by
Gary North
Tea Party Economist

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Are capital
controls coming to the United States? They may be for Switzerland,
The
Swiss National Bank has announced that it is considering the imposition
of controls. But these will be controls on euro accounts being
shifted into Swiss francs.

Why would
a central bank impose controls on money flowing in? Because this
will raise the market price of francs in relation to euros. The
central bank is dominated by mercantilist thinking. A rising currency
is seen as a liability. Why? Because exporters are hit by the falling
value of the foreign currency. Foreigners must pay more to buy francs
to buy Swiss goods.

Most nations
that have ever imposed capital controls have imposed them on the
“outflow” of money. I put “outflow” in quotation marks, because
there is no outflow of money.

Digits do
not flow across borders the way that goods and people do. Ownership
of digital accounts in one nation’s banks get traded for digital
accounts in foreign nations’ banks. The money supply does not change.
What changes are the owners of the digits on the various bank accounts.
Ownership of digital money shifts. The people trying to exchange
dollars for some other currency must find sellers of that currency
who are willing to sell. But the total amount of dollars in domestic
bank accounts does not change, nor does the total amount of foreign
currency digits in foreign bank accounts. Central banks and fractional
reserves establish the domestic money supply. Foreign exchange markets
do not. This is not widely understood.

To try to
stop the shift in owners of U.S. dollar accounts, the government
could impose export controls in the form of taxes on dollar transfers
of ownership. Or the government could declare it illegal for holders
of dollar accounts in American banks to exchange ownership for non-dollar
accounts in foreign banks.

Could this
happen here? One of my subscribers posted these questions:

How
likely is it we will see capital controls put in place prohibiting
financial assets from leaving the U.S.? If that happened, how might
this damage one’s personal wealth remaining in the U.S.? What is
the likelihood of a forced repatriation order mandating the return
of off-shore assets to the U.S.? It has been reported that: “Just
this week, two of the most powerful U.S. congressmen – Barney
Frank and Sander Levin – released a letter they’d sent to U.S.
Treasury Secretary Tim Geithner, expressing their concerns over
future U.S. free trade agreements if the government doesn’t address
capital controls. The headline of the letter is: Frank and Levin
Call on Administration to Clarify Position on Capital Controls.
Frank and Levin have long been concerned that the language in U.S.
trade and investment treaties was too restrictive and did not leave
adequate flexibility for governments to use controls to stem the
massive flows of speculative capital that can exacerbate economic
crises.

The congressmen
specifically state they want additional power to restrict the
flow of capital into and out of the United States… their letter
stated: We request an official written statement of U.S. policy
on the Administration’s interpretation that the scope and coverage
of the ‘prudential exception’ in U.S. free trade agreements and
bilateral investment treaties grants parties the ability to deploy
capital controls on the inflow or outflow of capital without being
challenged by private investors.” It seems capital controls will
be implemented, although I am not real clear what damages to personal
wealth this will cause. Also, what is the probability of a forced
repatriation order? If the government goes that far we can be
sure it would be very damaging to one’s assets.

WILL
THE TREASURY IMPOSE CONTROLS?

The question
is this: Does Barney Frank, a minority Democrat who is retiring
from public office at the end of this year, have any clout in the
House of Representatives? It does not seem to me that he does. What
of Sander Levin? He is an 80-year-old Democrat from Michigan. His
younger brother is Sen. Carl Levin of Michigan. He is the ranking
member of the House Ways and Means Committee. He has more clout
than Frank, but with Republicans controlling the House, this means
little.

Geithner so
far has resisted all attempts to impose capital controls. The U.S.
dollar is the world’s reserve currency. If there were restrictions
placed on the use of dollar accounts in U.S. commercial banks to
purchase non-dollar accounts in foreign commercial banks, foreign
central banks could impose a moratorium on the purchase of Treasury
debt. That would create a financing crisis for the Treasury Department.

The situation
today is that about 40% of the U.S. debt held by the public is held
by foreigners, mainly foreign central banks. To impose capital controls
would be to play a dangerous game of monetary chicken. The Treasury
could not impose controls without a lot of risk to its debt-rollover
financing plans.

WHO
WINS? WHO LOSES?

A person who
wishes to buy an appreciating asset – a foreign currency –
is harmed. He is stuck with dollars. He wants out. He cannot get
out.

A foreigner
who wishes to buy dollars at the lower price is harmed. This includes
foreign importers of American goods. He cannot find sellers of dollars.

The export
industry is harmed. Foreigners cannot buy dollars to buy American
goods. The dollar is kept artificially high on the legal currency
markets.

An American
who wants to buy American-produced goods that would normally have
been exported is benefitted. The exporter cannot find buyers abroad,
because buyers abroad cannot buy dollars. Americans are now the
buyers, because domestic prices are low for Americans, who own dollars.

Black marketers
of currency are benefitted. They find that the price spread between
dollars and other currencies increases. Their market niche gets
lots of new demand from buyers and sellers of dollars.

Companies
that get special export licenses are benefitted. There are always
special situations where businessmen with contacts inside the regulatory
agencies receive exemptions.

The overall
effect is to reduce liberty of people on both sides of the border.
But there are winners, too. The customers overall are harmed, because
the asset they want to use in voluntary exchange is no longer available
on the free market principle “high bid wins on the open market.”
There are still high bids, but these take place on hidden markets,
i.e., black markets.

THEN
WHY IMPOSE CONTROLS?

In earlier
eras, in which legally fixed exchange rates were imposed by means
of the Bretton Woods Agreement (1944), there were clear reasons
to impose controls. Not to impose them would expose the real conditions
of supply and demand for money. Why? Because the free market’s system
of voluntary exchange would expose the price controls on money –
fixed exchange rates – as being economically irrational. Speculators
would have been able to short the weak currency by going long on
the strong one. Speculators speed up price adjustments. The free
market’s pricing calls to the world’s attention the futility of
imposing price controls to support a weak currency,

The exchange
controls made it more difficult for speculators to work. They faced
uncertainty created by the controls. This left the field open to
people with inside information obtained from government agencies
in charge of the system of controls.

Nixon undermined
Bretton Woods in August 15, 1971, when he unilaterally froze retail
prices, closed the gold window, imposed export controls, and floated
the dollar. The system never recovered.

The Wikipedia
article on capital controls summarizes the shift of opinion on controls.

Capital
controls were an integral part of the Bretton Woods system which
emerged after World War II and lasted until the early 1970s. This
period was the first time capital controls had been endorsed by
mainstream economics. In the 1970s free market economists became
increasingly successful in persuading their colleagues that capital
controls were in the main harmful. The US, other western governments,
and the international financial institutions (the International
Monetary Fund (IMF) and World Bank) began to take an increasingly
critical view of capital controls and persuaded many countries to
abandon them.

This change
of opinion in favor of free markets over capital controls did not
last.

After
the Asian Financial Crisis of 1997-98, there was a partial shift
back towards the view that capital controls can be appropriate and
even essential in times of financial crisis, at least among economists
and within the administrations of developing countries. By the time
of the 2008-09 crisis, even the IMF had endorsed the use [of] capital
controls as a response.

But there
was a change in opinion regarding the kinds of controls. They are
now seen as a way to keep people from buying a national currency
(currency “inflow”), not selling it (currency “outflow”). What Switzerland’s
central bankers are now contemplating is becoming conventional opinion.

In
late 2009 several countries imposed capital controls even though
their economies had recovered or were little affected by the global
crisis; the reason given was to limit capital inflows which threatened
to over-heat their economies. By February 2010 the IMF had almost
entirely reversed the position it had adopted in the 80s and 90s,
saying that capital controls can be useful as a regular policy tool
even when there is no crisis to react to, though it still cautions
against their overuse. The use of capital controls since the crises
has increased markedly and proposals from the IMF and G20 have been
made for international coordination that will increase their effectiveness.
The UN, World Bank and Asian Development Bank all now consider that
capital controls are an acceptable way for states to regulate potentially
harmful capital flows, though concerns remain about their effectiveness
among both senior government officials and analysts working in the
financial markets.

By “harmful,”
the bureaucrats mean “free market-driven.” This is mercantilism:
protecting exporters. The controls did this under fixed exchange
rates, too. But the motivation has changed. The controls are imposed
to stop people from being able to buy a national currency, not sell
it.

By
2009, the global financial crisis had caused a resurgence in Keynesian
thought which reversed the previously prevailing orthodoxy. During
the 2008-2012 Icelandic financial crisis, the IMF proposed that
capital controls should be imposed by Iceland, calling them “an
essential feature of the monetary policy framework, given the scale
of potential capital outflows.” In the latter half of 2009, as the
crisis eased and financial activity picked up, several emerging
economies adopted limited capital controls to protect against potential
negative effects of capital inflows. This included Brazil imposing
a tax on the purchase of financial assets by foreigners and Taiwan
restricting overseas investors from buying time deposits.

Keynesianism
is mercantilism. It always has been. It is the belief that Keynesian-trained
bureaucrats have superior judgment to the knowledge possessed individually
by investors and entrepreneurs regarding what is good for a nation’s
economy. It is the belief that subsidizing exports is a good idea.
How? By means of a trade deficit and a national government deficit.
It is the position known as “beggar thy neighbor” with exports.
Capital flowing in has the effect of raising the value of the currency
and therefore reducing exports.

Those few
Americans who worry about capital controls in the future are operating
in terms of the old system, pre-1971. They worry about restrictions
imposed on Americans who are trying to get out of dollars and into
a foreign currency. The pre-1971 threat was that this would create
an outflow of gold, which had a government-subsidized price: $35
per ounce. Once Nixon ended the gold exchange standard, this threat
disappeared. So, the likelihood of this kind of control system is
remote.

Why would
the U.S. Treasury bother with capital controls today? What would
be the overwhelming advantage for the government? There is none.

The Treasury
would risk losing foreign central bank purchases of Treasury debt
by imposing controls on currency “inflow.”

Economic losses
imposed by the controls will reduce tax revenues. The federal deficit
will get larger. This will put upward pressure on interest rates,
which then threaten to bring on a recession.

This is why
major governments rarely impose capital controls on outflows of
money. (Once again, there is no “outflow.” There is merely an exchange
of ownership at a rate that decreases the value of the domestic
currency.) The centrality of the U.S. dollar in world trade rests
an open pricing system for the dollar. If this is removed by law
or dictate, the U.S. will suffer economic decline. The great advantage
of the U.S. dollar is that the Treasury can borrow dollars from
foreigners and pay the interest on these debts in dollars –
and at close to zero percent interest. No other nation in history
has possessed such an advantage. They do not want to stop the “inflow”
of foreign currencies to buy dollars to buy Treasury debt.

Economists
in the Treasury Department know this. Bureaucrats in the Treasury
know this. That Barney Frank and Sander Levin do not understand
this comes as no surprise.

CONCLUSION

I do not expect
currency controls imposed by the U.S. Treasury on the “outflow”
of dollars. I think the negatives offset special-interest benefits.
Capital controls on a capital-importing nation could be devastating.

The United
States is a capital-importing nation, to the tune of $500 billion
a year. The balance of payments deficit measures the size of the
net importation of capital. This reduces exports, but it grants
to the Treasury a unique benefit: borrowing dollars from investors
all over the world, and paying interest in dollars. I don’t think
the Treasury will change the system. It is too good a deal for the
Treasury.

May
30, 2012

Gary
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.

Copyright ©
2012 Gary North

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