Nowadays the greatest strategic risk for an investor is not a bad investment but political exposure in the form of capital controls and wealth confiscation. Here are some examples:
1. IMF Endorses Capital Controls
Bloomberg reported in December 2012 that the “IMF has endorsed the use of capital controls in certain circumstances.“
This is particularly important because the IMF, arguably an even more prominent institution since the global financial crisis started, has always had an official stance against capital controls. “In a reversal of its historic support for unrestricted flows of money across borders, the IMF said controls can be useful...”
Will individual governments jump on this bandwagon? “It will be tacitly endorsed by a lot of central banks,” says Boston University professor Kevin Gallagher.
2. Academic Support for Capital Controls
Many mainstream economists support capital controls. For example, famed Harvard Economists Carmen Reinhart and Ken Rogoff wrote the following earlier this year:
Governments should consider taking a more eclectic range of economic measures than have been the norm over the past generation or two. The policies put in place so far, such as budgetary austerity, are little match for the size of the problem, and may make things worse.
“Ms. Reinhart and Mr. Rogoff suggest debt write-downs and ‘financial repression’, meaning the use of a combination of moderate inflation and constraints on the flow of capital to reduce debt burdens.”
The Reinhart and Rogoff report basically signals to politicians that it’s not only acceptable but desirable to reduce their debts by restricting the flow of capital across borders. Such action would keep funds locked inside countries where said politicians can plunder them as they see fit.
3. Confiscation of Savings
“So, what’s the big deal?” Some might think. “I live here, work here, shop here, spend here, and invest here. I don’t really need funds outside my country anyway!”
Well, it’s self-evident that putting all of one’s eggs in any single basket, no matter how safe and sound that basket may seem, is risky—extremely risky in today’s financial climate.
The IMF, in a report entitled “Taxing Times,” published in October of 2013, on page 49, states:
“The sharp deterioration of the public finances in many countries has revived interest in a capital levy--a one-off tax on private wealth—as an exceptional measure to restore debt sustainability.”
The problem is debt. And now countries with higher debt levels are seeking to justify a tax on the wealth of private citizens.
So, to skeptics regarding the value of international diversification, I would ask: Does the country you live in have a lot of debt? Is it unsustainable?
If debt levels are dangerously high, the IMF says your politicians could repay it by taking some of your wealth.
The appeal is that such a task, if implemented before avoidance is possible and there is a belief that is will never be repeated, does not distort behavior, and may be seen by some as fair. The conditions for success are strong, but also need to be weighed against the risks of the alternatives, which include repudiating public debt or inflating it away.
The IMF has made it clear that invoking a levy on your assets would have to be done before you have time to make other arrangements. There will be no advance notice. It will be fast, cold, and cruel.
Notice also that one option is to simply inflate debt away. Given the amount of indebtedness in much of the world, inflation will certainly be part of the “solution,” with or without outright confiscation of your savings.
Further, the IMF has already studied how much the tax would have to be:
The tax rates needed to bring down public debt to pre-crisis levels are sizable: reducing debt ratios to 2007 levels would require, for a sample of 15 euro area countries, a tax rate of about 10% on households with a positive net worth.
Note that the criterion is not billionaire status, nor millionaire, nor even “comfortably well off.” The tax would apply to anyone with a positive net worth. And the 10% wealth-grab would, of course, be on top of regular income taxes, sales taxes, property taxes, etc.
4. Confiscation of Pension Funds
Unfortunately, it’s not just savings. Carmen Reinhart (again) and M. Belén Sbrancia made the following suggestions in a 2011 paper:
Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of ‘financial repression.’ Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks.
Yes, your retirement account is now a “captive domestic audience.” Are you ready to “lend” it to the government? “Directed” means “compulsory” in the above statement, and you may not have a choice if “regulation of cross-border capital movements”—capital controls—are instituted.
5. Eurozone Sanctions Money-Grabs
Germany’s Bundesbank weighed in on this subject last January:
“Countries about to go bankrupt should draw on the private wealth of their citizens through a one-off capital levy before asking other states for help.”
The context here is that of Germans not wanting to have to pay for the mistakes of Italians, Greeks, Cypriots, or whatnot. Fair enough, but the “capital levy” prescription is still a confiscation of funds from individuals’ banks or brokerage accounts.
A capital levy corresponds to the principle of national responsibility, according to which tax payers are responsible for their government’s obligations before solidarity of other states is required.
This view effectively nullifies all objections. It’s a clear warning.
6. Canada Jumps on the Confiscation Bandwagon
You may recall this text from last year’s budget in Canada:
“The Government proposes to implement a bail-in regime for systemically important banks.”
A bail-in is what they call it when a government takes depositors’ money to plug a bank’s financial holes—just as was done in Cyprus last year.
This regime will be designed to ensure that, in the unlikely event a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital.
What’s a “bank liability”? Your deposits. How quickly could they do such a thing? They just told us: fast enough that you won’t have time to react.
By the way, the Canadian bail-in was approved on a national level just one week after the final decision was made for the Cyprus bail-in.
Source: Casey Research (modified)