Devaluation - Making Good Wages a Reality for Americans

Would the U.S. workers who must compete with low-wage Mexican workers benefit from a twenty-five percent devaluation of the dollar, the change needed to balance overall U.S. trade? Absolutely. [1]

In fact, a twenty-five percent devaluation of the dollar would make the wages of workers in Mexico and other low-wage countries virtually irrelevant to the competitiveness of U.S. workers. This may sound like an outrageous claim, but the numbers back it up.

Before we turn to specific quantitative examples, let’s step back and look at the big picture. Why would correcting the dollar’s current twenty-five percent overvaluation benefit U.S. workers so greatly? According to data from the U.S. Bureau of Economic Analysis, payments to employees account for only 16 percent of the selling price of American manufactured output (Fig. 1). [2]   However, moving the U.S. dollar to its trade-balancing equilibrium exchange rate would increase the total selling price of America’s manufactured goods by 25 percent. [3]

Figure 1. Labor represents a small share of the selling price for manufactured goods.

And in sectors such food, beverages, motor vehicles and parts, and primary metals where labor only represents 10-12% of the selling price, the impact of competition from low-wage Mexican workers is even smaller. For these sectors, the 25 percent increase in selling prices that the dollar’s devaluation would make possible would have an even greater positive impact.

Quantifying the impacts of moving to a fully competitive dollar

This note presents a model that has been developed to make it easy to quantify the impacts of moving to a fully competitive dollar at the firm level under different assumptions regarding (a) the size of the devaluation; (b) the allocation of the “devaluation bonus” (the additional revenues that devaluation would generate for American manufacturing firms) between workers, investment, profit-taking, and (c) tradeoffs between raising dollar prices to increase revenues directly vs. lowering prices in foreign markets to increase sales volumes. (See Annex A. The model is also available online here.)

Some basic parameters such as the initial exchange rate, the devaluation needed to move U.S. trade to a true-zero balance, and the share of wages in U.S. manufacturing output are shown in Section 1 of the model. Other parameters, which are also highlighted in green, are located elsewhere in context. Incidentally, the model can easily be used for other countries by entering appropriate parameters.

Devaluation Could Raise U.S. Wages Sharply

If dollar selling prices for exports were raised by the full amount of the 25 percent dollar devaluation needed to balance U.S. trade, factories would earn an extra $25 for every $100 of sales (see Section 2). This devaluation bonus would be more than enough to cover any wage differentials between Mexico and the U.S. In fact, it would be enough to pay the entire $16 average labor cost embodied in goods selling for $100 – with money left over for increased investments and profits. Moving to a competitive dollar would make the current low wages in Mexico and similar countries irrelevant.

Under these conditions, if U.S. manufacturers kept wages at the current average level of 16 percent of the dollar value of output, a 25 percent devaluation would push wages from $16 to $20. Because the total volume of products shipped does not increase in this scenario, no additional output or workers would be needed to generate the added dollar revenues. Consequently, existing workers could share the additional revenues generated by devaluation as wage increases.

If workers were to receive the entire $25 devaluation bonus, wages per $100 of output measured would rise from $16 to $41. Such a massive increase in wages is, of course, highly unlikely. U.S. manufacturers would almost certainly retain part of the additional dollar earnings to invest in plant, equipment, and worker training – and to increase net profits. But this scenario demonstrates the powerfully positive impact that devaluation could have on the wages of American workers – regardless of wage rates in Mexico. Conversely, it indicates how seriously U.S. workers and enterprises have been harmed by the dollar’s current overvaluation.

Devaluation Could Raise U.S. Sales, Investment, Employment, and Economic Growth

With devaluation, U.S. producers could reduce their prices in foreign currencies while, at the same time, increasing their dollar prices. Lower prices in foreign markets would expand sales, production volumes, and economies of scale.
Section 3 of the model explores this scenario using two additional parameters – the share of the devaluation bonus used by U.S. producers to increase dollar prices, and the price elasticity of foreign demand.

With a trade-balancing devaluation in place, U.S. producers could increase the dollar price of their exports by the full extent of the devaluation, which is the implicit strategy for the Section 2 scenario. Section 3 can generate the same scenario if 100% is entered as the share of devaluation benefits “used by U.S. producers to increase dollar prices.” In this case, the devaluation fully offsets the dollar price increase, leaving the peso price unchanged, and the U.S. producer immediately enjoys a 25 percent increase in dollar revenues as discussed above.

At the other extreme, U.S. producers could keep their dollar prices at pre-devaluation levels. In this case, zero percent of the dollar’s devaluation would be used to increase the selling price in dollars, and one hundred percent of the devaluation’s impact would be used to lower selling prices in peso terms in Mexico – a strategy that would be attractive to companies wishing to expand total sales volumes in the country. (Any reasonable value between zero and 100 percent could, of course, be entered for this parameter.)

To complete this calculation, we need an estimate of the price elasticity of Mexican demand for U.S. exports – the percentage by which Mexican demand would increase for every one percent decrease in the price of U.S. exports expressed in pesos. If the price elasticity of demand is greater than zero, which it almost always is for goods and services, decreasing the peso price for American exports will increase sales in Mexico. For example, if the price elasticity of demand is -1.0, a widely used assumption, a 25 percent decrease in the peso price of American exports would generate a 25 percent increase in the dollar value of sales to Mexico. (Note: Price elasticities are normally negative numbers, reflecting the fact that, as prices decrease, demand increases and vice versa).

These simple scenarios show the range of impacts that are possible on variables important to U.S. producers and workers – including the value and volume of sales, wages, and gross profits.  Regardless of the strategy followed by individual producers, the positive impact of a trade-balancing exchange rate on prices, sales, wages, and profits is undeniable.

Total U.S. Employment Benefit from Devaluation

The memo item in Section 5 at the end of the model looks at the overall impact of devaluation on employment in the United States. Data from the International Trade Administration indicate that, as of 2016, a billion dollars of additional net exports will support 5,744 new jobs on average.[4]   BEA data indicate that America’s current account balance last year was a minus USD 461 billion, and that the merchandise trade balance was in the hole by USD 778 billion.

If 100 percent of the devaluation impact was used to reduce foreign currency prices of U.S. exports to make them more competitive, and if America brings the dollar back to an exchange rate that balances U.S. external trade by implementing the Market Access Charge (MAC), this could generate between 2.6 million and 4.5 million new jobs, depending on the target set.

Conclusion

Low wages in foreign countries contribute to low wages, falling employment in the United States, and growing trade deficits only if the U.S. dollar is overvalued. Moving the dollar to its trade-balancing equilibrium exchange rate would allow American producers to pay higher wages, employ more workers, investment more heavily in enhanced productivity and growth, and enjoy higher net profits.

A competitive exchange rate makes American workers competitive.

America Needs a Competitive Dollar - Now!

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Notes:
[1] For further information on the adjustment needed to move the dollar to a trade-balancing equilibrium exchange rate, see here, here, and here.
[2] U.S. Bureau of Economic Analysis, KLEM, Shares of Gross Output by Industry
[3] Should these calculations be based on the share of labor in value added, which is higher than its share in the value of output? No. Factories sell output, not value added. This applies to foreign exports as well as domestic sales. When Americans buy a cheap refrigerator from Mexico, they buy the entire refrigerator, not just the value that was added in Mexico. This is equally true when Mexicans buy America’s exports. They pay the total price, not just the cost of value added in America. Furthermore, exchange rates apply to the total price, not just the value added. 
[4] The model is also available on line in executable form at  https://drive.google.com/open?id=0B9wSlwkCYQy1MG9hbVFBejJKVWM

Will Offshore Dollar Trading Undermine the MAC?

Introduction

The Market Access Charge (MAC) would be a charge on foreign capital flowing into the United States when excessive inflows from abroad are driving the U.S. dollar to non-competitive levels on a sustained basis. As it would be difficult to impose this tax on transactions taking place in other countries, some have suggested that the untaxed trading of dollars and dollar-based assets outside the United States would undermine the MAC's effectiveness.[1]

This note summarizes the impact that offshore dollar trading might have on the dollar's exchange rate, then examines the reasons why the MAC would still be the best possible way to move the dollar to its fundamental equilibrium exchange rate – the exchange rate that would eliminate America's external trade deficits by restoring the international competitiveness of its goods and services, workers, factories, and farms, regardless of offshore trading activity.

Would offshore trading in dollars reduce the efficacy of the MAC

In the U.S., the MAC would lower the value of the dollar because the price of the dollar, like any price, is set by supply and demand. Charging the MAC whenever a foreigner purchases an asset located or registered in the United States will reduce the desirability of acquiring dollars, thus moving the value of the dollar towards its trade-balancing equilibrium exchange rate.

The MAC would be charged on (1) purchases of dollars and dollar-based assets from US resident owners by non-US residents and (2) sales of securities whose ownership is registered in the United States and must be re-registered when securities are sold by non-US residents to other non-US residents.

Sales of dollars already outside the US such as dollars trading in London would not be subject to the MAC. Although the volume of USD trade outside the US is very large, this volume is not a measure of the influence such trading has on the exchange rate because much of the trading is very short-term and is often reversed many times per day to exploit market fluctuations.

The MAC would divert the supply of dollars being traded from U.S. markets where the charge would have to be paid to offshore markets. By increasing the supply of dollars in offshore markets, the MAC would push down the dollar’s price, assuming a relatively fixed demand, and this would tend to lower the price of dollars traded even in offshore markets, thus reinforcing the price impact of the MAC on trades in U.S. markets.

The MAC would be applied to all purchases of U.S. financial securities, public or private, whose ownership is registered in the United States. For such securities, this means that, even if the transactions take place between foreigners located in other countries, the securities would have to be re-registered in the United States for the transaction to be legally binding. The MAC would be applied by the depository banks and companies such as DTC and Cede & Co. that manage the ownership registration for book-entry securities and entitlement transfers. In this way, the impact of the MAC can be extended well beyond the purchase and sale of securities across the border that would be taxed directly by the MAC.

The MAC would also cover the sale to foreigners of intellectual property, American homes, farms, factories, and natural resources such as mines – another important source of capital inflows that distort the dollar’s value.

In brief, while the offshore stock of dollars not subject to the MAC may reduce somewhat the initial impact of the MAC charge on the dollar’s value, this effect will be limited, and it will be offset to a considerable degree by the increased supply of dollars now trading in foreign markets not subject to the MAC and by capturing U.S.-based re-registration of foreign ownership. If further adjustment to the dollar’s price is needed to achieve balanced trade, the MAC charge will automatically increase to compensate.

Other Factors Enhancing the MAC’s Offshore Impact

Falling returns to speculators, the rising risk of losses caused by exchange rate adjustment, and the signaling effects of the MAC would further increase the efficiency with which the MAC moves the dollar to its trade-balancing equilibrium exchange rate.

Figure 1. 2013 Taper Tantrum: Market is Sensitive to Interest Rate Changes
                             – Even if Only Potential and Small

Falling Returns

The MAC will reduce returns to traders. This will reduce incentives to purchase dollars, and will increase the incentives to purchase other currencies such as Euros, British pounds, and Japanese yen. Markets are very sensitive even to the possibility of even small yield changes. Note, for example, the sharp and immediate response to Fed Chair Ben Bernanke's observation on June 19,2013, that, because of improved economic conditions, "it would be appropriate to moderate the monthly pace of purchases later this year." This triggered the famous "taper tantrum" of 2013 shown in Figure 1 (Neely, 2014).

Risk of Valuation Losses

Implementing the MAC will make it very clear that the U.S. intends to devalue the dollar by as much as required to balance U.S. trade. Any investor can quickly discover from the IMF, the Peterson Institute, the Coalition for a Prosperous America website, or the Americans Backing a Competitive Dollar blogsite that this will probably require a devaluation of 20-30 percent. This would ultimately translate into a similar valuation loss for foreigners holding assets denominated in dollars.

Signaling

Perhaps the MAC's greatest power will be as a signaling device. Its most effective signals will be the following:

• The U.S. has finally become serious about balancing its external trade and, to this end, will do "whatever it takes" to move the dollar to its trade balancing fundamental equilibrium exchange rate.
• The U.S. will no longer be the dumping ground for the "glut of savings" flooding in from countries like China that, through unfair mercantilist trade and currency policies, have run up huge surpluses with the United States, killing thousands of U.S. factories and millions of U.S. jobs.
• The U.S. will no longer be the "buyer and borrower of last resort" that the world has come to take for granted as the source of global growth. Future growth must be built on balanced trade, not on America's ever-growing external debts that future generations of Americans must repay.

The knowledge that the U.S. Government and the American people intend eliminate the U.S. trade deficit by moving the dollar to a fully competitive exchange rate will be an exceptionally powerful signal moderating the foreign demand for dollars. In fact, this effect will undoubtedly be far more important than the MAC charge of 50-100 bp itself!

Conclusion: MAC is the best option for making America Competitive Again
No other policy has been identified that would focus as sharply as the MAC on fixing the main cause of U.S. trade deficits the overvalued U.S. dollar.

• The MAC would be applied to the purchase of all securities with ownership registered in the United States.
• The MAC will reduce the demand for dollars and dollar-based assets by reducing the return to foreigners on such assets.
• The MAC's signaling effects regarding America's determination to devalue the dollar to a level that will balance trade will increase its efficacy.

The MAC is not a perfect solution for all of America's trade problems, and it will need to be complemented by other policies designed to combat outright currency manipulation by foreign governments, and unfair trade practices at the sectoral and product levels.  However, in a complex world, we cannot let a futile search for the perfect be the enemy of the good – especially since the MAC is a better way to fix the overvalued dollar than anything else on the table today.

John R. Hansen
September 22, 2017

Notes:
[1] A more detailed explanation of the MAC and how it would work is available here and here. The links between the MAC and balanced trade for American can be summarized as follows: MAC charge on capital inflows > smaller inflows > less upward pressure on the value of dollars and dollar-based assets > a more competitive exchange rate for the dollar > more exports & fewer imports > balanced trade > more employment, more investment, more profits & more growth.

[2] The trading volumes are many times larger than the actual stock of dollars held overseas because of the extremely high velocity and thus turnover of forex trading.

References:
Stumo, Michael, Jeff Ferry, and John R. Hansen. 2017.07.13. The Threat of U.S. Dollar Overvaluation: How to Calculate True Exchange Rate Misalignment & How to Fix It. Washington: Coalition for a Prosperous America. (http://www.prosperousamerica.org/The Threat of U.S. Dollar Overvaluation: How to Calculate True Exchange Rate Misalignment & How to Fix It.)

Hansen, John R.  2017.09.08. Why the Market Access Charge is Necessary to Fix Trade Imbalances. Washington: Coalition for a Prosperous America. (http://www.prosperousamerica.org/why_the_market_access_charge_is_necessary_to_fix_trade_imbalanceshttp://www.prosperousamerica.org/why_the_market_access_charge_is_necessary_to_fix_trade_imbalances)

Neely, Christopher J., 2014.01.28, “Lessons from the Taper Tantrum,” Economic Synopses: St. Louis, Federal Reserve. (https://research.stlouisfed.org/publications/economic-synopses/2014/01/28/lessons-from-the-taper-tantrum/ )

America Needs a Competitive Dollar - Now!

The Threat of U.S. Dollar Overvaluation: How to Calculate True Exchange Rate Misalignment and How to Fix It

Cross-posted from:

Coalition for a Prosperous America: Michael Stumo (CEO) Jeff Ferry (Research Director) and John Hansen (Advisory Board), July 2017

Introduction

This memo explains (1) the dollar overvaluation problem, (2) how to accurately calculate the dollar’s misalignment against trading partner currencies, and (3) how the Market Access Charge (MAC) that CPA and others favor would fix this serious threat to America’s future.

The foreign exchange value of the national currency should play the pivotal role in bringing excessive trade deficits (or surpluses) back into balance.
Unfortunately, however, exchange rates have lost their link with trade balancing equilibrium pricing. The graph below shows very problematic over and undervaluation of the currencies of the United States and its major trading partners.

We propose a new policy tool, the Market Access Charge (MAC), to move the dollar back to a competitive, trade-balancing exchange rate.

For remainder of the original article, click here.

For full data set showing derivation of exchange rate adjustments required for true-zero current account balances, click here.

America Needs a Competitive Dollar - Now!

NAFTA - The Problem is the Dollar's Overvaluation, Not Currency Manipulation by Mexico and Canada

Commentaries for the upcoming USTR hearings on NAFTA modernization from various labor and industry organizations have called for tough measures against currency manipulation.

Currency manipulation is of course a well-known hot-button issue and deserves to be addressed. But in the context of NAFTA hearings, this is simply the wrong focus.

To raise currency manipulation in the NAFTA context implies that Mexico and Canada are currently manipulating and undervaluing their currencies, thereby harming the United States. This is not true.

If a country has an undervalued currency, by definition it has an overall trade surplus with its global trading partners. However, as shown in the following graph, Mexico and Canada both run overall trade deficits.

In fact, for the past sixteen years Mexico has had an unbroken string of global trade deficits, averaging 1.7 percent of GDP, and Canada has had nothing but trade deficits since 2009, yielding an average trade deficit since 2000 of 0.7 percent of GDP. In 2016 alone, the respective deficits of Canada and Mexico were 3.7 percent and 2.7 percent. On average, their deficits are getting worse, not better.

How can we explain the fact that our NAFTA trading partners have been running significant trade surpluses with us, but despite these surpluses, their overall trade has been in deficit for years? The answer is very simple:

• The currencies of Canada and Mexico are overvalued, but the U.S. dollar is even more seriously overvalued. 

The solution to our trade deficits with Canada and Mexico lies not in forcing them to revalue – that would leave them with even larger global trade deficits. The solution lies instead with reducing the dollar’s overvaluation – currently estimated at about 25 percent with respect to the rate that would balance U.S. trade.

Launching futile fights against currency manipulation that does not exist within NAFTA today will do nothing to solve America’s trade problems and could easily undermine progress in other area important to America's future.

Instead, the road to a prosperous future for all Americans lies with bringing the U.S. dollar to a fair competitive value and keeping it there. The  Market Access Charge (MAC) is the only tool that can accomplish this important task.

The MAC can make U.S. factories, workers, and products more competitive, both within America and in export markets, by removing the 25 percent tax on the selling price of all US industrial, agricultural, and other products currently imposed by the dollar's overvaluation with respect to the exchange rate that would balance US trade. Furthermore, the MAC would eliminate the 25 percent subsidy automatically granted to all imported products by the dollar's overvaluation.

I hope that organizations making oral presentations at the NAFTA hearings will make this point loud and clear.

America Needs a Competitive Dollar - Now!

MAC - Expert References

This post provides a list of key explanatory posts about the MAC appearing on this website, plus selected references made by other economic experts to the MAC since the beginning of this year.

Key Explanatory Notes on the Market Access Charge

This website provides over 50 posts on the MAC's design, the reasons the MAC is needed, and the MAC's probable benefits for America. The most useful and most frequently visited are the following:

How the MAC Would Help Restore American Manufacturing
http://abcdnow.blogspot.com/2016/05/how-mac-would-help-restore-american.html

Currency Manipulation or Currency Misalignment
http://abcdnow.blogspot.com/2016/03/currency-manipulation-or-currency.html

Make the Better Way Even Better
http://abcdnow.blogspot.com/2017/01/make-better-way-even-better-add.html

Of these, the first provides the best overall view of the MAC's purpose, design, and implementation.

Expert References

Since the beginning of 2017, the following references to the MAC by other experts are particularly relevant:

2017.01. Robert E Scott. Growth in U.S.–China trade deficit between 2001 and 2015 cost 3.4 million jobs. Here’s how to rebalance trade and rebuild American manufacturing. Washington: Economic Policy Institute.

 “John Hansen (2016), another distinguished economist, has proposed the imposition of an adjustable “market access charge,” a tax or fee on all capital inflows that would reduce the demand for dollar-denominated assets and hence the value of the currency. By revaluing the currencies of surplus countries, the U.S. trade deficit could be reduced by between $200 billion and $500 billion dollars, raising demand for U.S. exports. (Rebalancing the dollar would also help exports in the services and agriculture sectors.)”
(http://www.epi.org/publication/growth-in-u-s-china-trade-deficit-between-2001-and-2015-cost-3-4-million-jobs-heres-how-to-rebalance-trade-and-rebuild-american-manufacturing/)

2017.02. Jeff Ferry. Fixing the Bloated Dollar. Washington: Coalition for a Prosperous America.

"... Joe Gagnon ... is intrigued by another, even more radical proposal, called the Market Access Charge or MAC.  The MAC is the brainchild of economist John Hansen, now retired after a career at the World Bank. Hansen’s vision is for a charge, starting at 50 basis points (half of 1%) on inflows of foreign capital into U.S. financial assets. The one-time charge upon entry would be levied not on the interest but on the principal invested into U.S. assets. There would be no political debate required over which nations pay the MAC. They all would. The revenue flowing to the Treasury would be counted in billions of dollars.
The advantages of the MAC are that it is relatively easy to administer and it is highly likely to drive down the dollar. Most important, it demonstrates to the world that the U.S. is serious about making sure that its currency serves the needs of its domestic economy instead of the other way around.
(www.Prosperousamerica.Org/Fixing_The_Bloated_Dollar).

2017.06. C. Fred Bergsten and Joseph E. Gagnon, Currency Conflict and Trade Policy: A New Strategy for the United States. Washington: Peterson Institute for International Economics.

“The United States could impose a transactions tax or a “market access charge” on new purchases of US assets by currency manipulators.”
(https://piie.com/bookstore/currency-conflict-and-trade-policy-new-strategy-united-states).

2017.06. Daniel DiMicco, Brian O’Shaughnessy, and Michael Stumo. CPA Testimony for NAFTA Negotiations. Washington: Coalition for a Prosperous America.

"First, and most importantly, a capital flow management tool called the Market Access Charge (MAC) should be implemented to push the US dollar towards its trade balancing equilibrium rate, increasing U.S. exports and reducing imports. CPA’s recent analysis, using the IMF Fundamental Equilibrium Exchange Rate (FEER) method, corrected to target a zero current account balance in 5 years, shows the dollar is about 25.5% overvalued today."
(http://www.prosperousamerica.org/cpa_testimony_nafta_negotiations)

2016.06. Bob Tita, "How to Revitalize U.S. Manufacturing," Journal Report: Future of Manufacturing, pp 1-2. New York: Wall Street Journal.

Although it did not appear in 2017, this expert reference to the MAC is well worth noting as it appeared in the Wall Street Journal. In the article, Mr. Tita noted:

"Lowering the value of the dollar is difficult, especially as long as foreign investors keep pumping their dollars into U.S. investments. John Hansen, a former economic adviser for the World Bank, has a solution that he says could keep a strong dollar from further swelling the trade deficit and discourage high-frequency, speculative trading by foreign investors in U.S. financial markets.
The idea: market-access charges. A base-rate charge of 0.5% could be applied on all foreign-originated inflows of money into U.S. investments. The rate would gradually climb to about 2%. Further increases would be linked to increases in the trade deficit, which is about 3% of U.S. GDP. If the deficit remains unchanged even with the fee, Mr. Hansen anticipates 0.25% increases in the fee every six months. When the deficit retreats, the fee would fall. The fee revenue could be used for government-funded research to help manufacturing."
(http://www.wsj.com/articles/how-to-revitalize-u-s-manufacturing-1465351501)

America Needs a Competitive Dollar - Now!

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.

Nature

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.

Purpose

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.

Size

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.



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 [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!

Tools for Balancing American Trade -- The MAC is Best

A variety of measures are currently on the table to solve eliminate U.S. trade deficits including tariffs, border-adjustable taxes, and various currency related measures. Each of these tools is needed for specific tasks. However, the Market Access Charge (MAC) is the best tool for providing the overall foundation of an equilibrium exchange rate that balances total trade.

Conventional Measures 

General tariffs, used as a threat, can be a useful bargaining tool. However, such tariffs are illegal, do not solve the dollar’s fundamental overvaluation, can easily trigger destructive trade wars, tend to escalate as interested parties argue their case for preferential treatment (i.e. higher tariffs), and adjustments as global realities change require politically-charged discussions.

Countervailing and anti-dumping duties are legal, provided specific conditions are met, and can be a very useful remedy for specific products, but they affect such a small part of total trade that they cannot fix the dollar’s overvaluation.

Border-adjustable taxes (BATs) have been proposed in the Ryan/Brady “Better Way” plan are not exactly “conventional” tariffs, but share many of the same characteristics: they are probably illegal, have encountered stiff resistance even within the Republican Party because of the negative impact on importers, would make dollar’s overvaluation even greater rather than fixing the overvaluation, and, like ordinary tariffs, provide no exit strategy.

Once in place, America would be forever dependent on BATs. Furthermore, they have no self-adjusting mechanism to respond to changes in relative global prices and productivity levels. The one advantage of BATs over normal tariffs, which tend to be recessionary because they only suppress imports, is that they subsidize exports. However, this involves a serious loss of potential budgetary revenues, making balancing the budget while supporting necessary investments in infrastructure, for example, even more difficult.

Market Access Charge (MAC) 

The MAC overcomes all the problems of conventional measures. It works quickly. It solves the underlying problem – the dollar’s overvaluation. It encourages the domestic production of expanded exports as well as of import alternatives. It generates billions of dollars of net revenues that are derived, not from the average American family, but from foreign speculators and from increased U.S. economic activity that would not have taken place had the MAC not been implemented. And it automatically adjusts to changing global realities without need for political intervention. (For details on the MAC mechanism, see here.)

America Needs a Competitive Dollar - Now!

Fixing the Bloated Dollar - Guest Blog by Jeff Ferry of CPA

Jeff Ferry, Research Director for the Coalition for a Prosperous America, recently published an excellent discussion paper on options for fixing the overvalued dollar, one of America's most serious trade problems today. Not only is the Market Access Charge (MAC) among the options listed. It is given top marks.

The CPA has kindly agreed to let us re-post Jeff's paper here on the Americans Backing a Competitive Dollar (ABCD) blog site. Enjoy!
---------------

Fixing the Bloated Dollar

February 14, 2017

By Jeff Ferry

Research Director, Coalition for a Prosperous America [1]

Fear is growing that a rising dollar could sabotage any effort by the Trump Administration to improve the U.S. trade balance as a means of improving the health of our manufacturing industry.

Commentators have suggested that the prospect of rising interest rates and higher U.S. economic growth, combined with any moves to boost net exports, could quickly lead to a rising dollar, throwing improvements in the trade balance into reverse. But there are bold, new solutions to get the overvalued dollar under control, including a plan to charge foreigners a fee to hold dollars, known as a MAC, that the government should consider.

The U.S. needs to address what could be called “macho dollar syndrome,” the belief that a strong dollar is somehow good for the U.S. economy. In reality, a strong dollar makes our exports more expensive, our imports cheaper, thus leading to a larger trade deficit, slower economic growth, and fewer jobs. That dynamic has been taught in introductory economics classes for years.

You can see the living proof simply by looking at Britain’s economic performance in the second half of last year. In June, the Brits voted to leave the European Union. The pound sterling promptly fell 15% as speculators worried about turmoil and trade agreements. The fall in sterling boosted British exports (up 18% year-on-year), leading to a significant uptick in economic growth in the fourth quarter, enabling Britain to finish 2016 with annual growth of 2.0%, the highest growth rate among the G-7 group of large countries.

Recently, some have shown renewed enthusiasm for labeling some of our most mercantilist trading partners currency manipulators. Senate Minority Leader Charles Schumer (D-NY) urged the president to put the label on China. The “currency manipulator” label, under current law, triggers dialogue with the offending country which could lead to further action at the discretion of the president.  The problem with this approach is that persistent Chinese currency manipulation has ebbed recently. According to an October report from the U.S. Treasury, China actually spent $566 billion pushing its currency up not down.

For an economist, “currency manipulation” is better understood not as direct intervention in exchange rates, but as policies that prevent a nation’s trade balance from balancing over a full economic cycle (typically 5-7 years).  According to economist Brad Setser, East Asian countries are managing today their economies to save as much as 40% of their GDP, contributing to their trade surpluses and our trade deficits.  Last October, Setser wrote: “The problem of the global savings glut is now more acute than in 2005…The social costs—and therefore also political costs—of relying on the United States and a few other countries as consumers of last resort are increasingly evident.”

A novel idea to address dollar overvaluation was advanced by Joe Gagnon and Gary Hufbauer of Washington’s Peterson Institute in a 2011 article, Taxing China's Assets.The core of the proposal was a 30% withholding tax on the interest paid on the holdings of U.S. financial assets by entities based in nations the U.S. deemed persistent surplus nations. The benefits of the proposal are that it would exert downward pressure on the dollar (and upward pressure on the renminbi), and it would make it plain to the Chinese and other surplus nations that they are not doing the U.S. a favor by buying our Treasury bonds. On the contrary, they are enabling their economies to grow at our expense, and we would much prefer they increase domestic consumption rather than rely upon U.S. consumers for growth.

The biggest problem with the Gagnon-Hufbauer withholding tax is that it raises an enforcement challenge because it creates incentives for foreign investors to disguise their country of origin. For that reason Joe Gagnon himself is intrigued by another, even more radical proposal, called the Market Access Charge or MAC.  The MAC is the brainchild of economist John Hansen, now retired after a career at the World Bank. Hansen’s vision is for a charge, starting at 50 basis points (half of 1%) on inflows of foreign capital into U.S. financial assets. The one-time charge upon entry would be levied not on the interest but on the principal invested into U.S. assets. There would be no political debate required over which nations pay the MAC. They all would. The revenue flowing to the Treasury would be counted in billions of dollars.

The advantages of the MAC are that it is relatively easy to administer and it is highly likely to drive down the dollar. Most important, it demonstrates to the world that the U.S. is serious about making sure that its currency serves the needs of its domestic economy instead of the other way around.

* * *

Thanks, Jeff. A great message of support for the MAC.

- - - - -
[1] The Coalition for a Prosperous America (CPA) is a nonprofit organization representing the interests of 2.7 million households through its agricultural, manufacturing and labor members. The CPA is working hard to working for a new and positive U.S. trade policy that delivers prosperity and security to America.

America Needs a Competitive Dollar - Now!

Foreign Direct Investors will Love the Market Access Charge (MAC)

Would the MAC discourage foreign direct investment in the United States? 

Some readers have suggested that capital being brought into the United States to finance greenfield foreign direct investment should be exempted from the MAC. We should not, they argue, do anything to discourage productivity enhancing investment in America's manufacturing sector, for example.

Although the MAC is explicitly designed to cover all incoming capital, the MAC will not adversely affect greenfield investments. In fact, the MAC will make foreign direct investments in productivity-increasing projects based in the US far more attractive.

Make the "Better Way" Even Better Add Exchange Rate Reform

                                                                                                                                                     John Hansen

Today we propose a new tax code built for growth -- for the growth of paychecks, for the growth of local jobs and economy, and the growth of America’s economy.”           
Kevin Brady

With these words, Representative Brady, as Chair of the Ways and Means Committee and leader of the Tax Reform Task Force, unveiled A Better Way for tax reform.

The Better Way notes that a Made in America Tax (MAT) puts American-made goods and services at a severe competitive disadvantage. The MAT exists because U.S. exports face two tax burdens not borne by the exports from most foreign countries: First, made-in-America goods must compete in U.S. markets with imports that are not similarly taxed. Second, when U.S. goods are shipped to foreign markets, they must pay the VAT charged by those countries.

To fix the Made in America Tax problem, the Better Way plan suggests a border-adjustable tax (BAT) that would exempt American exports from paying the “company tax” proposed in the Better Way to substitute for the current corporate income tax. It also proposes that America effectively impose a tariff-like charge on imports from foreign countries based on the company tax rate.

Although the BAT holds considerable promise, it also contains a potentially serious risk. As its proponents, have noted, the border taxes would serve as tariffs. As such, the proposal has been challenged by those concerned that the tariffs would raise the price of imports, hurting U.S. consumers of both finished and intermediate goods. Also, the BAT may conflict with WTO rules.

However, the proponents argue that the tariff effect of the BAT would be offset by appreciation of the dollar, leaving no net change in the dollar cost of imported goods to consumers.  This is sound thinking according to economic theory. However, this exchange-rate / tariff offset raises two other concerns. First, why are we considering a measure that will make the overvalued dollar even more overvalued? Second, what if the dollar valuation offset to tariffs overshoots the mark.

If the offset mechanism works, at least the dollar’s overvaluation will be no worse than it is today, but on the other hand, the BAT does nothing to make U.S. production more competitive against imports. Furthermore, if the exchange rate rises in line with the BAT rate, the BAT exemption on exports will be offset by the higher exchange rate. 

The Market Access Charge as a Complement to the Better Way

Given these problems with the BAT, I would suggest that, while considering ways to avoid the Made in America Tax, Congress needs to eliminate an even more serious tax on American goods – the overvaluation of the dollar that creates an Overvalued Dollar Tax (ODT). With a Market Access Charge (MAC), the ODT tax can be eliminated in a way that generates revenues that would help finance both a reform of the corporate tax system and the urgently-needed infrastructure problem proposed by the Trump Administration.

Data from the Peterson Institute for International Economics and the Federal Reserve indicate that the U.S. dollar is overvalued by about 35 percent today. Unlike the corporate tax, which is basically a tax on a company’s often small profits, the overvalued dollar tax is a tax on 100 percent of the final selling price of all US goods. Consequently, the Overvalued Dollar Tax can impose a far larger burden on corporate profitability than the corporate profits tax.

The overvalued dollar weakens the competitiveness of American producers both at home and abroad. In the short run, this weakness is often papered over with money borrowed from abroad to cover the deficits caused by America’s booming demand for “cheap” foreign products. But in the medium term, the dollar’s overvaluation makes American producers less competitive, less profitable, less able to maintain U.S. jobs, and less inclined to undertake the investments in real productivity urgently needed for America’s long-term strength and greatness.

The primary cause of the dollar’s massive overvaluation is an excessive inflow of capital from foreigners seeking profits by purchasing dollars and dollar-based assets in America’s attractive financial markets. Most of these flows go into trading that does little or nothing to improve the physical productivity and international competitiveness of America’s manufacturing sector.

Adding a Market Access Charge (MAC) to the Better Way proposal help resolve this problem. A modest MAC would be assessed on foreign capital inflows whenever the dollar was significantly overvalued as indicated by a trade deficit exceeding one percent of GDP. The MAC would reduce net returns to foreign investors ­ especially foreign speculators. With a MAC in place, foreign demand for dollars and dollar-based assets would moderate, and the dollar would gradually move back to its trade-balancing equilibrium exchange rate. Note that foreign traders, not Americans, would pay the MAC charges!

A trade-balancing equilibrium exchange rate would increase domestic and foreign demand for made-in-America goods, accelerate growth, and create more jobs with higher wages. Higher growth would mean larger tax revenues – even if tax rates were reduced as proposed in the Better Way plan. Thus, adding a Market Access Charge to the reform package proposed by Chairman Brady and his task force would make it easier to balance the budget  – while simultaneously increasing critical investments in our nation’s infrastructure and reducing the national debt.

In sum, a Market Access Charge (MAC) would be an invaluable component of the Better Way strategy because it would:

1. Increase the competitiveness and thus the profitability of U.S. companies – by about three times as much as would a border-adjusted tax.
2. Move the dollar closer to its trade-balancing equilibrium exchange rate. (The BAT could actually raise the dollar’s value, making U.S. goods less rather than more competitive.)
3. Stimulate the growth of well-paying jobs throughout the economy and reduce the incidence of poverty in our great nation.
4. Fix the key underlying problem causing the decline in America’s competitiveness – a seriously overvalued dollar.
5. Comply fully with WTO, IMF, and U.S. Government rules, laws, and agreements – thereby avoiding the WTO problems that face the border-adjustable tax proposal.
6. Stabilize the financial sector, thereby reducing the systemic risk of major disasters such as the Crash of 2008. This might even make it possible to reduce the sector’s regulatory burden.
7. Make important contributions to balancing the budget while providing a solid basis for reducing tax rates significantly, simplifying America’s broken tax code, and improving essential government services. 

For more on the Market Access Charge (MAC) and related issues, see the blog site Americans Backing a Competitive Dollar (www.abcdnow.blogspot.com).

March 23, 2017 (rev.)

John Hansen, PhD          Former World Bank Economic Adviser            hansenj@bellsouth.net

Founding Editor              Americans Backing a Competitive Dollar       www.abcdnow.blogspot.com

Trade Barriers Do Not Cause Trade Deficits -- Except When Currency Markets Fail

The tariff and non-tariff barriers imposed by China, Japan, and many other countries have been blamed repeatedly by many Americans for causing America’s trade deficits, lost jobs, and closed factories.  Their argument holds that, were it not for such trade barriers, America could export more of its goods and services to these countries, thereby helping balance its external trade.

However, trade barriers such as import duties, lengthy inspections, idiosyncratic technical requirements, licensing restrictions, and even bans do not actually cause trade deficits – unless currency markets fail.

In line with the classical trade theories of economists such as Ricardo and Hume, exchange rate markets will automatically assure that trade remains balanced, regardless of changes in factors such as inflation, productivity, and, yes, trade barriers.  However, forty years of trade deficits provide clear evidence that classical trade theory no longer works to balance U.S. trade.

The reason is straightforward: Today’s global currency markets fail to determine exchange rates that will balance U.S. trade because exchange rates are now determined by international trade in capital, not by trade in goods and services.

In the 18th and 19th centuries, if a country imported more goods and services than it exported, it paid for the difference with gold (or silver), or it paid with paper money backed by a precious metal. If the trade deficit was relatively large, cross-border payments made to cover the deficit would gradually deplete the country’s reserves.

When the gold ran out, the country would print more paper money. If it printed more than the world wanted to hold, the value of the country’s currency would fall, making exports cheaper and imports more expensive. As exports increased and imports decreased, trade would more back into balance – regardless of trade barriers.

Any trade barriers present would simply reduce trading volumes, thus reducing the efficiency and benefits of trade. Trade deficits did not cause the deficits. Currency misalignments caused the deficits, and these misalignments would automatically be fixed by a well-functioning global currency market.

The Case of America Today

Why doesn’t the global exchange rate system work like this for America today?
The answer is very simple. The world has changed dramatically over the past 200-300 years, but American trade policy has not. The key changes in the global economy include:

1. A surge in the number of countries trading on a global rather than regional basis, their level of development, and their average wage rates.
2. A sharply higher ratio of international trade to global GDP.  Globally important financial markets developing in countries around the world.
3. Greatly increased integration of global financial markets, thanks largely to the explosion of computer and information technology.
4. The U.S. dollar’s rise to dominant reserve currency status during the 20th century.
5. The emergence of U.S. financial markets as a global safe haven.
6. The collapse of the gold standard between WWI and WWII, and of the Bretton Woods system in 1971-73.

Despite these dramatic changes, most of which were dominated by or closely linked to global capital flows, the international monetary policies of the United States have changed but little. Forty years of virtually continuous U.S. trade deficits since the collapse of the Bretton Woods system prove that policies adequate to deal with the realities of the 21st century have not yet been implemented.

 Sure, some measures have been introduced. For example, changes were made in the way the U.S. handled global currency market interventions to manage the value of the U.S. dollar during and after the Bretton Woods system. Also, the Omnibus Trade Act of 1988 included measures designed to fight currency manipulation, but these measures have failed to solve U.S. trade deficits.

During the recent Trade Promotion Authority (TPA) discussions, strong emphasis was placed by many in Congress on the importance of including an enforceable clause against currency manipulation in the TPP, but as Bergsten and Schott noted recently with respect to the commitments that ministers of finance made in their Joint Declaration on currency manipulation: “Are the commitments … enforceable through the dispute settlement procedures of the TPP? … The short answer is, no.”  If not enforceable, they will fail.

For decades, the Federal Reserve has used the Federal Funds Rate to keep the flow of domestic capital consistent with its goals for growth, inflation, and employment. Furthermore, the Humphrey-Hawkins Full Employment and Balanced Growth Act of 1978 gave the Fed an official mandate to assure that its monetary policies are consistent, not only with employment, growth and inflation targets, but also with "an improved trade balance" based on, “improvement in the international competitiveness of agriculture, business, and industry.”

Nevertheless, the Fed lacks any policy similar to its Fed Funds Rate that would allow it to moderate the massive inflows of foreign capital that drive the dollar’s overvaluation and America’s trade deficits.

In short, the U.S. has no meaningful international monetary policies designed to keep the dollar close to its trade-balancing equilibrium exchange rate – and thus no meaningful instruments to prevent trade deficits from sapping the economic and social vitality of our nation.

Policies for the 21st Century

America needs to implement a set of international monetary policies that will bring the value of the U.S. dollar back close to its trade-balancing equilibrium exchange rate and keep it there – regardless of how illegal or misguided the trade policies of other countries may be. This could easily be accomplished by passing a law mandating the introduction of three policies. Ranging from general to specific:

• Market Access Charge (MAC): When ordinary market forces such as the dollar’s reserve currency status and America’s status as a safe haven for investors cause the dollar’s overvaluation, impose a modest Market Access Charge (MAC) on all foreign capital inflows whenever the trade deficit exceeds one percent of GDP. By moderating inflows, the MAC would reduce upwards pressure on the dollar, allowing it to return to its trade-balancing equilibrium exchange rate.
• Countervailing Currency Intervention (CCI): When currency misalignments are clearly the result of official currency manipulation by specific countries, the U.S. Government would make countervailing purchases of an equal value of the offending country’s local currency.
    
• Currency-adjusted Countervailing Duties (CCD): In line with legislation proposed by Schumer and Brown, allow the U.S. Government to treat currencies manipulated by foreign governments as subsidies to their exporters and add a proportional currency surcharge to countervailing duties on specific imports from such countries.

These three simple measures would fill a gaping monetary policy hole in America’s current trade policy tool box, and they would help America become more internationally competitive in the 21st century.

John Hansen     Aug. 31, 2016

America Needs a Competitive Dollar - Now!

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.

Will a MAC Discourage Repatriation of US Corporate Profits?

Some have suggested that imposing a MAC on all capital inflows would make it more difficult to get US corporations to repatriate profits held offshore. This is a non-issue for three reasons.

First, US corporations holding profits abroad rather than repatriating them are doing so to avoid corporate income taxes (CITs) of about 35 percent. Compared to this tax, a MAC charge averaging between zero and about 1.5%, depending on the size of the US current account deficit, would have no material impact. The issue is the 35% CIT rate, not a tiny MAC charge.

Furthermore, if Congress decided that this was an issue, the CIT rate could be reduced by the amount of the MAC. Doing so would assure that the MAC would have zero impact on capital repatriation while maintaining the very important principle that the MAC should be completely non-discriminatory.

Second, the US Government is not encouraging corporations to repatriate profits  because America is short of capital. The Government's motive is rather to collect taxes on such funds.

Third, if capital ever were to become relatively scarce, as indicated by elevated interest rates, this would also indicate that the inflow of foreign capital has dropped rather remarkably. Should this happen, the dollar would almost certainly move to a more competitive level. This in turn would reduce America's external deficit and the MAC rate would move to zero.

In conclusion, there is no reason to think that introducing a MAC would have any material impact on the repatriation of corporate profits currently held abroad.

America Needs a Competitive Dollar - Now!

Would the MAC be Legal under America's Bilateral Investment Treaties (BITs)?

Would the proposed Market Access Charge (MAC) be legal under America's Bilateral Investment Treaties (BITs). The answer is simple: Yes.

BITs generally follow a standard model, and the language in the model provided by USTR on its web site imposes absolutely no barrier to implementing a Market Access Charge (MAC). The relevant sections are Articles 3, 4, and 5. These deal respectively with:

1. National Treatment
2. Most-Favored-Nation Treatment
3. Minimum Standard of Treatment 

The MAC was designed to be totally non-discriminatory in terms of nationality of investor in order to comply with these provisions.

Moreover, Article 20 on Financial Services leaves absolutely no doubt of the MAC's legality under Bilateral Investment Treaties. This article provides that:

Nothing in this [Bilateral Investment] Treaty applies to non-discriminatory measures of general application taken by any public entity in pursuit of monetary and related credit policies or exchange rate policies. …  

For purposes of this provision, “public entity” means a central bank or monetary authority of a Party.

The MAC was specifically designed to conform with these standard BIT provisions as well as with the IMF guidelines for acceptable capital flow management tools. The MAC is also consistent with both WTO/GATT guidelines, which focus largely on current account rather than financial account trade, and with the OECD guidelines, which closely parallel those of the IMF.

The main reason that the MAC passes all of these tests is that, unlike most solutions currently being proposed for solving America's trade deficits, the MAC applies in an absolutely even-handed manner regardless of country of origin, type of owner, declared purpose, etc.

In conclusion, the Market Access Charge (MAC) approach is fully legal under both the language and the intent of existing US and international law.

               America Needs a Competitive Dollar - Now!

MAC vs a Nixon-Connally "Strategic" Tariff

Rather than implementing the Market Access Charge (MAC) as proposed on this blog-site, should America instead restore its external trade by implementing a “national strategic tariff” like the additional 10 percent tariff that President Nixon and John Connally, his Secretary of the Treasury, applied to all dutiable imports when the U.S. went off the gold standard in 1971. /a 

No. Aside from being almost impossible because of America's commitments to the WTO, such a tariff would not be as effective as the MAC for moving the dollar to a trade-balancing equilibrium exchange rate for the following reasons:

(a)   Tariffs reduce imports but do almost nothing to stimulate exports.

(b)  Consequently, tariffs tend to reduce rather than to expand economic growth.

(c)   Tariffs do nothing to correct fundamental exchange rate misalignments. Tariffs provide no automatic exit strategy, no automatic move to self-sustaining balance. Once in place, they have to stay in place, and this creates distortions.

(d)  Because tariffs affect only half of the current account balance equation, they have to be set at rates roughly twice the level that would be needed if adjustment were coming from increased exports as well as reduced imports -- exactly what the MAC is designed to accomplish.

(e)   Decades of global experience indicate that, once producers become accustomed to a certain level of tariff protection, reducing these tariffs is very hard. This creates an ongoing bias towards relatively inefficient import substitution and against more efficient export expansion.

Politically speaking, a tariff on incoming goods creates bigger problems than an exchange rate adjustment for at least two reasons:

·       First, those protected by import tariffs fight their elimination and will seek their expansion during business cycle downturns, thereby ratcheting up tariffs.

·       Second, those consuming imported goods will fight the introduction and maintenance of tariffs.

The MAC -- a tiny charges on financial transactions that the average person knows almost nothing about – will be far more palatable politically thanks to its relative invisibility – and to the fact that the MAC will (rightly) be seen as a charge that borne by foreign exploiters, not by good U.S. citizens.

Also, a MAC will be much easier to adjust up and down for two reasons. First, the entire process is basically invisible. Second, given the way the MAC is designed, changes in the rate will happen automatically through a formula linked directly to the CAB. Changes will never need to be discussed in Congress, and the charge will quietly disappear when the CAB has dropped below 1 percent of GDP, indicating that the dollar’s exchange rate has reached a sustainable equilibrium level.

===============================

a/ An interesting historical note: Abandoning the gold standard, which had been central to the post-war Bretton Woods monetary system, was triggered by America's gradual loss of gold reserves. However, 10 percent tariff was implemented in response to the exploding current account US trade deficit, which  reached a frightening 0.1 percent of GDP in 1971 - America's first deficit since the post-Civil War Reconstruction Period. What would Nixon have done if faced with the six percent trade deficits that America experienced during 2005-2006?

America Needs a Competitive Dollar - Now!

The TPP, Currency Manipulation, and Currency Misalignment

Ask any American factory owner, worker, union leader, politician, or reporter why America has been suffering job-killing, factory-closing, family-impoverishing trade deficits for some forty years with no relief in sight, and most will answer, "currency manipulation by Country X." Ask anyone who questions the Administration's headlong rush to approve and implement the Trans-Pacific Partnership (TPP) what their biggest concerns are, and most will probably note the absence of any enforceable rules to stop "currency manipulation." But is "currency manipulation" really the key problem that America should be focusing on?

This note explains why the current exclusive focus on imposing rules against currency manipulation is doomed to fail -- as it has for the past seventy years. The note concludes that, if America is to close its trade deficits – a step needed to assure full employment, higher paying jobs, expanding factory productivity, and more equitable income distribution – we will have to stop focusing on "currency manipulation"  and start focusing on fixing "currency misalignment." Furthermore, we should focus on designing and implementing a permanent way to fix currency misalignment before the TPP or any other free trade agreement is signed and put into effect.

We need to stop blaming countries like China -- to say nothing of Japan, Mexico, Germany, and perhaps a dozen other countries commonly accused of currency manipulation. We need to start implementing policies that will bring the dollar back to a fair, trade-balancing equilibrium level against all of its trading partners on average and keep it there.

Yes, at certain times in the past, certain countries such as China and Japan have pursued monetary policies that the IMF could possibly have defined as currency manipulation. However, even though anti-manipulation rules have been on the IMF’s books for about seventy years, it has never found a country guilty of manipulation.

Likewise, the United States and GATT/ WTO have had similar rules on their books for decades, but GATT/WTO has never convicted and penalized a country for currency manipulation, and the US has done so only on a handful of occasions -- with no lasting impact of any consequence.

As Einstein is credited with observing, “Insanity is doing the same thing over and over again and expecting different results.” After seventy years of failure using the “anti-manipulation” approach to fighting currency misalignment, it is high time we try something new.

This note suggests that the repeated efforts to put an end to trade deficits with rules designed to force currency manipulators to stop manipulating has nothing to do with insanity by is rather the inevitable result of an entirely normal human trait: It is always easier to blame someone for your own problems than to see if, just by chance, you could do something differently and solve the problem. Think beams in your own eye and specks in your brother's. The "blame game" goes back to time immemorial.
However, other reasons also help explain the failure of rules designed to fight currency manipulation:

• Currency misalignment, not currency manipulation, is the primary reason for America's trade deficits.
• Market failures are the primary cause of currency misalignment.

Currency manipulation is not the primary reason for trade deficits.

Currency manipulation as defined by the IMF has contributed in certain cases to bilateral US trade deficits. But as a cause and thus as the basis for ending these deficits, "currency manipulation" is little more than a dirty word used to blame other countries for our own international monetary policy mistakes.

Before discussing why this is so, we should agree on definitions for "currency manipulation" and "currency misalignment" -- a task made difficult by the fact that even the rules of the IMF -- the world's premier authority on currency values -- contain ambiguous terms and loopholes.

For example, the IMF rules state that members shall “avoid manipulating exchange rates or the international monetary system" without defining "the international monetary system." Does this include only "foreign exchange" in the sense of cash? Does it include securities with liquidity ranging from cash to closely held stock to real estate titles, provided that two different currencies are involved? Does massive quantitative easing, which at some point in time will almost certainly reduce the value of a country's own currency in terms of other currencies, count as manipulation? Economists hold very strong views on these definitions, but finding a well-defined consensus definition is difficult.

Furthermore, even if we agree that a given definition constitutes what the IMF really means when it talks about currency manipulation, we are faced with the problem that the IMF rules create loopholes the size of a Mack truck when it comes to deciding if the actions of a given country constitute manipulation. For example, the IMF rules contain statements such as:

"A member will only be considered to be manipulating exchange rates in order to gain an unfair competitive advantage over other members if the Fund determines both that: (A) the member is engaged in these policies for the purpose of securing fundamental exchange rate misalignment in the form of an undervalued exchange rate and (B) the purpose of securing such misalignment is to increase net exports.” 

"Any representation made by the member regarding the purpose of its policies will be given the benefit of any reasonable doubt."  (emphasis added)

Good trade lawyers can have a field day with language like this. But for the purpose of the present note, the author faces a practical problem -- to present a workable definition that is tighter than those commonly found in the daily press and that is also consistent with IMF rules. The following are proposed as appropriate for the current purpose -- to determine the relative importance of "currency manipulation" versus "currency misalignment" in explaining America's overall trade deficits:

Currency misalignment exists for a given currency whenever the issuing country experiences trade surpluses or deficits that exceed one percent of GDP and that last for at least three years./1

Currency manipulation, which is one possible cause of currency misalignment, is the purchase by an official body with assets denominated in its own domestic currency of assets denominated in a foreign currency -- provided that the intent and result is to reduce the value of the domestic currency to gain competitive advantage in international trade.

The key implications of these definitions for purposes of the following analysis, which seeks to demonstrate on the basis of empirical data that currency manipulation has never been the main reason for America's overall trade deficits, are the following:

1. Manipulation must involve purchases by official bodies because IMF rules only apply to "member governments." Consequently, transactions by the private sector cannot be regarded as "currency manipulation."
2. Manipulation must involve the purchase with domestic currency of assets denominated in a foreign currency.
3. The liquidity of assets purchased and sold is immaterial. The assets may be any combination of currency, bank accounts, derivatives, securities such as stocks and bonds, or real property.
4. When a country has earned foreign currency denominated assets by exporting real goods and services and uses these to purchase other assets denominated in a foreign currency, this is not currency manipulation because the purchase does not involve the domestic currency of the purchaser./2
5. Currency manipulation involves cross-border transactions. Transactions that take place within a country simply move around the existing domestic stock of assets denominated in various currencies.

Empirical Analysis

The US Treasury maintains the Treasury International Capital (TIC) database where America's financial inflows and outflows are recorded in considerable detail. The TIC data show flows in terms of duration (long- and short-term), country of origin, type of instrument (direct, portfolio, other), and whether the buyers and sellers of US securities are official or private. /3

The following graph clearly shows that official purchases of US securities play a very minor role compared to purchases by the foreign private sector. Private sector flows, which cannot be considered "currency manipulation" under IMF rules, have totally dominated official flows into the United States for most of the past 35 years -- which takes us back to the time when the US first started having regular trade deficits. Coincidence? I think not.

The same picture emerges from the table below, which clearly shows:

1. Official purchases in the US of dollars and dollar-denominated assets, the only source of flows that might qualify as "currency manipulation," are a very small part of total inflows.

2. Even during 1980-1995, the peak period of official inflows, the share of private sector inflows in total foreign purchases of US securities was fifty percent higher than the official sector (60% vs 40%).

3. After the period 1980-1995, the share of official inflows fell to about half its previous level, averaging about 20% of total inflows between 1995 and 2010. In other words, the private share of inflows, which cannot be defined as related to currency manipulation, was four times larger than the share that might possibly be considered as related to currency manipulation under IMF rules. To say, as some do, that America's trade deficits were all caused by official inflows, which were only one fourth the size of the private inflows during the same period, is like claiming the tail can wag the dog.

4. During the past five years, the impossibility that currency manipulation could explain the sharp rise in the dollar's value stands out even more sharply. During this period, official inflows were negative to the tune of about $7 billion, offsetting part of the private inflows during the same period, which totaled $237 billion.

5. By 2014-2015, potential currency manipulation was actually sharply negative by over $109 billion as foreign official bodies cashed in their dollar-based securities holdings in the US and took them home -- or to other more attractive locations. 

 Another useful way to test the hypothesis that normal private cross-border capital transactions, not official currency manipulation, has been the main driver of the dollar's exchange rate and thus America's trade deficits, is to add the trade-weighted exchange rate for the US dollar to the chart above so that we can directly compare official and private flows with changes in the dollar's value.

The graph below makes the story even more clear. Without question, private capital inflows track the dollar's valuation far more closely than official inflows do. In fact, official flows are little more than an inconsequential side show when you look at the big picture.

Furthermore, central banks may have perfectly legitimate portfolio allocation motives for investing part of their foreign exchange reserves in US treasuries purchased in the United States. These give at least somewhat better rates than leaving the reserves sitting as piles of cash in a vault earning nothing. Consequently, only a fraction of the small present total of official flows into the United States could ever be interpreted as making a country guilty of "currency manipulation" under IMF rules.

This quantitative analysis should make it clear that currency manipulation is a dead issue today -- and that it was probably never more than a side show compared to the massive private cross-border capital flows that have been taking place in today's highly financialized world. Private cross-border flows of foreign capital into America, not official currency manipulation, is clearly the main source of America's trade deficits, lost jobs, and closed factories.

From this we must conclude that, if America is to restore its global competitiveness, jobs, and world-class manufacturing sector, it must move the dollar back to its trade-balancing equilibrium exchange rate.

This can be accomplished only if we stop focusing so much of our attention on so-called "currency manipulation" and focus instead on moderating all foreign capital inflows in a way that keeps them consistent with a fair, competitive exchange rate for the dollar and thus with balanced trade.

Market failures are the primary cause of currency misalignment and trade deficits.

Why, you may ask, do we have to worry about private capital inflows. "Everybody" knows that, unlike official flows that are driven by the predatory instincts of self-serving governments, the free international movement of private capital is vital for global growth. Furthermore, "the market" will make certain that exchange rates adjust automatically to assure balanced growth and an optimal allocation of capital to activities with the highest returns, thus assuring the fastest possible growth.

What a nice world that would be! It might even have existed a century or two ago when capital was scarce and concentrated in money centers such as Amsterdam and London, where economic development was already well advanced, rather than being distributed to Africa, Asia, and Latin America where poor countries were crying out for the capital needed to build railroads, highways, water systems, and all the other infrastructure needed to support a prosperous, growing nation.

But that was yesterday. Since the First Oil Crisis if not before, excess capital has flooded the world, leading to one financial crisis after another -- even in developing countries. Think of the chain of crises that developed as the global cloud of excess capital drifted from country to country during the past 40-50 years -- from the OPEC countries in the 1970s through US banks to the Latin American countries and their debt crises of the 1980s, to Japan and the bubble that crashed, leading to its Lost Decade(s), and from there to the South-East Asian Crisis of 1997, the Russian crisis in the following year, the Dot-Com bubble in America throughout this period, then to the Housing Bubble of the mid-2000s, and finally the Crash of 2008.

No, private markets have not been doing a good job of allocating capital to the most productive uses. Instead, they create herd instincts that cause stampedes from one financial fantasy land to another, leaving in their wake ruined markets and ruined hopes.

The failure of global exchange rate markets to set trade-balancing exchange rates is a particularly important subset of the larger failure of financial markets -- a failure that has hit this country with special ferocity because America is home to the world's dominant reserve currency, to the world's deepest and broadest financial markets, and to the US Treasuries that serve as a safe haven when the rest of the financial world is in turmoil.

The result of America's "exorbitant privilege" is a set of exorbitantly serious debt and deficit problems. Though one of the richest countries in the world, America is also the world's largest debtor in terms of total debts owed to other countries, and it has the world's largest external deficits. For example, according to the IMF's WEO data, America's cumulative current account deficits between 2010 and 2015 exceeded the total of all such deficits for the next seven countries -- United Kingdom, Brazil, Turkey, India, Canada, Australia, and France!

Why hasn't "the market" set a trade balancing exchange rate for the US dollar since the 1970s the way it did for most of the 1800s and 1900s up to the mid-1970s? The answer is actually quite simple. When international trade was dominated by trade in real goods and services, exchange rates were set by the balance of demand and supply of such goods and services. If a country printed more domestic currency to pay for its trade deficits than the world capital markets wanted, the value of the currency would fall until balanced trade was restored. Conversely, if the country exported more than it imported, the inflow of capital from abroad to pay for the excess of exports over imports would lead to domestic inflation, and this would restore balanced trade by making exports more expensive and imports cheaper relative to the rising price of domestic goods.

Increasingly since the 1970s and 1980s, exchange rate determination has worked in exactly the opposite way. Cross-border trade in financial instruments today vastly exceeds cross-border trade in real goods and services, thus dominating the exchange rate determination process. If the dollar, for example, is in high demand because foreign investors want to exploit the advantages of America's best-in-class financial markets, to invest in the world's dominant reserve currency, or to find safe haven in America because of turmoil in other markets, the dollar's value will rise. Financial trade, not current account trade, is now what sets the exchange rate.

Unfortunately, however, there is no reason to think that an exchange rate for the dollar that balances global demand and supply for dollars and dollar-based assets will also balance America's imports and exports of real goods and services.

Consequently, whenever the demand for dollars and dollar-based assets is high, the dollar's exchange rate will be high, America's trade deficits will be high, and the American people will suffer.

Relevance to the TPP

The TPP is designed to expand significantly America's total volume of trade. As noted above, America's trade is already seriously unbalanced because of the overvalued dollar. Unless something is done to assure that the dollar moves quickly to its trade-balancing equilibrium exchange rate, America's trade deficits will grow larger. When this happens, more American jobs will be lost to foreign workers, more American factories will scale back or close entirely, family incomes will fall, and government deficits will rise as the result of a smaller tax base and the demand for larger expenditures on bailouts and stimulus plans for business, and income support for families.

Unfortunately, nothing of any significance is being done, either within the TPP or in parallel, to assure that the dollar moves to its trade-balancing equilibrium exchange rate. The note on currency values that was signed by finance officials in parallel with the TPP negotiations is basically a ruse. It is unenforceable; it carries no meaningful penalties for non-compliance; and it focuses on "currency manipulation" which, as demonstrated above, is not even the fundamental problem driving US trade deficits.

Advocates claim that the side note will provide better information and transparency regarding currency practices, but this is largely a smoke screen. Much of the information is already available in the context of IMF Article IV consultations with member countries, and the information related to currency manipulation by other countries is of little or no use since (a) currency manipulation is not the problem, and (b) even if it were, seventy years of failed attempts to bash alleged currency manipulators into compliance indicates that attacking trade deficits from the manipulation perspective is hopeless.

What America needs to do before a TPP is signed is to put in place policies that allow America to moderate all capital flows, both official and private, from all sources so that the inflows stay at levels consistent with globally balanced trade for the United States. Furthermore, the rules that are put into place should be consistent with IMF rules on capital flow management.

As demonstrated by the postings on this blog regarding a proposed Market Access Charge (MAC), the task of passing a law and implementing it could be accomplished in a matter of a few weeks or months if the necessary will and consensus were in place.

Clearly they are not. Furthermore, it is unrealistic to think that they will be until a new President has been inaugurated. We must therefore conclude that the TPP should not be implemented until the next Administration is in place and the necessary capital flow moderation policies and procedures have been established.

Despite the claims of analysts such as Petri and Plummer who urge immediate implementation, the benefits of the TPP for America are so small and the risks are so high that there is absolutely no reason to rush.

Instead, we need to use the time between now and early 2017 to build the understanding among economists, national policy makers, the media, and the public at large about the importance of establishing monetary policies appropriate to the 21st century before the TPP is implemented.

Now is the time to take the time to get the TPP right.

America Needs a Competitive Dollar - Now!

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Notes

1/ Appropriate adjustments could be made in this rule of thumb to deal with more severe deficits. For example, a trade deficit would be considered "actionable" if it exceeded two percent of GDP for two years, or three percent for one year.

2/ This point means that much of China's purchase of US treasuries and other US securities over the past decade was asset allocation, not currency manipulation. Given that the US dollar is the primary currency of transaction and settlement in trade between the US and China (and with the rest of the world), China earned the dollars that it used to purchase US securities through net exports. In fact, with its export surpluses, China earned dollars equal to nearly three-quarters of its total purchases of dollar-based U.S. assets between 1997 and 2014. For the most part, the Chinese simply turned dollars earned in cash into dollar securities rather than buying dollars with yuan. This is asset allocation, not currency manipulation.

3/   Because of confidentiality problems, the BEA data on foreign investment inflows presented here cover only Portfolio Investments (purchases of US securities) and Other Investments (changes in balances held by foreigners in the US banking system). Foreign direct investment into the United States, broken down by official and private flows, is not available on a directly comparable basis. However, it is possible to construct a parallel series showing investment by "Government and government-related entities" from data published in the September issue each year of the BEA's Survey of Current Business (SCB).

The official flows reported in the SCB averaged only 4 percent of total FDI inflows over the past eight years, the remaining 96 percent being from foreign private sector entities. Since total FDI inflows averaged only 20 percent of total foreign investment inflows in recent years, official incoming FDI represents only 0.8 percent of the total foreign investment inflows.

Adding the tiny share of official foreign direct investments to the already small share of official portfolio and other investment inflows further reduces the share of official FDI in total FDI inflows. This leaves private net investment inflows even more dominant than indicated above.

Conclusion: Even if 100 percent of all three types of official foreign investment inflows were found to be motivated by the intent to manipulate the US dollar -- an unthinkable situation, official currency manipulation as defined by the IMF would still be insignificant as a cause of the US dollar's overall misalignment and overvaluation.