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.

How Much Government Revenue Would a MAC Charge on Foreign Investors Generate?

Estimating the revenues that a MAC charge could generate is exceptionally difficult because this policy tool has never been used in a large, wealthy, reserve-currency country. Policies involving charges of various kinds on some types of capital have been tried in smaller economies such as Chile, Brazil and Malaysia. But nothing like the MAC has ever been tried in the United States. We therefore have little basis for estimating the response of foreign speculators and investors to the MAC and thus potential MAC revenues.

Nevertheless, it is useful to know the range within which the revenues might fall – if for no other reason than to satisfy curiosity. To help meet this need, two models are presented here based on cases designed to bracket the range of revenue that the MAC might generate.

Summary

In brief, the MAC is likely to generate at least $1.0 billion per year in the short term and could possibly generate up to $1.0 trillion per year if high-speed, in-and-out trading is not moderated by the MAC.

In the longer term, as the MAC moderated excessive foreign capital inflows, MAC revenues would decline. However, this reduction would be offset partially or fully by taxes on the additional economic growth stimulated by a MAC-based competitive exchange rate -- even if tax rates were reduced as part of a much-needed reform of the US tax code.