By doing so, the IMF has now made emerging market investments more risky, especially for retail investors.
What's more, they likely imposed a major new cost on the global economy.
The irony is that the IMF is trying to solve a problem that was caused by foolish global monetary policies. Relaxing its opposition to capital controls is just more of the same.
Removing Federal Reserve Chairman Ben Bernanke and his world-wide sympathizers, and restoring a true free global capital market would work much better.
The IMF does correctly note that capital flows have vastly increased in recent years. That's where the initial problem comes from. It's the solution that's dangerous.
Official foreign exchange reserves have increased to $10.5 trillion in the second quarter of 2012 from $2.2 trillion a decade earlier, a compound growth rate of 17% per annum - when nominal world GDP has grown at less than 6%.
And it's not all official reserves, either - the money in hedge funds, fast-trading schemes, private equity funds, sovereign wealth funds and other pools of fast money have increased much faster than output has.
Naturally, with all this money sloshing around, it can spill into and out of small countries' currencies in overwhelming amounts, making even a relatively large economy like Brazil unable to control its capital accounts and subjecting it to huge swings in capital availability.
Meanwhile, small, relatively poor countries like Vietnam and Mongolia have proved entirely unable to cope with massive foreign money swings, which have played havoc with their "real" economies and caused double-digit inflation.
So now to solve this problem, the IMF proposes to allow countries to engage in "capital flow management" both of "inflow surges" and "disruptive outflows."
But that poses a great danger to investors in emerging markets, not only small ones like Vietnam and Mongolia, but also huge markets like Brazil that are popular destinations for emerging market investment.
Emerging Markets and Capital Controls If controls are instituted, investors may not be able to buy these markets now without paying an artificial premium. More dangerous, their money may become trapped in the market, with a provision like that imposed by Chile in the 1990s, forcing the money to remain there for a year before being able to exit.
Capital controls are even more damaging if you live in the country that is imposing them.
I have bad memories in that regard. My own native country of Britain had severe capital controls from World War II until 1979.
As a result the British middle class had no alternative but to invest in their own moribund economy. Currently, since I don't like U.S. economic policies, I have most of my money invested in precious metals and Asian ETFs-- with capital controls I would be unable to invest in either.
With the money trapped, the British government was able to run an inflationary monetary policy from 1947-79 that ruined many families.
My great-aunt Nan, for example, invested her retirement savings in British government War Loan in 1947. By the time she died in 1974, War Loan was trading at 30% of its 1947 price - and its value had been eaten away even further by the fivefold rise in British prices over the period.
Being able to get your money out of a country is a key civil liberty, and an important check on looter governments, of which there are all too many.
It's not surprising that the IMF fails to recognize the civil liberties aspect of its recommendations, or to see that anti-democratic governments like China violate their citizens' rights by imposing capital controls, trapping money in the shaky Chinese banking system.
It is, however, no way to operate in a supposedly global economy of free peoples.
The problems of excess capital flows cited by the IMF are real. However, the solution is not more regulations and restrictions on the activities of ordinary investors (which the rich can almost always evade).
Instead, the printing press policies pursued by Fed chairmen Greenspan and Bernanke must be ended, and their counterparts in the European Central Bank, the Bank of England and the Bank of Japan must be equally thrown out of their jobs. Interest rates must be restored to a level safely above inflation.
When this is done, you can expect a huge caterwaul from Wall Street and the big international banks, and a lot of hedge funds and funny money operations will go out of business.
There may be short-term pain for the global economy, but in the long run these giant pools of speculation will not be missed.
Capital controls are simply not the answer.
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