Is America Doomed by the External Deficit Doom Loop?

No. We can Break It with the Market Access Charge

                                                                                                              John R. Hansen, PhD

For nearly 100 years following post-Civil War Reconstruction, America’s trade with foreign nations was generally balanced or running a modest surplus. The first major trade deficits only came in the 1970s with the OPEC Oil Crisis. Since then, we have become increasingly trapped in the External Deficit Doom Loop (EDDL) shown in the chart below.

                                  Stages of the External Deficit Doom Loop                         

This note discusses the causal connections between stages of America’s downward spiral over the past fifty years. These include growing exchange rate misalignments, rising external trade deficits, foreign capital inflows, and foreign liabilities used primarily to finance portfolio investments rather than directly productive investments such as factories.

These increasingly massive inflows of foreign-source money, which currently run about $90 trillion per year (over three times total US GDP and about thirty times the value our exports) contributed to inflation that further reduced the competitiveness of made-in-America goods, thereby reducing the profitability of US producers. Factories, lacking the profits needed to stimulate and finance investments that would increase productivity, saw reduced or even negative productivity growth and further loss of competitiveness and profits.

As factories failed, jobs and family incomes were lost, destroying the foundations of entire communities and regions. Government at all levels stepped in, trying to help create jobs and supplement incomes, but its ability to do so was reduced by stagnating or falling tax revenues and its limited ability to finance the needed programs with even more debt. The serious economic, financial, social, and political problems caused by the external deficit doom loop led the Government to borrow even more money from abroad. Because interest rates in America were generally higher than in other countries, foreign speculators were more than happy to provide the money— triggering yet another destructive trip around the EDDL.

Lessons Learned from the Past 50 Years

Are we doomed to sit by and watch this doom loop kill the American Dream of rising prosperity for all for another fifty or more years? 

No. As the remainder of this note explains, an innovative new external trade policy tool called the Market Access Charge (MAC) could break the doom loop and put America back on the path to growth based, not on rising debt, but on rising productivity. Here are the key steps in the doom loop.

Exchange Rate Misalignment

The world loves the US dollar -- its premier choice for trade, reserves, and investment. Since the 1970s, however, excessive global demand for dollars and dollar-based assets (e.g., US stocks and bonds) has attracted sharply rising flows of foreign currencies into the United States. Recently they have risen to about $90 trillion every year -- nearly four times total US GDP.

Unfortunately, governmental and private institutions abroad can "print" an almost unlimited quantity of foreign currencies -- not only as official currency notes, but also as bonds both government and private, central bank accounting credits, shares of stock, and other forms of commercial paper. Japan and China are leading examples of such practices and are the two leading sources of the trillions of dollars' worth of foreign "trash cash" that is dumped into America's financial markets every year. (NB: The official data on inflows from these countries probably understate total inflows by a considerable margin because the true origins of much of the money are disguised by the use of money-laundering techniques such as tax havens and shell corporations.)

These massive inflows, which total about thirty times total annual US exports, quickly drive down the global value of currencies like the Japanese yen and the Chinese yuan as they compete more and more aggressively by offering more and more of their money to buy the highly desired US dollars.

This de facto currency manipulation makes it almost impossible for made-in-America goods to compete as import alternatives or as exports. In fact, joint research on currency misalignment by the Coalition for a Prosperous America (CPA) and the Blue-Collar Dollar Institute (BCDI) indicates that the exchange rates for Japan and China give products from these countries an artificial price advantage of about 25-33 percent compared to the exchange rates that would be needed to balance the external trade of these countries in a world where all trade was basically balanced. 

In addition to the artificial price advantage enjoyed by goods from foreign countries like China and Japan, made-in-America goods suffer an additional price penalty of about 15-20 percent because of the overvalued dollar. Thus, American goods face a total artificial price penalty of 40-50 percent when competing with China and Japan because of the currency misalignment driven largely by the decades-long failure of the US Government to implement any legislation sufficient to remove this massive burden on America’s producers, workers, and families.

If US producers on average had a net profit (net margin as a percent of sales) of say 50 percent, the artificially low prices of foreign goods compared to US goods caused by currency misalignment would not be such a problem. However, a 2024 survey of gross and net profit margins by industry issued by Fullratio indicates that, for their sample of firms in industries producing goods and services commonly exported, the average gross margin percentage (revenue less direct cost of goods produced as a share of revenues) was only about 15 percent, and the average net profit margins (revenue less total costs as a share of revenues) was barely a miserable 2 percent. 

Today's massive currency misalignment, driven primarily by the de facto currency manipulation caused by foreign private sector speculators who dump trillions of dollars' worth of foreign trash cash into America's financial markets every year, is destroying the profitability of a major share of American factories trying to produce internationally traded goods. 

This process has created a crisis. Millions of good American jobs have already been lost. Many who have lost their middle-class factory jobs are falling into poverty — sometimes staying alive by working low-wage "gig" jobs. Others are dying deaths of despair at some of the highest rates in the world. Our trade deficits are massive and likely to cause serious international payment problems in the not-too-distant future. Poverty-stricken areas with rusted-out factories scattered like tombstones across the landscape are an all-too-frequent sight, one that I saw regularly while living and working in the otherwise beautiful mountains of Appalachia. Even those who have not yet lost their jobs suffer from rising domestic prices caused by reduced production, reduced economies of scale, and reduced incentives to invest in increased productivity. 

Although the focus of this note is on the manufacturing sector, currency misalignment also creates serious problems for America's farmers and ranchers. The undervaluation of currencies such as the Mexican peso and the Brazilian real relative to the US dollar means that American producers of products such as wheat, corn, and beef — goods that can be produced as efficiently in those countries as in America — must cut their prices to compete with foreign producers in global markets — and even in US markets. Hence the low and falling incomes of family farms across the United States.

Another problem has seriously delayed US efforts to solve the currency misalignment that is destroying so much of what is good in America. This is the massive legal, conceptual, and practical confusion regarding the definitions of currency misalignment and currency manipulation. It is hard to penalize that which cannot be defined unambiguously.

This is a problem even among professional economists -- especially those who have spent their careers studying and teaching from the classic "free trade" economics texts written by the rightly celebrated classical economists such as Smith, Hume, and Ricardo. Their work was brilliant and path-breaking -- but it was based on a world that existed about 250 years ago, back in the days of sailing ships, candle-lit workshops, oxcarts, and waterwheels (SCOWS).

Equally if not more important, those texts were written in the Gold Standard days when major national currencies were tied at relatively fixed rates to gold, and when international payments involved transoceanic shipments of gold and silver, could take months, and often faced the threat of pirates. Although some so-called "experts" seem to think that the free trade lessons of our economic forefathers should still be followed to the letter today, they fail to realize that the world of SCOWS has long disappeared, and that realities surrounding production and exchange rate determination have changed dramatically in the past 100-200 years.

They also fail to realize that the world has become massively integrated and "financialized," and that production technologies have been super-sized, creating opportunities for monopolistic practices through economies of scale that never existed in those long-gone days.

Most important, exchange rates are no longer determined as they were in the days of Hume when, thanks to almost universal gold standard anchor, normal market forces tended to move exchange rates in the way described by Hume’s price-specie flow mechanism, a mechanism that generally kept foreign trade reasonably balanced.

However, once the gold standard was abandoned by the IMF and by the world in the early 1970s, the value of currencies was no longer determined by markets in the export of real goods and services as described by Hume, but rather by the relative demand for different currencies in global forex markets where turnover is currently about 90 times the turnover in real imports and exports. Thus, for the past fifty years, the dollar's exchange rate has been determined, not by world demand for US exports and US demand for imports, but largely by world demand for the dollar as a currency.

Consequently, the value of the dollar -- the world's #1 choice as the currency for holding reserves, settling international transactions, and safety in times of crisis -- is no longer determined in the market for imports and exports of real goods and services. Consequently, there is absolutely no reason to think that today's exchange rates, determined in this manner, will balance trade in real goods and services for America — or for any other country with a currency in high demand. 

This is particularly true for countries like the United States and Great Britain, each of which face massive global demand for their currencies and for related financial instruments. This demand is almost totally independent from the demand for their real goods and services. As a result, for at least the past five years, the United States and Great Britain have suffered the largest average trade deficits relative to GDP of all of the more developed G-8 countries.   

Another major problem with getting the US Government to implement a trade policy like the MAC is that, ever since the 1970s, the US Government has blamed currency misalignment on currency manipulation by other countries. The doctrinaire view of many market fundamentalists including professors, think tanks, and others is that “markets are the best possible way to set prices,” and that we should "keep government out of the picture, avoid capital controls, and let the market work.” 

Another major problem is that even the IMF does not really provide a clear legal definition of currency manipulation. Instead, it speaks in generalities such as, "member countries are expected to avoid manipulating exchange rates or the international monetary system with the intent to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members." 

The key sticking point here is often the issue of "intent." In the past, countries (including the United States) have generally been able to avoid IMF sanctions even while intentionally increasing the money supply – a standard way to manipulate the value of a country's currency and to gain competitive advantage. They do this by arguing that the monetary expansion was undertaken only to stimulate economic growth, not to affect the exchange rate or the country's international competitiveness. 

Another enforcement problem centers on the issue of agency -- of "who done it?"  Was it the private or the public sector? For example, the vast majority of money coming into the United States from China is recorded by the US Treasury as coming from private sources.

Thus, when the United States tries to fight currency manipulation by taking action against, for example, the Government of China, the Chinese Government can claim -- apparently with considerable justification, that the "manipulation" was not undertaken by the Government of China and thus it cannot be sanctioned. Also, speculators can exploit the almost infinite number of ways available to avoid revealing where the money came from such as tax havens, falsified documents, and shell corporations.

Does this mean we cannot take action? 

Absolutely not. The MAC can fight de facto currency manipulation that destroys the competitiveness of US firms with no need to define who did it. This means that, by implementing the MAC, America could put an end to the tricks that have been destroying America's ability to fight currency manipulation for the past 50 years. MAC can do this by applying the small MAC charge of a few percentage points to all money coming into the United States, regardless of ownership, channel, currency of denomination, declared purpose, etc. This approach is economically as well as legally sound. Money is fungible, so it makes little difference where it is coming from or, for the most part, where it is going.

The one exception that the MAC could make would be for the US Treasury to refund the MAC charge retroactively if the payee can prove that the funds were used to create new productive physical facilities like factories, to pay for US exports, or to deliver funds borrowed from abroad by the US Government. In short, the MAC would allow making ex post refunds — much as VAT countries do for exported goods. The secret to success would be 100% collection at a flat rate when the funds enter America, followed by selective ex post refunds if the payee can provide a valid document from US Customs or a local US building code enforcement authority showing that the funds were in fact used for an accepted tax-exempt purpose such as paying for US exports or financing and putting into operation real fixed capital investments such as factories. (My thanks to Clyde Prestowitz for this idea.)

Foreign Capital Inflows. 

As shown vividly by America's rising trade deficits and the rising stock markets prior to the Crash of 2008, foreign capital flows into America tend to increase even when the US economy is suffering severe trade deficits. In fact, the foreign capital inflows used to purchase dollars tend to make the problem worse by pushing down the value of the incoming currencies used to by dollar assets, which in turn pushes the America's dollar and trade deficits ever higher, making trade deficits even worse. Statistical analysis show a clear correlation between incoming foreign-source money and rising US trade deficits because of the impact of that money on USD exchange rates. (See EPI paper Re-Balancing US Trade and Capital Accounts by Robert Scott.)  By moderating these foreign-source inflows, the MAC could easily control the problem. 

Portfolio and Direct Investment

Especially during periods of high trade deficits, the share of net foreign capital inflows going into financial investments like stocks and bonds rises compared to investments in physical investments like factories. This process increases America's net debt to foreigners. kills America’s competitiveness and does little if anything to increase America's productivity. 

Incidentally, the high ratio of portfolio to direct investment inflows in the United States stands in sharp contrast to the pattern in China over the past couple of decades. Most of the foreign capital during that period came into China to finance physical investment projects, not to buy financial assets already owned by someone else.

Money and Inflation Rise

Capital inflows from abroad, particularly the rising shares of money going into financial rather than into productive investments, increase the US money supply and thus the risk of inflation by about ten times the amount coming in -- or worse. For years, US bank regulations required banks to keep reserves on hand equal to at least 10% of funds deposited. This was designed to help keep banks from failing from inability to cover requests for withdrawals of deposits. However, effective March 26, 2020, the Federal Reserve removed this reserve requirement. Consequently banks can now multiply the money on loan by far more than ten times the money that has been deposited. 

This, together with the fact that the Federal reserve can also easily increase the availability of credit circulating within the United States by quantitative easing and by reducing interest rates, inflation is an ever-present danger, not only to the stability of our banking system, but also to the stability and well-being of American families -- especially those in the lower income classes. According to a recent survey reported by Forbes, 78% of Americans in 2023 were living paycheck to paycheck, and a substantial share of them were going deeper into debt every month, putting them constantly on the brink of a financial crisis. This is another important reason to implement the MAC as soon as possible.

Business Profits Fall

 US businesses currently face a double whammy because of America’s trade policy is running on the basis out-of-date currency policies — relics from the days of sailing ships, candle-lit workshops, oxcarts, waterwheels. They were relevant some 250 years ago when Smith, Ricardo, and Hume were writing about the glories of free trade and the gold standard that generally kept exchange rates quite close to trade-balancing levels. Today, however, they are counterproductive.

With the currencies of our major trading partners such as Japan, China, Taiwan and Vietnam undervalued by as much as about 60 percent, and with the dollar overvalued by over 15 percent compared to an exchange rate that would be consistent with balanced trade, US producers face "tax" of up to about 75 percent not only on their exports, but also on their goods that must compete with imports to the United States.  No wonder of tens of thousands of factories in America have been closed or off-shored, a process that has cost millions of good well-paying American jobs that once allowed even those without a college degree to live a good productive middle-class life. 

Productivity Growth Declines

Falling profits reduce the capacity and incentives for companies to make the investments in the research and development, equipment, and workforce training needed to improve productivity. This further reduces America's international competitiveness. The MAC is needed now to improve the profitability of producing goods in America so that such investments can be made far more easily than they are today.

Jobs and Personal Incomes Fall

As factories are closed in the US and production is offshored, jobs are lost, and family incomes shrink. The overvalued dollar also reduces domestic demand for made-in-America goods. This creates a vicious doom loop that hurts all Americans -- especially the 60 percent without a full 4-year college education. The next generation will suffer as well because, with family incomes dropping, opportunities for a good education and good health care dwindle.

I know firsthand that factory jobs once provided secure middle-class incomes. My wife's grandfather, who only had a high school education, delivered ice to local homes in a horse-drawn wagon before starting his lifetime of work as a machinist in a small factory on the outskirts of Denver, Colorado. His wife was not employed outside the house, but they could afford to raise three children, live in a lovely suburban home, lead very active lives in the life of their community, give their children college educations, and in their senior years, they enjoyed taking road trips in their beautiful Chrysler New Yorker sedan. Today, few Americans without a college degree can afford to live such a rewarding life. Passing legislation to implement the MAC will make such a life available to millions. 

Government Revenues Fall and Expenditures Rise

As the growth of personal incomes and business profits slows or turns negative, government revenues suffer. At the same time, the government comes under increasing pressure to support poor families, bail out failing companies, and to finance redevelopment programs for devastated areas such as America's Rust Belt zones where deaths of despair have become a major problem. With a shortage of the economic growth needed to grow tax revenues without raising rates, and with pressures for programs to help build better from the middle out, government deficits inevitably balloon. In short, the MAC is urgently needed to reverse this doom loop.

Government Borrowing from Foreigners Increases

Larger government deficits caused by slow economic growth and increased demands for public support mean more borrowing. Between foreign investors’ appetite for Treasuries and the U.S. Treasury’s search for relatively cheap money, the sale of U.S. government debt to foreign countries has grown dramatically. Again, this sad trend can be reversed by implementing the MAC.

The MAC rate would be fully market driven. The MAC rate would start low — perhaps at 0.5 percent, rise gradually until foreign demand for dollars was consistent with balanced US trade. Once reasonable balance had been achieved, the MAC would stop increasing. If the US began running current account surpluses, the charge rate would gradually be reduced until the current account was basically balanced and stable.

Some ask how a small MAC charge of say 1-3 percent could possibly balance US trade when experience with China tariffs of during the period from 2017 to 2020 showed that, while tariffs of up to 50 percent or more on goods from China had a significant impact on our trade deficit with China, our total global trade deficit actually increased significantly. A full explanation would go far beyond the space available here, but here are some of the key points.

The trillions of foreign-source money that flow into US financial markets every year are attracted, not by price differences between foreign and US products, but the spread between foreign and US interest rates, the safety and utility of the dollar, the potential for dollar appreciation, the diversity of types of investment possible in US financial markets, and the liquidity of US markets. Of these, spread is probably the most important.

For example, the spread or differences in interest rates on comparable investments such as government bonds of the same maturity can easily be, say, three percent higher in US than in foreign markets. A difference like this has little impact on the competitiveness of most physical products, partly because products like cars are commonly bought on the basis of physical features, prestige, etc.

However, when an investor can borrow funds in Japan say 0.5% and lend in the United States at 3%, this offers the opportunity to increase the yield by a factor of six — at virtually no risk. This leads to four very important conclusions:

1. While a tariff of 3% would have little impact on the sale of Japanese cars in the United States, a tariff (i.e., MAC charge) of 3% could eliminate the attractiveness of borrowing money in Japan at 0.5% and investing it in the US at 3%. In fact, assuming no other variables are significant, a MAC charge of 3% in such a case would eliminate the unwanted inflow of potentially billions of yen into America’s financial markets — an inflow that would otherwise drive the value of the yen down against the dollar, making it even harder for US products to compete against Japanese imports and harder to export our products to Japan.
2. Unlike tariffs, the MAC would stimulate US exports as well as reducing US imports. In short, it would give twice the bang for the same buck.
3. As the required MAC would be tiny and would be applied equally to all inflows regardless of country of origin, currency, ownership, purpose, etc., the MAC would be far less likely to trigger retaliation by foreign countries.
4. Because the MAC would be so much more efficient than tariffs in discouraging foreign imports and encouraging US exports, the risk that the MAC would cause serious economic distortions or crisis is a fraction of that with tariffs.

Implementation of the MAC

The MAC charge, which is fully legal under US and international law, could be implemented tomorrow by Executive Order under provisions of the International Emergency Economic Powers Act (IEEPA) of 1977, or preferably as legislation approved by Congress and signed by the President in normal order.  

Even at a very low rate of say 1.5 percent, the MAC, which would be paid entirely by foreign speculators, not Americans, could generate over $1 trillion dollars of new revenue per year. This could gradually be used to eliminate the US deficit, to finance urgently needed social and physical infrastructure investments, and to start paying down America’s internal and external government debts. This is by far the best way to escape the external deficit doom loop.

Other measures being discussed today to solve America's trade deficits such as eliminating the tax exemptions that are currently being given to foreigners on investment income earned in America as proposed by Kenneth Austin would be complementary to the MAC and should be given serious simultaneous consideration.

 Summary

Excessive foreign demand for dollars and dollar-based assets is clearly the prime cause of America's dangerous external deficit doom loop. The best way to escape the doom loop and to move onto a path of steady growth driven by rising American productivity, not by rising American debt, is to moderate global demand for dollars.

This could easily be done by forcing foreigners to pay a small market access charge when bringing money over a certain de minimis amount into the United States. The MAC would effectively be a tariff on the import of such money. If foreigners want to dump their speculative foreign currencies into America's financial markets when existing US trade deficits show that the global demand for dollars and dollar-based assets like stocks and bonds is already excessive, the MAC would easily moderate these destructive pressures. 

In short, implementing the MAC is urgently needed given the economic, financial, and social problems facing America today. Implementing the MAC, which could easily be done as noted above, would put America back on the road to the American Dream of growing prosperity shared by all.

John R. Hansen

January 15, 2025

 

 

 

 

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What Explains America’s Fifty Years of Trade Deficits and Job Losses to Foreign Countries?

The United States had reasonably balanced trade for about 70 years from the turn of the 20th century until the OPEC oil crisis in the 1970s when it began suffering increasingly regular trade deficits. These deficits have grown over the last 50 years to the point that, in recent years, America has sometimes accounted for up to 60-70 percent of all bilateral trade deficits in the world.  Why did this happen? 

By definition, trade deficits indicate that a country's exchange rate is overvalued. Yes, a trade or current account deficit of up to roughly 3% of GDP may be “sustainable” if the country is growing by 3% per year and debt service costs are not rising; in such cases, the outstanding debt will not rise as a share of GDP. However, for reasons that go well beyond the scope of this note, such trade deficits are rarely desirable. In any case, if there is a trade deficit, the currency is by definition overvalued with respect to the rate that, all other things being equal, would produce balanced trade. Thus, the question to be answered here is this:  Why has the US currency been overvalued for about 50 years?

Changes in Exchange Rate Systems

The simple answer is that, because of the dramatic change in the early 1970s in the way exchange rates are determined, the dollar's exchange rates for the past 50 years have had little or no connection to the dollar exchange rates needed to balance American trade.

• Gold Standard: Until the 1970s, exchange rates were generally fixed in terms of currency units per ounce of gold. For example, an ounce of gold from 1934 to 1972 was priced at $35. 

• As explained by the Scottish philosopher-economist David Hume in the late 1700s, with the gold standard, domestic prices adjusted automatically to maintain balanced trade. When a country ran a trade deficit and started running out of gold, the domestic money supply would shrink, a recession would be triggered, and domestic prices would fall. This would make the country's exports more price-competitive internationally and make its imports more expensive relative to domestic products. The country’s trade deficits would naturally shrink, and trade would rebalance. 

• Floating Exchange Rates: After the gold standard was abandoned in the early-1970s, the world went from fixed to floating exchange rates. Since then, the dollar’s exchange rate has been determined by the global demand and supply for dollars in the world’s foreign exchange markets.

This means that, since the 1970s, exchange rates for the dollar have been set, not by the balance between imports and exports as in Hume’s time, but rather by the world’s for-profit, speculative forex markets. 

Further evidence that exchange rates are now set by speculative currency trading is the relative size of the global markets for real goods and services compared to the size of global foreign exchange markets as shown in the chart below, which is based on data from the Bank for International Settlements (BIS).  The change has been truly dramatic. 

Less than 40 years ago, forex market turnover per year was “only” twenty times the size of foreign trade turnover in goods and services. Today, with the increasing financialization of world trade and the hourly speculation in currencies, the forex transaction volumes have been running eighty to ninety times real export/import transactions. 

This demonstrates beyond doubt that the largest factor determining exchange rates today is transactions in private for-profit forex markets. The solution to our trade deficits thus lies in moderating the casino-like flood of money into America's forex markets. 

Furthermore, the global demand for dollars and dollar-based assets is greatly increased because of the facts that the dollar is the world’s premier currency for (a) invoicing and settling international transactions, (b) providing an “intermediary” currency for forex transactions involving non-standard currency pairs, (c) accessing America’s exceptionally strong/deep/liquid/broad financial markets, and (d) holding financial reserves— especially in times of turmoil. These factors driving excess demand for the dollar means that the dollar's exchange rate set in forex markets is inevitably higher than the exchange rate that would balance real US imports and exports. 

Thus, for many reasons, the dollar is almost always overvalued and, as a result, America almost always has major trade deficits that reflect lost opportunities for growth. 

For example, if the trade deficit was three percent and we reduced it to zero from one year to the next by increasing exports and by replacing imports with globally competitive domestically-produced goods, GDP growth would increase by roughly three percentage points. In reality, the change would probably take several years so the annual boost to economic growth would be less, but the principle is the same. Regardless of what some people may say, trade deficit drags on growth are a reality.

Unfortunately, this is seen in America’s growth rates since the trade deficits began in the 1970s. Over the past 50 years, average economic growth in America has slowed by about half.

Even more important are the hidden costs of our trade imbalances such as lost jobs, lost family incomes and lives, lost communities, and lost lines of production due to offshoring. With our needless trade deficits and budget deficits caused to a significant degree by the overvalued dollar, we are literally living beyond our means and stealing from future generations in the process.

The MAC can fix these problems because it would restore balanced trade for America. 

America Needs a Competitive Dollar - Now!

The Market Access Charge Can Create a Competitive Dollar and Fix US Economic Problems Now

The rising value of the U.S. dollar on foreign exchanges has generated anxiety in the global financial community, foreign governments, and the media. Reports suggest some of Donald Trump’s campaign advisors are considering ways to devalue the dollar should Trump triumph in November’s election. Commentators at the Washington Post and the New York Times quickly reacted to those reports, calling such policies quackery and “economically destructive.”

However, there is one way the U.S. Government could engineer a gradual adjustment in the value of the dollar that would boost the domestic economy without any of the dangers that worry the media pundits. That solution is called the Market Access Charge or MAC.

The MAC is an innovative, internationally legal, centrist economic policy based on solid economic principles that would solve many of America’s key problems today.

The MAC was prepared by experts from the Coalition for a Prosperous America (CPA), the Economic Policy Institute (EPI), the Peterson Institute for International Economics (PIIE), and the World Bank (IBRD) working together in their personal capacities for a better America.

The legislation for the MAC that they created was presented to the US Senate on a bipartisan basis in 2019. Their proposal has received favorable commentary from many including, for example, the American Compass, the Coalition for a Prosperous America, the Reshoring Initiative, the Wall Street Journal, and the Washington Post. Furthermore, in his most recent book, former USTR Robert Lighthizer noted the MAC as one of the most promising ways to solve our trade deficits and many associated problems.

Unfortunately, some of America’s key trade policies today are based on the implicit assumption that exchange rates are still determined as they were over 200 years ago when the Scottish philosopher David Hume explained the mechanism by which exchange rates were determined in a way that created a strong link between exchange rates and balanced trade.

However, with the demise of the gold standard, and with the emergence of global foreign exchange markets with 80-90 times the turnover of global markets in real goods and services, the link between exchange rates and balanced trade has been lost.

Today, America needs a policy to restore the link between exchange rates and balanced trade.

The urgency of this need is seen in the following: Compared to the US dollar, the currencies of China and Japan are now 40-60 percent cheaper than they would be if the yuan and yen were set at trade-balancing levels. As a result of exchange rate distortions like these, we Americans spent nearly one trillion dollars more on imports in 2022 than we earned producing exports.

By destroying the competitiveness of America-made goods both here and abroad, today’s distorted exchange rates have also created trillions of dollars of debt that our children will have to repay. In fact, our net debt to foreigners is currently almost $20 trillion dollars – over 70% of GDP.

Excessively cheap foreign currencies relative to the dollar are also the key source of related problems including millions of lost jobs, tens of thousands of closed factories, economic growth that on average has slowed by half since the 1960s, lower tax revenues, and higher government expenditures to support our factories, farms, banks, and workers who are suffering as a result of trade deficits.

The MAC would fix these serious problems by collecting a small charge of about two percent on the excessive inflows of foreign-source money. This small charge would be just enough to eliminate much of the average gap between the low interest rates abroad and the higher interest rates in America. By taxing away the difference between US and foreign interest rates that drive largely speculative inflows, the MAC would keep inflows of foreign-source money consistent with our real need for foreign capital.

The MAC would also allow the Federal Reserve to maintain higher domestic interest rates when needed to fight domestic inflation without stimulating the massive inflows of foreign-source money that today are undermining its inflation-fighting efforts and risking yet another recession.

The sooner the MAC is approved, the sooner it can begin to help fix these and the following problems facing Americans today. In sum, implementing the MAC will:

·        Accelerate economic growth by eliminating the current trade deficit drag that reduces our GDP growth rate.

·        Restore millions of middle-class jobs for Americans who have lost their jobs because of made-in-America goods that can no longer compete with imports because of the artificially cheap currencies of countries like Japan and China.

·        Reduce income inequality and socio-political fragmentation by giving more Americans the opportunity to earn middle-class incomes.

·        Increase tax revenues by hundreds of billions of dollars per year – all paid by foreign speculators, not by Americans.

·        Make the Fed’s efforts to fight inflation more effective by discouraging excessive
inflows of foreign-source money – inflows that increase domestic credit availability just when the Fed is trying to tighten credit.

·        Reduce inflation by increasing the efficiency of making goods in America, by increasing domestic competition by keeping more US businesses in operation, and by reducing the Government’s need to print money to help failing banks, companies, and families who have lost their jobs.

·        Reduce the $3 billion dollars per day that the Government spends on interest payments.

·        Sharply reduce the US budget deficit and start reducing our huge outstanding public debt.

·        Finance urgently needed government investments in physical and social infrastructure – without raising domestic taxes.

·        Support the development and production of advanced technology goods in America, including the equipment and products needed to meet our environmental goals, to enhance our international security, and to improve our health at more affordable costs.

Implementing the MAC as soon as possible will help prevent our outdated international trade and currency policies from tanking our economy and the country we love

John R. Hansen, PhD
International Economist
World Bank Economic Advisor (retd.)

Alexandria VA
June 24, 2024

 

 

America Needs a Competitive Dollar - Now!

How the Market Access Charge (MAC) Would Help Restore American Manufacturing

How the Market Access Charge (MAC) Would Help Restore American Manufacturing

John R. Hansen

America’s growing trade deficits, especially in manufactured goods, indicate that our nation’s international competitiveness – the ability of Americans to earn as much producing exports as they spend on imports – has fallen dramatically. Since the mid-1970s, rising trade deficits have killed millions of American jobs and have forced tens of thousands of American factories to downsize or close their U.S.-based production lines. 

This note describes how a Market Access Charge (MAC) could put these U.S. workers and factories back on the job.

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

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

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

America’s international trade policies served it well for much of the 20th century. Today, however, the policies are badly out of date because, starting in the 1970s, the market forces that determine exchange rates began to change dramatically.

Historically, the demand and supply of real imports and exports determined exchange rates, much as in the days of Adam Smith and David Ricardo. But starting about 40 years ago, world commerce has become increasingly dominated by financial trade in capital and foreign exchange. As a result, exchange rates set in today’s financial markets are rarely consistent with the rates needed to balance imports and exports. This problem is particularly severe for the United States because it consistently attracts excessive inflows of foreign capital that drive the value of foreign currencies down against the dollar, thereby making American goods more expensive for foreigners and foreign goods cheaper for Americans -- a process that inevitably causes US trade deficits. Inflows of foreign-source money are driven by the following factors:

1. The U.S. dollar, which is the world’s premier reserve currency, is more widely used than any other currency for the invoicing of international transactions, for their settlement, and for storing wealth.
2. The U.S. financial markets are the largest, deepest and most liquid in the world, and they are regarded as a global safe haven in the time of financial problems – even if the problems started in the U.S. markets as happened with the Crash of 2008.
3. As the largest market in the world for consumer and industrial goods and services, America has for years been the target of currency manipulators. Countries like Germany, Japan, and China have bought billions of dollars of U.S. currency and other dollar-denominated assets with their own local currencies to drive the value of their currencies down against the dollar. This makes it very difficult for American producers to compete either at home against imported products or abroad with exports.

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

If America is to have an exchange rate consistent with balanced trade, it must implement policies that keep the foreign demand for dollars and dollar-based assets consistent with America’s need for imported capital. 

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

The best possible way to achieve this would be a Market Access Charge (MAC). A MAC is simply a “peak load pricing” mechanism, very similar to those used around the world by both the private and public sectors to balance demand and supply for services such as airline flights, rental cars, hotel rooms, electricity use, and vehicular access to the central business districts of cities like London during rush hours. America needs a similar demand-moderating mechanism when its financial services markets are clogged with excess foreign capital.

A Market Access Charge would reduce the demand by foreigners for access to our markets under such conditions by reducing net yields by just enough to make such investments less attractive to foreign traders, speculators, and manipulators. As a result, the demand by foreigners for dollars and dollar-based assets would be moderated by just enough to reduce upward pressures on the dollar – the primary cause over time of the overvalued dollar, U.S. trade deficits, lost jobs, and failing factories.

How would the MAC Operate?

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

Trigger 

•       A non-zero U.S. trade deficit over the past 6-12 months (the review period) would trigger a non-zero MAC rate. [2] [3]  

Rate

•      An initial MAC rate equal to half of the current spread between average foreign and US interest rates would be charged on the value of the incoming foreign-source money once the deficit trigger point was reached. (Note: the cross-border interest rate spread is the main factor driving cross-border flows of foreign-source money. Setting the initial MAC rate at half this level would allow introducing the MAC without shocking international currency markets.) [5] 

•       At the end of each review period (say every six to twelve months), data on the trade deficit as a percentage of GDP would be reviewed to see if the MAC charge should be increased or reduced.

•       The rate would rise or fall in line with changes in the trade deficit according to an elasticity factor. For example, if the elasticity factor were set at one (1.0), an increase in the trade deficit equal to one percent of GDP over the review period would increase the MAC charge by one percentage point (100 basis points) for the following 12 months. Once the trade deficit began to fall relative to GDP, the MAC rate would decline in the same way, returning to zero once the trade deficit dropped to zero for the previous twelve months.[4]

Base

•       All inflows of foreign-source money would be subject to the same MAC rate. Applying the same rate to all inflows avoids the problems of evasion, corruption, favoritism, and economic distortions that other countries like Brazil encountered with capital inflow charges when they tried to discriminate between “good” and “bad” capital inflows.

•       Because the MAC is charged every time foreign-source money enters the United States, a common rate for all inflows automatically discourages short-term speculative in-and-out flows. Conversely, a common rate imposes a minuscule effective burden on the life-time yields of foreign direct investments because such investments come in only once, stay for a long time, and almost always have a much higher expected rate of return per dollar invested than speculative investments do.

Administration

•       The MAC would be collected automatically and electronically on all inflows of foreign-source money by the computer systems already present in the handful of U.S. banks that handle most of America’s cross-border financial transactions. Under traditional correspondent banking arrangements, these gateway banks would also service incoming cross-border transactions for other banks.

•      Foreign speculators seeking access to US financial markets would pay the Market Access Charge. The MAC is not a tax on Americans.

•       The MAC charges collected by the gateway correspondent banks would immediately be transferred electronically to the General Fund of the U.S. Treasury. 

•       Funds delivered to the US Treasury could be used at the discretion of the Treasury in line with authorizations by Congress and orders of the Administration. Where feasible, special preference would be given to programs designed to improve the global competitiveness of American enterprises and workers. Such programs could include, for example, the National Network for Manufacturing Innovation (NNMI), other types of support for R&D, worker training and trade adjustment assistance programs, infrastructure development, a bank for American International Competitiveness to help finance productivity-enhancing private sector investments in plant and equipment, more efficient border protection operations including antidumping and countervailing duty programs, the liquidation of foreign-held U.S. government debt, and a special fund to help offset any increased costs of borrowing to finance government operations linked to MAC charges on the purchase of government debt obligations.

In sum, a Market Access Charge (MAC) offers the best hope of providing the basis for restoring America’s international competitiveness by fixing the undervaluation of foreign currencies against the dollar.  And to address U.S. trade problems and job losses associated with trade cheating by other countries, the MAC should be supported by parallel legislation that would increase the effectiveness of our traditional measures against trade cheating.

These policies, coupled with supporting efforts to simplify the overly complex tax code, to bring effective tax rates more into line with international standards, to introduce a VAT-like refund for foreign source money used to purchase exported US goods or to build and complete physical assets such as factories in the US.  The MAC-generated funds could also be used to bring health care costs for US workers down, making them closer to those paid by manufacturers in other countries.

In short, introducing the MAC could generate millions of well-paying middle-class jobs, save thousands of factories from closure, and leave future generations free of excessive debt caused by America’s living beyond its means today, spending more on imports than it earns producing exports.

4/8/2024

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Notes:

[1]  See for example the work of Bergsten and Gagnon at the Peterson Institute for International Economics here and here where they propose countervailing currency intervention as a way to fight currency manipulation by countries like China.

[2]  The U.S. trade deficit is suggested as the key parameter triggering the MAC because it is a well-established and officially available number that directly reflects the misalignment of the dollar. Its relevance and objectivity make it far superior, for example, to debatable, subjective criteria such as the difference between the market exchange rate and the “fundamental equilibrium exchange rate,” an indicator that has been suggested as a test for currency manipulation.

[3]  The MAC charge rates on incoming foreign-source money, the trade deficit trigger point level, the adjustment factor, and the review period used here to explain the MAC’s operation are all reasonable estimates of appropriate values. The actual values for these four parameters would be discussed during the legislative review process with members of the Advisory Committee on International Exchange Rate Policy mandated by Sec. 702 of the Trade Facilitation and Trade Enforcement Act of 2015  (H.R.644), experts from organizations involved in trade policy such as the Coalition for a Prosperous America (CPA), the Peterson Institute for International Economics (PIIE), the Economic Policy Institute (EPI), and others as appropriate. Once consensus was reached, these four parameters would be set into law to provide clear guidance for the Government officials responsible for implementing the MAC. The basic logic of the values suggested here is as follows:

A basic MAC charge of 50 basis points may seem too low to affect foreign capital inflows. However, this rate was chosen for several reasons: 

• First, capital inflows, especially those from the private rather than the public sector, are highly sensitive to opportunities for profit and thus to relatively small changes in perspective net yields. For example, the “taper tantrum,” which was driven by the hint that the Fed might begin to raise rates by tapering off the quantitative easing program, triggered massive flows of capital from emerging market countries into the U.S. 

• Second, we know from Federal Reserve experience that changes as small as 25 basis points in the policy rate can have a significant impact on capital markets. 

• Third, an excessively high MAC rate could cause damaging disruptions rather than gradual adjustments in international capital markets.

The trade deficit trigger point for a non-zero MAC charge is set at zero because there is no reason that the United States should have to suffer trade deficits and the consequent loss of well-paying jobs, productive capacity that is often critical to national security, international technological leadership, and debt that future generations will have to repay in one way or another.

The adjustment factor – the elasticity or ratio of percentage point changes in the trade deficit to percentage changes in the MAC rate – is set at unity for two reasons. First, this would assure a more rapid response to rising exchange rate values and trade deficits than would a value of less than one. Second, in line with the philosophy that trade changes generated by the MAC should be constructively gradual rather than damagingly fast, a factor of unity avoids the risks associated with a higher adjustment factor such as two, which would, for example, increase the MAC charge by two percent for every one percentage point of increase in the trade deficit as a percent of GDP.

A review period of twelve months is suggested for two reasons. First, because the MAC affects the dollar’s exchange rate indirectly by moderating capital flows into U.S. financial markets rather than changing exchange rates directly by fiat or by direct government currency market intervention, a few months may be required before the dollar’s exchange rate moves by enough to even begin affecting U.S. trade balances. 

Second, once the MAC begins to change the dollar’s exchange rate, two or more years may pass before trade patterns change significantly. This time is required because changing trading patterns requires buyers to complete existing contracts, find new suppliers, negotiate new contracts, and accept delivery of goods. This is true even if, as can be expected, the new suppliers are located within the United States rather than abroad.

The MAC would create a “signaling mechanism” that could change market sentiment and yield results more quickly. However, realizing the full impact of a MAC on structural trade deficits will almost certainly take three years or so. 

Consequently, it would be a mistake to keep reviewing the past six months’ experience and raising the MAC charge if the desired results were not seen. Also, making adjustments in the MAC rate too frequently would increase administrative burdens, generate confusing market price signals, and risk overshooting the zero-deficit target. On the other hand, it would be a mistake to put the process on auto-pilot and wait for two or three years before reviewing the situation. Too much could go wrong in the meantime. An annual review therefore seems reasonable.

[4] Under this system, the MAC charge rate can be calculated as follows: MAC = (Deficit – Trigger) * Factor, where Deficit and Trigger are percentages of GDP and Factor is the “elasticity” of the MAC charge with respect the excess of the deficit over the trigger. Thus, when the trade deficit reached 3 percent of GDP, the MAC charge would be equal to (3%-1%) * 1.0 or 2%. An elasticity factor of 1.0 appears to represent a reasonable compromise between getting rapid results and excessively shocking the international trade system, but this is subject to further analysis and discussion.

[5] The relatively slow introduction of the MAC is designed to give the international monetary and trade system time to adjust to a new system. This gradual approach would moderate the initial impact on the countries and companies that have become addicted to America serving as the borrower and buyer of last resort in a world where supply often exceeds effective demand. The MAC’s purpose is sustainable balance through moderation, not revolutionary upheaval. While perhaps more exciting than gradual change, the latter could be a recipe for disaster in our highly integrated modern world.