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!