February 28, 2016

A MAC would Reduce Private Sector Flows into the US.
Isn't This a Mistake?

A reader recently noted, “I'm actually not sure I would want to counteract private capital inflows with a MAC. Isn't this a mistake? The implication of such inflows is that the U.S. is the best place to put money because there are no safe investment opportunities elsewhere.”

The answer is quite simple: The United States has no obligation to take in the world's glut of capital when doing so hurts the US immediately -- and hurts the rest of the world in the long term by reducing the dynamism of the US economy needed to drive global demand and economic growth.

As noted in the post of Feb 18 on this blog, the excessive flow of foreign capital into dollars and dollar-based assets in America is one of the most important factors driving the dollar’s overvaluation and America’s consequent problems. Why should America give private capital flows a “free pass” despite the fact that such flows clearly constitute the largest share of the inflows that drive the dollar’s overvaluation? Some Heritage and Cato analysts may believe that everything done by the private sector is good, and everything done by the official sector is bad, but good policy cannot be based on black and white distinctions like this -- especially given clear evidence that private financial activities commonly have no meaningful social benefit.

There is absolutely no reason that America should be the dumping ground for Bernanke’s “glut of savings” – money generated by:

  1. the private sector through unbridled credit expansion by central banks through using money policies that were good in the immediate aftermath of the Crash of 2008 but that have created a problem that will ultimately come back to bite us, and
  2. ill-advised international monetary policies, especially of the United States, that have generated the world’s largest flow of annual trade deficits, and the world’s largest stock of cross-border debt.? 
Why should America be the borrower and buyer of last resort for the world when evidence abounds that this model has created a fragile global economy, one heavily dependent on debt and credit and  therefore subject to inevitable financial crashes and economic destruction?

Some claim that these flows of foreign capital into the United States indicate that the U.S. is a better place to put money because there are no safe investment opportunities elsewhere. Even if this were true, this is no reason to allow excess capital from the rest of the world to pollute our economy, destroying financial stability, jobs, factories, and U.S. budget balances.

If we were to follow this line of thinking, we would allow capital from  poor countries all around the world to flow “uphill” into capital-saturated U.S. markets, making the situation worse for us and worse for the rest of the world. When capital flows are driven, not by long-term investments in productivity-enhancing projects but in financial speculation, both the US and the rest of the world suffer because growth built on debt and speculation is unstable -- as shown by the Crash of 2008, which started in the U.S., then spread around the world as the Great Recession.

Put another way, U.S. financial markets may be a relatively “good” place to invest from a short-term perspective for those with excess capital and a desire to play the markets. But allowing unfettered access to America’s financial markets has two very big longer term downside risks that should be given primary weight when designing policies for the future.

The unfettered access of foreign capital to US financial markets when they already suffer a glut of capital:
Hurts America: We know from experience that the excess capital flooding American markets is seriously hurting the American economy and the American people because too much money goes into speculative trading rather than into real investments that improve our nation’s long-term productivity and ability to generate well-paying jobs. Furthermore, excessive capital inflows generate job-killing, factory-closing trade deficits that weaken the American economy as a source of global demand.
Hurts Developing Countries: By making it easy for the rich elites from developing countries and from countries like those in the southern periphery of the Eurozone to continue taking money out of their countries and bringing it to the U.S. to seek short-term profits in America’s financial casino, we reduce the incentive for them to invest their capital in longer-term projects that raise their own countries standard of living by improving schools, hospitals, transport systems, industrial infrastructure, governance systems, and the like.

Official capital flows into dollars and dollar-based assets have been used in the past to manipulate the U.S. dollar’s value. However, as experts including Joe Gagnon have noted recently, official interventions are not currently a significant problem and do not explain America’s continuing external deficits.

On the other hand, private flows of capital into the United States are many times the size of official inflows and must be considered a key source of the dollar’s current overvaluation.

Therefore, if America wants to restore balanced trade, its policies must focus, not just on currency manipulation through official flows, but on the broader issue of currency misalignment, which is driven largely by private capital flows.

America Needs a Competitive Dollar - Now!

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