I believe the U.S. dollar will lose its role as the world’s premier reserve currency. When that happens, capital controls will have an effect on you. This is why it’s crucial to your financial future to understand what capital controls are, how they are used, and what you can do to protect yourself.
Why Governments Impose Capital Controls
Think of the government as a thief trying to steal your wallet as you (understandably) try to run away. With capital controls, the thief is trying to block all the exits so you can’t reach safe ground.
A government only uses capital controls when it’s desperate…when it can no longer borrow, inflate the currency, tax, or steal money in one of the “normal” ways. In most cases, governments use capital controls in severe crises. Think financial and banking collapses, wars, or chronic economic problems. In other cases, they’re just a way to control people. It’s much more difficult to leave a country when you can’t take your money with you.
[box]Regardless of the initial catalyst, capital controls help a government trap money within its borders.[/box]
As strange as it sounds, capital controls are often politically popular. For one, they are a way for a government to convince people it’s “doing something.” The average person loves that. Two, a government can usually convince people that moving money offshore or investing in foreign assets is only for rich tax evaders or the unpatriotic. If freedom and private property matter to you at all, you know that’s obviously false.
How It Happens
For the unprepared, it’s like a mugging, capital controls is a surprise.
Here are the four most common forms of capital controls:
1. “Official” Currency Exchange Rates
The government’s official rate for converting foreign currency to local currency is always less favourable than the black market rate (more accurately called the free market rate).
This applies to official prices for gold, too.
Getting the more favourable black market rate usually involves informal transactions on the street. Of course, this is technically illegal.
However, should you follow the law and exchange money at the official rate, it amounts to a wealth transfer from you to the government. The wealth transfer equals the difference between the free market rate and the official rate. It’s a form of implicit taxation.
2. Explicit Taxation
The government imposes explicit taxes to discourage you from buying foreign investments. Your investment overseas is either a Controlled Foreign Corporation or a Passive Foreign Investment Company (PFIC). All passive income overseas is a PFIC unless it is specifically recognized by the IRS as not being a PFIC.
Knowledge about the problem before providing the “OH!, so easy” solution
“Look Before You Leap!” offshore because a Passive Foreign Investment Company has no favourable outcomes or planning opportunities.
Unfortunately, when seeking alternatives overseas to restore retirement savings, attempting to diversity to reduce volatility or to geo-diversify for safety & security, investors are frequently rebuffed by brokers, bankers, or advisers. They typically respond, either out of ignorance or self-interest, “you can’t do that,” or “it’s illegal,” or “it’s very complicated and we don’t handle those types of investments,” etc. In all fairness, some of these professionals don’t know because the companies that employ them are not interested or informed themselves.
U.S. brokers are compensated when they sell stocks, bonds, and mutual funds of their own inventory. Therefore, they are not trained in the details of performing overseas transactions. In addition, many professionals, including CPAs, attorneys, and financial planners, are not aware how to open a foreign bank or investment account that is not a Passive Foreign Investment Company (PFIC).
FATCA is an information gathering exercise, the consequence of which is to find Passive Foreign Investment Companies (PFIC) held by U.S. persons overseas. Therefore, FATCA at the institutional level has the purpose to gather information about PFICs at the individual U.S. person level, because a PFIC at the individual level is taxable at the highest marginal tax rate. The source to find that information is any transfer in U.S. Dollars from anyone, U.S. person or Non-U.S. person.
FATCA reporting brings transparent enforcement to the financial and tax environment for Americans working, living, or investing abroad, any non-U.S. person causing a capital transfer in U.S. Dollars and in fact FATCA enforcement has changed the behavior of U.S. Financial institutions who are dealing with a foreign counter party.
3. Money Transfers out of the country
Another tactic is taxing money transfers out of the country to a foreign account. In this case, you could still move your money, but it would cost you.
Governments want you to hold your wealth inside the country and in the local currency. Your 401k must be held in U.S. Dollars.
Ultimately, this makes it easier for them to tax, devalue with inflation or, heaven forbid, confiscate.
4. Restrictions and Regulations
A government might restrict how much foreign currency or gold you can own, import, or export. It might require you to get permission to take a certain amount of money out of the country. Today an IRA Trustee will not send money out of the USA. They did before but not since FATCA.
4b. Outright Prohibition
This is the most severe form of capital control. Sometimes a government explicitly prohibits the ownership of foreign currencies, foreign bank accounts, foreign assets, or gold, or the moving of any form of wealth outside the country.
U.S. History of Capital Controls
The U.S. government has used capital controls before. In 1933, through Executive Order 6102, President Roosevelt forced Americans to exchange their gold for U.S. dollars. It’s no surprise that the official government exchange rate was unfavourable. The U.S. government continued to prohibit private ownership of gold bullion until 1974.
Today, with no conceivable end to the U.S. government’s runaway spending, sky-high debt, and careless money printing, is it only a matter of time until the government decides that more capital controls are the “solution?” There’s no doubt statist economists like Paul Krugman would cheer it. All it would take is the stroke of the president’s pen on a new executive order.
Whatever the catalyst, it’s critical to prepare while there’s still time.
What Could Happen if You’re Too Late?
Capital controls are almost always a prelude to something worse. It might be a currency devaluation, a so-called “stability levy,” or a bail-in. Whatever the government and mainstream media call it, capital controls are a way to trap your money so it is easier to steal by means of inflation. Anything they don’t steal immediately, they box in for future thefts.
What You Can Do About It
The solution is simple.
Place some of your savings outside your home country by setting up a foreign investment account that is government regulated, registered by FATCA and recognized ”deemed compliant” by the IRS and excluded from being a PFIC.
That way, no one can easily confiscate, freeze, or devalue your savings at the drop of a hat. A registered foreign financial account that is exempt from foreign financial account reporting will help ensure that you have access to your money when you need it the most.
Despite what you may hear, obtaining a foreign investment account is completely legal. It is specifically recognized on IRS Form W-8BEN-E. It’s not about tax evasion or other illegal activities. It’s simply about legally diversifying your political risk by putting your liquid savings in sound, well-capitalized institutions.
Control over your financial situation
Even without capital controls, it still makes sense to move some of your savings outside the USA under your control. Control over your financial situation is only what your investment account allows it to be. Control is owning a foreign investment account that is a deemed professional investor, foreign resident and non-U.S. person. Whether you are or are not a U.S. person is exempt from foreign financial institution reporting; which means there is no U.S. person blockage and you purchase investments from a tax free environment globally.
Photo credit: <a href=”https://www.flickr.com/photos/szacharias/5970636277/”>StephenZacharias</a> via <a href=”https://visualhunt.com”>Visualhunt</a> / <a href=”http://creativecommons.org/licenses/by-nc-sa/2.0/”>CC BY-NC-SA</a>
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