Gold will Gain in a Capital & Exchange Controlled Climate. Are They on Their Way?

Source: Julian D.W. Phillips, Gold Forecaster - Global Watch  (10/5/07)

In today’s world as we have already seen this year, tsunami-like capital flows can wreak havoc with exchange rates, confidence and global money stability.

When Exchange Controls were imposed in Britain in 1971 the country was caught off-guard by the speed of their imposition. That was when the gold price really took off eventually rising from $42 an ounce to $850 in the 1980’s.

This week HSBC a leading U.K. bank warned of a massive outflow of capital over the next six months on the U.K. After President Nixon closed the ”Gold Window” in 1971 Britain imposed Exchange Controls known as the “Dollar Premium” on the country. The author became a dealer in the Dollar Premium at that time and saw from the inside just how Capital Controls affected markets and investments to the benefit and detriment of different Investors. He is braced to see them imposed again. Will they be?

And if so, which countries will see them? As capital flows far bigger than we have ever seen wash across the global monetary system in the ebb tide of national wealth flowing eastward, the specter of Capital and Exchange Controls rises again. It is prudent, therefore, for all types of Investors to guard against the pernicious effects of these now and take advantage of the benefits that also come with them! In today’s world as we have already seen this year, tsunami-like capital flows can wreak havoc with exchange rates, confidence and global money stability. With the continuation of these capital flow dangers, at some point one or many more will seek to quarantine their national economies against outside dangers such as these.

We know that unless such Capital flows are restrained, foreigner Investors and dis-investors can hamper growth, or institute recessions and worse. In the case of inflows of capital inflation can be stimulated to the detriment of the surplus nation. But more dramatically Investors can be caught inside a net reducing their investment choices.

Because we are so sure that many countries will face capital flow problems in the future, we will continue to include pieces on what can be expected under Exchange Controls in our newsletters. Such controls could affect far more than one country, developed or under-developed. Many seem amazed that such a possibility could become a reality. The mere thought that the $ would cease to be the globe’s sole reserve currency appeared ludicrous to these readers years ago, but now the prospect is real. We can understand that as the $ has been just that for over a quarter of a century, more than half the working life of the bulk of professionals in the financial world.

It was Mr. Ben Bernanke who forecast that foreign investors in the $ and $ assets, would become ‘sated’ with them. It as Mr. Ben Bernanke who stated strongly that the U.S. Trade deficit is unsustainable. These were not simply gentle observations but warnings to us all. One of the best indicators on just how close Exchange Controls are is to watch the maturities of assets held by foreign holders. These will shorten down towards ‘call’ or ‘spot’ maturities as is possible. Then the run can start that triggers the imposition of Controls.

As a piece of evidence this pattern was set in South Africa in 1986. Over the previous 10 years the average maturity of assets held by foreigners there fell from long to 10 years quickly, thereafter slipped down to maturing assets or ‘call’ money. When Mr. Butcher was head of Chase Manhattan, which had a branch in South Africa, lending to the Apartheid government of the day, he was faced with a dilemma. Chase Manhattan branches in the States were losing business because of the bank’s presence in South Africa, more than the South African business was worth. What was he to do? He took the step that would have impressed the original Rothschild. He demanded the immediate repayment of all the loans present in South Africa, which had reached full term. Of course the South African government could not allow such a ‘run’ on the capital in the country, despite its being foreign owned, so it imposed Exchange Controls. The result? Chase Manhattan was then seen as a victim inside the States so the Stateside depositors who had left them, returned and increased their presence there. As to the South African loans from Chase, the South African government ensured they were serviced on time and repaid within the terms of the “Scheme of Arrangement” eventually. From a banker’s point of view, Chase Manhattan not only increased its depositor base, but continued to profit and get repayment from the South African government, the best of both worlds!

So to clarify what we said before, the imposition of Exchange Controls would have to follow the fact that foreign Investors were “sated” with U.S.$ investments, i.e. not buying anymore. This would leave them holders or sellers of these investments, either way, that situation would precipitate an exit of capital from the States.

Of course, if there were still buyers sufficient to maintain a form of stability on the Balance of Payments, that would not happen. That is why Mr. Ben Bernanke’s statements are so alarming. That he should expect the situation makes it at least a probability? The upside to this scene, obtuse though it may seem, such controls will actually hope to promote investment in the U.S.A.

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