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  October 31, 2011

Will G20 Control Hot Money?

Southern countries pitted against US and France over capital controls
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Kevin P. Gallagher is professor at Boston University and senior researcher at the Global Development and Environment Institute at Tufts University. Ilene Grabel is Professor at the Josef Korbel School of International Studies at the University of Denver. She has been a Research Scholar at the Political Economy Research Institute of the University of Massachusetts since 2007, and was a lecturer at the Cambridge University Advanced Programme on Rethinking Development Economics since its founding. Grabel has worked as a consultant to UNDP/International Poverty Centre, UNCTAD/G-24, UNU WIDER, and with ActionAid and the NGO coalition, "New Rules for Global Finance." She has published widely on financial policy and crises, the political economy of international capital flows to the developing world, the relationship between financial liberalization and macroeconomic performance in developing countries, central banking, exchange rate regimes, the political economy of remittances and, most recently on the normalization of capital controls and the effect of the global financial crisis on policy space for development. Grabel is co-author (with Ha-Joon Chang) of Reclaiming Development: An Alternative Policy Manual (London: Zed Books, 2004. Grabel also blogs for the TripleCrisis (


PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay in Washington. In the era of neoliberalism ushered in by Reagan and Thatcher, one of the great sins was for a country to control capital in or out. To restrict capital flow in any way was considered a restriction on the strength and dynamism of the free market. Well, there's a lot of second thoughts about that now and a lot of discussion about capital controls. Now joining us to talk about it and deconstruct this is, joining us from Boston, Kevin P. Gallagher. He's a professor at Boston University, senior researcher at the Global Development and Environment Institute at Tufts University. And Professor Ilene Grable. She's at the international--she's a professor of international finance at the Joseph Korbel School of International Studies, University of Denver. Thank you both for joining us.


JAY: So, Kevin, why don't you kick it off and tell us why this discussion over capital controls matters.

GALLAGHER: It matters because capital controls are a tool to help countries smooth out the business cycle. Many developing countries are getting much too much speculative capital into their economies. It's creating asset bubbles, making they were currencies appreciate. The use of capital controls or capital account regulations in the form of taxes or limits on certain kinds of foreign investment help make sure that bubbles don't get too big and burst.

JAY: So, Ilene, if I understand correctly, specifically what's happening now is that banks--and I suppose other big players, but particularly banks--can borrow money at next to no interest rates from the Fed or other sources. They take this money and they go to what's called hot markets and loan the money at higher interest rates and pick up the spread something people call the carry trade. So what's wrong with that?

ILENE GRABEL, PROF. INTERNATIONAL FINANCE, UNIVERSITY OF DENVER: Well, there may be nothing wrong with that from the perspective of individual investors. But, of course, from the perspective of the countries that are the recipients of those large inflows of speculative capital, they end up finding that their currencies come under pressure to appreciate, which necessarily threatens their export performance and the performance of their real economy. It also makes their financial systems very vulnerable, because just as all of that money can come in overnight to a developing country, it can also exit. And when it exits suddenly, that can expose the economy to all kinds of risk and financial fragilities that can culminate in crisis. So it's a problem on the inflow side because it threatens the currency and exports, and on the outflow side can create instability.

JAY: Well, I guess the big fight is over this whole issue of where is your currency and what's it do to your exports. And Dun & Bradstreet had an interesting report today where they said that countries with appreciating currencies--and I guess a lot of the reasons why some of these countries' (like Brazil's) currencies are appreciating is this flow, hot money flow from Europe and the United States--those countries are more likely to adopt currency--capital controls. And then it says, which is kind interesting for Dun & Bradstreet, because you would think they would not be big fans of capital controls, they actually say that countries that have capital controls are outperforming countries that do. What's the significance of them saying this, Kevin?

GALLAGHER: Well, it's really significant, because it's just yet another example of the mounting evidence that shows that capital controls are prudential means to prevent and mitigate financial crises. And slowly but surely the stigma for these instruments is starting to be peeled away, and they're just being seen as instruments that countries use to manage themselves in a prudent manner. I haven't read the full report that you mentioned, but it certainly squares with some of the recent evidence. The International Monetary Fund in 2010 did a study that showed that those nations that use capital controls were among the least hard hit during the financial crisis. The National Bureau of Economic Research in the United States found that those countries that use capital controls in the aftermath of the Asian financial crisis were also among the worst hard hit. And so the evidence is just mounting at a pretty significant rate that these measures should be seen as just regular pieces of the economic toolkit to prevent and mitigate a crisis, and it can help create stability and growth.

JAY: Well, it seems like capital controls are here. I mean, China has capital controls, and they've made it pretty clear they're not giving up on them. So what seems to be happening at these G-20 meetings that are coming up is that the IMF wants to decide on what basis you can use capital controls, and create rules under the control of the IMF. How is that likely to play out, Ilene?

GRABEL: Well, it's a really complex and interesting question, because the IMF, and also the French government, have had an interest over the last year in creating a kind of code of conduct, as you said, to determine under what circumstances countries can use certain types of capital controls. But as the IMF has started to articulate that aspiration, there has been a really important pushback that's come from some of the developing countries within the G-20. For example, a country like Brazil has pushed back very hard against the IMF and the French government's interest in developing a code of conduct for capital controls. Indeed, the Brazilian government, and also in conjunction with the Group of 24, issued a very sharp rebuke to the IMF's efforts to try to push in that direction. So I would expect that if the IMF tried to move much further along those lines, they would meet even stiffer opposition from the developing world. After all, the IMF can really no longer afford to ignore countries like Brazil, because these are countries that the IMF is now having to borrow money from. So the politics have really changed quite a bit.

JAY: So I guess to some extent this is recognition by the IMF and the powers that be in Europe, and to some extent the United States, that this free flow of capital just hasn't worked. And a lot of people say that one of the reasons for the crash and the problem in the finance sector is this unrestricted free flow of capital. But the IMF and others want to control this process. If they're going to concede that there needs to be some capital controls, they don't want to hand it over so that countries will have sovereign control over it. Is that what this issue is coming down to? Kevin?

GALLAGHER: Yeah, that's essentially it. When Sarkozy charged the IMF to put together a set of guidelines, he explicitly said that the guidelines would be monitored and enforced, in his opinion from the IMF, and that such guidelines would be on the road for countries to fully liberalize their capital accounts, meaning fully deregulate over the long term the--any restrictions on the ability to have financial flows go from one country to another. So that's one of the reasons why Ilene is pointing to this stiff resistance to the IMF-led effort. It's a little bit ironic that the IMF has done a lot of studies showing that these types of measures are working in developing countries, and now they're turning around and putting together a set of guidelines about when the measures should be used and when they shouldn't be. However, those guidelines don't square with the way that they were used by the countries when they worked in the first place. For instance, the IMF says use a capital control as a weapon of last resort after you've tried increasing your reserves, shrinking your budget deficit, increasing the capital requirements for a bank. If you've tried all those things and you just can't think of anything else, then you might want to try a capital control. And all the other evidence shows that the countries that use capital controls use them as a whole package of macroeconomic management tools that'll include all of those different things. But the capital control works best when it's part of a whole fabric of policies that are trying to meet a stated goal.

JAY: Ilene, put this into terms of why this matters either to ordinary North Americans or ordinary Brazilians. How does all this matter? 'Cause usually this issue gets reported from the point of view of investors.

GRABEL: Well, I think what we've seen, thanks to the financial crisis, is that when the financial sector is given the ability to pursue policies absent any restraint, absent oversight or regulation, we can see what kind of a mess that gets the world into. And, of course, what we're seeing now in Europe is that not all of the bad news is even out at this point. And so the fact that there's now discussions of things like the right of developing countries to implement capital controls, as Kevin noted, that the evidence really supports that case, it means that we could be entering a period where developing countries are able to set the terms of their own financial policy, so that they could use their financial sectors as they have a right to do, as a tool of economic development, as something which serves their larger aspirations of promoting employment, ameliorating poverty, promoting financial stability. Of course, this is a mess that originated in the wealthy countries that were the home of liberalized financial markets. And so the crisis has really done great violence to the ideal of the liberalized financial system of countries like the US. So we're really starting to see a change in sentiment, and I think that change in sentiment is also being associated with shifts in power in the global economy. So the countries that have controls in place are outperforming those that don't. Those are also countries that are emerging as lenders to the IMF. And it's becoming much more difficult for the IMF to try to run the world the way that they have traditionally run the world. They really can't afford to tell the Brazils, the Chinas, the South Koreas, the Indias what they should and should not be doing, because, after all, the global economic recovery very much depends on conditions in those countries, not in the US, not in the eurozone. Those are not the countries that are going to lead us out of the crisis.

JAY: Kevin, same question to you, Kevin.

GALLAGHER: Yeah. It really affects jobs and livelihoods not only in places like Brazil, but also in places like the United States. So when you have these carry spreads, as we were just talking about, and you're just getting, you know, significant amounts of capital inflows from places like the United States to places like Brazil, it causes the currency to appreciate and makes their exports too expensive to sell. And therefore they're laying off all sorts of people in their industrial sector. The Brazilian industrial sector is really, really concerned about the rise of the real because it's having a real impact on their bottom line and eventually they have to lay workers off. It also hurts people here in the United States. We have these very low interest rates in here with the purpose to try to revive the US economy and put people back to work. Unfortunately, investors are taking advantage of those low interest rates, taking the money outside of the United States and putting it into countries that don't necessarily need or want it. So it's sort of a lose-lose on both ends for the people, but win-win on both ends for the financiers. I've also advocated re-tweaking US policy to make sure that the low interest rates actually benefit people and jobs here in the US. If the US also played a coordinating role in capital flows and had some sort of limits on foreign finance, it would be more apt to direct the low interest rates into actual lending for small- and medium-sized enterprises and businesses in the real economy here at home.

JAY: Thank you both for joining us.

GALLAGHER: Thank you.

GRABEL: Thank you.

JAY: And thank you for joining us on The Real News Network.

End of Transcript

DISCLAIMER: Please note that transcripts for The Real News Network are typed from a recording of the program. TRNN cannot guarantee their complete accuracy.


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