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Europe, a Troubled Region

April 18, 2013 in Economics

By Steve H. Hanke

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Steve H. Hanke

The most recent banking crisis in Europe erupted on the Island of Cyprus. Among other things, one result of the final EU-IMF bailout package was the imposition of capital controls, or restrictions on currency convertibility.

Currency convertibility is a simple concept. It means residents and nonresidents are free to exchange domestic currency for foreign currency. However, there are many degrees of convertibility, with each denoting the extent to which governments impose controls on the exchange and use of currency.

The pedigree of exchange controls can be traced back to Plato, the father of statism. Inspired by Lycurgus of Sparta, Plato embraced the idea of an inconvertible currency as a means to preserve the autonomy of the state from outside interference.

The temptation to turn to exchange controls in the face of disruptions caused by hot money flows is hardly new. Tsar Nicholas II first pioneered limitations on convertibility in modern times, ordering the State Bank of Russia to introduce, in 1905–06, a limited form of exchange control to discourage speculative purchases of foreign exchange. The bank did so by refusing to sell foreign exchange, except where it could be shown that it was required to buy imported goods.

Otherwise, foreign exchange was limited to 50,000 German marks per person. The Tsar’s rationale for exchange controls was that of limiting hot money flows, so that foreign reserves and the exchange rate could be maintained. The more things change, the more they remain the same.

Before more politicians come under the spell of exchange controls, they should reflect on the following passage from Nobel laureate Friedrich Hayek’s 1944 classic, The Road to Serfdom:

“The extent of the control over all life that economic control confers is nowhere better illustrated than in the field of foreign exchanges.

Nothing would at first seem to affect private life less than a state control of the dealings in foreign exchange, and most people will regard its introduction with complete indifference. Yet the experience of most Continental countries has taught thoughtful people to regard this step as the decisive advance on the path to totalitarianism and the suppression of individual liberty. It is, in fact, the complete delivery of the individual to the tyranny of the state, the final suppression of all means of escape—not merely for the rich but for everybody.”

Hayek’s message about convertibility has regrettably been overlooked by many contemporary economists. Exchange controls are nothing more …read more
Source: OP-EDS

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