300 years before the birth of Christ, a man named Neoptolemus took what was alleged to be his ill-gotten gains and fled the city-state of Athens. The leader of Athens, Lycurgus, demanded that Neoptolemus be executed for fleeing with his wealth.
Lycurgus then instituted measures to make certain other Athenians couldn’t follow the example of Neoptolemus. These included revoking the legal tender status of gold and silver, as well as forcing debts to be settled in iron, which couldn’t easily be transported.
This was the one of first known examples of capital controls (also known as foreign exchange controls), laws that restrict the movement of wealth outside the political boundaries of a nation-state.
More than 2,000 years later, dozens of governments have imposed capital controls to curb the flow of wealth out of their respective countries. These measures stem from a common dilemma: governments worldwide are running out of money.
Capital controls take many forms:
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Prohibiting residents from holding financial accounts either in foreign banks or denominated in another currency;
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Banning the use or possession of foreign currency;
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Prohibiting exporters from drawing against a bank account except for internal transfers;
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Forcing currency to be exchanged at a fixed rate to discourage speculation;
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Restricting the amount of currency that may be imported or exported; and
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Prohibiting residents from owning gold or exporting gold abroad.
Unfortunately for Lycurgus and the statists who followed in his footsteps, capital controls don’t work, especially as a long-term measure. Individuals subject to the controls perfect endless schemes to evade them. The controls lead to a huge black-market and an accompanying criminal class. This phenomenon is also well known in countries with criminal penalties against the sale or use of mind-altering drugs.
Capital controls destroy the economies over which they’re applied. Their appeal is a fatal attraction, because they lessen the wealth of everyone in a country. All assets decline in value. Residents can no longer legally protect themselves from any future decline in the international value of that currency or from inflation at home.
Venezuela is an example of a once wealthy country with an economy ravaged by capital controls. There are three different official exchange rates, ranging from 6.3 to 172 Venezuelan bolivars per dollar, with the black-market rate around 900:1. The bizarre consequence is Venezuela is simultaneously the world’s cheapest and most expensive country, depending on whether you exchange currency at the lowest controlled rate or the black-market rate.
The real world consequences of capital controls have been catastrophic. Imports by Venezuela of medicine, industrial goods, and just about anything else have slowed to a trickle, because no foreign company wants to accept bolivars at the official exchange rate. The country owes billions of dollars to pharmaceutical companies, food importers, and airlines. It hasn’t helped Venezuela that its major export, oil, is priced at the lowest level in more than a decade. But oil prices only exacerbated the crisis caused by capital controls; it didn’t cause the crisis.
Yet, incredibly, capital controls have suddenly become acceptable to mainstream economists. Referring to the global economic crisis that began in 2008, Olivier Blanchard, former chief economist at the International Monetary Fund (IMF) states:
“The general presumption was that capital-account liberalisation was always good, and capital controls were nearly always bad. I’ve seen the thinking change, partly because it was already wrong then, and because it was particularly wrong in the crisis.”
To underscore the new acceptability of capital controls, IMF Managing Director Christine Lagarde endorsed them in a recent speech – but only to deal with “the short-term nature and inherent volatility of global capital flows.” Just try telling that to an urban resident of Venezuela, where capital controls have been in effect for over a decade. Or in Zimbabwe where they’ve been in effect in one form or another for more than 50 years.
How do governments impose foreign exchange controls? In most cases, it is a step-by-step process. The first step is already complete, in the form of laws already in place in every country. These laws prohibit citizens (or anyone else) from exchanging their national currency for a fixed quantity of gold through the national treasury or central bank.
The second step is to impose rigorous reporting requirements for moving cash into and out of the country, and for foreign accounts. These laws are also in effect in virtually all countries, purportedly to fight “money laundering.”
The third step is to eliminate higher value notes in the national currency. In the US, the highest denomination bill once was $100,000. Today, it’s $100 – and proposals are now in place to eliminate that denomination as well. Naturally, the justification is once again to fight money laundering, terrorist financing, and the like.
The fourth step is to expand the reporting requirements to include any transfer of assets into or out of the country, not just in cash or cash equivalents. Many countries have these laws in effect as well. In the US, Congress has authorized the Treasury to study this initiative. Reporting rules are already in place when you move more than $2,500 of any commodity – including gold – out of the US.
Once comprehensive reporting requirements are in place, the government can impose more outright capital controls very quickly. In the US, President Obama could impose them with the stroke of a pen, via an executive order. The enabling legislation is already in place, via the International Emergency Economic Powers Act (IEEPA).
At the moment, the US dollar is the world’s strongest currency. As long as that status continues, there’s a near-zero probability Obama or any future president would impose capital controls. But when – not if – investors begin fleeing the dollar, and its value collapses, capital controls could quickly follow.
The most basic strategy to protect yourself from capital controls is to open a foreign bank account or store precious metals at an offshore safekeeping facility. However, the controls might prohibit this strategy or even require you to repatriate your foreign assets in exchange for dollars at the official exchange rate. This rate could be much less than the market exchange rate.
A more effective strategy is to create an international structure in which you are not the owner of the underlying investments, but only a beneficiary. An offshore trust and some types of non-US life insurance and annuity investments provide this sort of protection. An additional benefit is that these structures provide significant protection against claims in civil litigation.
Are capital controls coming to the US? Probably not anytime soon, which means you have time to make arrangements to protect yourself. But when they do arrive, I hope you’re prepared.
Capital controls may seem unlikely in the near term, but you've worked too hard to risk losing the wealth you've built. The Nestmann Group provides the expertise to protect your nest egg from the threats of a post-9/11, post-FATCA world. In fact, the Offshore Freedom Blueprint
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Mark Nestmann
Nestmann.com
