You and I live in a world that is essentially borderless when it comes to money. Goods and services smoothly flow from nation to nation every day. Store shelves are regularly re-stocked with items from factories halfway around the world. Likewise, money to finance this robust global trade effortlessly changes hands across borders in a never-ending whirlwind.
However, this state of affairs is by no means guaranteed, or even normal from a historical perspective. Nations can institute what are known as capital controls. These are taxes, tariffs or laws that prohibit or deter international trade or financial transactions. In many instances countries institute capital controls to defend their currency or balance of trade. Indeed, in the depths of a severe financial crisis, capital controls become almost a necessity for less developed countries.
This impetus to impose capital controls is often driven by an economic conundrum called the Impossible Trinity. The Impossible Trinity is the realization that a nation cannot simultaneously maintain a fixed exchange rate, independent monetary policy and also allow its currency to be freely traded internationally. Any two out of three can be achieved, but the third policy goal always proves elusive.
This means that countries sometimes sacrifice international currency convertibility via capital controls in order to maintain the other two policies of the Impossible Trinity. This isn’t always as bad as it sounds. For example, during the Bretton Woods era from 1945 to 1971, most of the world was subject to capital control regimes of one sort of another. In spite of this fact, Japan, Western Europe and the United States still prospered during this period.
However, international finance is very different today than it was during the Bretton Woods era. Currently, capital controls are more often used as an emergency measure by countries that are suffering from a financial panic or currency crisis. For instance, capital controls were widely used during the Asian financial crisis in the late 1990s. Even today, China presently limits the free international flow of its currency, the renminbi, in order to relieve downward exchange rate pressure.
Many times nations institute capital controls because they can’t afford to pay for imported foreign goods any longer. Venezuela is a country in this sorry situation right now. As of summer 2017, they have a tiered exchange rate. The lowest official exchange rate, named DIPRO, is 10 bolivars to the dollar, but the black market rate is over 16,000 bolivars to the dollar. Needless to say, only the most politically well-connected companies and individuals can get access to the advantageous 10 to 1 exchange rate through the government. Regular people have to take the dreadful 16,000 to 1 exchange rate from street corner money changers.
Perhaps the worst part about capital controls is that they are a looming inevitability for much of the world. We can see the warning signs in a country like Greece. Although technically still part of the eurozone, Greece has intractable financial problems that will only be resolved by exiting the monetary union and reintroducing a new national currency unit. But the introduction of a new currency will also mean a significant currency devaluation. Nobody wants to take this loss.
So the Greek financial authorities must prevent every last euro from fleeing the country. Funnily enough, they’ve already gotten a head start on the problem. In June 2015 Greece declared an emergency 20 day bank holiday. They then quickly moved to limit currency withdrawals and severely restrict money transfers abroad. Worse yet, where Greece has gone, many other Southern European nations – Portugal, Spain and even Italy – will eventually follow.
If these sorts of financial regulations sound bad to you, it is because they are. Capital controls of this nature inevitably hurt average people far worse than they impact the rich or politically-connected. In fact, the primary reason capital controls are imposed is to cut off the ability of money to flee before a major currency devaluation is implemented. The financial authorities want to trap your money.
Most of the assets that people hold – bank deposits, bank CDs, government savings bonds, etc. – are disproportionately affected by currency devaluation. In fact, any financial instrument that has a fixed face value like a bond, whole life insurance policy or savings account will depreciate significantly under most capital control scenarios. Even stocks, which are theoretically fractional ownership in operating businesses, generally do poorly under capital controls due to widespread financial chaos.
There is, however, one type of asset that does exceptionally well under capital controls – hard assets. These include commodities, precious metals, gemstones, fine art and antiques. Because these assets are all physical in nature, they cannot be arbitrarily devalued at the stroke of a pen by some incompetent central banker or corrupt politician.
Therefore, I recommend that everyone should have, in addition to some bullion holdings, at least 5% or 10% of their investment portfolio allocated to investment grade art and antiques. The financial authorities may be able to lock down your bank account, but your collection of tasteful mid-century chronograph wristwatches or elegant old mine cut diamonds is completely beyond their reach. There’s only one catch, you have to buy these assets before the crisis hits. Otherwise, it is simply too late.
