Currency Controls & Exchange Rates

Currency Controls, Black Markets, And The Retiree Abroad

“This year, mostly starting in September,” writes Retirement Planning Correspondent Paul Terhorst from his current perch in Argentina, “we have seen a rapid decline of the dollar.

“Could this rapid decline create the need for capital controls around the world? What are capital controls, exactly, and how might they affect those of us who are living and investing overseas?

“Capital controls are restrictions on the free flow of capital across borders. They take the form of taxes, investment limits, exchange controls, and outright bans on sending money abroad.

“Many countries have used capital controls at one time or another. I have dealt with controls in Argentina, Thailand, Italy, China, and other places. I remember traveling to Italy on business in 1982. As I pulled out my travel documents, the Italian immigration guy noticed I had some U.S. dollars in my travel pouch. ‘You can’t have those dollars in Italy!’ he exclaimed.

“Here I was, a prudent businessman carrying a few dollars for the trip home, who, apparently, by so doing, was breaking some obscure Italian law, a relic, I guess, of the post-war recovery. To refloat their economies, European nations banned the purchase of dollars. Banning dollars forced Europeans to stick with the local money–francs, lira, whatever–thereby building the local economies.

“During the 1980s and 1990s, poor countries around the world used similar controls, nearly always to prevent money running from the weak local currency (peso, baht, whatever) to the stronger currency (dollar). I remember traveling to China in 1988, when it had recently opened to tourism. The Chinese believed they needed to protect the yuan. As foreigners we were forced to buy special, expensive ‘foreigner yuan’ for tourists.

“Vicki and I lived in Argentina in the 1980s. In those days, at every economic bump in the road, Argentines rushed to buy dollars. One government after another had the tough job of trying to protect the peso. Other countries from Brazil to Thailand–remember the meltdown of the Thai baht in 1998?–also had to stop crisis flows into dollars.

“All that has changed. Yesterday’s capital controls to support pesos and baht have become today’s capital controls to suppress pesos and baht. Why? Because of what’s happening in the United States.

“Here’s America’s most desperate problem.

“America’s most crucial economic task these days is to create inflation. The government is pulling out all the stops to try to pump up prices and to make sure people see those higher prices. Anything, we figure, is better than deflation.

“With deflation, consumers believe goods tomorrow will be cheaper than those goods today. We wait to buy a house, car, or camera because, tomorrow, it will be cheaper. By waiting, we cause demand to decline and prices to fall.

“Deflation becomes a self-fulfilling, self-perpetuating evil. Japan has struggled with deflation for two decades with no relief in sight.

“To avoid deflation, the Fed has expanded the money supply, lowered interest rates, and bought bonds. Look at your last U.S. bank statement to see how low interest rates have fallen. The government wants Americans to spend this cheap money on cars, washing machines, and houses–especially houses–to get the U.S. economy rolling.

“Instead, Americans are paying off credit card debt, which costs 25% or so.

“So the Fed stimulates more. With so many cheap dollars floating around, investors lose confidence in the dollar. A decade ago, it cost US$.80 to buy a euro; now it costs close to twice that. A decade ago, a dollar bought 50 Thai baht; now it buys only 29.

“Successive U.S. Treasury secretaries have professed strong-dollar policies. But it’s been just lip service. Especially now, I think a weaker dollar makes sense. A weak dollar means imports become more expensive. Toys at Wal-Mart, shirts at the Gap, and cars from Germany are bound to cost more when the dollar is worth less.

“Commodities priced in dollars go up, too.

“And this is where capital controls come in. The United States may benefit from a lower dollar, but other countries hate it.

“A lower dollar means countries have a harder time exporting and competing. So some countries have started capital controls to keep out the flood of dollars, just the opposite of what they did a few years ago. Brazil, for example, placed a 2% tax on foreign investment in their bonds. During the dollar decline that began in September 2010, Brazil doubled the tax to 4%, in a further effort to slow the flow of dollars and the move up in their money.

“In recent months, Thailand has seen the baht strengthen from 33 to 29 against the dollar. The Thai economy minister states he’s unable to stop the flow of dollars into the baht. He, too, is considering capital controls, as are South Korea and Singapore. Meanwhile, these Asian governments buy dollars every day to prop up the dollar. Argentina, China, India, and other countries also buy dollars. Anything to prop up the dollar.

“I predict the United States will win this race to the bottom. That is, the U.S. will be successful in weakening the dollar, and flooding the world with those dollars, in spite of capital controls. I’m also cautiously optimistic that we’ll see more inflation in the U.S. as a result, and the economy will continue to recover.

“Here come the black markets.

“Any country that sets up capital controls will next see a black market for currency transactions. Remember that black markets tend to pop up when a profitable activity or product is restricted or made illegal.

“Ticket scalpers and prostitutes, for example, function in the black market. Ditto for those who sell marijuana. Argentines have an expression that means ‘make a law, make a way to cheat it.’

“Normal buying and selling, whether candy and peanuts or companies and airplanes, require capital flows. If dollar transfers are blocked, black markets will develop quickly to get money to anyone when and where they need it.

“Getting our money abroad these days, without capital controls, costs a lot. Credit cards and even some debit and ATM cards charge 3% foreign transaction fees. On top of that, some overseas ATMs now charge usage fees. In Argentina, ATMs will give you at most US$250 per transaction, with a fee of US$4, or 1.6%. And on top of that, you pay a foreign exchange spread to Visa or American Express, anywhere from 1% to 5% or so.

“Bank transfers, traveler’s cheques, and other ways to send or receive money abroad, these all cost money, too.

“In a black market, you avoid all those fees. But you’ll have to pay something to the market-makers. You could pay more or less than the current vig, depending on how strictly the U.S. enforces the controls.

“What does all this mean for you, as a current or a would-be retiree or expat overseas?

“To be on the safe side, if you’re concerned about controls in the coming couple of years, you might want to increase your cash holdings abroad. For example, if you live in Thailand, you could increase your baht balance in your Thai bank account.

“An American friend in Malaysia keeps more than a year’s living expenses in a Malaysian bank, in Malaysian ringgits. He figures keeping that much money on hand will buy him time if controls come in. One thing about capital controls, you get no warning. If controls are announced, they’ll go into effect immediately.

“When I say ‘to be on the safe side,’ I’m talking about the safe side of capital controls, not the safe side of the dollar. I’ve written before about protecting against a dollar decline. The safe side here refers to protecting against taxes or an outright ban on bringing your dollars to where you live.

“Finally, while capital controls can sound scary, in my experience, they never work. They’re hard to legislate, hard to enforce, easy to ignore. Black markets soon make the controls ineffective, thereby bringing about their collapse.”

Kathleen Peddicord