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 ongoing global financial crisis deepens, many other countries have imposed foreign exchange controls in recent months, including Argentina, Iceland and Nigeria. Is it possible that the United States would ever impose these types of controls? The answer may surprise you… but first, let’s explore the history and mechanisms of exchange controls.
Exchange controls date all the way back to ancient Greece. The philosopher Plato proposed an inconvertible currency to prevent anyone outside Athens from interfering with its economic autonomy. And only a few decades ago, exchange controls were common in western countries: France and Great Britain had them in effect until the late 1970s. Indeed, one form of exchange control remains in effect worldwide—no government, anywhere in the world, will redeem its national currency in gold.
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.
Foreign Exchange Controls Step-by-Step
The main reason a government initiates foreign exchange controls is to discourage speculation in its national currency. This helps preserve foreign currency reserves and props up the international value of the national currency. In most cases, the national treasury or central bank of a country that imposes exchange controls has created an excessive amount of money out of thin air. Exchange controls appear to offer the government an opportunity to achieve what would otherwise be economically impossible.
In most cases, governments don’t impose foreign exchange controls overnight, but rather, in a step-by-step process:
Step 1. 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 bank.
Step 2. 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, including the United States, purportedly to fight "money laundering."
Step 3. 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. Legislation before the U.S. Congress would impose these requirements in the United States as well.
Step 4. The fourth step is for the national treasury or central bank to assert control over all movements of money into or out of country. Transfers deemed vital to the economy are exempted from this requirement. However, any person or company making "non-vital" transfers must receive permission from the government to make them. After going through whatever approval process exists, the treasury converts the local currency to the international currency, or vice versa, and sends the payment along to its ultimate destination. Generally, the conversion isn’t made at the market rate, but at an artificially high rate set by the government.
Step 5. If these steps don’t succeed in curbing speculation or inflation, the fifth step is to require residents to exchange their holdings in international currencies or gold for holdings in the national currency. This makes it impossible for them to legally protect themselves from any future decline in the international value of their national currency, or from inflation at home.
Why Exchange Controls Don’t Work</p
Unfortunately for the governments that impose them, exchange controls simply don’t work. The longer they’re in place, the more ways clever people find to get around them. To begin with, exchange controls create a huge black market and an accompanying criminal class. This phenomenon is well known in countries with stiff criminal penalties against mind-altering drugs.
Exchange controls also inevitably disrupt legitimate businesses. For instance, Venezuelan exchange controls, re-imposed in 2003, bankrupted thousands of small and middle-sized businesses because they could no longer obtain foreign currency.
Moreover, while Venezuela’s foreign currency reserve position stabilized after it imposed exchange controls, remittances of foreign currency fell dramatically. This led to a steep decline in the standard of living for most residents. Many of Venezuela’s most successful citizens emigrated to other countries, particularly those lucky enough to qualify for another passport, or wealthy enough to purchase one.
Despite the many shortcomings of exchange controls, the historical record is clear. In times of economic crisis, protectionist sentiments grow. Those advocating protectionist measures label anyone with offshore investments or other financial interests as traitors. Foreign exchange controls are a way of dealing with these purportedly disloyal citizens.
In the United States, the dollar has actually appreciated in value in the current economic crisis, so there’s no immediate pressure for Congress—or President Barack Obama—to impose exchange controls. However, Obama has advocated that offshore "tax havens" be shut down. And if investors begin fleeing the dollar, and its value collapses, exchange controls may quickly follow. Indeed, if Congress fails to act, 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).
How to Prepare for the Prospect of Exchange Controls
U.S. residents concerned about the prospect for exchange controls in this country need to prepare for them now. The most basic strategy is to open a foreign bank account or to store precious metals at an offshore safekeeping facility.
However, any U.S. exchange controls (in common with those in most other countries) may prohibit U.S. residents from maintaining a foreign account or other foreign investments without a "permit" to do so. Without a permit, the government may force you to repatriate your foreign account in exchange for dollars at the official exchange rate. This rate may be much less than the market exchange rate.
A better strategy may be to create an international structure in which you are not the owner of the underlying investments, but only a beneficiary. An offshore trust and some types of offshore insurance investments provide this sort of protection. Historically, payments from overseas life insurance and annuity policies have been exempt from foreign exchange controls—although there’s no guarantee they would be in the future. An additional benefit is that these structures provide significant protection against claims in civil litigation. (My book The Lifeboat Strategy, contains complete details on how to set up these types of international structures.)
Are foreign exchange controls coming to the United States? I certainly hope not. But if they do, I hope you’ve made arrangements to prepare for their arrival.
By Mark Nestmann
Copyright © 2009 by Mark Nestmann