By Jeff Ferry, CPA Research Director
The fear is growing that a rising dollar could sabotage any effort by the Trump Administration to improve the U.S. trade balance as a means of improving the health of our manufacturing industry.
Commentators have suggested that the prospect of rising interest rates and higher U.S. economic growth, combined with any moves to boost net exports, could quickly lead to a rising dollar, throwing improvements in the trade balance into reverse. But there are bold, new solutions to get the overvalued dollar under control, including a plan to charge foreigners a fee to hold dollars, known as a MAC, that the government should consider.
The U.S. needs to address what could be called “macho dollar syndrome,” the belief that a strong dollar is somehow good for the U.S. economy. In reality, a strong dollar makes our exports more expensive, our imports cheaper, thus leading to a larger trade deficit, slower economic growth, and fewer jobs. That dynamic has been taught in introductory economics classes for years. You can see the living proof simply by looking at Britain’s economic performance in the second half of last year. In June, the Brits voted to leave the European Union. The pound sterling promptly fell 15% as speculators worried about turmoil and trade agreements. The fall in sterling boosted British exports (up 18% year-on-year), leading to a significant uptick in economic growth in the fourth quarter, enabling Britain to finish 2016 with annual growth of 2.0%, the highest growth rate among the G-7 group of large countries.
Recently, some have shown renewed enthusiasm for labeling some of our most mercantilist trading partners currency manipulators. Senate Minority Leader Charles Schumer (D-NY) urged the president to put the label on China. The “currency manipulator” label, under current law, triggers dialogue with the offending country which could lead to further action at the discretion of the president. The problem with this approach is that persistent Chinese currency manipulation has ebbed recently. According to an October report from the U.S. Treasury, China actually spent $566 billion pushing its currency up not down.
For an economist, “currency manipulation” is better understood not as direct intervention in exchange rates, but as policies that prevent a nation’s trade balance from balancing over a full economic cycle (typically 5-7 years). According to economist Brad Setser, East Asian countries are managing today their economies to save as much as 40% of their GDP, contributing to their trade surpluses and our trade deficits. Last October, Setser wrote: “The problem of the global savings glut is now more acute than in 2005…The social costs—and therefore also political costs—of relying on the United States and a few other countries as consumers of last resort are increasingly evident.”
A novel idea to address dollar overvaluation was advanced by Joe Gagnon and Gary Hufbauer of Washington’s Peterson Institute in a 2011 article, Taxing China’s Assets. The core of the proposal was a 30% withholding tax on the interest paid on the holdings of U.S. financial assets by entities based in nations the U.S. deemed persistent surplus nations. The benefits of the proposal are that it would exert downward pressure on the dollar (and upward pressure on the renminbi), and it would make it plain to the Chinese and other surplus nations that they are not doing the U.S. a favor by buying our Treasury bonds. On the contrary, they are enabling their economies to grow at our expense, and we would much prefer they increase domestic consumption rather than rely upon U.S. consumers for growth.
The biggest problem with the Gagnon-Hufbauer withholding tax is that it raises an enforcement challenge because it creates incentives for foreign investors to disguise their country of origin. For that reason Joe Gagnon himself is intrigued by another, even more radical proposal, called the Market Access Charge or MAC. The MAC is the brainchild of economist John Hansen, now retired after a career at the World Bank. Hansen’s vision is for a charge, starting at 50 basis points (half of 1%) on inflows of foreign capital into U.S. financial assets. The one-time charge upon entry would be levied not on the interest but on the principal invested into U.S. assets. There would be no political debate required over which nations pay the MAC. They all would. The revenue flowing to the Treasury would be counted in billions of dollars.
The advantages of the MAC are that it is relatively easy to administer and it is highly likely to drive down the dollar. Most important, it demonstrates to the world that the U.S. is serious about making sure that its currency serves the needs of its domestic economy instead of the other way around.