The South African Civil Society Information Service

Will G20 Control Hot Money?

5 Nov 2011

In the era of neoliberalism ushered in by Reagan and Thatcher, one of the great sins was for nations to control capital flows in and out of a country. To restrict capital flows in any way was considered a restriction on the strength and dynamism of the free market.

There are lots of second thoughts about this now and evidence is mounting that capital controls are important tools that help countries avoid financial crises. 

Capital controls are a tool to help countries smooth out the business cycle. Many developing countries are getting too much speculative capital into their economies that are creating asset bubbles and making their currencies appreciate. 

Countries that are recipients of large inflows of speculative capital find that their currencies come under pressure to appreciate, which threatens their export performance and the performance of the real economy. It also makes their financial systems very vulnerable because just as all that money can come in overnight, it can also exit and when it exits suddenly, that can expose an economy to all kinds of risks and financial fragilities that can culminate in crisis.

Currently big banks borrow from the US Fed at low interests rates and then take this money and loan the money in hot markets (such as South Africa) at higher interest rates, making their profits on the spread or "carry trade."

The use of capital controls or capital account regulations in the form of taxes or limits on certain kinds of investments helps ensure that bubbles don't get too big and burst.

A special report by business reporting company, Dunn and Bradstreet, finds that countries, which institute capital controls are outperforming countries that do not. Even the IMF found that countries that instituted capital controls weathered the 2008 financial crisis better.

However, controversy is stirring at the G20 as the IMF with the support of the French government seeks to establish a global code of conduct for capital controls. Despite proposing capital controls as an economic tool, the IMF proposes it as a measure of last resort. Accordingly, in the long term, the IMF still seeks to realize the liberalization of markets.

Brazil and the G24 countries have pushed back very strongly against this, rejecting the idea that nation states should not have sovereign control over capital flows.

Meanwhile in a move that goes against Brazil and other emerging economies, South Africa's minister of finance recently announced a further relaxation of capital controls.

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You can find this page online at http://sacsis.org.za/site/article/453.19.