Investment

Get Ready for Exchange Controls! [Part II]

  • author Mark Nestmann
  • calendar February 16, 2009

In my most recent blog entry, I described how exchange controls—laws restricting private ownership of, or transactions in, foreign currencies and gold—are spreading from third world countries to the industrialized world.  Since exchange controls proliferate in economic crises, they may be coming to your country.

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 in effect 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.

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 most countries, purportedly to fight "money laundering."

The third step is to expand the reporting requirements to any transfer of assets in or out of the country, not just in cash or cash equivalents.  Many countries have these laws in effect as well.  In the United States, Congress has authorized the U.S. Treasury to study this initiative.

Once these reporting requirements are in place, the government can impose more stringent controls very quickly. In the United States, President Obama can impose exchange controls with the stroke of a pen, via an executive order.  The enabling legislation is already in place, via the International Economic Emergency Powers Act (IEEPA).

First, President Obama would issue a "declaration of economic emergency" under the IEEPA.  He would then issue an executive order giving the U.S. Treasury control over all movements of money into or out of the United States. Transfers deemed vital to the U.S economy would likely be exempted from this requirement.  However, any person or company making "non-vital" transfers would have to route them through the U.S. Treasury. After going through whatever approval process the executive order describes, the Treasury would convert your U.S. dollars to whatever currency you desire.  It would then send the payment along to its ultimate destination.  Funds coming to you from abroad would be subject to the same process.

Requiring Treasury approval of many inbound or outbound financial transfers would be enormously disruptive to international commerce (not to mention financial privacy).  But the most important aspect of foreign exchange controls is that the Treasury would convert dollars and foreign currencies at an official, fixed rate.  That rate may differ markedly from the market rate.

For instance, in Venezuela, the central bank trades U.S. dollars for "new" Venezuelan bolivars at the rate of 2.15 per dollar.  (The "old" bolivar was valued at 21,500 per dollar, so the government simply lopped three zeroes off.  This is something governments that impose foreign exchange controls to fight inflation do frequently.)  But on the black market, a dollar buys five or more bolivars.  The Venezuelan government forces its citizens to exchange foreign currencies for bolivars at less than half the market rate, or risk fines and imprisonment.

Exchange controls always end up causing more problems than they solve.  The most serious problem is that the controls permit the government to continue irresponsible financial practices far longer than they would otherwise be able to do if not constrained by market forces.  In addition, graft and corruption always accompany foreign exchange controls.  Treasury officials and those with political connections always commit the most serious violations.

Nonetheless, under his mandate for "change," President Obama may well decide to strengthen exchange controls further if the original ones aren't effective in preventing capital flight.  This initiative could take forms such as:

  •  Requiring that U.S. persons close all foreign bank accounts and repatriate the assets to the United States at the official exchange rate, unless the first apply for and receive a license to hold the account
  •  Prohibiting the purchase or sale of gold, and requiring the sale to the Treasury of privately-held gold at the official exchange rate
  •  Formally declaring a two-tiered currency conversion rate: a market rate for foreign purchasers of U.S. Treasury debt (perhaps backed by forcibly sold gold) and a below-market rate for U.S. residents.

Whatever the form foreign exchange controls take, you need to prepare for them.  I'll describe some steps you can take to protect yourself 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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