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Kevin Gallagher: Countries Using Capital Controls to Defend Against Speculators

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News. I’m Paul Jay, coming to you again from Tufts University in Boston. In South Korea on the 11th and 12th, the G-20 countries will be meeting. The specter of currency war haunts the meetings. Capital controls, one of the pillars of neoliberal economics, meaning do not control capital in and out of a country, no government regulation, no capital controls, this was supposed to give prosperity to the world. Instead, perhaps free flow of capital has led to the unraveling of the global financial situation. And now even the IMF is suggesting capital controls to some of the Third World or emerging economies. Now to help us deconstruct all of this is Kevin Gallagher. Kevin’s an associate professor of international relations at Boston University, a senior researcher at the Global Development and Environment Institute at Tufts University. Thanks for joining us again.


JAY: So what’s going on here? The IMF is actually suggesting capital controls. This was something that was considered a cardinal sin for decades.

GALLAGHER: Cardinal sin, and even by the IMF in 1998. The IMF wanted to change its fundamental rules to make capital controls globally outlawed. And here they are, in the wake of this crisis, advising Iceland to use capital controls.

JAY: So what’s instigating this or sparking this? And who’s buying into capital controls?

GALLAGHER: A number of countries are buying into capital controls, and more of them will buy in right after this G-20 meeting. The reason why they’re buying in or reason why the IMF is buying in is, one, it’s just been showed to work and they just can’t deny it. And here we are in the middle of a crisis where countries need as many things as they can use in their toolkit, and the IMF is resorting to this and saying, yep, here’s one of a number of tools that countries can do to get themselves out of this crisis.

JAY: So let me understand one of the reasons this is happening. You’ve got massive amounts of capital in very few hands around the world looking for places to go, and there’s not a heck of a lot of productive places to put it, if I understand it correctly, particularly in United States and some of the other�Europe. There’s so little consumer demand. It’s not like you’re going to open up a new shoe factory. So you run around looking for margins on your money. And so capital’s jumping from one country to another to see if they can get a spread on cheap money�borrow cheap money over here and earn it over there. So what’s the effect of that? And what would capital controls do to prevent that or stop that?

GALLAGHER: Yeah, you’ve got it exactly right, Paul, that interest rates are low and demand is low in the developed world, and so global investors say, hey, I can get money cheap out of the developed countries, mainly the United States, Europe, and so forth, and I can park it in places with higher interest rates or that seem to be growing a little faster, to recover from the crisis and make a quick buck, and then maybe pull it back into the United States or put it somewhere else. This in theory is a good thing, but it’s actually wreaking havoc on many of the developing countries. It’s causing a high demand for their currencies and for things in their economy, which is making their currency appreciate, and it’s causing things like asset bubbles, housing bubbles, stock bubbles in different countries as well.

JAY: It’s a little counterintuitive. For so long, countries were competing to get foreign investment. Now they’re getting these inflows and they actually want to use capital controls to slow it down. So what countries have capital controls right now? And what’s the mechanism? What does it look like?

GALLAGHER: Sure. Well, first, countries are competing to get foreign investment, but they’d rather have that shoe factory you were talking about than a short-term bond that they’re going to pay back in 30 days and then you’re never going to see the money again. Their banking system just can’t handle this kind of stuff, and it is so destabilizing. So there’s a need for real-economy investments. But the way that the global financial system is currently structured, that there’s more of an incentive right now for hot money to move around, and it’s very destabilizing [snip] So what do you do to deal with this hot money? One of the things in your toolkit can be capital controls. Right now, countries are worried about too much capital coming into their country in a short-term basis.

JAY: So Brazil, for example, has some. What is the Brazilian capital control?

GALLAGHER: Yeah, there’s two different kinds. There’s what we call market-based capital controls and quantity-based capital controls. Brazil’s an example of a market-based. They have a tax. It just works just like a tax or a tariff. So they say for certain kinds of investment that come in, speculative capital, it has to have a 6 percent tax, and they get taxed 6 percent. Other countries, like Thailand a few years ago, had something called unremunerated reserve requirements. Sounds nerdy. It’s sort of a tax and a quantitative control as well. They take your money but say 30 percent of the value of this investment has to go into the central bank, denominated in a local currency, for six months. So if something bad is going on in the country, at least some of the money�or perceived to be bad going on in a country, and investors want to pull their money out real quick, at least a certain amount of it is staying in the country, so it isn’t as destabilizing.

JAY: And how effective has this been? And what’s the reaction of global finance capital to all of this?

GALLAGHER: Well, one of the reasons why these are starting to be recommended is just there’s just a mountain of unignorable evidence by the IMF, Asian Development Bank, academics, and so forth, that shows that capital controls have been working since the crisis. As a matter of fact, a landmark IMF report in February 2010 showed that the countries that used capital controls were among the least hard hit in this financial crisis. And so they just can’t deny the evidence. They tell countries that it’s one of the possible things that you can use to stop capital from coming into your country in such a quick manner. The global investors are not as excited about it, because it’s other folks telling them what they can do with their money. They want to be able to move it around freely. The fact of the matter is, the benefits of capital controls are going to outweigh the short-term costs on some of these investors. I’d much rather have a stable financial system that allows countries to grow than a couple investors that aren’t going to make, you know, billions of dollars in a short-term move.

JAY: Now, what stops a Brazil from just saying, okay, we don’t want your short-term money, period? Like, are they buying Brazilian government bonds? I mean, the government of Brazil can simply stop issuing bonds.

GALLAGHER: Brazil, each month, they get closer and closer to that. They started out with a 2 percent tax, and it was a little low. A lot of investment was still coming in. They bumped it up to 4 percent, and then they bumped it up to 6 percent.

JAY: And at 6 percent it’s still worth sending money to Brazil? Or do they just start moving it to other countries?

GALLAGHER: They’re still moving it into Brazil. Brazil is really concerned about the QE2, the quantitative easing. They’re really concerned about the appreciation of their currency, ’cause money’s flowing in. Money’s just flowing in. It’s considered one of these emerging hot markets, and money’s pouring into the region. One of the problems is eventually, if it gets to too high of a level, investment might go to another country. But if you don’t necessarily want that kind of investment or you don’t want too much of that kind of investment, that’s not such a bad thing.

JAY: Now, this money essentially is coming, to a large extent, from the American public, one way or the other, isn’t it? I mean, is the American public benefiting in any way from all of this?

GALLAGHER: It’s not clear that the American public benefits from it, because a lot of the financial system’s deregulated, and the ability to keep track of where all that money goes and have it cycle back into the US coffers and so forth is difficult to track, and it’s not clear that it happens.

JAY: For decades US policy, directly through US government and also US control of the IMF, was so against these capital controls. So what’s the legality of this now?

GALLAGHER: If you don’t have a trade agreement with the United States, you’re free and easy to use capital controls. But if you’ve signed a trade agreement with the United States during the first Bush administration, the Clinton administration, or the last Bush administration, capital controls are actually illegal. Not only are they illegal, but a private investor, say a bond holder or a private firm, JPMorgan, can sue another country if they put in place capital controls.

JAY: But most of the countries we’re talking about must have trade agreements with the United States. So, like, Brazil must have trade agreements. But they seem to�.

GALLAGHER: Interestingly, Brazil has always refused�sorry to interrupt. Brazil’s always refused major trade deals with the United States. They prefer to deal with us at the World Trade Organization. We tried to do something called the Free Trade Area of the Americas, and they said no, they didn’t want a trade agreement that looked like the North American Free Trade Agreement or the Chile Free Trade Agreement, two agreements that make capital controls illegal. They didn’t want those agreements, for that and a number of other reasons.

JAY: So the relative independence of many of the Latin American countries, then, who refused to be part of these free trade agreements has given them more tools, you could say, to resist this currency war?

GALLAGHER: Absolutely. And what’s interesting is that at the G-20 meeting, Obama�one of the deliverables might be a US-South Korea free trade agreement. South Korea actually just put in place currency controls a couple of weeks ago that would be illegal under the free trade agreement that the United States wants to sign with them.

JAY: Thanks for joining us.

GALLAGHER: Thanks for having me.

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

End of Transcript

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Kevin P. Gallagher is Associate Professor of International Relations at Boston University and a Faculty Fellow at the Pardee Center. He also serves as Senior Researcher at the Global Development and Environment Institute at Tufts University. This policy brief is an update
and expansion of his forthcoming book with Roberto Porzecanski, "The Dragon in the Room: China and the Future of Latin American Industrialization""."