Would a MAC Raise Interest Rates, Hurt Consumer Demand, and Slow the Economy?

Background

Largely because of an overvalued dollar, America has suffered a virtually unbroken string of trade deficits for nearly forty years. The dollar will return to an equilibrium rate that balances imports and exports only when an automatic link has been re-established between exchange rates and balanced trade in goods and services.

Starting in the 1970s, the link between the dollar’s value and the exchange rate needed to balance trade was gradually destroyed as global trade in capital assets overwhelmed global trade in real goods and services. Today, as the Wall Street Journal recently noted, “Currency values are largely determined by central banks and capital flows,”[1]   For example, enough foreign exchange is traded across America’s borders in half a day to finance our trade deficits for an entire year, and enough comes in during less than two weeks to finance all American imports and exports for an entire year. The remaining fifty weeks are dedicated, shall we say, to other purposes.

Because of this fundamental shift in the way exchange rates are determined, any connection between the market exchange rate established by financial account transactions and the exchange rate needed to balance America’s external trade is nothing more than a happy accident – one that has not happened for nearly forty years!

To help fix this growing problem, I have proposed a Market Access Charge (MAC) that would automatically moderate the flow of capital coming into the United States whenever flows reached the point that excessive foreign demand for dollars and dollar-based assets had pushed the dollar so high that America was running trade deficits of one percent of GDP or more.[2]

While agreeing that steps such as a MAC should be taken to restore America’s international competitiveness with a fairly valued dollar, some have expressed concern that reducing foreign capital inflows would tighten the domestic credit supply, causing interest rates to rise, and reducing consumer demand, especially for large-ticket items such as automobiles.

Based on historical data for the U.S. motor vehicle industry, this note demonstrates that the MAC is highly unlikely to hurt consumer demand and economic growth in this way. In fact, implementing the MAC would greatly increase both domestic and foreign demand for made-in-America automobiles and other goods.

The Dollar’s Value and America’s Share of its Own Automobile Market

Summary

America’s automobile manufacturing industry demonstrates the importance of maintaining a competitive value for the U.S. dollar. Using empirical data for the last 35 years, this note shows that, when foreign-made cars become significantly cheaper because the dollar’s value has risen, most consumers can and do purchase alternative foreign cars, and domestic producers lose market share.[i]

The future for America’s motor vehicle manufacturing industry – and for the domestic durable goods production in general – depends heavily on establishing and maintaining a competitive exchange rate for the U.S. dollar – something that America has not done for about forty years!