I wanted to talk about the possible effects of exchange controls, people always think they are milder that they eventually end up being. Then I received this (in Spanish) from Roberto Rigobon, a Venezuelan who is a Professor at the Sloan School at MIT. He defintely can do it better and is more qualified.
What’s the big deal with foreign exchange controls?
By Roberto Rigobon
I do not understand why we Venezuelans have to get so worked up about foreign exchange controls. After all, since when do they last more than three months?
It is customary for authorities to say:” In the past the controls were not implemented correctly, we- who know how to control- will do it well”. I understand that today’s authorities are different. But a great friend once told me something that is absolutely true: “Countries that impose capital controls always claim they are different, -but surprisingly, they look identical at the end-they all collapse in the same way”
Foreign exchange controls is only a reflection of the ignorance of the economic authorities to handle a situation that is escaping their hands. It is exactly what a scolded kid does when he throws a temper tantrum on the floor. Since when is this an act that deserves our minimal attention? The question is not if the exchange control will last, it is knowing what will happen during and after it.
Today the Venezuelan Government is desperate for financing, and its only alternative is the Central Bank and the domestic financial system. I know that the Central Bank law says that it is prohibited to lend to the Government, but this was not really designed to be followed. It will be one of a gazillion laws that has been violated. And to be sincere, it is not as if the reputation of the Government will be drastically damaged for such an event-it has done worse things.
Thus the Government will expropriate the savers and the Venezuelan Central Bank. The typical mechanism is: the Government goes into debt through the financial system-issuing bonds that banks are forced to purchase. Whether it is because the Central Bank increases legal reserves and allows them to use such instruments as part of reserves, or simply because they open a desk where you can discount them at a sufficiently juicy price. In this transaction two things occur: The implicit indebtedness of the Government increases so much, both in the Central Bank and in the banking system- and since the monetary base increases, in a country with free mobility of capital, there is capital flight and reserves fall.
Let’s look at this in more detail. Forcing the banking system to accept Government bonds implies that savers have implicitly lent money to the Government. Of course, nobody sane would lend money to this Government if they knew what they were doing. In these circumstances, before depositing in the banking system, account holders would take their money out. Ah!! But that is what capital controls are good for-to stop savers, that do not want to lend the Government money and that have excess liquidity, from having any recourse.
Unfortunately, for the Government, capital flight can only be stopped for a limited time-in general, very limited (three to six months maximum). What ends up happening is that Governments are forced to freeze bank accounts-which implies a massive devaluation and expropriation of the account holders.
Now, expropriating account holders has never been a good idea. This has happened a few times in Latin America in 1989 and 2002 in Argentina, in 1990 in Brazil, in 2000 in Ecuador (To mention only a few) By the way, in each of these occasions (i) depositors lost between 60 and 70 percent of their savings, (ii) the Governments devalued the currency at least a factor of three (let’s see, today it is at Bs 1800 per US$, mmmmm….Bs. 5400 could be a good number, if history repeats), (iii) and even more important, each Government ended up leaving through the back door because the economy turned unmanageable-I don’t want to think what will happen in Venezuela where things are already unmanageable
Foreign exchange controls are not the problem, they are the symptom of the inability, of the ignorance, of the incredulity, and of the arrogance of those Governments that think they know more than savers. And certainly the savers do not have a graduate degree in economics, nor a Ph.D. from Chicago, but dummies they are not.
Only someone with one neuron (which it obviously needs to breathe) will think that controls are an alternative for the Venezuelan situation. Thus, to the mono-neuronic economists that thought of this terrible idea, tighten your belts because what is coming is a stampede.