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May 25, 2016

How the MAC Would Help Restore American Manufacturing

America’s growing trade deficits, especially in manufactured goods, indicate that its international competitiveness – its ability to earn as much producing exports as it spends on imports – has fallen dramatically. Since the mid-1970s, rising trade deficits have killed millions of American jobs and have forced thousands of American factories to downsize or close their U.S.-based production lines. This note describes how a Market Access Charge (MAC) could put millions of workers and thousands of U.S. factories back on the job.

Many factors have contributed to America’s declining international competitiveness, but most important has been misaligned exchange rates that are inconsistent with balanced trade. Other contributing problems such as low R&D expenditures, inadequate investment in plant, equipment, and deficient staff recruitment and training can be solved only when American companies can be confident that such investments will be profitable. In most cases, profitability can be assured only if exchange rates between the dollar and other trading partner currencies are, on average, consistent with balanced trade.

Why America Needs a New Trade Policy for the 21st Century

Today’s trade policies clearly do not defend America’s right to a level playing field for international trade, a fundamental requirement if America’s labor and capital resources are to be employed with maximum efficiency, and if future generations are not to be burdened by foreign debts caused by America’s trade deficits today.

America’s international trade policies served it well for much of the 20th century.  Today, however, the policies are badly out of date because, starting in the 1970s, the way in which exchange rates are determined by market forces has changed dramatically.

Historically, exchange rates were determined by the demand and supply of imports and exports, much as they were in the days of Adam Smith. But starting about 40 years ago, world commerce has become increasingly dominated by financial trade in capital and foreign exchange rather than by real trade in goods and services. As a result, the exchange rates set in global financial markets today are rarely consistent with those needed to balance imports and exports. This problem is particularly severe for the United States because it consistently attracts excessive inflows of foreign capital that drive up the dollar’s value, flows driven by the following factors:
1.     The U.S. dollar, which is the world’s premier reserve currency, is more widely used than any other currency for the invoicing of international transactions, for their settlement, and for storing wealth;
2.     The U.S. financial markets are the largest, deepest and most liquid in the world, and they are regarded as a global safe haven in the time of financial problems – even if the problems started in the U.S. markets as was the case with the Crash of 2008.
3.     As the largest market in the world for consumer and industrial goods and services, America has for years been the target of currency manipulators. Countries like Germany, Japan, and China have bought billions of dollars of U.S. currency and other dollar-denominated assets with their own local currencies to drive down the value of their currencies and to drive up the dollar’s value. This has made it very difficult for American producers to compete either at home against imported products or abroad with exports.

If America’s need for foreign capital and its supply of dollar-denominated assets had no limit, the foreign demand for these assets would not cause dollar’s value to rise. But this is clearly not the case. Excess demand for the dollar and dollar-based assets drives the dollar’s exchange rate to levels far above the rate needed to balance U.S. imports and exports.

If America is to have an exchange rate that is consistent with the need to balance imports and exports of real goods and services, thereby maximizing employment and the efficient use of U.S. capital, it must put in place policies that keep the foreign demand for dollars and dollar-based assets consistent with America’s need for imported capital.

In the short- term, measures against currency manipulators and other unfair trade practices are needed.[1] For the longer-term, America must restore the now-broken link between the dollar’s exchange rate and balanced U.S. trade. This can only be done by moderating net capital inflows to levels consistent with a competitive, trade-balancing exchange rate for the dollar.

Perhaps the best possible way to achieve the latter goal would be a Market Access Charge (MAC). A MAC is simply a “peak load pricing” mechanism very similar to those used around the world by both the private and public sectors to balance demand and supply for services such as airline flights, rental cars, hotel rooms, electricity use, and vehicular access to the central business districts of cities like London during rush hours. 

A Market Access Charge would reduce the net yield to foreign capital seeking access to U.S. markets by just enough to make such investments somewhat less attractive. As a result, the demand by foreign investors for dollars and dollar-based assets would be moderated by just enough to reduce excessive upward pressures on the dollar – the primary cause over time of the overvalued dollar, U.S. trade deficits, lost jobs, and failing factories.

How the MAC would Operate?


The Market Access Charge (MAC) would operate as follows:

Trigger 

·       A U.S. trade deficit exceeding one percent of GDP over the past 12 months (the review period) would trigger a non-zero MAC rate. [2] [3]

Rate

·       Once the trigger deficit rate was exceeded, the initial MAC rate would be a charge of 50 basis points on the value of the incoming foreign capital.
·       At the end of each review period (say every twelve months) data on the trade deficit as a percentage of GDP would be reviewed to see if the MAC charge should be increased or reduced.
·       The rate would rise or fall in line with changes in the trade deficit according to an elasticity factor. For example, if the elasticity factor were set at one (1.0), an increase in the trade deficit equal to one percent of GDP would increase the MAC charge by one percentage point (100 basis points). As the trade deficit began to fall relative to GDP, the MAC rate would decline in the same way, returning to zero once the trade deficit dropped below a very manageable one percent of GDP for the previous twelve months.[4]
·       Transition: If the trade deficit exceeds the one percent of GDP trigger at the time the MAC is approved, the initial MAC charge would be set at 50 basis points, then raised by 50 basis points every six months until the average trade deficit over the past twelve months began to decline.[5]

Base

·       All capital inflows would be subject to the same MAC rate. Applying the same rate to all inflows is needed to avoid the problems of evasion, corruption, favoritism and economic distortions that other countries like Brazil encountered with capital inflow charges when they tried to discriminate between “good” and “bad” capital inflows.
·       Because of the MAC’s design, a common rate for all inflows automatically discourages short-term speculative in-and-out flows because the MAC is charged every time foreign capital enters the United States. Conversely, a common rate imposes a minuscule effective burden on the life-time yields of foreign direct investments because such investments come in only once, stay for a long time, and almost always have a much higher expected rate of return per dollar invested than speculative investments do.

Administration

·       The MAC would be collected automatically and electronically on all foreign capital inflows by the computer systems already present in the handful of U.S. banks that handle most of America’s cross-border financial transactions. Under contract, these banks could also service incoming cross border transactions for other banks.
·      Foreign investors seeking access to US financial markets would pay the Market Access Charge. The MAC is not a tax on Americans.
·       The MAC charges collected would automatically and electronically be transferred to the Federal Reserve as the nation’s executing authority for monetary policy. Part of the charges would be retained by the Federal Reserve to execute countervailing currency interventions as proposed by Bergsten and Gagnon. The remainder would be transferred to the U.S. Treasury. However, to prevent the Government’s becoming “addicted” to MAC revenues to finance normal budgetary programs, MAC revenues would be placed in a separate “American International Competitiveness Account” (AICA).
·       AICA funds could be used for programs designed to improve the global competitiveness of American enterprises and workers. Eligible AICA programs could include, for example, the National Network for Manufacturing Innovation (NNMI), other types of support for R&D, worker training and trade adjustment assistance programs, infrastructure development, a Bank for America’s International Competitiveness to help finance productivity-enhancing private sector investments in plant and equipment, more efficient border protection operations including anti-dumping and countervailing duty programs, the repurchase of foreign-held U.S. government debt, and a special fund to help offset any increased costs of borrowing to finance government operations linked to MAC charges on the purchase of government debt obligations.

In sum, a Market Access Charge (MAC) offers the best hope of providing the basis for restoring America’s international competitiveness by fixing the overvaluation of the dollar with respect to trading partners in general. The MAC would also help generate the resources needed to finance targeted Countervailing Currency Intervention as suggested by Bergsten and Gagnon to fix the undervaluation of specific currencies caused by currency manipulation, either past or present. 

These policies, coupled with supporting efforts to simplify the overly complex tax code, to bring effective tax rates more into line with international standards, introduce a border-refundable VAT (at least for export products), and to bring health care costs for workers down closer to those in other advanced countries, hold the promise of  generating millions of jobs, saving thousands of factories, and leaving future generations free of excessive debt caused by America’s living beyond its means today, spending more on imports than it earns producing exports.

(rev. July 25, 2016)






[1] See for example the work of Bergsten and Gagnon at the Peterson Institute for International Economics here and here where they propose countervailing currency intervention as a way to fight currency manipulation by countries like China.
[2] The U.S. trade deficit is suggested as the key parameter triggering the MAC because it is a well-established and officially available number that directly reflects the misalignment of the dollar. Its relevance and objectivity make it far superior, for example, to debatable, subjective criteria such as the difference between the market exchange rate and the “fundamental equilibrium exchange rate,” an indicator that has been suggested as a test for currency manipulation.
[3] The MAC charge rates on incoming capital, the trade deficit trigger point level, the adjustment factor, and the review period used here to explain the MAC’s operation are all reasonable estimates of appropriate values. The actual values for these four parameters would be discussed during the legislative review process with experts from Peterson Institute for International Economics experts and elsewhere as appropriate, then set into law to provide clear guidance for those in Government responsible for implementing the MAC. The basic logic of the values suggested here is as follows:
A basic MAC charge of 50 basis points may seem too low to affect foreign capital inflows. However, this rate was chosen for several reasons: First, capital inflows, especially those driven by private rather than public sector decision-making, are highly sensitive to opportunities for profit and thus to relatively small changes in perspective net yields. For example, the “taper tantrum,” which was driven by the hint that the Fed might begin to raise rates by tapering off the quantitative easing program, triggered massive flows of capital from emerging market countries into the U.S. Second, we know from Federal Reserve experience that changes as small as 25 basis points in the policy rate can have a significant impact on capital markets. Third, an excessively high MAC rate could cause damaging disruptions rather than gradual adjustments in international capital markets.
The trade deficit trigger point for a non-zero MAC charge is set at one percent of GDP for the following reasons: First, a zero rate (perfect trade balance) would represent a degree of precision impossible to attain in the real world, creating the risk overshooting the exchange rate adjustment. Second, an external trade deficit equal to one percent of GDP would produce levels of debt and debt service that would create absolutely no sustainability problems under any reasonable assumptions about economic growth. Third, given that the MAC is designed to generate non-destructive, gradual adjustment, starting the adjustment process only after the trade deficit exceeded two or three percent of GDP would risk substantial additional damage to the U.S. economy before the exchange rate adjustment was sufficient to bring the trade deficit as a share of GDP back to one percent.
The adjustment factor – the elasticity or ratio of percentage point changes in the trade deficit to percentage changes in the MAC rate – is set at unity for two reasons. First, this would assure a more rapid response to rising exchange rate values and trade deficits than would a value of less than one. Second, in line with the philosophy that trade changes generated by the MAC should be constructively gradual rather than damagingly fast, a factor of unity avoids the risks associated with a higher adjustment factor such as two, which would, for example, increase the MAC charge by two percent for every one percentage point of increase in the trade deficit as a percent of GDP.
A review period of twelve months is suggested against the following background. A tangible impact of exchange rate changes on trade balances is well known to require two years or more. Changes in capital flows and exchange rates can take place more quickly, but will add to the total response time. Finally, changing capital inflows by changing the market access charge on such flows will also require additional time.
Even though the MAC would create a “signaling channel” that could change market sentiment and yield results more quickly, realizing the full impact of a MAC on structural trade deficits will almost certainly take three years or so. Consequently, it would be a mistake to keep reviewing the past six months’ experience and raising the MAC charge if the desired results were not seen. Also, adjustments in the MAC rate should not be made too frequently because of administrative burdens, the risk of confusing market price signals, and the risk of overshooting given normal lags between changes in exchange rates and exchanges in trade balances. On the other hand, it would be a mistake to put the process on auto-pilot and wait for two or three years before reviewing the situation. Too much could go wrong in the meantime. Thus an annual review seems reasonable.
[4] Under this system, the MAC charge rate can be calculated as follows: MAC = (Deficit – Trigger) * Factor, where Deficit and Trigger are percentages of GDP and Factor is the “elasticity” of the MAC charge with respect the excess of the deficit over the trigger. Thus, when the trade deficit reached 3 percent of GDP, the MAC charge would be equal to (3%-1%) * 1.0 or 2%. An elasticity factor of 1.0 appears to represent a reasonable compromise between getting rapid results and excessively shocking the international trade system, but this is subject to further analysis and discussion.
[5] This relatively slow introduction of the MAC for the first time is designed to give the international monetary and trade system time to adjust to a new system. In particular, this approach would moderate the initial impact on the many countries who have become addicted to America serving as the borrower and buyer of last resort in a world where supply often exceeds effective demand.

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