Investment

Get Ready for Exchange Controls! [Part I]

  • author Mark Nestmann
  • calendar February 11, 2009

Exchange controls—laws restricting private ownership of, or transactions in, foreign currencies and gold—are blossoming throughout the world.  Residents of Cuba, Malaysia, Myanmar, Venezuela, and Zimbabwe have long dealt with these restrictions.  So have residents of India and China, although the restrictions there aren't as severe.

But as the global financial crisis has deepened, in recent months, Argentina, Iceland and Nigeria have imposed exchange controls.  And in the next few months, they may be coming to your country.  No matter where you live, you need to get ready for this possibility.

Only a few decades ago, exchange controls were common.  France and Great Britain had exchange controls in effect until the late 1970s.  In 1963, the United States imposed an “Interest Equalization Tax” on foreign borrowings in U.S. capital markets.  And indeed, one form of exchange control remains in effect worldwide—no government, anywhere in the world, will redeem its national currency in gold.

Foreign exchange controls take many forms:

  •  Prohibiting residents from owning a bank account denominated in another currency or an account in a foreign bank
  •  Banning the use of foreign currency within the country
  •  Banning residents from possessing foreign currency
  •  Prohibiting exporters from drawing against a bank account except for internal transfers
  •  Limiting bank trading in a domestic currency to discourage currency speculation.
  •   Restricting the amount of currency that may be imported or exported
  •   Prohibiting residents from owning gold or exporting gold abroad

Why do governments impose foreign exchange controls?  Mainly because they appear to offer a solution to a dilemma faced by an increasing number of countries. These countries want a fixed exchange rate, which encourages domestic price stability. But they also want the ability to stimulate their economy through massive deficit spending, which depresses the value of the national currency. Foreign exchange controls offer these countries the apparent opportunity to achieve what would otherwise be economically impossible.

However, foreign exchange controls are a disaster for residents of the countries where they're imposed.  Generally, residents must exchange their holdings in "hard" currencies or gold for holdings in the national currency.  They can no longer legally protect themselves from any future decline in the international value of that currency, or from inflation at home.

Could foreign exchange controls be coming to Europe or the United States?  Iceland imposed exchange controls last fall after its currency fell to an all-time low in the wake of bank failures in that country. Russia, whose currency is in free-fall, may be next.

In a global financial crisis, governments begin considering economic "solutions" that would have been unthinkable under more benign conditions.  And it's hardly unthinkable that foreign exchange controls may well spread to major industrialized countries in Europe—and the United States.

How can you tell whether foreign exchange controls will be imposed in your country?  More importantly, what can you do to protect yourself from their impact?  I'll be discussing those issues in my next blog entry.

 

Copyright © 2009 by Mark Nestmann

(An earlier version of this post was published by The Sovereign Society)

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