In the last issue of "Gold - Authentic Money" [see below for subscription details] we looked at the possibility of Capital Controls being imposed in the U.S.A. in the event of a $ falling out of control. To many, so used to the dominance of the U.S. over global affairs for the last 100 years, such a thought is not merely repulsive, but ridiculous. In this last article we demonstrated just how easily and acceptably [to U.S. citizens] possible they can be imposed, to protect the U.S.A.
When there is too extensive a drain of Capital from a country, tremendous liquidity problems occur. Often disguised by the rising velocity of money and the inflation that roars out of control, the destructive element of such crises is the loss of liquidity. Capital Controls are imposed to prevent that and the collapse of the currency on Foreign Exchanges.
We are all familiar with the decay of nations who defy the basic norms of civilization taking their countries to wrack and ruin [such as Zimbabwe], but pertinent to our story is where it happens in a nation that maintains a high level of civilization from its financial nadir to its zenith. This is what we would expect in the case of the States were it to happen there. To take the darkness of the unknown away from this possibility in the future, a look at a nation where Capital Controls were imposed in their most extreme form, together with outside pressure. We look in this article, at the story of South Africa and its Capital Controls.
South Africa - Capital and Foreign Exchange Controls: -
South Africa was and still is a country dependant on the outside world for its financial health. Founded primarily on outside capital, which developed the mining industries there, the country became wealthy on the back of its exports of the richest treasure chest of diamonds and precious metals. The attitude of Investors into South Africa had, from day one, always been that South Africa was a "colony" where its riches were to be brought back to the developed world for refining and selling, leaving the country bereft of the profits on those riches. Hence Investors always sought a return on their investments, by way of the repayment of capital, plus interest payments and dividends, paid away from the country. This always left South Africa vulnerable to a withdrawal of money to the extent it could cripple South Africa's economy completely. Had the profits and beneficiation of these treasures been developed in South Africa, it would be one of the wealthiest of nations around today. But as a 'colony' ruled from overseas, such developments were not encouraged. Even today, the nation is hungry for foreign capital to develop itself. Only now are steps being taken to develop beneficiation industries, but with threats of increased taxation on those who do not cooperate.
"Blocked Rand Discount".
The first protective step taken by the government of the country came as its political attitudes started to offend the outside world. This brought the imposition of the "Blocked Rand Discount". Essentially all residents of South Africa, who had brought their external savings to the country, found their capital exit "blocked" [These funds are still blocked today, available only to their owners should they return to the country again]. This rate of discount was determined by the price which residents of the country were prepared to pay to take their capital with them, until finally this exit was blocked entirely.
The name of this 'pool' of funds was clearly intended to make an investment of capital attractive to foreign Investors, wanting to bring capital into the country. It provided a source of Rands, cheaper than those used in Trade, but restricted the repatriation of their investments, unless it was through the same cheaper "Blocked Rand Discount" through which they had entered the country.
As this system was accepted over the years, many found it attractive, because not only did they invest at a discount, but also the system allowed for the repatriation of interest and dividends through the "Commercial Rand", the Rand that traded at the same value as in normal trade transactions. This raised the level of the return very nicely. After all, a 30% discount to full value, turns far better when interest or dividends are paid on the residual amount.
e.g. the residue is 70%, so a 10% dividend on 100% becomes a [100/70 x 10%] 14.86%! And hopefully, you get your capital back at the same 70% rate, so suffering no loss.
Evolving the system.
Always a rich country capable of servicing its debt, South Africa continued to be a source of great investment opportunities. So, despite the offensive politics of the day, South Africa grew into a country with a fully developed economy, imposed on a completely undeveloped African population, except where labor was required to support the developments [particularly in the mining industry].
The author became the nations Electricity Supplier's Macro-Economist. This company, "Escom", was the largest international borrower in the country. In 1976 the nations had a foreign loan maturity of 10 years +, a level that was maintained through easily available loans. But as the world objected to the decaying politics, in the country the 'life' of these loans dropped all the way down to an effective 'call' money situation. Something had to give. Chase Manhattan Bank had many extremely healthy loans to South Africa who was exemplary in interest payments and capital repayments, when due. But Chase was losing its Afro-American client base in the States because of this. The chief executive of the bank at the time had to do something to resolve this dilemma. It made excellent financial sense, to raise its voice in objection to the political scene and to demand instant repayment of all outstanding loans [which 'call' money is]. The South African government, fully appreciating what damage this would do to the country, froze all capital repayments including loans. This 'run' on the country by the bank and others "in concert", forced the South African government to close its doors.
The effective damage was slight, even with sanctions. Back doors appeared, through which South Africa's exports continued to flow. Appearances and realities separated.
Even Chase Manhattan had cause to celebrate as its South African loans were now captive loans and continued to be well serviced and 'rolled-over' for longer periods, to the banks continued profitability, and their Afro-American clients returned to the bank in the States as the image of 'Martyr' enveloped the bank.
The Financial & Commercial Rand and the Scheme of Arrangement.
No 'run' situation can remain unattended by either Creditors or Debtors, as both are essentially prejudiced at least in the public eye. South Africa still able maintained its excellent debt servicing record, while seeking to repair the damage it had suffered as far as it was able.
- So along came the "Financial Rand" replacing the "Blocked Rand Discount" as the extent of the capital controls widened to encompass all capital including non-resident capital, resident in South Africa.
- The price of these "Financial Rands" dropped to close to 40% cheaper than the "Commercial Rand".
- New investment was allowed in through this cheaper door, permitting entrepreneurs developing schemes to introduce capital for investment into local companies, who converted their "Financial" Rands into "Commercial" Rands" to purchase factories from overseas to enhance South Africa's manufacturing base.
- In addition the government through the Reserve Bank introduced a "Scheme of Arrangement" whereby a means of allowing partial capital repatriation was permitted.
• All loans could be converted into investment funds and berepatriated through the "Financial" Rand, but suffering the loss of the differencebetween the two currencies. Few took that route except the desperate.
• All loans could be repatriated through the Commercial Rand,after a minimum of 10 years, provided they were converted to Medium term loansfor that period.
As the political climate improved, Mandela released and the A.N.C. un-banned, the difference between the two currencies narrowed [around 1994]. Suddenly loans to and investment in South Africa became politically acceptable. In that scene, what banker in his right mind could resist converting their loans into medium term loans? No other stable, developed country [which South Africa still was] offered such returns.
After all, you invest at, say: -
• 70% of the "Commercial Rand" exchange rate.
• Receive income on it as though it was 100% [100/70 x 10%]= 14.29%
• Receive interest on it all the way to maturity, at which timeyou are repaid.
• Get repaid at the Commercial Rand rate on maturity, not 70%[the price at the time of the introduction of the funds] but at 100%, a capitalprofit of 100/70 =42.86%.
Many a bright boy with a requirement to invest in fixed interest securities, followed such a route, often reinvesting his income back in through the same route, until full term, extending the total return dramatically!
Limited damage to South Africa
During all this time South Africa has been a country with two facets, the first world country within a third world country. During all this time the only real loss of those against whom the Political and Financial attacks on the country were leveled, were essentially cosmetic. The country has remained well developed all the way through. The back door the sanctions developed, developed Mauritius, who fronted for South Africa in many ways, as did many countries that gained the benefit of being a halfway point for South Africa's exports. Such Capital Controls did work and protected the nation through these dark periods of its existence.
Illegal Laws
What has to be said is that such Controls are offensive to the international community who often treat such a country as committing illegal acts. In rare instances this can lead them to confiscating the assets of the nations who resort to such measures.
Indeed, when Britain imposed such controls back in 1970, a Scotland Yard detective, who tried to find the details of secret Swiss Bank accounts held by Britons who had contravened such exchange controls, found himself in a Swiss prison for contravening Swiss banking secrecy laws.
After all it is an invasion if individual ownership rights. Despite that, you can be sure that if a nation's interests conflict with those of its citizens, the nation will trample the citizen's rights.
Present Day South Africa.
Today, although the Financial Rand has gone, there are extensive controls on capital movements by non-residents. They are more harshly imposed on the Residents of South Africa.
The government maintains it is removing these restraints, but is being painfully slow about doing so. The investment realities in South Africa provide the same realities they did in the last 100 years and the same restraints they have in the last 35 years.
With the pervasion of government interference with Black Empowerment and mounting taxation the threat to foreign investment funds remains as strong as ever. We can see no prospects of this changing. The present government is placing the development of the country over those of foreign Investors, compared to the past. It believes it has been charged to do so by its own citizens. Hence there is a large reappraisal by foreign Investors at the moment on new investments in South Africa.
Capital Controls in the States or other parts of the developed world?
The main points to be garnered from this experience is that with Capital Controls, a nation can protect the state of its internal economy when threatened by a massive withdrawal of capital from the country.
We have no doubt that the creditors of the United States of America are painfully aware of these dangers, so are disinclined to be tempted by such an option.
The price it will pay will be primarily a political one, as we demonstrated in the article we featured in the last issue of "Gold - Authentic Money" [which will be sent free to new Subscribers - see details below]. But for the United States of America, while it still has the power to dominate [and that is being eaten away steadily now, a move in the near future along these lines may well retain its power for longer still?
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