April 12, 2017

Would a MAC Harm America's Financial Markets?

"A MAC could cause chaos in America's financial markets."
True or False?

A reader asked the other day if introducing a MAC could seriously upset America's financial markets, thereby causing more harm than good.

This question can be addressed from several different perspectives such as interest rate levels, liquidity, and profitability.

Without doubt, the MAC could have an impact in each of these areas. For example, moderating the inflow of foreign capital will mean less capital circulating in US financial markets, and this could raise interest rates. However,  would be good rather than bad. Today's pathologically low rates today discourage savings, encourage speculative risk-taking, and facilitate wasteful expenditures. Raising interest rates gradually, as the MAC would do, would provide a "soft-landing" transition to a stable environment that supports sustainable real economic growth.

Likewise, moderating excessive capital inflows would reduce market liquidity, but excessive liquidity can hurt rather than help growth and stability as IMF studies  have shown. Furthermore, liquidity in America's financial markets, as proxied by the ratio of stock market capitalization to GDP or total credit market debt outstanding to GDP, is far higher today than it was when America was growing on average by three percent per year -- about 50 percent faster than it is growing today.

But these are issues for another time. Perhaps the best way to look at the probable impact of the MAC on US financial markets is to look at the impact of changes in the Fed Funds rate. This approach is very reasonable given that the MAC and the Fed Funds rate are similar in nature, purpose and size.


The Fed Funds rate is an interest rate. Without going into all the details, we can safely say that changes in the Fed Funds rate produce changes in the effective cost of capital circulating within the United States.

The nature and impact of changes in the MAC rate are directly analogous to changes in the Fed Funds rate -- both change the effective cost of capital in America's financial markets.


The Fed Funds rate and the MAC are both designed to moderate the demand and supply of capital. The Fed Funds rate affects capital circulating within the United States, while the MAC provides its long-missing counterpart, a tool needed to moderate the demand and supply of foreign-source capital.

The Fed Funds rate moderates the domestic flow of capital by changing the cost of borrowing.[1]  The MAC moderates the inflow of foreign capital by changing the cost of borrowing from abroad.  

By making foreign-source capital slightly more expensive to US borrowers, the MAC encourages borrowers to obtain capital from domestic rather than foreign sources.  Conversely, by leaving foreign lenders with a lower net return, the MAC reduces the inflow of foreign capital, thereby reducing upward pressures on the dollar's value. Highly analogous to the impact of changes in the Fed Funds rate.


In addition to being similar in purpose, the size of proposed periodic changes in the MAC and actual changes in the Fed Funds rate over the past several decades are similar.

The Fed Funds rate normally changes in increments of 25 to 50 basis points, which is the same as that recommended for the MAC. [2]  As the MAC is very similar in design to the Fed Funds rate, it is reasonable to predict that the impact of changes in the MAC rate on domestic financial markets will be essentially the same as that of similar changes in the Fed Funds rate. On this basis, we can draw the following conclusions regarding the probable impact on US financial markets of implementing a MAC:

  1. The Fed Funds rate has been in operation for decades. During this period, rate changes have occasionally caused larger-than-normal fluctuations in the short term, but they have never created a crisis in US financial markets. Quite the contrary, changes in the Fed Funds rate have continued to be used for over sixty years precisely because they help prevent market instability and crises.
  2. The MAC would serve as a vital complement to the Fed Funds rate, helping prevent havoc like the housing and stock market bubbles that ended with the Crash of 2008. These crises, by the way, were caused to a very significant degree by excessive foreign capital inflows.
  3. The size of periodic changes in the Fed Funds rate and those proposed for the MAC charge are identical. Since changes in the Fed Funds rate have never wrecked havoc with America's financial markets, there is no reason to think that changes in the MAC would.
  4. Changes in the MAC rate would be made for the same reason as changes in the Fed Funds rate -- to "take away the punch bowl" whenever US financial markets become overheated. Traders who make their living from the market -- and who make the most when the market is "hot" -- rarely like to see the punch bowl removed. But taking away the punch bowl strengthens and stabilizes markets -- it does not wreck havoc.
Introducing a MAC would certainly change the status quo. In the process, some groups will benefit more than others.We know what groups benefit most from hot markets and overvalued dollars. We know what groups are seriously harmed by hot markets and overvalued dollars.

In the end, we Americans must decide if our country is best served by assuring out-sized profits for those engaged in speculative trading, a portion of the economy that adds relatively little to real output, or if it is better served by assuring the competitiveness of America's factories, farms, and other directly productive activities.

 [1] For simplicity, "borrowing" as used here covers obtaining money through both equity and debt transactions.
[2] Since 1990, 70% of the changes in the Fed Funds rate have been 25 bp and an additional 26% have been 50 basis points. The remaining 4% have been changes of 75 bp.

America Needs a Competitive Dollar - Now!

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