A column last week suggested the free flow of money around the world could be a boost for Canada as cash from troubled emerging markets sought a safer home. I may have jumped the gun.
On Friday the Shanghai correspondent for the Financial Times, Gabriel Wildau, reported that China is moving to step up capital controls in an effort to stem the flood of cash out of the country.
This week it will be interesting to see if other countries begin to follow suit, which could reduce the amount of cash seeking safety in the world's developed countries.
- Global capital still looking for a Canadian home
- North American stock markets end week on losing note
In the unstable period after the Second World War, capital controls were the rule, not the exception.
The idea was that fixed exchange rates between countries, pegged to gold or the U.S. dollar, were a force for stability. In the simplest terms, countries feared that cash moving from one country to another robbed value from the home country and made everyone poorer.
Governments were still wary of the financial shenanigans that led to the Great Depression and did not trust bankers to work in their interests. Any outflow of, say, Italian lire to France or Britain had to be approved by finance ministry officials.
Jewelry not cash
The strict rule affected many ordinary people, including Canadian immigrants. As a kid I remember family friends who had immigrated from India bringing jewellery instead of cash, because they were not permitted to export currency.
Since about 1970 currency controls have gone out of style. In an increasingly globalized world, money was seen as just one more asset moving back and forth across borders.
The new free market paradigm is that the free circulation of money across borders is only a good thing.
As Canada's chief central banker Stephen Poloz reminded us last week, freely exchangeable currencies — those that trade for the same price inside a country as they do on world markets — act as a buffer during periods of international economic realignment.
"This is exactly why countries choose to have flexible exchange rates," said Poloz. They help Canada adjust to lower resource prices.
In the era of globalized capitalism, moving to a free-floating currency is like joining the club of sound and balanced world traders. When Poland floated the zloty in 2000 it was as if the currency had finally made the grade.
"It puts capital where it's most useful, maximizing prosperity. What's not to like?" quipped financial writer Ye Xie earlier this year in a Bloomberg backgrounder on the subject.
A liberal attitude to the free flow of money seems wonderful when it is flowing in, funding new development and maximizing prosperity. But what happens when it starts gushing out?
In times of crisis, when people line up at bank machines to get cash and then urgently convert it at any cost into U.S. dollars or gold, that's when countries suddenly rediscover the advantage of currency controls. Especially when the country is small or frightened of internal instability.
During the Asian crisis of 1990 Malaysia instituted controls. According to Bloomberg's Xie, between 1995 and 2010, 37 countries found ways to block the outflow of money.
Iceland recently lifted controls six years after its banking crisis. Cyprus put on controls during its banking meltdown of 2013, Ukraine during its conflict with Russia. In 2014 Argentina and Venezuela increased controls.
Now China, which has been struggling to turn its renminbi — also known as the Chinese yuan — into a freely floating currency, has started to backtrack.
Foreign issues of renminbi bonds mean there are plenty of yuan trading outside China. But in a worrying sign, the value of domestic yuan and foreign yuan are diverging.
One of the effects of the rush of money out of countries like China, Russia and those in South America has been a surge in developed-country real estate. If a trend toward currency controls develops suddenly, that growing flood of money could turn to a trickle.
That's if the currency controls work. There are so many ways to move money now, including untraceable bitcoin transactions, that determined individuals can always find a way.
Without truly stringent restrictions that would interfere with trade, even a government determined to stop the flow will only be able to slow it.
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