Capital Flight, Controls & Fear

SUBHEAD: Governments may also decide that the contents of safe deposit boxes may constitute evidence of criminal activity.  

By Nicole Fosse on 19 June 2012 for the Automatic Earth -

 [IB Editor's note: This article as several lengthy quotes and references to support position that we have removed. Go to original source (link above) for that material.]

Image above: An artist's incendiary response to his JP Morgan Chase bank statement from CEO Jamie Dimon. From (

The ending of extend-and-pretend is ushering in a new era of fear and uncertainty which is rapidly evolving into the next phase of the on-going credit crunch.

It is becoming clearer to many that the problems run much deeper than they had perceived, and more people all the time are realizing the systemic nature of the risks we are facing. Fear leads to knee-jerk reactions. In financial markets, it leads to volatility and self-fulfilling prophecies to the downside. It leads to capital flight, and then to capital controls.

Capital controls were an integral part of the Bretton Woods regime, but went out of favour in the expansionist Washington Consensus era that followed. They remain controversial.

Capital controls appear to have limited contagion and economic damage in the Asian Financial Crisis in 1997/98. In later cases of relatively isolated financial crises, notably Iceland, they have also been credited with limiting the scope of krona currency crisis.

Capital controls are rapidly returning to official favour, but the likelihood of being able to employ them to contain a crisis orders of magnitude larger in scope is very small. Under such conditions, the risk is that capital controls will amplify the fear that is the driving force for capital flight.

The spread of financial contagion - fear by another name - is increasingly evident in Europe at the moment. Interest rates are one measure of fear, representing the perceived risk of default and thus a risk premium. As this perceived risk rises, interest rates go up, but this has the effect of making the debt harder to repay, leading to a further increase in the perceived risk of default, and therefore higher interest rates yet again.

Once a country is trapped in this vicious circle, collective psychology tells us where it will lead - to default. Similarly, austerity programmes force default by making it more difficult to repay loans by forcing economic contraction. Positive feedback loops have an inexorable progression that picks up momentum as they proceed.

Perception of risk drives capital flows - away from problem states and toward safe havens. What happens is that spreads rise. Perception of high risk leads to much higher rates, whereas perception of lower risk leads to falling rates, at least in the early stages of a financial crisis. Safe haven status does not require objective measures of safety or sounds fundamentals. All one has to be is the least worst option. Money goes from where the fear is to where the fear is not, pushing some over the edge, while buying time for others. In either case, large capital flows are destabilizing, and governments will try to use capital controls to prevent them.

The situation with the erstwhile European single currency is the epicentre of financial crisis this time. It is creating multiple risk distinctions - periphery versus core within the eurozone, long term versus short term, and also an increasing disparity between the euro countries and those outside the single currency. Clearly the interest rates are rising in the countries of the European periphery, to the point where these countries are effectively being shut out of international credit markets, and the businesses, local authorities and individuals within them are experiencing knock-on drying up of liquidity.

Funds are leaving these countries and moving towards the core states, but this move reflects only risk disparity within the eurozone. Some parties remain comfortable with the euro as a concept and are content seeking the relative security of the stronger states within it. Others take a broader view and have already lost trust in the single currency. For them, an acceptable level of risk begins with holding no euro-denominated assets at all.

Interest rate spreads are broadening within the eurozone, but core country rates are also beginning to rise, albeit from a very low level. To some this appears confusing.

Spreads can continue to rise within the eurozone while rates for the whole region rise relative to other sovereigns believed to represent a lower risk. All risks are relative, and the risk-averse psychology of a decline magnifies all differences. Attempts by central authorities to fight the psychology of decline with bailouts perversely reinforce it under such circumstances, by convincing investors that there really is something to worry about. The psychology of a rally is supportive of central interventions, making them appear successful, but declines make central authorities look incompetent, no matter what they do.

Each subsequent bailout, meant to be definitive, buys less and less time before the spiral of fear continues upward again. In the case of Spain, yields began to rise again mere days after a $100 billion bailout that was not even contingent on austerity measures, as previous bailouts for other countries had been.

The growing impetus for fear-driven risk avoidance is already causing problems, not just for the countries where capital is leaving, but also for the safe-haven recipients. The US, representing the safe haven of the reserve currency, has seen substantial inflows that are causing problems for the banking system.

Europe’s financial crisis is also supporting the value of the US dollar. A knee-jerk flight to safety into the reserve currency has been underway for some time already, and shortages of dollars are now increasing demand beyond supply. This dynamic has a lot further to go as dollar denominated debt, of which there is more than any other kind in the world, begins to deflate in earnest. Dollar liquidity will be in increasingly short supply. Safe haven status can lead to negative nominal interest rates, as interest rates are a risk premium. Rather than asking for a return, spooked investors are prepared to pay for the privilege of capital preservation. They are less concerned with the return on capital than the return of capital. In Switzerland, a major safe haven recipient of capital fleeing the eurozone, negative rates already apply. In the US, short term rates are likely to stay low, but longer term rates may well be on the verge of rising.

States are seeking to prevent destabilizing capital flows. We are currently seeing the beginning of a process that has very much further to go. Switzerland responded early on with determination to peg its currency to the euro, in an attempt to prevent its currency appreciating to the point where its export markets would suffer. However, currency pegs merely present a tempting target for speculators. They may stand for a while, but if the underlying condition that gave rise to capital flows is not addressed, currency pegs can prove impossible to maintain, costing sovereign states a lot of money while making a fortune for tenacious speculators with far more ammunition than states can defend against.

What we are headed for are global currency wars, with rounds of beggar-thy-neighbour currency devaluations, ultimately leading to the end of the fiat currency regime. The every-state-for-itself mentality is a major part of the psychology of contraction. This is the attitude that is tearing at the socioeconomic fabric of not only the eurozone, but ultimately of the European Union as well.

Where national interest become paramount, and the interests of the collective are lost, the endgame has arrived for the supranational entity. Political aggregations are increasingly fissile under such circumstances. For now, it is Europe in the crosshairs, but broader global divisions are on their way.

Capital controls, on both inflows and outflows, will be far more extensive than currency wars, however. We can expect all manner of attempts to control money flows at all scales. The impact will be widely felt by people trying to protect their scarce resources by removing them from the system while that is still possible. This can be difficult, and for ordinary people without the ability to send funds abroad leads there is a need to protect it domestically. Options are limited and increasingly risky.

The crisis may now increase the social divide in Greece, just as it has done many times in recent years. While members of the upper class have long managed to stash their money in safe places, a possible currency reform and the subsequent devaluation would probably hit many low-income earners unprepared.

Safe deposit boxes are not a secure option in the event of a bank run. If the bank’s doors are shut, the likelihood of being able to access a safe deposit box is vanishingly small. The odds of the contents remaining where they were left for long enough for the owners to be reunited with their property are also rather low. Even when there is no threat of an imminent bank run, financially-strapped central authorities may be minded to help themselves to the assets of others.

Governments may also decide that the contents of safe deposit boxes may constitute evidence of criminal activity, and reserve the right to assess the property stored, making the owners prove legitimacy. In a liquidity crunch, it is quite likely they will regard there being no legitimate reason for holding cash, and private gold ownership may be declared illegal. Both cash and gold could be subject to confiscation.

Legal niceties are very likely to go by the wayside as deleveraging proceeds and the global grab for scarce cash begins in earnest. Those who posses the power to grab assets left in harm’s way are very likely to do so, then possession will be nine tenths of the law.

Moving money abroad to a safer haven is not the simple solution one might imagine either. Governments that could not stop the hemorrhage as it was happening are seeking to reverse the capital flight after the fact. Of course, such actions will only further inflame fear, while doing nothing to address the reason for capital flight. They will thus increase the impetus for capital to flee in any way that it can.

Capital flight from the periphery is currently being quietly financed by other European central banks, allowing Greeks and other depositors in the periphery to continue withdrawing funds without banks closing their doors. Instead of a bank run, we have seen what has been described by several commentators as a "bank jog".

However, the rest of the eurozone cannot continue such support indefinitely, especially as fear causes the pace of the ‘jog’ to pick up, and contagion spreads the problem to other states. When that support ends, bank insolvency will be revealed.The kind of capital controls one should expect, and prepare for, include:
  • Restrictions on bank withdrawals
  • Restrictions on money market fund redemptions
  • Greater restrictions on retirement fund liquidations
  • Fixing an official exchange rate and criminalizing market rate transactions
  • Banning the conversion of domestic currency to foreign currency
  • Banning the movement of assets out of the country to foreign financial institutions
  • Barriers, restrictions, additional transaction costs imposed on foreigners seeking to deposit funds or make investments in safe havens
  • Forcing sovereign debt owners to accept longer maturities rather than principal repayment
  • Banning gold ownership
  • Reissuing the currency in a new form (an acute risk in Europe obviously)
  • Restrictions on the size of cash transactions
Assets held within the grip of the system are at risk. There is a critical dependence on the solvency of middle men, on government guarantees, and on the powerful resisting the temptation to grab what they can in the financial free-for-all of deflation and deleveraging that is picking up momentum. None of these is a good bet. Whatever actions one might plan to take, it is necessary to take those actions before push comes to shove. That way they can be taken under conditions of relative calm.

There are no no-risk solutions, but different options will suit different people, depending on their circumstances. Some may choose to store assets in another jurisdiction or in another currency if those options are available, but losing control over assets abroad is a distinct possibility, as is difficulty in converting the currency chosen as a store of value back into something that will functions as cash at home.

Physical travel may become much more difficult as capital controls lead to border controls of other kinds. Holding assets close to home gives one the greatest degree of control, but with certain obvious risks attached. Typically, he who loses the least in a deflation is the winner, as there are no easy answers.

Once fear is in the ascendancy, it is very difficult to combat. Governments and central banks simply do not have the control they think they do, and they do not understand the nature of battle they are engaged in. It is not a matter of restoring certain objective conditions. Central authorities are trying to fight the inexorable recognition that the magnitude of the debt that has resulted from our 30 year credit expansion dwarfs the wealth of the world, that the $70 trillion in G10 debt underpins some $700 trillion in derivatives.

That realization, and the natural reactions stemming from it, are the problem. As confidence evaporates, so does liquidity. Credit - the vast majority of the effective money supply - ceases to be equivalent to money. The resulting crash of the effective money supply is deflation by definition. This is what we have been predicting since the inception of TAE. This is how credit expansions always end - with the implosion of credit instruments that amount to no more than a pile of human promises that cannot be kept.


  1. "Once fear is in the ascendancy, it is very difficult to combat. Governments and central banks simply do not have the control they think they do, and they do not understand the nature of battle they are engaged in."

  2. Several years ago, I used to visit my safe deposit box at First Hawaiian Bank every Friday to keep my Momʻs paperwork and expense money while she was in a care home.

    One day, I arrive at the bank and get re-directed to the teller who has the contents of my box ʻsecuredʻ in a brown bag SITTING ON A COUNTER. I also had several thousand dollars emergency cash in the box for ʻsafe keepingʻ.

    They had drilled my box open and told me it was the wrong box number that ʻaccidentlyʻ got drilled but informed me: "they counted my money for me".

    Believe me, I do not need these clowns ʻcounting my money for meʻ.

    There was nothing I could do about it since it was my word against theirs as to how much cash I had and some other reasons they stated.

    I hope you can print this Juan as it is true. I have a witness. And surely it is in their records/and the locksmithʻs that they drilled this box. If not, the burden of proof would be on them.