Currency Controls
December 2007

They exist in various sizes in many places. JFK imposed them in the US in his term in a limited way. Ditto Europe. UK kept them on for years after WWII; Brits could only send/take £5 (each) out of the UK in 1947 (£20 if biz trip); later rose to £50. FXC ended 32yrs later, 1979, by M.Thatcher.

It’s serious. Nov 23 headline in respected Telegraph, London, says: Will Europe impose exchange controls to head off disaster? Ace writer Ambrose Evans-Pritchard wrote: “The die is now cast. As the euro brushes $1.50 vs the US$, it is already too late to stop the eurozone from hurtling into a full-fledged economic & political crisis. We now have to start asking whether the European Union itself will survive in its current form. It takes 18 mos +/- for the full effects of currency changes to feed through, so damage will snowball late 2008 & beyond into 2009 - - although ‘damage’ is a relative term. Airbus chief Enders warned that Airbus, EU's champion plane-maker, is now facing a ‘life-threatening’ crisis. It has ‘massive losses’ on the horizon. So much for those currency hedges analysts like to cite. Have they ever tried to buy one? They would discover how expensive these instruments are. Hedges can’t protect a company with $220bil in delivery contracts priced in US$’s when the euro/£ cos t-base is leaping skyward.

“The sudden rocketing in sovereign bond spreads this week between core German bunds & Club Med debt-- Italian, French, Spanish, Portuguese, Greek, Irish, Belgian, & Slovenian--is a clear sign mkts are starting to price in a break-up risk for the euro, however remote. Italian spreads have risen beyond the danger point of 40 basis points. This is less than the 100 basis pts seen in Quebec (viz Ontario debt) when it looked as if the separatists might prevail. But, it is dangerous nevertheless. Also, these bond spreads tell us liquidity is drying up, that monetary policy is too tight for the eurozone, as it is in much of the developed world. 2-year bond yields are collapsing in the US, Britain, & Anglo-Saxon states, a signal mkts are discounting recession. The whole central banking fraternity seems behind the curve, spooked by residual (lagging) inflation--& prisoners of a defective economic model (Neoclassical/New Keynesian synthesis). This is how the 1930 depression metastasized.

“For sure: French Pres Nicolas Sarkozy will not let Airbus go bankrupt, nor see decimation of the French industrial core, without an almighty fight against nations deemed engaging in a beggar strategy of currency devaluation-- benign neglect in Washington, less benign in Beijing. He’ll have allies soon, once housing bubbles collapse in Spain & across the Med. Mr Zapatero won’t long be in power in Madrid. Mr Prodi is on borrowed time in Rome. A new political order will soon take hold in much of Europe, bringing in a new wave of prickly national populists. ••• How will they fight? Will Mr Sarkozy & allies resort to 1970s-style FXC controls to stem the euro rise? They have the power to do so. Four years ago a little-known cellule at the EU Comm. wrote a report exploring the legal basis for measures to stabilize the currency. It concluded Brussels may impose ‘quantitative restrictions’ on capital inflows. If extremely disturbing capital movements endanger the operation of economic & monetary union, Article 59 EC provides for the adoption of restrictive measures for a period not exceeding 6mos. But renewable each 6mos, so the policy cou ld in fact become permanent.

“Any decision would be taken by EU finance ministers
via majority vote. UK won’t have a veto, even though effects of this move on the City of London would be catastrophic--& trigger the certain withdrawal of UK from the EU. (And good riddance, some might say in Paris) This‘disturbing’ capital movement is occurring right now. Portfolio inflows into euro zone reached a record €46.2 billion in Sept. China, Asian wealth funds, Petro$ sheikdoms, & now even Nigeria have joined a stampede into euros, ••• The commission cellule, says: ‘Among actions that can be taken when a member state has serious balance of payments difficulties, Articles 119 & 120 EC provide for the possibility to reintroduce ‘quantitative
protective measures' against 3rd countries’ [eg, US]. The measures are of course exchange controls. This is the nuclear option, but EU's politicians could equally invoke Article 104 of Maastricht Treaty giving politicians power to set fixed exchange rates (by unanimous vote) or a dirt y float for the euro (by majority).

“Pres Sarkozy seems inclined to go this route. He again invoked his ideas for Community Preference--ie, a closed trade bloc--in a Nov speech to the Euro Parliament. ••• The ECB may/may not intervene in the currency mkts to cap the euro. But this is a red herring. Europe's retort--if & when it comes--will be far more political, & far more dramatic. We are at one of history's inflexion points. One recalls the months leading up to the collapse of the Gold Standard in 1931. That was triggered first by Credit Anstalt in Austria & then by a British naval mutiny in Scotland. Any bets on what will trigger the collapse of Bretton Woods II? I wager it will be a decision by the Gulf states to break their $ pegs, leading to a temporary surge of euro purchases. That will tip Mr Sarkozy over the edge.” – For the complete story see: CLICK HERE