Given today's highly interconnected plumbing (gilt repo, FX swaps, CCPs, non-bank leverage) and the fact that Thatcher's government first used an Order in Council in 1979 to switch off exchange controls and then, in 1987, repealed the Exchange Control Act itself so there's no longer any off-the-shelf legal framework, introducing measures like this would obviously require a very strong and determined government.
What do you think the first practical steps would be in terms of legislation, the Bank of England's remit, and PRA/FCA rules to introduce capital controls that actually work in the system we have now? I'm aware there's a growing literature on this, but in everyday discussion this is the question people most often use to dismiss or undermine any proposal for radical change, a bit like Rory constantly asking “yes, but how would you actually do it in practice?”. I'd be really interested in how you'd answer it in concrete, worked-through terms.
You are right to say that Thatcher did two things: first, she used an Order in Council to switch off exchange controls in 1979; then, eventually, she scrapped most of the legal framework.
She also removed the “Corset” (Supplementary Special Deposit Scheme), which was the Bank of England mechanism designed to restrict the growth of the broad money supply between 1973 and 1980 by penalising banks that lent too much, as well as relaxing hire purchase rules and deregulating Building Societies to allow them to lend more. Thatcher's changes were widespread.
Ever since, those who benefit from an open-door system have pretended that this history makes capital controls impossible. It doesn't. It just means we have to legislate again.
First, we would need a new Capital Management Act. That would give the Treasury powers to require registration and reporting of cross-border financial positions, to impose quantitative limits or charges on classes of flows (for example, short-term wholesale funding), and to direct the Bank of England and the regulators to use their tools to achieve those aims. The old Exchange Control Act is a precedent: it shows Parliament has done this before.
Second, the Bank of England's remit would have to change. Alongside price and financial stability, it must have an explicit duty to maintain external and capital-flow stability. It would then be required to use macro-prudential tools, such as counter-cyclical capital requirements on foreign exposures, reserve requirements on short-term foreign liabilities, and limits on FX mismatches, to pursue that goal. Access to sterling liquidity could be restricted to institutions that comply.
Third, the PRA (Prudential Regulation Authority) and FCA (Financial Conduct Authority) rulebooks would need to be revised. All sterling payment, clearing and repo activity for UK residents should take place in supervised entities that disclose their beneficial ownership and meet new reporting standards on FX, derivatives and securities financing. Time-varying regulatory charges (otherwise known as a Spahn tax), which are the equivalent of a transactions tax, could be applied to destabilising, short-term financial flows. Highly leveraged non-banks reliant on foreign funding could face tighter liquidity and leverage rules as a result.
Finally, we should not underestimate the importance of transparency. A public register of major cross-border positions, linked to company accounts and trust disclosures, would itself change behaviour.
None of this is technically challenging: banks already track these positions. What is missing is not the how, but the political will to say that managing capital flows is a normal function of a state that wants an economy which serves its people.
I now believe that this is an essential direction of travel.
Comments
When commenting, please take note of this blog's comment policy, which is available here. Contravening this policy will result in comments being deleted before or after initial publication at the editor's sole discretion and without explanation being required or offered.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
There are links to this blog's glossary in the above post that explain technical terms used in it. Follow them for more explanations.
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Buy me a coffee!
If your proposals mean that a state can monitor flows of cash into the country and also determine their effects – ill or good – (asset stripping vs. real investment), then I’m all for it.
Maybe worth noting that the Maastricht treaty effectively prohibited capital controls; the free movement of capital is one of the core “freedoms” of the EU.
It is only following BREXIT that the UK has the freedom to reintroduce capital controls.
Perhaps this is a silver lining amounts the disadvantages of BREXIT.
So, we need to show the EU where to go
Absolutely 🙂 🙂
We do need closer ties and integration with Europe. We are European both geographically and, perhaps more importantly, culturally. That later being particularly evident in the age of Trump.
Sadly the EU is hampered by it’s current economic structure. This, IMO, is part of the reason for it’s economic malaise (not hogwash about it not being sufficiently antisocialists, a.k.a. neoliberal).
I’d very much like to see the UK lead with proper economic policies such as you espouse. Then, please, they might reform economically, given an example of what can be achieved. And then, perhaps, we may rejoin a reformed EU. I can dream.
The EU at least has an emergency valve in the form of Article 66 TFEU, which allows temporary conditions to be put on some cross-border capital flows to and from third countries in a crisis. Post-Brexit, the UK could in theory go much further than that if it chose, but in practice we have no dedicated capital-management legislation at all only the Bank of England’s crisis hosepipes once things have already gone wrong.
I can see your argument for capital controls terms of preventing sudden flight capital and curbing speculative attacks on the pound. That said we are heavily reliant on foreign investment flows (circa £60 billion annually) and obviously for financial services which is approximately 10% of GDP. Controls would signal weakness potentially triggering the very flight they intend to stop and deterring genuine foreign direct investment. I have no doubt capital restrictions would also raise the cost of capital. Indeed Bof E stress testing on this have indicated that yields on gilts could increase between 1-2%, so you are looking at higher medium and longer dated borrowing costs.
Obviously it is a deeply analytical issue which would cause many ripple effects, mostly negative, over the benefits you outline.
Why do we want such a strong finance sector?
See my recent video on the finance curse, and posts on hot money.
And why would this stop genuine flows? It would be designed to encourge them.
And rates would fall – that is what happens when you do not target hot money.
In the short run, inward investment looks good – indeed, it is an indication that the UK is “open for business”. However, it speaks volumes about our (lack of) investment capabilities – we should be making these investments ourselves and keeping the returns that accrue to these investments rather than allow the them to be syphoned off overseas. The controls I envisage would not really impact this sort of investment…. but if it did it might force us to address our chronic lack of investment.
With regards to the Financial Sector. Whether one sees it as a blessing or a curse it would be largely unaffected by capital controls as this would apply to GBP activity only and the vast bulk of business is in USD or EUR…. and could continue unhampered.
The first question is “What are Capital Controls for?”. In my view, it is not to restrict investment into the UK or, indeed, those who have investments in the UK (be they residents or foreigners) from selling and moving their money to other countries.
Rather, they are to prevent speculative selling of the currency that might destabilise the real economy. In order to sell short (ie. sell something you don’t own) you need to borrow it and there should be restrictions placed on Banks on lending to people for the purpose of FX speculation – perhaps along the lines of Singapore?
Those who remember the UK’s withdrawal from the ERM in 1992 will recall how rates where hiked from 10% to 12% in the morning and then 15% in the afternoon – the idea being that this high cost of borrowing would deter short-selling of sterling. It was unsustainable as everyone realised that the real economy could not sustain such high rates and devaluation followed.
Contrast this with France where similar pressures were at work on several occasions when I was trading FRF bonds in the 1980s as France shifted from a policy of regular devaluations to the “franc fort” policy. FX controls meant that speculators were having to pay massive rates to borrow/short French francs – up to 100% while “domestic rates” were relatively stable. Consequently, France maintained the FX rate v the DEM. By 1992 France had relaxed some of these controls and it did struggle to maintain the DEMFRF rate but managed to do so with rates at 13% (and clear political will that did not exist in the UK).
The purpose of this “history lesson” is not to approve/disapprove of the ERM or Single currency project – merely to show that these restrictions can work.
Thanks
So by way of example, every reinsurance contract at Lloyds of London with an overseas insurer (the overwhelming majority) would have to be registerted and approved by some Richard Murphy-appointed bureaucrat before it came into force?
A check valve on capital. Inflow will completely stop. Outflow will expand. All foreign owned businesses will cease growth and major maintenance, and begin planning their exit.
Econocide.
Politely, you are talking total nonsense.
Then, those who oppose the interests of society always do.
But, whilst you are here, please explain why people in the U.K. should suffer risk from Lloyds – a market I have never trusted?
I was using Lloyds by way of example.
But if you want to know it generates billions in foreign exchange earnings, employs thousands in high-skilled jobs, supports UK financial services leadership globally, and provides vital insurance capacity for international trade and complex risks. Indeed the reason it is so successful is because it is “trusted” because of its claims payment history (major catastrophes like 9/11, hurricanes, etc.). I presume your comment stems from the 1980/90s period when individual “names” faced unlimited liability? Since then the underwriting process has changed significantly and an entirely different structure has evolved where multiple layers or corporate capital is now in place. It is also regulated by the FCA with annual audits and public reporting. In fact Lloyds is one of the great success stories in UK business in recent decades.
However i used Lloyds anecdotally to explain the likely damage capital controls will do to businesses reliant on international capital.
All noted.
But you wholly miss the point. This charge on genuine transactions is minute. The Spahn tax in speculation is what matters. So, why do you think it a problem for real trades that will not be hit, as precisely please. I have made my case. You have not tried.
Capital controls come in many flavours but the aim (or my aim) would be to prevent GBP volatility. Contracts in USD (I presume this covers the vast majority of the reinsurance market) could be traded without hindrance. I am also guessing that the assets backing these contracts are not GBP denominated so, again this would be no problem.
Singapore has similar controls in place as I write and this has not prevented international trade in that island state.
Agreed