Iceland’s Example Points to European Exchange Controls
Foreign exchange (FX) controls are a popular way for governments to deal with economic crisis. Such laws and regulations typically restrict private ownership of or transactions in foreign currencies and gold.
Only a few decades ago, exchange controls were common in Europe. France and Great Britain had exchange controls in effect until the late 1970s. More recently, Iceland imposed them in the aftermath of the collapse of its banking system in 2008. And, if Greece, Spain, Italy, etc. pull out of the “eurozone,” FX controls would be a convenient populist measure to persuade voters that each respective government is “doing something” to prevent or at least slow down capital flight.
FX controls take many forms:
- Prohibiting residents from owning bank accounts denominated in foreign currency or an account in a foreign bank
- Banning the use of foreign currency within the country
- Banning residents from possessing foreign currency
- Prohibiting exporters from drawing against a bank account except for internal transfers
- Limiting bank trading in a domestic currency to discourage currency speculation.
- Restricting the amount of currency that may be imported or exported
- Prohibiting residents from owning gold or exporting gold abroad
Iceland is a case in point. This tiny country, with a population less than 300,000, experienced a catastrophic financial collapse in October 2008. Unlike Greece, it wasn’t part of the eurozone. Iceland has its own currency, the króna. But only 10% of the credit in its financial system is denominated in króna. When Iceland’s three largest commercial banks failed in October, 2008, the króna fell by 70% or more on global currency markets. When the last major Icelandic bank failed Oct. 8, 2008, the foreign exchange market for króna also collapsed.
Within hours, the central bank imposed FX controls restricting the purchase of foreign currency within Iceland. These controls remain in effect nearly four years later. Icelanders leaving the country can only take about US$2,600 in foreign currency with them to cover travel expenses. International investments by local residents are banned completely.
The exchange control rules from the Central Bank of Iceland read in part:
“Investing in securities, unit share certificates in UCITS [mutual funds] and investment funds, money market instruments, or other transferable financial instruments with foreign currency is prohibited. However, parties that have invested in such financial instruments prior to the entry into force of these rules are permitted to reinvest. If the proceeds of sale or full payment of financial instruments are utilised, in whole or in part, to invest again in the same type of foreign instrument within two weeks’ time, this is considered reinvestment in the sense of the second sentence.”
Basically, Iceland residents who invested in foreign currencies or gold outside Iceland before the FX controls came into effect can keep them. But those who didn’t take this precaution have their savings trapped in the króna.
I think the situation in Greece could develop in a similar way. If Greece leaves the euro—something that could happen within days—the country will revert to its pre-euro currency, the drachma. Many experts believe the drachma could drop by 50% or more against the euro in a matter of days or even hours.
If that happens, capital flight out of Greece will accelerate. The Greek Central Bank could emulate Iceland’s example by banning money transfers out of Greece and even limiting ATM withdrawals.
Unfortunately for governments considering them, FX controls never work, because companies and wealthy individuals always take precautions to safeguard their savings. But that won’t necessarily stop them from being imposed.
Just look at Greece: both individuals and businesses are already taking precautions. Greek banks are shedding approximately $1 billion per day in assets as customers line up to withdraw their savings. Many ordinary Greeks have withdrawn their entire life savings in euros and are storing it at home. Others are stocking up on food, gas, and other necessities in the expectation of civil unrest and rationing. Firearms sales have soared. Other Greek residents have set up foreign accounts to keep their money safe from FX controls, set up businesses outside Greece–or have left Greece altogether.
Businesses are also taking precautions. Banks with exposure to Greek loans or investments are trying to move contract renewals into other jurisdictions to avoid being bound by possible FX restrictions. Multinational corporations with Greek operations have been sweeping euros out of their Greek accounts daily and moving them abroad to limit their risk in the event of a forced conversion of euros to drachmas.
Should Greece impose FX controls, they could spread very quickly to other countries. Ireland, Italy, Portugal, and Spain all have debt exposures as bad as or exceeding those of Greece, and may choose to revert to their pre-euro currencies. In an effort to stem capital flight, all of these countries could impose FX controls.
What about the United States? Perversely, at least in the short term, I think the U.S. dollar could appreciate significantly in the months ahead as the euro crisis unfolds. Since the dollar faces no short-term threat of devaluation, it’s unlikely the United States would impose FX controls in the near future.
Over the longer term, however, the U.S. financial system is grossly over-leveraged with debt. If the dollar suffers a sharp collapse in value, FX controls could be imposed virtually overnight using the legal mechanisms I described here.
The most basic strategy is to protect yourself from FX controls is to imitate what ordinary Greeks are doing, right now. Stockpile cash, food, water, fuel, guns, ammunition, etc. If you have the funds available, open a foreign bank account or store precious metals at an offshore safekeeping facility. Even better, set up a foreign business that generates non-U.S. dollar income.
An even more effective strategy may be to create an international structure in which you are not the owner of the underlying investments, but only a beneficiary. An offshore trust and some types of offshore annuity investments provide this sort of protection. Historically, payments from overseas life insurance and annuity policies have been exempt from foreign exchange controls—although there’s no guarantee they would be in the future. An additional benefit is that these structures provide significant protection against claims in civil litigation.
Are foreign exchange controls coming to the United States? I certainly hope not. But if they do, I hope you’ve made arrangements to prepare for their arrival.
About Mark Nestmann
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