How offshore financial centres will save countries

after the collapse of the welfare state

Read the article in the Cayman Financial Review Magazine 

The year 2013 might well go down in
history as the year that the major democratic welfare states collapsed.
Every major developed democratic country in Europe (with the exceptions
of Switzerland, Sweden and oil-rich Norway), in the Americas (with the
exceptions of Chile, Canada and Mexico), and in Asia (with the
exceptions of Australia and South Korea) is on an unsustainable fiscal
downward slope.
 

The great curse
of democracies is that eventually a majority of the people become
addicted to and demand ever more government benefits that cannot be
funded by the diminishing numbers of taxpayers or through borrowing. The
politicians, in order to please the majority to ensure their own
re-election, make promises that neither they nor their successors can
keep, ultimately leading to fiscal ruin.

As politicians resort to
ever increasing taxes and borrowing, the higher taxes drive away those
who are being required to bear the burden, thus diminishing economic
output and in turn making the state increasingly un-credit worthy.
Governments that print their own money increasingly turn to the printing
presses to cover the excess spending until the inflation makes the
currency almost worthless. Those governments that do not print their own
money, such as Greece or California, are forced into ever increasing
austerity and economic decline.

Many countries have experienced
what is referred to as a financial collapse in the last half century –
which, at its end stage, is almost always accompanied by a
hyper-inflation. The world has experienced a couple of dozen
hyper-inflations in just the last three decades, most notably Russia,
the countries of the old Soviet Union, and many of those in Eastern and
Central Europe. In 2008, the inflation rate in Zimbabwe reached a level
where the government ended up printing a hundred trillion dollar
banknote, which was almost worthless.

High and hyper-inflations
wipe out most of the government debts but at the same time also wipe out
much of the savings of the people. The real value of pensions becomes
miniscule. Bonds, money market funds and cash deposits in financial
institutions lose most of their purchasing power. Both private and
government debts are extinguished at the expense of the creditors. But
then what happens?

Private individuals find ways of coping by
engaging in barter or use of foreign currencies or using gold coins,
etc. Governments radically downsize by firing most of their employees
and dropping almost all transfer payments. As with individuals, they
subsist by selling assets and borrowing from foreign governments or
international institutions until they are able to set up new monetary
and tax systems.

The euro, the Japanese yen, the British pound
and the US dollar will all lose most of their purchasing power (ie,
suffer high inflation) unless the issuing jurisdictions make radical
political changes, which seems unlikely at the moment. The currencies
will decline at different rates, causing massive currency flows from the
weaker currencies to the stronger which will delay the collapse of the
stronger – but only temporarily.

All of the above is well understood by those who have read economic and financial history.

The
offshore financial centres (OFCs) are likely to prove to be the
salvation after the financial collapses. To restart their economies
relatively quickly, governments, private individuals and businesses are
going to need seed corn – that is, new sources of financial capital. Not
all of the world’s financial capital is going to be destroyed. As the
situation in the major democratic welfare states continues to worsen,
both individuals and businesses will increasingly move some of their
wealth to places where it is likely to be legally protected from
rapacious governments and tax authorities – to OFCs.

This
process has already begun. Switzerland is correctly viewed as being
fiscally sound, with a very stable government and a strong commitment to
the rule of law.

As a result, financial wealth has been flooding into
Switzerland at a rate greater than the Swiss can profitably invest it,
so many Swiss financial institutions are now only offering negative
interest rates to foreigners – that is, the foreign parties must pay the
Swiss to hold their money. In a world of increasing financial
instability where the probability of confiscation of financial assets
through inflation or taxation is rising, a small annual loss on
financial assets can rationally seem to be a better alternative than a
less certain, but major, loss.

The collapse of the Soviet Union
and Eastern Europe gives us a historical roadmap of what is likely to
happen when governments are left with currencies with little or no
value. At first, the people increasingly used foreign currencies, the US
dollar and D-mark being the currencies of choice in Eastern Europe.
They obtained such currencies through official loans and grants to their
governments and other institutions, through remittances of nationals
who had left the country, and through legal and black market commercial
activities.

Most OFCs allow financial and other institutions to
hold assets in a variety of currencies, and most do not have any “toll
charge” for taking funds in any currency in and out of the OFC. Most
OFCs also have institutions for providing safe keeping for both bearer
and registered securities, deeds and other legal forms of ownership. The
major successful OFCs also have judicial systems that provide clarity,
and honest and competent judges and other legal officers, enabling them
to legally protect assets.

These assets can then be used both in
the form of loans and equity capital to assist the countries whose
currencies have collapsed to help them start over. Countries that have
tangible assets, such as gold or land, will be able to use those in part
or whole to back a new currency. Countries that do not have much in the
way of real assets that can be sold will need to obtain loans to fund
either new central banks or currency boards, and likely sources of such
funds are assets that have been placed in OFCs.

OFCs that use the
currency of a major debtor nation, or have currency boards, whose
reserves largely consist of the sovereign debt of one or more major
debtor nations, might be forced for their own financial survival to
change the backing of their currency and move to a floating exchange
rate. But such changes are readily doable if the OFC is basically sound
and well managed.

Those who wish to rebuild, restart or create
new businesses in the countries that have suffered the currency meltdown
and whose financial institutions have been destroyed or greatly
diminished are likely to find sources of capital in the OFCs.

The OFCs
can be viewed as the financial equivalents of “strategic petroleum
reserves” which can be tapped into during a time of crisis to help
profligate governments transition to sound economic policies.

By
not taxing financial capital and providing the rule of law with a
sensible regulatory environment, OFCs enable individuals and companies
to be places to park financial assets until the crisis has abated and/or
profitable investment opportunities emerge.

Unfortunately, the
leading profligate nations are waging a regulatory war against the OFCs.
They are demanding that they too engage in destructive taxation and
submit to corrosive and unsound international financial regulation. In
the same way that poorly managed businesses or abusive unions seek
tariffs or other barriers against better managed and more consumer
friendly competitors, the high-tax and regulatory states are trying to
crush OFCs with false charges that OFCs endanger the world economy.

Arguably,
the leading academic expert on OFCs, University of Michigan Professor
James Hines, writes “the evidence strongly suggests that the policies of
the OFCs contribute to investment, employment, and efficient
functioning of markets and government policies in other countries”.

The
OFCs need to strongly resist the global financial imperialism primarily
coming from the US, the European Union and international financial
institutions, such as the OECD. Resistance is necessary for OFCs’ own
survival, for the preservation of global economic growth, and as the
financial seed corn depository in cases of financial meltdowns in the
bigger countries.

Is the world better off having a Switzerland, the Channel Islands, Cayman, Hong Kong, Dubai, etc or worse off?

The answer should be obvious.

 

 

 

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Richard W. Rahn

Richard W. Rahn is Chairman of Improbable Success Productions, Chairman of the Institute for Global Economic Growth, and a former Member of the Board (2002-08) of the Cayman Islands Monetary Authority.

Richard W. Rahn, Ph.D.
Chairman
Institute for Global Economic Growth
PO Box 2100
Reston, VA 20195 USA

T.+1 (703) 338 9439, +1 (703) 553 3700
E. RWRahn@aol.com 

 

IGEG

The Institute for Global Economic Growth (IGEG) was formed in 2002 to assist both governments and economic policy organizations in developing and promoting pro-economic growth policies. It is a non-profit (IRS code – 501-C-4) organization.

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Institute for Global Economic Growth
PO Box 2100
Reston, VA 20195
USA

T.+1 (703) 338 9439, +1 (703) 553 3700
E. RWRahn@aol.com
W igeg.org