard Kline is, as usual, quite right in his observations about China. Many Latin Americans glance across the Pacific and long for the clairvoyance, or the ability, to have rejected the Washington Consensus outright as many Asian countries did. But as many are quick to point out, Latin America, by the sheer weight of propinquity and the United States’ knack for “imposing the rule of law, property rights and other guarantees, at gunpoint if necessary,” as the neocon Max Boot so candidly put it, really left Latin America with no other choice than to succumb to neoliberalism.

      But now that the devastating effects of neoliberalism are coming home to roost to the developed world, maybe we’ll learn that what’s good for the goose isn’t so good for the gander after all. As long as it was some other country being sacrificed on the altar of neoliberalism, denizens of the developed countries didn’t seem to be too objectionable to free capital flows.

      But Majia (see comment above) also makes an excellent point. Is the United States, as Fuentes put it, still “a democracy inside”? Many in the finance industry, quite unlike Ferguson, still obviously cling to the belief that neoliberalism can be imposed upon the United States, and, as was made clarion in Pittsburgh during the G20, “at gunpoint if necessary.”

      I think that the struggle currently taking place for the heart and soul of America is nowhere better captured than in this video the students at the University of Pennsylvania posted on their forum:


  8. yu-mei

    Capital controls are already in effect for average citizens; have you ever try to open a bank account abroad?

  9. Siggy

    Can someone tell me what public good is accomplished by imposing capital controls? If there is the general perception that capital controls will produce a public benefit, capital controls will occur.

    Then there is the issue of a government that believes that it can absolutely control its economy. Can such a state exist in an interdependent world. Is there a state that is an effective autarky?

    1. Peripheral Visionary

      Siggy, the public good is the protection of the capital markets from the destabilizing “hot money” flows that can take down banks and other vulnerable institutions.

      It should be noted that the U.S. experienced significant growth throughout the 19th Century, even as tariffs were high, capital markets unstable and/or illiquid, and government meddling in the economy significant. The accepted wisdom that the strongest growth comes when borders are open, capital markets extremely liquid, and the government hands-off may be true; however, the flip side of that is the devastating economic collapses that seem to inevitably follow such policies, as we saw in both the 1930’s and now at present.

      The protectionist and mercantilist policies of previous eras had their own problems, but it is not at all self-evident that they are fundamentally worse than the current regime.

  10. Hugh

    Unregulated international capital flows are a major piece in the architecture of the paper economy which has proved so good at creating bubbles followed by great wealth destruction. Controls are in order. The trick is for them to be tight enough to give countries some control over their economic planning and loose enough to permit global trade.

  11. john c. halasz

    I’ll just post an old comment of mine from another blog, to avoid redundant effort.

    “As to Foley and for-ex, he seems to be referring to a reversion to Keynes original intention in conceiving Bretton Woods, namely to encourage international trade in goods, while discouraging free flowing international finance capital and allowing for sovereign control of domestic monetary and fiscal policy. The system of adjustable-peg fixed rates didn’t prevent currency adjustments, but controlled the process. Google “1948 Havana Charter”, which was actually ratified by some 60 nations, except one, the U.S.A., whose refusal scuttled the treaty because the U.S. didn’t want to cede its “sovereignty”, so GATT, which was only supposed to be a stop-gap interim accord, remained in place, until transformed into the WTO. The Bancor proposal, which would have place the responsibility for trade and currency adjustments on creditor/surplus national economies was also nixed by U.S. veto. I think Foley’s point is that floating exchange rates tend to be swamped by short-run capital flows and remain for extended periods far from PPP “equilibrium”, as can be amply seen in the current crisis. Thomas Palley has similar ideas about pegging with a crawling peg to a basket of major currencies to replace U.S.$ as international reserve currency. Capital controls against short-run flows would presumably also be part of the system. (Those who charge the Chinese with mercantilism have it only half right; just as important to their thinking, I think, is the maintenance of capital controls and domestic control over their financial economy).

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