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 balanced or running a modest surplus. The first major trade deficits came only 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. Taking the problems in order clockwise around the chart, these key stages in the doom loop include: 

(1) Growing exchange rate misalignments, 

(2) Rising external trade deficits, 

(3) Foreign capital inflows, 

(4) 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 thirty times the value our exports), contributed to 

(5) Inflation that further reduced the competitiveness of made-in-America goods, thereby causing

(6) Reduced profitability for US producers. 

(7) 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. 

(8) As factories failed, jobs and family incomes were lost, destroying the foundations of entire communities and regions. 

(9) Government at various 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. 

(10) 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 the 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. In fact, only about 3% of foreign capital inflows are used to finance real productive investments in America. 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. It 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 a number of very important conclusions:

a)     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.

b)     Furthermore, at about $90 trillion per year, the annual inflow of foreign-source money (the tax base for the MAC) has recently been nearly 30 times the average $3 trillion annual value of imported goods. Thus, for a given percentage rate, MAC would have about 30 times the revenue generation potential as a tariff, Conversely, the average tariff would have to be about 30 times the MAC charge to yield an equal volume of revenues.

c)     The 60 percent average global tariff on goods that would be needed to generate the same amount of revenue as a 2 percent MAC would be far more likely to trigger intense retaliation than the MAC.

d)     Unlike tariffs which only restrict imports, the MAC would also stimulate US exports by reducing their costs when expressed in foreign currencies.

e)     Because the MAC would be so much more efficient than tariffs by encouraging US exports as well as discouraging US imports, the risk that the MAC would cause serious economic distortions, costs, or a crisis is a fraction of that with tariffs.

f)      Furthermore, a 60 percent tariff would trigger massive retaliation similar to that triggered by the high recent tariffs on Chinese goods while a 2 percent MAC charge, which could well be sufficient to balance US trade, would be highly unlikely to trigger evasion.

g)     Evasion of the MAC would be difficult because virtually100% of all significant inflows of foreign-source money would pass through international payments systems. (To minimize transaction costs, a de minimis exemption from the MAC would extended to tourists.)

h)     A MAC charge of about 2%, which would eliminate most of the spread between foreign and US interest rates that is commonly a major driver of cross-border flows, would generate about $1.8 trillion of new net government revenues paid entirely by foreigners. This would have been sufficient to cover the US Government deficit for the fiscal year ending 2024.

In short, the MAC would give about twice the bang for the buck as tariffs, reduce the size of tariffs needed, generate far more revenues (out of the pockets of foreigners) than tariffs would, minimize the economic distortions caused and the risk of a serious crisis, and virtually eliminate the risk of evasion and retaliation.

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 following normal order.  

The MAC would probably be implemented initially at a rate of say 1/2 percent to avoid disrupting global trade and to give US authorities a sense of the response that the changes that MAC will stimulate in terms of exchange rate changes, inflows of foreign source money, and changes in the trade balance. In addition to reducing or eliminating the US budget deficit, the MAC could be used to help finance urgently needed social and physical infrastructure investments and to start paying down America’s massive internal and external government debts.

The actual implementation would be very easy and low cost: Most monetary capital coming into the United States comes through established banking channels such as SWIFT and the MAC would be collected by the "correspondent" banks licensed to handle such transactions. In the United States only a handful of large banking and financial organizations handle the majority of such transactions. These banks, which would be allowed to deduct a very small fee for handling each transaction, would already have qualified staff, and a simple tweak to the computers that print the transaction receipts  in the banks would automatically deduct the MAC charge of say 1% from each transaction and forward it to the US Treasury electronically and automatically. 

The MAC is by far the best way to escape the external deficit doom loop. The concept has been noted favorably by a number of authors including, for example, Bergsten & Gagnon, Cass, Klein & Pettis, Lighthizer, and Prestowitz. While modest tariffs can help shape the content of US imports to encourage domestic development of high-priority industries, sky-high tariffs at the levels needed to fix the US balance of payments are likely to fail for the multiple reasons regularly and rightly cited by "free trade" economists and others. are likely to cause more problems than they solve. However, parallel measures to reduce America's trade deficits such as eliminating the tax exemptions that are currently given under US law to foreigners on investment income earned in America, a measure recommended by Kenneth Austin, would be low risk and highly complementary to the MAC. Such measures 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 and competitiveness, not by rising American debt, is to moderate global demand for dollars.

This could easily be done by charging a small market access charge money above a certain de minimis amount as it enters the United States -- 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 could easily and flexibly be used to 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, PhD

   World Bank (retd.)
   January 17, 2025

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

C:\OneDriveOffLine\__Action Writing\MAC FAQs\Notes\895; HO; MAC Legislation Needed Now-EDDL.docx

 

America Needs a Competitive Dollar - Now!