Is the era of free capital movement just a bubble?
Let me make a broader point: we’ve now seen three island nations around Europe become huge international banking hubs relative to their GDPs, then get into crisis because their domestic economies don’t have the resources to bail out those metastasized banking systems if something goes wrong. This strongly suggests, to me at least, that we have a fundamental problem with the whole architecture (to use the preferred fancy word) of international finance…
All of which raises the question, is the era of free capital movement just a bubble, fated to end one of these years, maybe soon?
Hm. Well, the world’s second largest economy maintains very tight controls over capital flows. The third largest economy is actively engaged in managing its currency. The sixth-largest economy has used capital controls to limit appreciation of its currency. Many of the world’s other large economies are part of a monetary union actively experimenting with a handful of financial-repression mechanisms. The International Monetary Fund has taken the official position that the use of capital controls may be warranted as a financial stability tool. And so on. I would say that the era of free capital mobility is definitely on life-support.
Now, many of these policies may be designed to be temporary. And China looks interested in gradual liberalisation of its capital controls. But there are two reasons to think that the trend will continue toward less rather than more mobility. One is that a half-open world is probably not a stable equilibrium. Everyone can hold hands and jump into mobility and create a stable equilibrium that way. But as some defect from that equilibrium openness begins to look much less attractive for the others, who may absorb outsize inflows or outflows, or who may bear the brunt of others’ currency manipulation. One might argue that open countries will therefore press others to return to the open equilibrium, but that moves us to the second issue: capital flow restrictions will be very useful to countries interested in using a bit of inflation to chip away at high debt levels. And that includes just about everyone.