The Online Library of Liberty

A project of Liberty Fund, Inc.

• Foreword
• Author’s Preface
• Interventionism
• Introduction
• 1.: The Problem
• 2.: Capitalism Or Market Economy
• 3.: The Socialist Economy
• 4.: The Capitalist State and the Socialist State
• 5.: The Interventionist State
• 6.: The Plea For Moral Reform
• I.: Interference By Restriction
• 1.: The Nature of Restrictive Measures
• 2.: Costs and Benefits of Restrictive Measures
• 3.: The Restrictive Measure As a Privilege
• 4.: Restrictive Measures As Expenditures
• II.: Interference By Price Control
• 1.: The Alternative: Statutory Law Versus Economic Law
• 2.: The Reaction of the Market
• 3.: Minimum Wages and Unemployment
• 4.: The Political Consequences of Unemployment
• III.: Inflation and Credit Expansion
• 1.: Inflation
• 2.: Credit Expansion
• 3.: Foreign Exchange Control
• 4.: The Flight of Capital and the Problem of “hot Money”
• IV.: Confiscation and Subsidies
• 1.: Confiscation
• 2.: The Procurement of Funds For Public Expenditure
• 3.: Unprofitable Public Works and Subsidies
• 4.: “altruistic” Entrepreneurship
• V.: Corporativism and Syndicalism
• 1.: Corporativism
• 2.: Syndicalism
• VI.: War Economy
• 1.: War and the Market Economy
• 2.: Total War and War Socialism
• 3.: Market Economy and National Defense
• VII.: The Economic, Social, and Political Consequences of Interventionism
• 1.: The Economic Consequences
• 2.: Parliamentary Government and Interventionism
• 3.: Freedom and the Economic System
• 4.: The Great Delusion
• 5.: The Source of Hitler’s Success
• VIII.: Conclusions
• Reading References

4.

The Flight of Capital and the Problem of “Hot Money”

It is claimed that foreign exchange control is necessary to prevent the flight of capital.

If a capitalist fears complete or partial confiscation of his property by the government, he seeks to save whatever he can. It is, however, impossible to withdraw capital from enterprises and to transfer it to another country without heavy losses. If there is a general fear of confiscation by the government, the price paid for going businesses drops to the level which reflects the probability of such confiscation. In October 1917, enterprises in Russia which represented investments of millions of gold rubles were offered for the equivalent of a few pennies; later on they became completely unsalable.

The term “capital flight” is misleading. The capital invested in enterprises, buildings, and estates cannot flee; it can only change hands. The state which intends to confiscate does not lose anything by it. The new owner becomes the victim of the confiscation instead of the previous owner.

Only the entrepreneur who has recognized the danger of confiscation in time is able to avoid the threatening loss by means other than the sale of his entire business. He may refrain from renewing the parts of the equipment which become used up and worn out, and he may transfer the amounts he thus saves to other countries. He may leave abroad funds resulting from export transactions. If he uses the first means his plant will sooner or later cease to be productive or, at least, competitive. If he chooses the latter he will have to restrict or even close down his production because of the lack of working capital, unless he can borrow additional funds.

With this exception a state which intends to confiscate, completely or partially, the enterprises located in its territory does not run the risk of losing part of its spoils by the flight of capital.

The owners of money, promissory notes, deposits, and other claims find themselves in a better position than the owners of enterprises and real property. They, however, are threatened not only by confiscation; inflation too may deprive them of all or part of their property. But they are the ones who are able to buy foreign exchange and to transfer their capital abroad because their property consists of ready cash.

The governments do not like to admit this. They believe it to be the duty of every citizen to suffer quietly the confiscatory measures; and this even in the case when—as in inflation—the measures do not benefit the state but only certain individual citizens. One of the tasks assigned to foreign exchange control is to prevent such a flight of capital.

Let us look at an historic example. During the first years following the armistice of 1918, it was possible to sell abroad German, Austrian, and Hungarian bank notes, bonds, and debentures payable in the currencies of these countries. The governments impeded such sales either directly or indirectly by forcing their subjects to give up the foreign exchange received in such transactions. Did the German, Austrian, or Hungarian economies become richer or poorer by this intervention? Let us assume that in 1920 Austrians succeeded in selling Austrian mortgage bonds to foreigners at a price of $10 for each 1,000 kronen par value. The Austrian creditor would thus have salvaged about 5 percent of the nominal value of his claim. The Austrian debtor would not have been affected at all. However, when the Austrian debtor had to repay the debt in the nominal value of 1,000 kronen, which in 1914 was about $200, the 1,000 kronen he repaid in 1922 would have equaled only about 1.4¢. The loss of approximately $9.98 would have been suffered by the foreign holder, not by an Austrian. Could one say, therefore, that a policy which prevented such transactions was justified from the standpoint of Austrian interests?

The holders of ready cash try as far as possible to avoid the dangers of devaluation which today threaten in every country. They keep large bank balances in those countries in which there is the least probability of devaluation in the immediate future. If conditions change and they fear for these funds, they transfer such balances to other countries which for the moment seem to offer greater security. These balances which are always ready to flee—so-called “hot money”—have fundamentally influenced the data and the workings of the international money market. They present a serious problem in the operation of the modern banking system.

During the last hundred years all countries have adopted the single-reserve system. In order to make it easier for the central bank to pursue a policy of domestic credit expansion the other banks were induced to deposit the greater part of their reserves with the central bank. The banks then reduced their vault cash to the amount necessary for the conduct of everyday normal business. They no longer considered it necessary to coordinate their payables and receivables as to maturity so that they should be able to fulfill their obligations at all times fully and promptly. To be able to meet the daily maturing claims of their depositors, they deemed it sufficient to own assets which the central bank considered a satisfactory basis for the granting of credit.

When the influx of “hot money” began the banks did not see any danger in the increase of demand on short-term deposits. Relying on the central bank they accepted the deposits and used them as a basis for extending loans. They were unaware of the danger they were inviting. They did not give any thought to the means which they would someday need to repay those deposits which obviously were always ready to move.

It is argued that the existence of such “hot money” necessitates foreign exchange control. Let us consider the situation in the United States. If, as of June 5, 1933, the United States had not forbidden the private holding of gold, the banks would have been able to carry on a gold deposit business as a particular branch of activity, separate from their other transactions. They would have bought gold for this branch of their activity and would have either held it themselves or deposited it earmarked for safekeeping with the Federal Reserve banks. Thus, this gold would have become sterilized from the standpoint of the American currency and banking system. It is only because the government has intervened by forbidding individuals to own gold that a “hot money” problem comes into being. The fact that the unwelcome effect of one intervention makes other interventions necessary does not justify interventionism.

Of course, the entire problem is today no longer of importance. The fleeing funds have reached their last haven, America. There is no safe place left to which they could escape should this refuge prove vain.

IV.

Confiscation and Subsidies