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markets in order to protect a political ideology, monetary nationalism,
that produces a scarcity of local resources is hardly sound economics.
Imagine what Microsoft and Amazon.com would be today if their small
home state of Washington banned short-term capital flows. They would
be capital-starved corporate pygmies. Now imagine such a capital-flow
policy writ large, state by state, across the American continent. The dam-
age to the development of the U.S. economy would be massive.
The theoretical case for capital flows is compelling to the point of being
obvious. When capital can flow freely from where it is overabundant to
where it is scarce, the return on savers capital is maximized and its cost to
growing companies is minimized. Free capital flows also allow financial
risks to be pooled, and therefore lessened through diversification, and bet-
ter allocated among those with different abilities to bear and manage
them.
Norway was a huge importer of capital, as high as 14% of GDP, in the
1970s, allowing it to develop its oil reserves far more cheaply than it could
have relying on domestic savings. Singapore, on the other hand, was a
mirror-image exporter of capital in the 1990s, allowing its citizens to achieve
much higher returns on their savings than they could ever have achieved at
home.10 When capital flows function in this manner, they are a major stim-
ulant to economic growth and higher living standards.
Are high levels of capital inflows inherently dangerous? Not on their
own. Between 1870 and 1890, Argentina imported capital equivalent to
18.7% of GDP, compared with barely over 2% from 1990 to 1996, in the
years prior to a major currency crisis. Indeed, international capital flows
for twelve major trading nations were roughly 60% higher as a percentage
of GDP from 1870 to 1890 than they were in the 1990s (3.7% versus
2.3%).11 There is proportionately less capital crossing borders today than
there was a century ago.12
Consider too that capital today flows freely, instantaneously, and often
massively within countries. During the 1990s tech boom, billions of dol-
lars were raised in New York and invested in California. When the tech
bubble finally burst with the dawning of the new millennium, both the
GLOBALIZATION AND MONETARY SOVEREIGNTY 125
California and New York economies were hit hard, as companies and their
investors suffered the grim aftermath of irrational exuberance. Yet through
the highs and the lows, there were no current account crises, no specula-
tive currency attacks, no cessations of credit, no interest rate spikes, no
bank runs, no IMF missions, no violent protests, and no political up-
heavals.
We know of no economist who questions the wisdom of free capital
flows between the continental United States and the commonwealth of
Puerto Rico; or Panama, Ecuador, and El Salvador which all use the
U.S. dollar as their currency for that matter. While the evils of hot
money rushing into and out of emerging markets are widely proclaimed,
the condemnation is reserved exclusively for dollars sweeping through
states whose governments restrict their use, or refuse to use them in deal-
ings with their citizens. In other words, it is not the movement of money
between the rich and poor parts of the world that is damned, but the
movement of dollars in and out of countries whose governments don t
want their citizens to use them. The political presumption on the part of
capital-flow critics is in favor of the governments, and therefore the solu-
tion is always to stop citizens from importing or exporting capital.
Commodities to the Rescue?
For some of the countries in Table 5.1, the ratio of foreign to local
currency deposits has declined in recent years. For example, Russia wit-
nessed a decline in foreign currency deposits from 35% of total deposits in
2003 to 23% in 2005.13 This is consistent with the positive empirical corre-
lation between commodity prices and the exchange rates of commodity-
export dependent developing countries, and the negative correlation
between exchange rates and the foreign currency component of de-
posits.14 The latter is illustrated in Figure 5.5 for the case of Chile.
The clash between the mythology and psychology of money, between its
role as an emblem of sovereignty and a fundamental tool of individual
choice, is not always visible. It can lay dormant for years. Years of high and
rising commodity prices have improved fiscal and current account balances
in many developing countries, and supported solid economic growth.
Many developing country currencies have appreciated in consequence,
126 GLOBALIZATION AND MONETARY SOVEREIGNTY
Figure 5.5. The effect of exchange rates on Chilean dollar deposits.
Data source: IMF International Financial Statistics and Central Bank of Chile.
Note: A fall in the real exchange rate index represents a rise in the Chilean peso.
spreading optimism and willingness to run currency exposure risks in such
countries in particular, on the part of rich-country institutional investors.
Yet, as has happened repeatedly in the past, storm clouds will return once
commodity prices start falling again. Currencies will depreciate, fiscal and
current account deficits deteriorate, capital inflows turn to outflows, and
foreign exchange exposures turn into big losses. Currency crises will return
as locals and foreigners alike scramble for dollars, and the mythology and
psychology of money will diverge once again.
This history has repeated itself many times. The rise and fall of com-
modity prices was the basis of the 1890 London panic, in which the storied
merchant bank Barings faced near-collapse over failed loans to Argentina
during the decade prior. It was the basis of the 1980s currency and debt
crises that followed the reversal of the commodity price boom of the
1970s. We saw it yet again in the late 1990s.
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