Paul Krugman: Hot Money Blues

The end of an era:

Hot Money Blues, by Paul Krugman, Commentary, NY Times: Whatever the final outcome in the Cyprus crisis — we know it’s going to be ugly; we just don’t know exactly what form the ugliness will take — one thing seems certain:... the island nation will have to maintain fairly draconian controls on the movement of capital in and out of the country. ... And ... Cypriot capital controls may well have the blessing of the International Monetary Fund, which has already supported such controls in Iceland.

That’s quite a remarkable development. It will mark the end of an era ... when unrestricted movement of capital was taken as a desirable norm around the world. ... To some extent this reflected the ... rise of free-market ideology, the assumption that if financial markets want to move money across borders, there must be a good reason, and bureaucrats shouldn’t stand in their way. ...

But the truth, hard as it may be for ideologues to accept, is that unrestricted movement of capital is looking more and more like a failed experiment.

It’s hard to imagine now, but for more than three decades after World War II financial crises of the kind we’ve lately become so familiar with hardly ever happened. Since 1980, however, the roster has been impressive: Mexico, Brazil, Argentina and Chile in 1982. Sweden and Finland in 1991. Mexico again in 1995. Thailand, Malaysia, Indonesia and Korea in 1998. Argentina again in 2002. And, of course...: Iceland, Ireland, Greece, Portugal, Spain, Italy, Cyprus.

What’s the common theme...? Conventional wisdom blames fiscal profligacy — but ... that story fits only one country, Greece. Runaway bankers are a better story... But the best predictor of crisis is large inflows of foreign money: in all but a couple of the cases I just mentioned, the foundation for crisis was laid by a rush of foreign investors into a country, followed by a sudden rush out. ...

Now what? I don’t expect to see a wholesale, sudden rejection of the idea that money should be free to go wherever it wants, whenever it wants. There may well, however, be a process of erosion, as governments intervene to limit both the pace at which money comes in and the rate at which it goes out. Global capitalism is, arguably, on track to become substantially less global.

And that’s O.K. Right now, the bad old days when it wasn’t that easy to move lots of money across borders are looking pretty good.