Speculative flight of capital

During the course of a monetary crisis, or when some such crisis is suspected as imminent, massive movements of short-term capital occur between currencies and capital markets. These drain the country's foreign exchange reserves. Such movements can take many forms, ranging from leads and lags in commercial payments on through outright purchases of foreign securities. In the most benign case, capital flight may result when domestic residents attempt to diversify their portfolios abroad. Private residents may also take steps resulting in an effective transfer of domestic capital for reasons of safety or higher returns. This practice is usually adopted by members of the national elite, of minority communities, and foreign investors and depositors who through legal and illegal means remit capital out of their country into overseas accounts. Such flows tend to be associated with political events and uncertainties, fiscal crisis, inflation or taxation of domestic assets, perhaps related to external debt. Capital flight can also be explained by overvalued exchange rates, by large fiscal deficits and by uncertainty arising from the income distribution policies of future governments. Finally, even in the absence of such types of market and currency distortions, capital flight frequently arises due to a conflict of interest in the agency relationship between the population of a country and the country's leadership. In other words, in situations where this behaviour cannot be controlled by the population, the government leader exports national funds for self interest. Where the capital so expropriated is borrowed, such behaviour can only exacerbate external debt problems.

Capital movements are extremely unsettling to the economy of an affected country and to the confidence in the international monetary system.

It is difficult to arrive at precise conclusions regarding the magnitude and trend of the flow of domestic capital out of countries. It can be roughly estimated by reviewing the "errors and omissions" account in the balance of payments. In many countries, in which the inducements for outward movements of funds are powerful, residents cannot legally export capital without a licence (which the authorities are unlikely to grant). In such cases, any large outward movements of funds are likely to be concealed, taking the form, for instance, of non-repatriation of export proceeds, over-remittance for imports, or purchases of foreign exchange outside official markets from foreign tourists and others. Depending on the methods used in compiling the balance of payments, capital movements of this sort may not even be reflected in the residual item. It is usually impossible to be precise about the amount of money that has moved across frontiers in currency crises: both those who gain and those who lose have every reason to conceal the truth in order to dampen the enthusiasm of speculators. The lessons of the past decade of currency crises are that each new one brings with it a larger wave of hot money than the previous one.

All estimates of capital flight are highly uncertain, but it has been shown to be a significant factor in the debt accumulation process of countries. One study by a New York bank, after examining the balance of payment accounts of 23 debtor nations, discovered that while those nations added $381.5 billion to their foreign debts, $103.1 billion flowed back out as capital flight in the period from 1978 to 1983. The total for seven highly indebted countries was $92 billion, compared with an aggregate debt of $307 billion. In one case cited, the Philippines under the influence of Ferdinand Marcos added on $19.1 billion in new debt as $8.9 billion left.

Zaire's ruling clan is estimated to have US$4 to $6 billion invested in Swiss accounts and foreign real estate. Zaire's total foreign debt in 1982 was US$4.2 billion. A 1986 study by the Nigerian government showed that in 1978 corrupt officials were transferring $25 million a day abroad. An investigation by the government of Ghana in the early 1980's revealed that the country was losing at least $60 million a year through over-invoicing of imports.

It is estimated that wealthy Latin Americans have at least US$180 billion personally invested outside their continent. This amounts to one half of the region's foreign debt. The estimate of cumulative capital flight from Argentina during 1974-82 was $31.3 billion. During 1979-1984 Argentina's capital flight was 60% of gross capital inflow, and in 1989 it had $46 billion in savings outside its borders. Brazil had $31 billion. Venezuela has $58 billion is assets abroad, nearly twice its foreign debt. In 1989, Venezuelan citizens expatriated some US$27 billion, or 117% of their nation's new borrowing. In 1989, Mexico owed foreigners about $100 billion and had an estimated $84 billion in assets overseas. Some 10 billion sterling is held illegally in foreign bank accounts by Indians. Another obvious example is Haiti under Baby Doc Duvalier.

Only 27% of the $99 billion that flowed into Mexico from 1989-1994 was in the form of direct investment; the rest were mainly speculative – purchase of government bonds and some of the 269 state-owned companies which were privatized by the Salinas government. But when the Mexican peso was devalued in December 1994, massive portfolio capital flight commenced which went well on until the next year. Unfortunately, Mexico was unable to impose capital controls – as Malaysia imposed – since its membership in the North Atlantic Free Trade Association precluded it from doing so. The IMF and the World Bank acknowledged the fact that too much financial speculation and too little real investment were the root causes of the Mexican debacle. When Mexico was bailed out, among the prime beneficiaries were Wall Street investment firms responsible for the speculative investments in the first place.

The global financial crisis is not, as claimed by the IMF, due to the fiscal indiscipline of the so-called "emergent markets." It has come about due to two things. Firstly, the expanding opportunities for profits from short-term unproductive speculative investments made possible by developments in information technology and the emergence of the global financial casino. Secondly, the dearth of profitable opportunities for productive investment intrinsic in a system characterized by grossly inequitable social and economic structures. Given the accumulation of capital in the hands of the few – further driven by demographic changes in developed countries and the growth of pension funds – these have resulted in the unleashing in the South of flows of vast amounts of destructive and destabilizing financial capital.