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Persistence of Unregulated International Capital Flows

Some international capital flows remain unregulated or less regulated than those under banking supervision. These consist of capital flowing through the carry trade market, in which investors borrow in low-yielding currencies and invest in high-yielding currencies. Although hedge funds must now be registered with the Securities and Exchange Commssion (SEC) in the US and in Europe, these and other actors, counting on i nterest rate differentials and exchange rate appreciation, have played a large role in procyclical carry trades (D’Arista and Griffith-Jones 2009). Carry trades, during downturns as yields reverse, can create deepening currency mismatches that necessitate international intervention, as in the case of Iceland and Hungary in 2008. Eurocurrency markets, which consist of dollar or other deposits held by banks in foreign countries, were subjected to some regulation after Basel I, but continue to evade regulation, and are the main suppliers of funds for the carry trade (D’Arista 2006). American and European regulation implemented in the wake of the Great Recession has not put specific controls on the eurocurrency market.

These evasive capital flows are dangerous. Trade in goods and trade in capital are not equal (Bhagwati 1998). The argument for free trade does not extend to free capital; restricted capital mobility is not tantamount to protectionism. This is because free capital flows can experience sharp reversals, harming economies in their wake. Because of this, some countries have instituted capital controls to curb this maleffect of international financial flows.

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