Sneaking Your Money Across Borders: Capital Flight On The Rise

It's called capital flight, and it is seen by more people as the solution to plunging currency values and contracting economies. It's also a growing challenge for governments whose policies have produced runaway inflation, weak job creation or both.

Based on the most natural of human instincts for safety, capital flight occurs when a large amount of money that was previously available in a country's banking system as a backstop to investment is suddenly pulled out by depositors and moved abroad. Depositors range from large local institutions that have lost faith in the national banking system, individual accountholders scared their balances will soon be decimated by government whim or previously optimistic foreign investors pulling hot money back after a booming economy hits a skid.

For many people, capital flight also involves some illegal, caper-worthy maneuvering, such as smuggling money like contraband. Once you've fooled the authorities into believing your trip from Argentina to Uruguay is because you've always wanted to hike the Cuchilla Grande, not because you have dollars crammed into car tires, then your money has gotten off scot-free. 

Of course, the risk to this particular form of capital flight lies in the fact that, as with cocaine and Semtex explosives, police dogs can be trained to sniff out the ink used to print greenbacks. In Argentina, where capital flight is a big issue in an economy with a 23 percent rate of inflation, hundreds of dogs sniffed out at least $2.7 million in contraband dollars in the last three months of 2011, according to Bloomberg Businessweek.

A more finessed, if still illegal, approach is favored by elites in many African nations with connections in the export-import world. It involves cooking the books, lowballing the value of your exports in customs forms and receipts and keeping the proceeds in a foreign bank. The method works until it doesn't, and the consequences of faking customs documents can be harsh. It doesn't hurt to have a well-greased palm in the right place at the local customs depot.

The result: The African Development Bank estimates that nearly $90 billion a year between 2000 and 2008 was taken out of African economies illegally by government officials and well-connected, tax-evading rich people.

Not all forms of capital flight have the flavor of international criminal intrigue to them. In Japan, where a cottage industry of financial advisory has been built up over the past year based on the idea savvy savers should be looking to escape Japan, a hyper-popular strategy has middle-class professionals funneling their money to buy second homes in Malaysia and New Zealand.

Japan overtook Iran last year as the country that is applying most for Malaysian second-home visas, according to data analyzed by Reuters.

Of course, those legal ways to engage in the massive migration are only acceptable until the situation gets bad enough the government decides to intervene, either imposing limits on foreign exchange transactions, on bank withdrawals or on specific cash-management strategies.

Such an inflection point appears to be in Russia. Capital flowing out of the country last year totaled some $80.5 billion, and, in the first four months of 2012, the movement of monies has intensified to total $42 billion, according to the Russian government. And even though the finance minister said in a recent interview that restricting capital flows by fiat is a dangerous fix that can significantly limit Russia's investment attractiveness, the government is working on putting restrictions in for capital from oil and gas revenue.

Not that allowing capital flight to run unchecked is a much better option. A report by Global Financial Integrity, out earlier this year, that estimated the cost of capital flight between 2000 and 2009 puts a sobering perspective on the problem. Ethiopia, for example, one of the poorest nations in the world, saw the illegal movement of money out of the country doubling in 2009, to $3.26 billion. This might be less than what a Wall Street bank makes in a quarter, but in East Africa, the absence of this cash can be a matter of life and death for many people living in some of the poorest conditions on Earth.

Europe: the special case

All those considerations will need to be taken into account soon if the situation of capital transfers in Europe persists. Because the 17-member nations of the eurozone face a hybrid monetary system where a common currency and monetary policy is shared but fiscal policy and banking stability is the responsibility of individual member states, the current crisis has meant many people have seen an incentive to move their monies abroad, even as national governments appear institutionally incapable of addressing the issue.

Depositors in Greece, Spain and Italy have been busy sending their money to German banks in the past few months, either because they fear a future where those countries return to national currency models and expect such moves would decimate the value of their savings or because they simply don't trust the banks will be there next week to provide them with their money on demand.

One solution that has been floated in this month involves the establishment of some kind of pan-European deposit insurance system, which would have institutions in Brussels and Frankfurt back euro deposits made in Thessaloniki and Barcelona. But the Germans soundly shot down that idea when it was suggested by the European Commission last week.

Still, if the situation gets much worse, something must be done.

As Bill Gross, co-founder of mutual fund manager PIMCO said last week, capital flight has the power to override political maneuvering in determining the future of Europe, so much so that it may not necessarily be decided at the ballot box. It's decided at the ATM machine in assets, to the extent that those machines are drained of euros.