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Capital Flow Management Lessons from Other Countries

May 30, 2018

CDJPA Research Note #3

By John Hansen (CPA Advisory Board) and Jeff Ferry (Research Director)

Passage of the Competitive Dollar for Jobs and Prosperity (CDJP) Act by Congress will establish the Market Access Charge as America’s first permanent tool to drive the US dollar to a competitive value and keep it there with a tax on foreign purchases of dollar-denominated assets. No other major free-market economy has implemented a capital flow management (CFM) tool for any length of time. However, there are several episodes of emerging market economies (EME) adopting CFM tools for short periods of time. They provide notable lessons for the United States as we move to institute the Market Access Charge for the US economy.

• Minimize Exemptions
Many capital flow management tools enacted by nations in Latin America and Asia in recent years offered exemptions for capital inflows deemed by the government to be “good” capital inflows. Foreign direct investment has been a typical example of “good” or approved capital flows, while short-term capital can be an example of a “bad” flow. However well-meaning, such exemptions encouraged abuse. Clever investors will always find ways to exploit such exemptions, weakening the effect of the CFM tool. Investor avoidance of market controls often has a snowballing effect, undermining the overall credibility and thus effectiveness of the capital flow management tools.

The Market Access Charge to be established by the CDJP Act will have few exemptions; the MAC will be applicable at a uniform rate to virtually all foreign capital inflows. (The major exception is capital brought into the US to pay for US exports, and the Competitive Dollar for Jobs and Prosperity (CDJP) Act provides tough mechanisms to prevent this exception from becoming a loophole.) The MAC charge is payable by all foreign ”persons” including individuals, foreign-domiciled corporations, and other foreign entities. The broad base of the MAC will ensure compliance and a fair and equitable application of the charge. It will also assure the MAC’s ability to restore balanced trade to America and to generate significant revenue for the US Treasury.

• Persistence
Many capital flow management tools have been established in emerging market economies to respond to short-term financial and economic crises. As a result, they are designed quickly in ad hoc fashion to combat the perceived challenges of the moment. Thus, it is often easy for vested interests to evade or weaken them, sometimes from the very day they go into effect. As the crisis fades, the tools are abandoned – only to be reinvented in a rush when the next crisis hits. The short-term nature of those tools undermines their impact on key economic variables, including the exchange rate.

Persistence is at the heart of the MAC that the CDJP Act would establish. by. The goal of the Act is to bring the US current account back to balance. Once balance is achieved, the MAC would be used to maintain balance. It is a long-term, persistent tool that is designed to be permanently active in the US economy. By designating the Federal Reserve Board to manage the tool, we further strengthen the permanence of the MAC. Established in 1914 by Act of Congress, the Federal Reserve Board has proved itself to be an enduring, valuable, and highly respected institution in the management of the US economy.

The MAC has been designed though a collaborative multi-year process involving a wide range of think tanks, academics, trade groups, representatives of key sectors, experts from banking and finance, government officials, elected representatives, and others with relevant knowledge and experience. It will take its place, alongside other long-established tools managed by the Federal Reserve, as a key weapon in the armory for government economic management.

• Flexibility and Transparency
Because exchange rates must constantly change to keep them consistent with balanced trade in a constantly changing world, the only way to maintain stability is to ensure that the CFM includes an appropriate adjustment mechanism that can adjust as circumstances change. The CDJP Act charges the Federal Reserve with managing the MAC rate flexibly to ensure it accommodates changes in the global economic picture, while keeping US external accounts headed towards balance. As economic growth rates, inflation rates, global interest rates, and other key variables change, the Federal Reserve will be able to vary the MAC to ensure capital flows and the dollar exchange rate are pushing the external account towards balanced trade.

While all the details are not yet established, we envisage that the Federal Reserve will be mandated to review and set the rates at periodic intervals with the goal of establishing balanced trade within five years.

In recent years the Federal Reserve has moved to deliver greater transparency into its decision-making process, for example by publishing the minutes of key committee meetings. The CDJP Act supports that process, encouraging the Federal Reserve to be transparent with the public about the considerations and decision-making process behind the management of the Market Access Charge and the global competitiveness of the American dollar.

Conclusion
The CDJP Act leverages the lessons of international experience with capital flow management tools, as well as the reputation of the United States for sound, thoughtful economic management and responsible participation in the international financial system. The Act will create a sound, reliable, predictable, and transparent regime of capital flow management ensuring the United States moves steadily towards balanced trade, with benefits for greater US and global economic prosperity.


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