John R. Hansen, PhD
Stages of the
External Deficit Doom Loop
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.
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:
- 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.
- 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.
- 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.
- 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.
