What is a closed currency?

Thomas Ross

Featured in CurrencyTransfer

Did you know that in certain countries, the cash in your pocket becomes completely useless as soon as you cross the border? 

A closed currency is a type of currency that can’t be freely traded outside its country of origin. With strict controls on their export and import, travellers may face difficulties taking more than a specified amount of closed currency outside the country, encountering further problems attempting to trade it elsewhere. 

It’s important for travellers and businesses to understand the regulations and exchange rules of closed currencies, to avoid costly mistakes at the border.

What is a closed currency?

A closed currency, or non-convertible currency, is a type of currency that cannot be freely traded on the global foreign exchange market. Issuing countries enforce restrictions on its use and exchange, leading to difficulties for travellers and businesses looking to trade the currency outside its country of origin. Without easy access through regular banking channels or foreign exchange markets, travellers are required to exchange their money for local currency on arrival. 

Examples of countries enforcing closed currency rules include Cuba, utilising the Cuban Convertible Peso (CUC) alongside the Cuban Peso, and North Korea, with its strict regulation of the North Korean Won (KPW).

Advantages of closed currencies

The main advantage of implementing a closed currency is that it allows governments greater control over their economy. This can be achieved in a number of ways, including regulating exchange rates. When official exchange rates are enforced, a government can maintain greater control over the value of its currency, avoiding the inevitable fluctuations from external market forces. 

It also allows for the prices of imports and exports to be influenced, to maintain favourable balances in trade. Forcing visitors to purchase local currency within the country’s borders bolsters demand, contributing to the stabilisation of value.

By regulating inflows and outflows of currency across borders, through controlling foreign investment or implementing physical limits on the amount of cash able to be moved by travellers, governments can avoid ‘capital flight’. This refers to large sums of money leaving a country for any reason, most likely in response to a crisis or general economic instability. With this peace of mind, governments have greater freedom in long-term economic planning, avoiding a ‘boom-and-bust’ cycle commonly found in free-market economies.

Through a closed currency system, central banks can more effectively enact monetary policy. Without the interference of external markets, setting interest rates and controlling money supply allows for greater control in targeting inflation or stimulating growth. This can be done efficiently, without fear of external interference such as speculative short-selling in foreign markets, or other destabilising financial activity.

Controlling the currency also allows a government to protect local industries from competition abroad. Tariffs, quotas and trade restrictions can encourage the growth of domestic industry, preventing dependency on large, vulnerable supply chains. Without a dependence on foreign imports, government subsidies can go further in maintaining affordability of essential goods and services for domestic citizens, such as fuel, food or healthcare.

Disadvantages of closed currencies

The main disadvantages of closed currencies are direct consequences of their complex regulation, and the barriers these present. Foreign investment becomes far more difficult when closed currencies are involved, making it less attractive for investors whose capital inflows could spark economic growth.

While shorter supply chains and supporting local industry brings obvious benefits, it is not always possible to support an economy entirely domestically. When import is required for raw materials, for example, complicated international trade laws may greatly slow development. This can also lead to higher transactional costs for otherwise simple trading.

Closed currencies inevitably lead to a rise of black market activity, with illegal currency trading boasting more favourable rates than the official rate. This calls the official rate into question, distorting the ‘real’ value of the currency, leading to inefficiencies.

While globalisation doesn’t come without criticism, an economically isolated country utilising closed currency misses out on the benefits of a connected economy, such as shared technology, international partnership and global economic trends. Overall, this can stunt the growth of an economy.

It would be naive to state excessive government control hasn’t produced examples of corruption in the past, as well as bureaucratic inefficiency. Through holding absolute power over currency exchange processes, officials could potentially exploit it for personal gain. Furthermore, the prices imposed by governments can lead to ‘artificial prices’, leading to an imbalance of supply and demand. While the official government figure might seem stable, the ‘real’ value may be different - a ‘hidden inflation’ that affects citizens’ purchasing power. Through such heavy reliance on government policy, the stability of an economy is placed almost entirely on the competence of a government. There are few external mechanisms that can correct mistakes of poor management.

In response to the external shock of a black swan event, for example, closed currency systems may be slow to respond due to their rigid nature, leading to less adaptability. Through this rigidity, reduced competition from the international market stifles the need for technological innovation or improvements in domestic productivity.

At an individual level, citizens may feel they have restricted liberties in travelling abroad, due to the complicated processes involved in converting their closed currency. With restricted access to foreign goods and services, one could argue this affects freedom of choice and overall quality of life.

Conclusion

While the closed currency can be a powerful tool for governments to gain greater control over their economy through financial stability and protection from external influence, it can also lead to multiple difficulties. Inefficiency, black market activity and isolation on the global stage present their own problems that citizens need to be aware of. For travellers and businesses, it’s important to research the specific rules associated with their chosen closed currency. 

For example, different countries impose wildly contrasting limits on the amount of currency allowed to be taken beyond their borders. Forward planning, budgeting and careful research will ensure a smooth travel experience when dealing with a closed currency.

For more currency news and insight into the ever-changing world of currency, make sure to stay up to date with our Expert Analysis, as well as our Market Commentary.