Friday, February 11, 2011

Capital Flight

Simon Black writing on his Sovereign Man Website suggests that American citizens if they can, should open overseas bank accounts. He writes from Chile and holds the opinion that capital controls in various forms are coming to countries across the globe. As a child and even as a young adult who liked to travel I grew up with the post World War Two restrictions on capital flows across Western Europe. At my financial level it just made vacation travel a pain in the ass, smuggling currency across borders and finding banks to change devalued currency into something that would buy the necessaries of life as I traveled. For businesses at the time foreign spending involved getting governmental permission to do almost anything in a foreign country that meant spending cash. it was a cumbersome way of life and credit cards started to tear down those controls. Now according to the author of this essay these restrictions may be on the way back. Pessimists think a global currency is an idea whose usefulness has passed so if they are correct we may all be shrinking back to village status in one restricted form or another. Unless we are hugely wealthy of course.


In the late 1920s, the economy of the Weimar Republic was beset by numerous fiscal troubles. The global depression spread quickly to Germany, undermining the government’s ability to make its reparation payments from the Great War.

Fearing a return to hyperinflation, many Germans who had spent the last decade building up a small fortune during the Weimar Republic’s own ‘Roaring 20s’ decided to pack up and leave; they remembered the days when banknotes were used as wallpaper and had no desire to repeat the experience.

In 1931, Chancellor Heinrich Bruning imposed a ‘flight tax’, which levied a 25% tax on the value of all property and capital for Germans leaving the country.

Total revenue collected from this tax amounted to roughly 1 million Reichsmarks (RM) in its earliest days ($56 million today). By the late 1930s under Hitler’s rule, flight tax revenue soared to RM 342 million ($21.5 billion today) as more people headed toward the exits.

This flight tax constitutes one of the earliest modern examples of capital controls. They’ve evolved substantially since the days of Hitler, but the end goal is the same– governments controlling the flow of capital across borders.

Governments impose these for a variety of reasons– rapidly developing nations may want to restrict the flow of capital into their country, preventing ‘hot money’ from pumping up prices and affecting local markets. We see this today in places like Brazil and Thailand.

In other instances, bankrupt governments seek to trap capital within their borders, maximizing the amount available for subsequent taxation or other forms of confiscation. This tactic is usually employed when lost confidence has impaired the government’s capability to borrow.

We’re seeing strong indications of both examples today, though the latter is the most alarming. As I scan the headlines and hear from colleagues in the US and Europe, it’s clear to me that the march towards stricter capital controls is quickening its pace.

The British government, for example, just announced an increase to its bank levy that taxes UK-domiciled banks on their worldwide balance sheets. In response, HSBC has indicated that it may move its headquarters elsewhere.

I suspect the British government will enact legislation to discourage or prevent this from happening, likely with a modern day corporate flight tax (albeit with a more patriotic sounding name).

Capital controls can take a variety of other forms– including taxation on outward remittances, restrictions on the movement of financial instruments, bureaucratic approval processes for foreign transactions, reporting requirements for foreign assets, and government control over banks.

This last is important– when politicians and bankers are in bed with each other, banks can be compelled to loan a portion of their deposits to the treasury at unrealistic terms, sticking bank customers with sub-optimal yields below the rate of inflation.

In the US, I think retirement accounts will be the first to go. They’re the easiest to grab because most people hold their retirement accounts domestically with a large financial institution that will happily sell every customer down the river when the government comes calling.

The way they’ll do this is simple– the next time there’s a market meltdown (bear in mind that insiders are selling like crazy right now…), the government will step in with new legislation that requires these institutions to invest a portion of their accounts in the ‘safety’ of government securities.

Insider politiconomists like Teresa Ghilarducci have already strongly advocated for government managed retirement accounts in the US, and we’ve seen numerous examples of other bankrupt nations from Argentina to Hungary moving to seize their citizens’ pensions.

The next step would be against retail bank accounts, specifically setting up provisions that discourage moving money overseas… and eventually restrict it altogether.

This would happen through new approval processes at the banking level, additional reporting requirements for foreign accounts, and disincentives for foreign banks to accept US customers.

Curiously, all of these have started to happen.

For example, while there are still a multitude of banks around the world who happily accept US customers, Americans are unwelcome at most foreign financial institutions thanks to continuous threats and pressure from the IRS. As one banker in Hong Kong told me recently, ‘they are very scaaaaary’…

Also, the new HIRE Act legislation imposes additional reporting requirements and restrictions for foreign accounts that gradually phase in over the next two years.

This certainly jives with the timeline of the US government’s ticking debt bomb; at a minimum, the market will require higher yields, and politicians will need cheap sources of capital to continue financing their waste.

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