Part 1. Income Distribution and The Impact of Trade Deficits

Trade is killing our jobs! We must build a wall! We must abandon international trade agreements!

Introduction

A growing chorus of voices around the world is challenging the traditional view of economists that trade is a win-win proposition. This view can be summarized as follows:

“Everyone gains from increased efficiency stimulated by growing trade. Some people will have to find new jobs, but they will be better jobs. And if they don’t, the winners from growing trade will compensate the losers, and all will be better off.” 

The voices opposing this view are especially loud in the United States, which is in the midst of its most contentious presidential election in years. And they are being joined by people in Britain, particularly those who voted for Brexit, and in countries throughout the European Union, especially in the Mediterranean area where unemployment rates have been at record levels.

What happened? Why isn’t international trade working as it should? 

Should we restore American manufacturing, employment and family incomes by introducing tariffs and other trade barriers? Or should we expand trade to reap the benefits that expanded trade and specialization are supposed to bring to America ? This  post is the first in a series of three that seek to resolve these conflicting views.

• This post shows that, if a country has negative trade balances, expanding trade tends to make income inequality worse.

• The second post will show that countries with more openness to trade – with a higher ratio of imports to GDP –  tend to have higher incomes and less income inequality.

• The final post will conclude that implementing currency-related measures that erase trade deficits by moving the nation’s exchange rates to its trade-balancing equilibrium exchange rates will reduce income inequality and will increase average income levels.

This trilogy of essays, along with footnotes and more technical information, will soon available as a single online document.

Income Inequality and Trade Deficits

In the United States, opposition to international trade comes, not from the urban elite or from agrarian communities, but from middle class men and women who are losing their jobs in manufacturing. Middle-aged workers feel particularly vulnerable. After a lifetime of making good wages doing honest work, they resent their decline into relative poverty and fear what lies ahead.

Statistical analysis as well as micro-level studies of the realities facing these individuals indicate that they are at least partially right in blaming foreign trade for their woes. But they too often assume that their suffering is caused by hostile acts of foreign governments such as currency manipulation by the Chinese.

They fail to realize that the biggest problem may well be America’s currency policies – policies that are more relevant to the world of fifty to one hundred years ago than to today’s world where international trade in capital assets vastly outweighs trade in real goods and services. Furthermore, they tend to blame “trade” in general without focusing on the fact that the problem is not the volume of trade but rather trade imbalances. In fact, as shown in the next post, countries with larger ratios of trade to GDP tend to enjoy a more equitable distribution of income.

External Deficits and Income Inequality – A Cross-Country Overview

A clear correlation exists between external deficits and income inequality throughout the OECD countries. In Figure 1, the average external balances as a share of GDP for 1980-2015 and the Gini coefficients for 2012 for these countries are shown as a scatter plot.

Figure 1

The Gini coefficient reflects the difference between a perfectly equal distribution of income where the bottom 50 percent of the population enjoys 50 percent of total national income, and the actual distribution of income where the bottom 50 percent of the population enjoys only 25 percent of total national income, for example.

The downward slope of the dashed blue line, which reflects the trend line for the plotted data, shows that income inequality increases as the average current account balance declines from surplus to deficit.
  
The correlation is certainly not tight enough to say that external trade imbalances are the sole driver of income inequality. But an important relationship clearly exists. Furthermore, micro-level analysis of the lives of those affected by trade deficits show the causal links between trade imbalances and income distribution.

Causal Links Between Trade Deficits and Income Inequality

The people most at risk of suffering stagnant or falling incomes because of expanding unbalanced trade are those least able to compete with workers in low-wage countries. As indicated in the excellent studies by David Autor and his colleagues, at-risk workers include those who:

1. Have less than a college education.
2. Lack advanced manufacturing skills.
3. Are older and cannot work long enough to repay the cost of additional training.
4. Work in factories producing textiles, apparel, footwear, furniture and other labor-intensive products where low-wage countries have a comparative advantage.
5. Work in regions dominated by plants producing similar at-risk products.
6. Work in single-factory “company towns” where alternative jobs are scarce.
7. Live in areas already suffering high unemployment and low wages.
8. Live in isolated, traditional communities far from alternative sources of employment.
9. Are bound to their present community by poverty, inadequate information about jobs elsewhere, illness, housing costs, family ties, or tradition. 

In short, those most likely to suffer a further relative loss of income from foreign import competition are those already most likely to be relatively poor, thus making overall income inequality even more severe.

If trade were balanced, international competition would drive producers to expand production and jobs, and this expansion would tend to take place in products where America has its greatest comparative advantage. But if the dollar is overvalued, the price signals that would otherwise encourage producers to invest in more competitive production and better jobs are distorted.

An overvalued currency actually discourages production by making made-in-America products too expensive to compete in either the domestic market against imports or in foreign markets as exports. The result – more job losses and more poverty. And as Scott has pointed out, job losses will be particularly high among those with less than a college education.

In contrast, balanced trade is good for growth, employment, income equity, and national economic stability because balance encourages the most efficient use of a nation’s resources –  not only of workers, but also of capital stock, raw material endowments, and infrastructure.

Balanced trade is particularly good for income distribution because, as demand for American goods increases, the domestic demand for American workers will increase, raising worker incomes in two ways. First, wages for existing workers will rise as the labor market becomes tighter. Second, higher wages will draw workers out of joblessness and back into the labor force, producing major increases in family incomes.

Furthermore, by helping to assure maximum possible growth, balanced trade increases the revenues available for the government to finance supporting investments in worker training, research, regional development plans, infrastructure and other productivity-enhancing investments that will further accelerate growth and living standards for all.

Finally, even if tax rates were lowered as part of a major overhaul of the tax system, balanced trade would tend to reduce the government deficit because balanced trade would mean less need for expenditures to bail out failing corporations and out-of-work households.

Conclusion

America’s forty-year history of trade deficits has been a major factor driving increases in income distribution inequality over the period because job losses caused by trade deficits have the most serious impact on those who are already in or relatively close to poverty.

Eliminating U.S. trade deficits would make a major contribution to reducing poverty and improving income distribution.

The next post will show that expanding trade -- if trade is balanced -- would not only improve income distribution, but would also raise average income levels for all Americans.

America Needs a Competitive Dollar - Now!

How the MAC Would Help Restore American Manufacturing

John R. Hansen

America’s growing trade deficits, especially in manufactured goods, indicate that our nation’s international competitiveness – the ability of Americans to earn as much producing exports as they spend on imports – has fallen dramatically. Since the mid-1970s, rising trade deficits have killed millions of American jobs and have forced tens of thousands of American factories to downsize or close their U.S.-based production lines. 

This note describes how a Market Access Charge (MAC) could put these U.S. workers and factories back on the job.

Many factors have contributed to America’s declining international competitiveness, but most important has been misaligned exchange rates that are inconsistent with balanced trade. Other contributing problems such as inadequate investment in plant, equipment, R&D, and staff training are very real and serious, but these can be solved only when American companies are once again confident that such investments will be profitable. And in most cases, profitability can be assured only if exchange rates between the dollar and other trading partner currencies are, on average, consistent with balanced trade.

Why America Needs a New Trade Policy for the 21st Century

Today’s trade policies clearly do not defend America’s right to a level playing field for international trade – a fundamental requirement if America’s labor and capital resources are to be employed with maximum efficiency, and if America’s future generations are not to be burdened by foreign debts caused by today’s trade deficits.

America’s international trade policies served it well for much of the 20th century. Today, however, the policies are badly out of date because, starting in the 1970s, the market forces that determine exchange rates began to change dramatically.

Historically, the demand and supply of real imports and exports determined exchange rates, much as in the days of Adam Smith and David Ricardo. But starting about 40 years ago, world commerce has become increasingly dominated by financial trade in capital and foreign exchange. As a result, exchange rates set in today’s financial markets are rarely consistent with the rates needed to balance imports and exports. This problem is particularly severe for the United States because it consistently attracts excessive inflows of foreign capital that drive the value of foreign currencies down against the dollar, thereby making American goods more expensive for foreigners and foreign goods cheaper for Americans -- a process that inevitably causes US trade deficits. Inflows of foreign-source money are driven by the following factors:

1. The U.S. dollar, which is the world’s premier reserve currency, is more widely used than any other currency for the invoicing of international transactions, for their settlement, and for storing wealth.
2. The U.S. financial markets are the largest, deepest and most liquid in the world, and they are regarded as a global safe haven in the time of financial problems – even if the problems started in the U.S. markets as happened with the Crash of 2008.
3. As the largest market in the world for consumer and industrial goods and services, America has for years been the target of currency manipulators. Countries like Germany, Japan, and China have bought billions of dollars of U.S. currency and other dollar-denominated assets with their own local currencies to drive the value of their currencies down against the dollar. This makes it very difficult for American producers to compete either at home against imported products or abroad with exports.

If America’s need for foreign capital and its supply of dollar-denominated assets had no limit, the foreign demand for these assets would not cause dollar’s value to rise. But this is clearly not the case. Excess demand for the dollar and dollar-based assets drives the dollar’s exchange rate against foreign currencies to levels that are totally inconsistent with rates needed to balance U.S. imports and exports.

If America is to have an exchange rate consistent with balanced trade, it must implement policies that keep the foreign demand for dollars and dollar-based assets consistent with America’s need for imported capital. 

In the short term, specific measures such as countervailing currency intervention are needed to fight currency manipulation and other unfair trade practices. [1]  For the longer term, America must restore the now-broken link between the dollar’s exchange rate and balanced U.S. trade. This can only be done by moderating net capital inflows to levels consistent with a competitive, trade-balancing exchange rate for the dollar.

The best possible way to achieve this would be a Market Access Charge (MAC). A MAC is simply a “peak load pricing” mechanism, very similar to those used around the world by both the private and public sectors to balance demand and supply for services such as airline flights, rental cars, hotel rooms, electricity use, and vehicular access to the central business districts of cities like London during rush hours. America needs a similar demand-moderating mechanism when its financial services markets are clogged with excess foreign capital.

A Market Access Charge would reduce the demand by foreigners for access to our markets under such conditions by reducing net yields by just enough to make such investments less attractive to foreign traders, speculators, and manipulators. As a result, the demand by foreigners for dollars and dollar-based assets would be moderated by just enough to reduce upward pressures on the dollar – the primary cause over time of the overvalued dollar, U.S. trade deficits, lost jobs, and failing factories.

How would the MAC Operate?

The Market Access Charge (MAC) would operate as follows:

Trigger 

•       A non-zero U.S. trade deficit over the past 6-12 months (the review period) would trigger a non-zero MAC rate. [2] [3]  

Rate

•      An initial MAC rate equal to half of the current spread between average foreign and US interest rates would be charged on the value of the incoming foreign-source money once the deficit trigger point was reached. (Note: the cross-border interest rate spread is the main factor driving cross-border flows of foreign-source money. Setting the initial MAC rate at half this level would allow introducing the MAC without shocking international currency markets.) [5] 

•       At the end of each review period (say every six to twelve months), data on the trade deficit as a percentage of GDP would be reviewed to see if the MAC charge should be increased or reduced.

•       The rate would rise or fall in line with changes in the trade deficit according to an elasticity factor. For example, if the elasticity factor were set at one (1.0), an increase in the trade deficit equal to one percent of GDP over the review period would increase the MAC charge by one percentage point (100 basis points) for the following 12 months. Once the trade deficit began to fall relative to GDP, the MAC rate would decline in the same way, returning to zero once the trade deficit dropped to zero for the previous twelve months.[4]

Base

•       All inflows of foreign-source money would be subject to the same MAC rate. Applying the same rate to all inflows avoids the problems of evasion, corruption, favoritism, and economic distortions that other countries like Brazil encountered with capital inflow charges when they tried to discriminate between “good” and “bad” capital inflows.

•       Because the MAC is charged every time foreign-source money enters the United States, a common rate for all inflows automatically discourages short-term speculative in-and-out flows. Conversely, a common rate imposes a minuscule effective burden on the life-time yields of foreign direct investments because such investments come in only once, stay for a long time, and almost always have a much higher expected rate of return per dollar invested than speculative investments do.

Administration

•       The MAC would be collected automatically and electronically on all inflows of foreign-source money by the computer systems already present in the handful of U.S. banks that handle most of America’s cross-border financial transactions. Under traditional correspondent banking arrangements, these gateway banks would also service incoming cross-border transactions for other banks.

•      Foreign speculators seeking access to US financial markets would pay the Market Access Charge. The MAC is not a tax on Americans.

•       The MAC charges collected by the gateway correspondent banks would immediately be transferred electronically to the General Fund of the U.S. Treasury. 

•       Funds delivered to the US Treasury could be used at the discretion of the Treasury in line with authorizations by Congress and orders of the Administration. Where feasible, special preference would be given to programs designed to improve the global competitiveness of American enterprises and workers. Such programs could include, for example, the National Network for Manufacturing Innovation (NNMI), other types of support for R&D, worker training and trade adjustment assistance programs, infrastructure development, a bank for American International Competitiveness to help finance productivity-enhancing private sector investments in plant and equipment, more efficient border protection operations including antidumping and countervailing duty programs, the liquidation of foreign-held U.S. government debt, and a special fund to help offset any increased costs of borrowing to finance government operations linked to MAC charges on the purchase of government debt obligations.

In sum, a Market Access Charge (MAC) offers the best hope of providing the basis for restoring America’s international competitiveness by fixing the undervaluation of foreign currencies against the dollar.  And to address U.S. trade problems and job losses associated with trade cheating by other countries, the MAC should be supported by parallel legislation that would increase the effectiveness of our traditional measures against trade cheating.

These policies, coupled with supporting efforts to simplify the overly complex tax code, to bring effective tax rates more into line with international standards, to introduce a VAT-like refund for foreign source money used to purchase exported US goods or to build and complete physical assets such as factories in the US.  The MAC-generated funds could also be used to bring health care costs for US workers down, making them closer to those paid by manufacturers in other countries.

In short, introducing the MAC could generate millions of well-paying middle-class jobs, save thousands of factories from closure, and leave future generations free of excessive debt caused by America’s living beyond its means today, spending more on imports than it earns producing exports.

rev. May 25, 2023

________________________________________

Notes:

[1] See for example the work of Bergsten and Gagnon at the Peterson Institute for International Economics here and here where they propose countervailing currency intervention as a way to fight currency manipulation by countries like China.

[2] The U.S. trade deficit is suggested as the key parameter triggering the MAC because it is a well-established and officially available number that directly reflects the misalignment of the dollar. Its relevance and objectivity make it far superior, for example, to debatable, subjective criteria such as the difference between the market exchange rate and the “fundamental equilibrium exchange rate,” an indicator that has been suggested as a test for currency manipulation.

[3] The MAC charge rates on incoming foreign-source money, the trade deficit trigger point level, the adjustment factor, and the review period used here to explain the MAC’s operation are all reasonable estimates of appropriate values. The actual values for these four parameters would be discussed during the legislative review process with members of the Advisory Committee on International Exchange Rate Policy mandated by Sec. 702 of the Trade Facilitation and Trade Enforcement Act of 2015  (H.R.644), experts from organizations involved in trade policy such as the Coalition for a Prosperous America (CPA), the Peterson Institute for International Economics (PIIE), the Economic Policy Institute (EPI), and others as appropriate. Once consensus was reached, these four parameters would be set into law to provide clear guidance for the Government officials responsible for implementing the MAC. The basic logic of the values suggested here is as follows:

A basic MAC charge of 50 basis points may seem too low to affect foreign capital inflows. However, this rate was chosen for several reasons: 

• First, capital inflows, especially those from the private rather than the public sector, are highly sensitive to opportunities for profit and thus to relatively small changes in perspective net yields. For example, the “taper tantrum,” which was driven by the hint that the Fed might begin to raise rates by tapering off the quantitative easing program, triggered massive flows of capital from emerging market countries into the U.S. 

• Second, we know from Federal Reserve experience that changes as small as 25 basis points in the policy rate can have a significant impact on capital markets. 

• Third, an excessively high MAC rate could cause damaging disruptions rather than gradual adjustments in international capital markets.

The trade deficit trigger point for a non-zero MAC charge is set at zero because there is no reason that the United States should have to suffer trade deficits and the consequent loss of well-paying jobs, productive capacity that is often critical to national security, international technological leadership, and debt that future generations will have to repay in one way or another.

The adjustment factor – the elasticity or ratio of percentage point changes in the trade deficit to percentage changes in the MAC rate – is set at unity for two reasons. First, this would assure a more rapid response to rising exchange rate values and trade deficits than would a value of less than one. Second, in line with the philosophy that trade changes generated by the MAC should be constructively gradual rather than damagingly fast, a factor of unity avoids the risks associated with a higher adjustment factor such as two, which would, for example, increase the MAC charge by two percent for every one percentage point of increase in the trade deficit as a percent of GDP.

A review period of twelve months is suggested for two reasons. First, because the MAC affects the dollar’s exchange rate indirectly by moderating capital flows into U.S. financial markets rather than changing exchange rates directly by fiat or by direct government currency market intervention, a few months may be required before the dollar’s exchange rate moves by enough to even begin affecting U.S. trade balances. 

Second, once the MAC begins to change the dollar’s exchange rate, two or more years may pass before trade patterns change significantly. This time is required because changing trading patterns requires buyers to complete existing contracts, find new suppliers, negotiate new contracts, and accept delivery of goods. This is true even if, as can be expected, the new suppliers are located within the United States rather than abroad.

The MAC would create a “signaling mechanism” that could change market sentiment and yield results more quickly. However, realizing the full impact of a MAC on structural trade deficits will almost certainly take three years or so. 

Consequently, it would be a mistake to keep reviewing the past six months’ experience and raising the MAC charge if the desired results were not seen. Also, making adjustments in the MAC rate too frequently would increase administrative burdens, generate confusing market price signals, and risk overshooting the zero-deficit target. On the other hand, it would be a mistake to put the process on auto-pilot and wait for two or three years before reviewing the situation. Too much could go wrong in the meantime. An annual review therefore seems reasonable.

[4] Under this system, the MAC charge rate can be calculated as follows: MAC = (Deficit – Trigger) * Factor, where Deficit and Trigger are percentages of GDP and Factor is the “elasticity” of the MAC charge with respect the excess of the deficit over the trigger. Thus, when the trade deficit reached 3 percent of GDP, the MAC charge would be equal to (3%-1%) * 1.0 or 2%. An elasticity factor of 1.0 appears to represent a reasonable compromise between getting rapid results and excessively shocking the international trade system, but this is subject to further analysis and discussion.

[5] The relatively slow introduction of the MAC is designed to give the international monetary and trade system time to adjust to a new system. This gradual approach would moderate the initial impact on the countries and companies that have become addicted to America serving as the borrower and buyer of last resort in a world where supply often exceeds effective demand. The MAC’s purpose is sustainable balance through moderation, not revolutionary upheaval. While perhaps more exciting than gradual change, the latter could be a recipe for disaster in our highly integrated modern world.

America’s Overvalued Dollar and the External Deficit Doom Loop

Why has it taken so long to restore solid economic growth in America?  Why have so many American families lost their jobs, their incomes – even their homes?  A key reason may well be the overvalued U.S. dollar and the External Deficit Doom Loop.

No one really noticed the doom loop developing, but over the past 40 years, the American economy became trapped in a downward spiral driven by an overvalued dollar and rising trade deficits. As shown in the graphic below, the external deficit doom loop touches every sector of the economy. 

Let’s see how problems at each stage have become linked to form a job-destroying, growth-destroying doom loop.

TPP: As Strong as its Missing Link – Fair Currency Values

The Trans-Pacific Partnership (TPP) will not produce the benefits promised for America unless policies are in place that link currency values directly to balanced trade. In fact, the TPP is not even likely to become law unless America implements a mechanism that moves today’s overvalued dollar to an equilibrium level that balances U.S. imports and exports and keeps it there. Only then will Americans be able to earn as much producing exports as they spend on imports.

Why a MAC charge on FDI will Stimulate FDI

A common question from ABDC Now! readers: 

"Why not exempt foreign direct investment from the MAC?  Imposing a MAC charge on all incoming capital would discourage investments in physical assets that could improve American manufacturing's productivity and international competitiveness,"

The answer is quite simple and revolves around two issues -- (a) the need to create a level playing field that minimizes the risk of distortions, evasion, and high administrative costs, and (b) the fact that, because of its very design, the MAC creates a natural bias in favor of FDI.

Is a Market Access Charge Better than Higher Taxes on Imports?

Readers have asked why the Market Access Charge (MAC), the centerpiece of this blog site, would work better than the options being considered by Congress, most of which involve currency manipulation taxes (CMTs) -- taxes that would be added to the import duties already paid by the American consumers of various imported goods. 

The MAC approach would be simpler and far more effective for many reasons, reasons that will be discussed in future postings, but let's start by looking at the simple issue of complexity. Maintaining a currency manipulation tax system would be complicated and costly, to say nothing of subjective, debatable, difficult to defend in WTO hearings, and damaging to free trade.

Trade Deficits -- Growth Stimulant or Depressant?

Summary

Understanding the impact of trade deficits and foreign debt on economic growth is vital to understanding the origins of America’s current economic problems and to designing trade and monetary policies that will put America back on the path to prosperity for all in the 21^st century. 

Unfortunately, economists are sharply divided regarding the impact of trade imbalances on growth.

Progressive economists such as Scott and Baker generally say that trade deficits are the leading cause of slow growth, excessive unemployment and growing social inequality in the United States, that trade deficits threaten the nation’s long-term economic viability. 

In sharp contrast, conservative economists such as Riley, Griswold and Ikenson would generally say that trade deficits mean faster economic growth and falling unemployment, that the foreign loans used to finance these deficits are an important vote of confidence in America.

The 2015 Economic Report of the President by the Council of Economic Advisors presents both of these conflicting positions but fails to reconcile them or to provide meaningful policy options for action. 

This note reconciles the conservative and progressive views and presents a possible consensus position on U.S. trade policy for the 21^st Century, one that could simultaneously increase business profitability, stimulate innovation, maximize employment, and reduce income inequality.

Restore the American Dream – Abolish the Overvalued Dollar Tax

The dollar is currently overvalued by about 35 percent. [1] Consequently, US producers must sell their goods for 35 percent less than if the dollar were fairly valued.  This applies equally to the prices of exports and to the prices of goods that must compete with "the China price" of imports – the price at which countries like China can sell goods in America.

In short, the overvalued dollar places a severe tax on U.S. producers. America cannot eliminate its trade deficit, restore millions of jobs, or create a thriving economy unless it removes this severely burdensome overvalued dollar tax.

Overvalued Dollar Tax is worse than the Corporate Income Tax

 The Overvalued Dollar Tax is an especially heavy burden because it is imposed on the final selling price of made-in-America goods, not on profits like the despised Corporate Profits Tax (CPT). This is critically important.

If a business has a profit margin equal to 15 percent of the selling price, the CPT takes 35 percent of the profits -- or 5.25 percent of the selling price. In contrast, a 35 percent ODT takes over 200 percent of the profit when the profit margin is 15 percent, leaving the company with a substantial net loss.

A very important corollary is the following: Reducing the corporate income tax rate does nothing to help firms that are making zero profits or losses. The benefit of reducing the corporate tax rate from 35 percent to 20 percent when a producer’s net income is zero is exactly that – zero. It does nothing to stimulate jobs, output, or investment. On the other hand, implementing the Market Access Charge (MAC), which affects the final selling price, can massively increase after tax profits – even if the corporate income tax rate remains the same.

Until the dollar is restored to its equilibrium value, firms will continue to fire workers, reduce output, close plants, and move offshore. Nobody can stay in business with a tax that can exceed 100 percent of profits! Compared to the overvalued dollar tax, the business profits tax is relatively unimportant. It is the overvalued dollar tax that must be fixed before we can restore the American dream.

Overvalued Dollar Tax:  Foreigners win - U.S. loses

Nobody likes taxes, but at least normal tax revenues generally stay in America. However, the Overvalued Dollar Tax is entirely different – it goes directly to foreign producers. The ODT effectively gives foreigners a 35 percent subsidy on their exports and places a 35 percent tax on our exports. Truly the worst of all taxes.

Because the ODT kills American businesses and jobs, it puts pressure on the US Government to raise taxes to make up for revenues lost because of falling business profits and family incomes, and to help cover the high costs of corporate bailout, economic stimulus, and family income support programs.

Despite shortfalls in revenues and sharp increases in expenditures, Congress has understandably resisted pressures to raise taxes. Consequently, the ODT has caused Government deficits and borrowing to explode.

Even worse, nearly 100 percent of the net government borrowing in recent years has been from abroad, mainly from China and Japan. Such borrowing is far worse for the American economy than domestic borrowing because it adds to total domestic spending power and thus to inflation, making it even harder for U.S. producers to compete. And thanks to fractional reserve banking, the impact on total domestic spending power may be up to ten times as large as the initial borrowing.

Overvalued Dollar Tax and the External Deficit Doom Loop

The overvalued dollar is driving an "External Deficit Doom Loop" that condemns our children and future generations to a bleak future unless the dollar returns to a trade-balancing equilibrium rate. The doom loop works as follows:

1. The dollar's value rises as foreign capital assets seek yield and safe haven in America's attractive financial markets. 
2. Because of the rising dollar, trade deficits increase, further increasing foreign capital inflows.
3. Trade deficits create a bias against direct foreign investment by making production in America less profitable.
4. Consequently, the share of speculative in total foreign investment rises. This adds to financial instability and, by increasing asset values in U.S. financial markets, pushes the dollar’s value even higher.
5. Borrowing capital from abroad rather than from domestic savers is like printing money, so inflation increases.
6. With higher domestic prices, US firms can't compete with foreign producers, and business profits fall.
7. With reduced profits, firms cut back on investments needed to increase productivity – or move offshore. U.S. firms also sell domestic production capacity to foreign investors, further reducing the strength of the economy for future generations.
8. As firms shrink or move offshore, personal incomes fall and jobs disappear, worsening US unemployment.
9. Even if real assets sold to foreigners remain in the United States, foreigners, not U.S. citizens, will own the future income streams from these assets, further reducing the ability of future generations to repay our debts to foreigners. And attempting to reclaim these assets by force, a.k.a. nationalization, would lead to unthinkable legal, economic and perhaps even military complications.
10. With falling business profits and household incomes, Government revenues fall and expenditures on bailouts for families and businesses rise.
11. The Government borrows more from abroad, facilitating currency manipulation by China and Japan.
12. Currency manipulation overvalues the dollar further, and the External Deficit Doom Loop starts again. 

Restoring the American Dream – Prosperity for All

Excessive demand for dollar-denominated assets in the United States, home to the world's finest financial markets and issuer of the world's premier reserve currency, is the key cause of the dollar's over-valuation. The best way to moderate the dollar's overvaluation is to moderate foreign demand for these assets. The following summarizes the key measures under discussion today for attaining this goal.

Restoring Competitiveness for Specific Products and Sectors. 

The legislation recently discussed in Congress focused on increasing the effectiveness of countervailing duties (CVDs) by adding a surcharge treating currency undervaluation due to currency manipulation as an additional countervailable subsidy.

Product-specific ADDs and CVDs are legal and can play an important role in protecting U.S. firms from unfair trade practices. However, CVDs only cover about one percent of all US imports and do nothing to stimulate exports. Furthermore, the proposed duties would apply only to imports from countries declared as "currency manipulators" – and such countries only account for fraction of the dollar's total overvaluation.

Competitiveness for the Entire Economy 

Although product-specific duties can help at the firm and sectoral levels, additional policies are needed to handle the far larger problem of overall currency misalignment -- a problem that may be caused by official currency manipulation or by private sector capital flows seeking profits in the global economy.

Fighting Currency Manipulation: In the past, currency manipulation as defined by the IMF was a significant cause of the currency misalignment with countries such as China. This gave manipulating countries an unfair competitive advantage over U.S. producers.

To fight misalignment due to manipulation, the United States should consider Countervailing Currency Intervention (CCI) as suggested by Fred Bergsten and Joe Gagnon.  Under this proposal, whenever the Government of China, for example, intervened in international currency markets by purchasing, say, $100 million worth of dollars with $100 million worth of its domestic currency to drive down the domestic currency and drive up the foreign currency, thus attaining a competitive advantage in international trade, America would respond in kind by purchasing a like volume of yuan with dollars, thereby countervailing China’s original purchase of dollars. The same would apply to any country attempting to manipulate the dollar’s value.

This approach appears to be legal and would be an excellent way to target country-specific exchange rate distortions caused by manipulation, thus responding to wide-spread support in Congress and the Administration for ways to counteract country-specific threats caused by currency manipulation. On the other hand, it would probably be necessary to raise the U.S. debt ceiling before the U.S. could undertake sufficiently large purchases of foreign currencies, and even though this would not technically increase the budget deficit because assets of like value were being swapped, the optics could make this a heavy lift.

Furthermore, since no country that is a significant source of U.S. trade deficits is manipulating its currency today, the main value of the CCI approach at present would be to warn countries that any future attempts to manipulate currency values would be countervailed and rendered ineffective.

Fighting Currency Misalignment with the MAC: Even when China was actively manipulating currency values in the first decade of this century, currency manipulation per se was only a small subset of overall currency misalignment. The broader problem of currency misalignment was and still is caused primarily by private capital flows – flows that respond to opportunities to make profits in global financial markets.

The dominance of private capital flows is seen clearly in the two graphics below:

Two key messages emerge from these graphics. First, official flows were only about one fifth the size of official flows on average between 1995 and 2010. Second, between 2010 and 2015, official flows became negative on average, while private flows were sufficient to make total net inflows positive.

In other words, even if 100 percent of all official flows had been for currency manipulation during the past twenty years, the impact of those flows would have been significant only for selected cross rates such as the dollar vs. the yuan, and they would have been largely insignificant for the dollar’s overall value. Second, official flows are now negative. This eliminates any possibility that active currency manipulation is a significant cause of the overvalued dollar tax today.

Given this stark reality, balancing U.S. trade will clearly require far more than countervailing currency manipulation. Instead, it will require a major effort to moderate the inflow of private capital that pours into the United States because our first-rate financial markets offer such good profits and security.

The Market Access Charge (MAC) is specifically designed for this task. By reducing the net yield on foreign-source capital seeking access to US financial markets, the Market Access Charge (MAC) would moderate such inflows, allowing the dollar to return to its trade-balancing equilibrium exchange rate. (For more details on the MAC, see How the MAC Would Help Restore American Manufacturing.)

Summary

While countervailing duties will help solve unfair trade practices for specific products and sectors, and while countervailing currency intervention will help reduce bilateral trade deficits if and when individual countries begin manipulating their currencies again, the only way to eliminate the dollar’s overall overvaluation and thus America’s overall trade deficit is to implement a Market Access Charge (MAC).

March 13, 2015
(rev. March 16, 2017)

Notes:

[1] The latest Peterson Institute for International Economics calculations, based on data from mid-2016, indicated that, for the US to attain fully balanced external trade, the dollar would need to become about 25 percent more competitive. Since mid-2016, the dollar has appreciated by more than 10 percent. Hence the 35 percent estimate presented here.

[2]  By the end of the Tech Bubble in 2000, the flood of foreign capital that fed this market frenzy had driven the dollar 's overvaluation to nearly 50 percent. No wonder US firms began failing or moving overseas, destroying American jobs.

                         America needs a more competitive dollar - now!

ABCD - Americans Backing a Competitive Dollar

 This new blog will focus on what may be the most important problem facing America today --
     the loss of millions of jobs and thousands of factories to foreign countries.

These losses are driven by capital inflows from foreign investors, both public and private, who are seeking to exploit the best capital markets in the world -- those in America. These flows -- the vast majority of which are speculative and do not increase the productivity of America's industries, have pushed the value of the US dollar so high that American workers, factories and goods now find it hard to compete with imports in domestic markets or with other country's products in export markets -- despite the fact that America's factories and workers are among the most productive in the world..

This blog is not designed to generate a daily string of sound bites.  Instead, its purpose is to make available serious analysis of the challenges and policy alternatives facing America as it seeks to restore jobs and factories by balancing its international trade. Meeting this challenge will make America a better place to live, both now and in the future.

The plan is to issue a new post of 500-1,000 words by the start of each week. You can easily get new weekly postings by signing up for email delivery - see box near top right of home page, 

Best regards,

John


                          America Needs a More Competitive Dollar - Now!