Tackling Trade Imbalances Through Investment
On July 31, 2019, U.S. Senators Tammy Baldwin and Josh Hawley submitted a bill “to establish a national goal and mechanism to achieve a trade-balancing exchange rate for the United States dollar, to impose a market access charge on certain purchases of United States assets, and for other purposes.” According to an earlier memo that further explains the bill:
The Competitive Dollar for Jobs and Prosperity Act would task the Federal Reserve with achieving and maintaining a current account balancing price for the dollar within five years. It would create an exchange rate management tool in the form of a Market Access Charge (MAC)—a variable fee on incoming foreign capital flows used to purchase dollar assets. The Fed would set and adjust the MAC rate. The Treasury Department would collect the MAC revenue. The result would be a gradual move for the dollar toward a trade-balancing exchange rate. The legislation would also authorize the Federal Reserve to engage in countervailing currency intervention when other nations manipulate their currencies to gain an unfair trade advantage.
Whether or not this bill is passed, it marks the beginning of a necessary reappraisal of the forces driving international trade and U.S. trade imbalances. The heart of the bill would be a stipulation that the Federal Reserve levy a variable tax on overseas capital used to buy U.S. assets whenever foreign investors invest significantly more capital in the United States than U.S. investors send abroad, which has been the case for more than forty years. The purpose of the tax would be to reduce capital inflows until they are largely in balance with outflows. A country’s capital account and current account must always match up exactly, so a balanced U.S. capital account would mean a balanced current account, and with this the U.S. trade deficit would disappear.
Putting the Investment Cart Before the Horse
Some might think that imposing tariffs on imported goods is a more effective way to reduce U.S. trade deficits than levying duties on imported capital, but that’s the wrong approach. The key is to understand what drives the trade imbalances. If the recent Senate bill had been proposed in the nineteenth century—when trade finance dominated international capital flows—the proposal to tax capital inflows wouldn’t have made much sense. But today, as I have explained before (including here and here), the global economy is overflowing with excess savings. The need to park these excess savings somewhere safe is what fuels global capital flows, in turn giving rise to trade imbalances. As I explained in a recent Bloomberg piece, “Capital has become the tail that wags the dog of trade.”
After all, even though interest rates are historically low and U.S. corporate balance sheets are amassing heaps of nonproductive cash, the U.S. economy is still absorbing massive sums of capital from overseas. Clearly, this isn’t happening because U.S. firms need foreign capital. The reason for these imbalanced capital flows is that foreign investors need a safe place to direct their excess savings. With the deepest, best-governed, and friendliest capital markets, the United States is the obvious destination.
Economists who contend that the U.S. economy needs foreign capital to compensate for low domestic savings rates are mostly confused about why U.S. savings rates are so low and how they respond to capital inflows. A fundamental requirement of the balance of payments is that net capital inflows must boost the gap between investment and savings, and if capital inflows do not cause domestic investment to rise, they must cause domestic savings to decline. There is no other possibility, and as I’ve explained elsewhere, capital inflows force the U.S. economy to adjust either by increasing unemployment or, more likely, by setting off conditions that cause fiscal or household debt to grow. Put another way, the United States doesn’t absorb foreign capital because the country has a low savings rate—the country’s savings rate is low because it has to absorb so much foreign capital.
This is why it is a mistake to think—as many do—that Americans need foreign capital to counter low domestic savings rates, or even that the U.S. current account deficit is driven in part by a burgeoning fiscal deficit. If one country saves more than it invests, another country must save less than it invests: that is how the global balance of payments works. Americans automatically tend to assume that it must be the United States that sets the savings schedule of the whole world, but this is unlikely. The high savings rates of countries like China, Germany, and Japan are too obviously a function of the distribution of domestic income (see here and here for why), making it far more likely that excess savings in those countries drive down savings elsewhere.
Taxing Capital Inflows Is the Smart Play
If it is excess savings in surplus countries that drive capital and trade imbalances globally, then taxing capital inflows is not just the most efficient way to rebalance the U.S. trade ledger—it may perhaps be the only way. And there are more reasons why the United States should consider restricting the capital account. If designed well, a tax on capital inflows could have at least five other advantages:
- Balancing trade flexibly: A well-designed system of taxing capital inflows would help broadly rebalance the U.S. current and capital accounts over several years. Having the Fed impose a variable tax on capital inflows at its discretion would give the United States a tool for managing trade imbalances that is far more flexible than WTO interventions, trade negotiations, tariffs, or subsidies. At the same time, this approach would allow for the temporary trade imbalances that are a normal feature of any well-functioning global trading system.
- Enhancing financial stability: Because it would be a one-off tax on transactions, this tax wouldn’t treat all investment equally. It would more heavily penalize short-term, speculative inflows while barely affecting returns on longer-term investment into factories and other production and logistics facilities, much like a Tobin tax. Among other things, such a tax would not require huge shifts in the value of the dollar because it focuses so effectively on the most damaging kinds of capital inflows. For example, if the tax were 50 basis points (or half of a percentage point), the annual yield on a three-month investment in the United States would drop by more than two percentage points, making short-term investment a losing proposition. A one-year investment would fare better, but annual yields would still drop by just more than half of a percentage point.
A ten-year investment, on the other hand, would reduce expected yields by a mere five to seven basis points, hardly enough to matter to an investor interested in building a factory in the United States, while a twenty-year investment would see yields drop even lower, by three to four basis points. The impact of the tax, in other words, would be to skew foreign investment away from short-term, speculative inflows. Long-term investments in productive facilities, however, could even become more attractive to the extent that the measure would lower the value of the dollar. In effect, this would enhance the stability of the U.S. financial system. - Treating economic actors more efficiently: Whereas tariffs subsidize some U.S. producers at the expense of others, taxing capital inflows would benefit most domestic producers with the costs borne primarily by banks and speculators. Major international banks would lose out on a tax on capital inflows because they profit from the intermediation of capital flows into and out of the country, and because they fund themselves with cheap, short-term money that they redirect to borrowers at higher rates. This is why the biggest opponents of a tax on capital inflows are likely to be major international banks. But to the extent that these banks, many of which are considered too big to fail, are too large and have an excessive role in the economy and in policymaking, forcing them to pay for the benefits accrued by U.S. producers might actually create a further benefit to the U.S. economy.
- Avoiding broader economic disruptions: Unlike issuing tariffs, levying a tax on capital inflows doesn’t disrupt value chains to anywhere near the same extent or distort relative prices on tradable goods. Tariffs favor some sectors of the productive economy over others, so they can be highly politicized as well as highly distorting to global value chains and the role of U.S. producers. Taxing capital flows works by forcing financial adjustments—by adjusting the value of the dollar, for example, or by reducing debt—so such a tax is likely to be both less politicized and less distortionary to the real economy. In fact, to the extent that trade imbalances are driven by distortions in global savings, taxes on capital inflows will even drive prices closer to their optimal level.
- Allocating capital more efficiently: Some observers might argue that, by reducing the capital available for U.S. investment, a tax on foreign capital inflows would distort productive investment and make the capital allocation process in the United States less efficient. This would be true if most international capital consisted of sophisticated investment capital seeking its most economically efficient use, but only academic economists believe this is the case. In fact, much of the flow of international capital is driven by temporary investment fads, capital fleeing from political or financial uncertainty, reserve accumulation strategies by foreign central banks, debt bubbles, and speculative plays on currency or emerging markets. For that reason, a variable tax on capital inflows would actually improve the capital allocation process by discriminating against nonproductive uses of capital and so preventing them from distorting the financial markets.
The biggest risk of a tax on capital inflows is that the U.S. economy might indeed experience periods when there are capital shortages and U.S. businesses are unable to access cheap capital. At such times, of course, the Fed would simply set the tax to zero.
The trade shortfalls that plague the U.S. economy are chiefly a product of imbalanced capital flows, which are driven by distortions in global savings. Selectively restricting capital inflows is the best way to address these imbalances. Tariffs are a far less effective tool: they mostly just rearrange bilateral imbalances and distort the underlying economy without addressing structural issues. Whether it passes or not, the recent Senate bill is the right approach and an encouraging sign because it is the first time lawmakers have sought to address the persistent U.S. trade deficit by way of capital imbalances.
My Twitter account is @michaelxpettis. Aside from this blog, I write a monthly newsletter that covers some of the same topics. Those who are interested in receiving the newsletter should write to me at chinfinpettis@yahoo.com, stating affiliation.
This post is based on a recent piece that the author wrote for Bloomberg.
Comments(82)
How does this work in practice? Does a large US trading partner pay a "lower" tax than a country that is simply accumulating dollars? Also, I assume that the immediate consequence of such a rule is that actors will try to game it. Are there any reasonably simple ways to do so (for example, can players get around this tax by simply entering into derivatives obligations so that no cash actually change hands?)
Until an actual bill is passed there's no way to know how it will be gamed, but there will certainly be attempts to do so. Most derivative obligations will include the tax in their pricing (selling a derivative abroad and hedging it will result in the purchasing of a US dollar asset by a foreign account), so that shouldn't be a problem. more likely is the development of a secondary market abroad for ownership in short-term US assets, but this is probably something the regulators can figure out. Capital controls are never perfect, after all, but they can nonetheless be effective.
Thanks for the replies (and for the article, of course!). Given the types of decisions that need to be made (e.g. how to allot the taxes, since it cannot simply be on a first come first served basis), it's surprising (to my naive eyes) that responsibilities for this would be assigned to the Fed rather than the Treasury Department.
The Fed was chosen b/c (1) it tends to follow statutory mandates, Treasury is more subject to political winds, (2) It also has more tools to carry out exchange rate mgmt than Treasury. (3) Fed has more modeling expertise than Treasury, and the charge must be modeled for future effects on the dollar price.
Sorry, Michael S--I didn't see your reply (and thank you for it). I guess that even though the Treasury is more subject to political winds, the question of who gets to buy the dollars is an inherently political question--is the Fed equipped to deal with such issues? Also, I thought that the Treasury is responsible for determining the value of the dollar?
Not that the US particularly cares, but I assume also that this basically ends external countries from pegging their currencies to the USD, as it adds an additional layer of complexity and volatility to managing a country's economy?
It could make reserve management more complex, but the Fed can easily cut deals with individual central banks in cases in which it does not believe the central bank is manipulating the currency, or is willing to allow it.
Which means, because the Dollar is used to import necessities, the US can dictate which countries starve and which prosper. Are u insane?
A brilliant article, as always (mmm... no this one is historically brilliant!). I was surprised by the sentence "like a Tobin tax"... Is it not a Tobin tax? Which would be the difference?
I always feel so smart after reading Michael's essays. Thanks again.
Michael, First rate piece. Thanks so much for your interest and support. The MAC indeed holds promise of moving the dollar to a trade-balancing level , thereby helping to bring back thousands of factories and to put millions of Americans to work at well-paying jobs while reducing the debt we leave to future generations.
I question two points in the analysis: (1) Is it more ;ossible that the tax will drive up interest rates as an accomodation for the tax? (2) Is it true that "The trade shortfalls that plague the U.S. economy are chiefly a product of imbalanced capital flows, which are driven by distortions in global savings," or is this another example where the identity S=I is used to formulate specious equations and spurious statements?
Unless you believe in a mysterious and beneficent god that manages every country's trade and capital accounts so skillfully that they are always and exactly in balance, Dan, then there must be a direction in which causality flows. My point is that those who argue that trade accounts are always where the primary imbalances lie, and capital accounts simply balance trade, which is what most people assume, are simply assuming an obsolete condition. This is nowhere implied in the accounting identity. In which case you should ask yourself: do you really believe that international capital flows mostly consist of trade finance?
As for whether limiting capital inflows will drive up interest rates, that is easy to test. Just look at the relationship between US interest rates and the US current account deficit. If you believe reduced capital inflows should raise interest rates, then you would expect that higher current account deficits are always associated with lower interest rates.
Just got to get Sean Hannity to do a special on this idea and Trump will implement!
Here is a comment I made elsewhere to someone who is sympathetic to this idea but thinks it works by weakening the dollar, which worries him: "A lot of people believe that a tax on capital inflows works by weakening the dollar, Marshall, but I think that’s a mistake. It works by forcing up the US savings rate or, more technically, by preventing capital inflows from forcing down the US savings rate. While causing the dollar to appreciate is one of the ways capital inflows force down the US savings rate, I think it is among the least important. As an example, consider how German capital flows after 2004-05 affected Spain, Italy, Greece, France, etc. The euro prevented any currency adjustment, and yet savings in all of those countries collapsed in an explosion of debt and wealth effects driven by asset bubbles. To me the main impact of an American tax on capital inflows is to reduce American reliance on household and fiscal debt to drive growth."
Wouldn't it cause a massive deflationary shock to the world economy? 2 channels, a) Chinese exports don't find a home anymore => lower prices; b) Disruption/panic in the financial world with a possible mirroring recession in the real world. Point B due to the fact that this measure effectively cancels the free movement of capital in the world by removing the centrepiece of the entire edifice.
Yes it would, Michael, if the goal was to implement such a high tax that the inflows would collapse overnight, but I really don't see why anyone would want to do that. The bill gives the Fed five years to bring the capital account into balance, and even then it provides flexibility.
Actually, now that I really (think I) understand the implications for USDs held outside of the US, I guess it's also surprising that this would be telegraphed ahead of time and implemented gradually instead of as an overnight surprise move, since the advanced notice gives players the ability to front-end enormous purchases between the bill's passage and its implementation, thereby offsetting the intended effects of such a bill.
The tax is a variable one that can be adjusted in response to capital inflows. If capital inflows surged, so would the tax, os it is automatically counter-cyclical
It's counter-cyclical once it is implemented; however, if it is only implemented five years from now, this should be highly pro-cyclical between now and 2024 (or 2025, or whenever), as the major creditor nations would presumably rush to buy as many dollars as possible in anticipation of not being able to do so later. Or is my logic flawed?
Mike. Once again I'll give you my opinion. Not on the economics of the idea, but on the dynamics of implementation - the wealthy and the powerful won't go for it. For them, the freedom to act, using unimpeded wealth and power, in their selfish interests, is always placed above national interests. It will take some type of crisis.
It will certainly be strongly opposed by those who benefit from the flee flow of capital, Yok, including most obviously the big international banks, but that's because, like all monetary and financial policies, this tax creates winners and losers. The point here is that winners far outnumber losers and, just as importantly, making the winners in this case wealthier benefits all of society, whereas making the losers in this case poorer might also benefit society. See my previous essay "Wealth Should Trickle Up, Not Down"
Great article, as always. I was wondering if someone could explain the following statement: "capital inflows force the U.S. economy to adjust either by increasing unemployment or, more likely, by setting off conditions that cause fiscal or household debt to grow". I see why capital inflows force up investment and decrease savings, but I don't see how we get to unemployment from there.
Capital inflows either increase investment or force down savings, Peter. If in a world of low interest rates and abundant capital they don't force up investment, then they must force down savings, and the various ways they do so are either by raising unemployment or by raising household or fiscal debt. I explain this many times in previous blog entries.
Here's another explanation, in addition to Mike's. When a country increases it's savings, when it increases the amount of excess production, so to export to another country, that production received in another country makes redundant that nature of production in the receiving country. This renders without purpose or full use a portion of the capital structure of the receiving country. In this manner the savings of the receiving country has been reduced. Capital structure without full, designed for use, is a loss of savings, a loss of investment value. Hope I helped.
If I remember correctly, there was an Interest Equalization Tax in the 1960’s in the US. That was enacted to solve the perceived opposite problem of too many US investors investing abroad, and the intent was to stop capital outflows to help balance the US trade deficit. It basically stopped the trade of foreign stocks in the US. The market response to that was to create Euro-bonds, which were US Dollar bonds of US firms that traded and settled overseas. That was the reason the Eurodollar market came into existence. So the market will continue to trade, but offshore. I see crazy things going on in markets today, but a lot are caused by government and quasi-government bodies. No sane person would buy negative yielding bonds, but there is a European Central Bank there to help the process. Having the Trump administration sticking its regulatory thumb on the scale of free movement of capital can’t help efficient capital allocation. I would think that, if implemented, the idea would be copied by others. Balkanization of finance and the inefficiencies that would accompany this tax regime seems a recipe for a recession and a gift to tax lawyers.
If I remember correctly, there was an Interest Equalization Tax in the 1960’s in the US. That was enacted to solve the perceived opposite problem of too many US investors investing abroad, and the intent was to stop capital outflows to help balance the US trade deficit. It basically stopped the trade of foreign stocks in the US. The market response to that was to create Euro-bonds, which were US Dollar bonds of US firms that traded and settled overseas. That was the reason the Eurodollar market came into existence. So the market will continue to trade, but offshore. I see crazy things going on in markets today, but a lot are caused by government and quasi-government bodies. No sane person would buy negative yielding bonds, but there is a European Central Bank there to help the process. Having the Trump administration sticking its regulatory thumb on the scale of free movement of capital can’t help efficient capital allocation. I would think that, if implemented, the idea would be copied by others. Balkanization of finance and the inefficiencies that would accompany this tax regime seems a recipe for a recession and a gift to tax lawyers.
Rich L. I think you got the dynamic reversed for the "Interest Equalization Tax" of the 60s. The US enacted the tax on incoming money. When US dollars go abroad, they contribute to a trade surplus, not a deficit. The Tax was to inhibit foreign money coming to the US and causing a US trade deficit.
Actually, Yok, at the time (1963) the US was running surpluses and exporting capital, and there was some concern that this was contributing to excessively high domestic interest rates, so the tax (as high as 15% on equity and some bonds) was indeed aimed at reducing the amount of money leaving the US. It is believed to have been very successful, although there are some who dispute this.
Interesting development. Given the sizeable USD balances held outside the US, can such tax result in two different exchange rates for onshore and offshore USD, the former subject to the tax and the latter not and would that matter or not ? Thank you
Yes, DvD, it could. In fact the eurodollar market had different interest rates relative to the onshore dollar market in the 1960s, 1970s and early1980s, when the withholding tax was eliminated, and of course different interest rates mean that the currency forwards were different.
Is it better that a community have its government tax or borrow to fund public expenditures? The answer to this question would seem with cursory thought obvious to any person. For those confident that Taxation is the correct answer there is a great surprise to be unveiled. The following proof confirms the opposite: That Borrowing is invariably the better choice. Let us say that government shall fund public expenditures in 2 scenarios: Taxation and Borrowing with effects wrought upon the aggregate Disposable Income (Y) of a community. Two time periods, T1 and T2, are required to illustrate, firstly, initial taxing and borrowing and, secondly, subsequent repayment of borrowed funds. Govt. expenditure has a value of G in T1 and nil in T2. Only resident citizens may lend to the government. Scenario 1 – Taxation T1: Disposable income is Y1 – G. T2: Disposable income = Y2. Scenario 2 – Borrowing T1: Disposable income is Y1 – G = Y1 – loaned Savings (S) = Y1 – S T2: Disposable income is Y2 – public debt + loaned savings, both with interest (R) added = Y2 – S(1 + R) + S(1 + R) = Y2 – 0 = Y2 An amount of money, S which equals the cost of the public good G, has left the accounts of community residents in the scenarios of Taxation and Borrowing. In Borrowing, community residents, specifically, its lenders are enriched with an asset or IOU of S after ceding funds for G, and community residents are burdened with an equivalent liability of S or the claim against the aggregate Disposable Income or Y of the community. After a time, the public debt claimed against Y and the equivalent IOU added to Y have grown to S(1 + R), R being the rate of interest. The accrued public debt: S(1 + R) annihilates the IOU held: S(1 + R), leaving the remainder of Y2 under both scenarios of Taxation and Borrowing. The startling conclusion is that it makes no difference whether a community has its government tax or borrow to fund public expenditures. By levying taxes to erase the incurred debt and IOU of S (1 +R), the community is no better off in the transaction. Thus, Pure or True Ricardian Equivalence as advocated by David Ricardo in the early 19th century, not Barro’s recent and contrary Ricardian Equivalence Theorem, does exist theoretically and appears irrefutable. David Ricardo was right though he may have lacked the tools to explain why. I offer $10,000 to any person able to find the flaw that defeats this proof.
First, not at all starting but in fact a kind of identity. Second, taxation versus borrowing has huge and obvious distributional impacts. Third, the purpose of this and many other taxes isn't to raise revenues; in this case it is to reduce capital inflows.
Hello Mr. Pettis, So you don't dispute that that in raising say $5 for public expenditures there is on the face of it no difference between taxing and borrowing from the aggregate of the assets, property, incomes that comprise That Which Funds Government? A just distribution of funds already occurs through the workings of a market economy. There may be need to assist some, but certainly not in the amounts seen today. The markets are far more adept at tegulating trade, investment, and money flowd than tools exercised by government.
Mr Economart. I couldn't follow all the mumbo jumbo of your proof. To me it proved nothing. I have a hard time following the line of your thinking. You raise the question "which is better for a community to fund it's government, taxation or borrowing?" On which level? State and Local or Federal, currency issuing? On the Federal Level the question is nonsensical! The question in and of itself is a lie. It's a misrepresentation of the truth. It projects the type of deception that the wealthy and the powerful, and the neo-liberals seek to maintain and support, because it favors their own interest. The question is a self-serving lie of the wealthy and the powerful. To seek to answer the question as you would hope brings the responder into a mis-understanding of reality. Let's take borrowing. The Federal Government is the monopoly issuer of currency, it never, under any circumstances, has to borrow to fund its' expenditures. The government bond issuing process is corporate welfare, welfare for the wealthy and the powerful. It's meant to preserve the existing wealth and power structure. Let's look at taxation. The government does not tax to obtain currency to spend - THE GOVERNMENT CAN CREATE ALL THE MONEY IT NEEDS. The taxes are used to redistribute wealth in the domestic economy. And to free up resources for its' own use. Free trade right. My Arse. Trade and commerce can only take place within the authority and jurisdiction of the community expressed as government. FREE TRADE, A LEVEL PLAYING FIELD, THE MARKETPLACE, only exist in rough , distant, approximation in reality.
Hello Mr. Yok, Borrowing would happen at all levels of government. That Gov't may drop off it bonds at the Fed for full credit to its Treasury account is known to all. But as with Zimbabwe, North Korea, Venezuela, the old Soviet corpse it never ends well. Other than that you have left me with little to say. You don't refute the proof, preferring rather to reject it. Ot may work in the abhorrent universities, but that it doesn't work in the real world. Better luck next time.
Well said Yok.
Silly me. I thought by the rticle’s title you were suggesting that our gov’t tax lobbyist funds flowing into the capital and used to buy our politicians. I think mine is an equally valid idea.
Valid to what, meaningless in relation to blog posting, level of discourse and depth of discussion.
I don't know if you have the time and patience to answer two more questions, but here goes: (1) Could Germany, China, Japan, Korea counteract this by shifting purchases to their companies and then giving tax breaks to the companies who pay the tax? (2) Presumably if the US imposes this, every other country running large capital account deficits (e.g. England) would have to follow a similar policy, or else risk ever greater imbalances. Is there any practical outcome other than forcing the current account surplus countries to rebalance (possibly extremely quickly)? As always, thank you for such a great blog!
I am an Australian. I used to think the USA was a place to look upto. All of a sudden the USD will drop if this legislation is passed and overseas investors will be the fall guy just like in 1985 after the Plaza Accord, poor Japanese. Fine you go and play with your own dollars and maybe we can put an exit tax on your investments in Australia.
Could not agree more.
Lapswim. Nonsense.
"The trade shortfalls that plague the U.S. economy are chiefly a product of imbalanced capital flows, which are driven by distortions in global savings". Rather, I suspect that excess taxation and regulation and high labour costs drives up extended bills of materials costs of American exporters of tradable goods and domestic manufacturers alike.
Let me get this right Lapswim: The level of taxation and regulation is lower in a communist country, than in the free market economy of the United States. Consumption here takes up 65% of gdp and in communist China it is allocated 45%(correct me if I'm off much Mike), so households here are taxed too heavily. Nonsense. Taxation is much higher in China. In China I understand that public surveillance and limited access to the internet and outside information is sharply curtailed, but you'll tell me that China is less regulated. Nonsense. Yes, incomes are higher here. But I don't see that as a problem. I see it as a blessing.
For the US there are international competitors other than China. To win a contract one has to beat all other competitors. I thought that Americans pay tax on overseas income and that is not true for all other countries so American contractors have an extra cost burden there, to supply and instal plant overseas somewhere for example.
Lapswim and Economart: You guys are late to the Party to be recycling these stale old premises and faulty beliefs here. All hear have spent a long time reflecting on on the inadequacies of the common discourse, and find Michael's work to be both compelling and structurally, systemically and historically sound.
Obvious Chinese troll, as they are particularly concerned with Plaza accords over last couple of years, even though the Chinese government were forced to strengthen the Yuan from 2005-2010. In aftermath, it became popular to imagine, we will not Plaza Accords when they had printed so much debt that the RMB is on-way bet lower. Potential implications Orwellian; CCP management of Netizens who seem to be deluded.
More govt. intervention in markets is not the answer as 1000s of years of experience confirms.
Premise of Globalization theory, which is but a couple decades old, there is no valid comparison between markets of 3 decades ago, to today, let alone "thousands of years ago". Complex adaptive systems require complex and adaptive actions, tactics, strategies and consideration, not attempts to hold to the premises of an imaginitivw ideology. Then, to state, would have to hold ignorance of how your premise is unmet globally, yet, needed to be strengthened where it holds the most? So, you won't find many ears for that here.
Especial systems and stategies may be needed, but government, the most incompetent, wasteful, destructive, arrogant and corrupt organization in existence, is certainly not the choice of any sane being to create and develop them as 1000's of years of experience and knowledge confirm.
Economart. Greed and selfishness, the lust for wealth and power always leads to human suffering, as 1000's of year of experience confirms.
Hello Yok, That's correct. People are greedy. But better that they are forced to produce a worthy good and sell it in free markets to enrich themselves instead of commandeering the crushing arms of govt to provide goods bereft of value.
Excellent analysis. I'm glad you put this out in Bloomberg (though you're a better editor than Bloomberg). I wonder how well this type of tax on capital flows would work in combination with tariffs on trade with mercantilist nations like China. The capital tax would increase economic efficiency by reducing financial volatility. As a complement to this strategy, the tariffs would be designed to prevent the deliberate destruction of specific companies and industries through the type of subsidized national industrial policy that China deploys. I agree that tariffs "work by distorting the real economy and rearranging bilateral imbalances." However, that is also how Chinese state capitalism works. Tariffs, then, could function as a useful counterbalance to the economic structure of the world's second largest economy. That tariffs threaten to disrupt supply chains can also be seen as a feature: it adds an extra incentive for China to play fair, since if it doesn't businesses will be increasingly wary of including tariff-exposed Chinese partners in their supply chains. Unfortunately, just as I am suggesting that a tariff system on China is caused by Chinese corruption, such a system is itself vulnerable to becoming corrupt. Apparently the Hawley bill would stabilize net foreign holdings of US assets. I wonder if there is a calculable optimal level of these holdings. It seems to me that the essay arguing that wealth ought to trickle up suggests that net foreign holdings by less wealthy countries of the assets of rich countries ought to be lower.
I read almost all your linked articles, but still struggle to see where you conclusively think the causality direction is from capital inflows to trade deficit? For instance, if China wants to invest its USD, wouldn't it be in our control to put it to good use? Can't we use (some of) that to increase govt. saving (and pay off existing debts)? Why are we spending / investing it instead?
Just a suggestion, but wrt to your first question, I found that the best approach to understand this it to read Pettis' Appendix in The Great Rebalancing. But as for a straightforward "logical" argument, here's an interpretation--someone will no doubt correct me if they disagree: . . . . . . . . . . . . The Capital Account identically equals the Trade Account to a first-order approximation. However, Capital flows dwarf trade flows by orders of magnitude. This leaves two options: (1) Every dollar of trade between countries causes literally orders of magnitude of capital to transfer across borders (not necessarily between the same countries), or (2) Capital drives trade, and the trade balance is the simply the net difference of the capital flows. . . . The latter is more intuitively obvious, and in any case it is much easier for capital to flow across borders than for goods and services. . . . Under this model, China (to use your example) must be net buyers of foreign currencies in order to create and sustain its trade surpluses. Due to the size of its trade surpluses, it must buy *lots* of foreign currencies. Only two countries (US and Britain) have the market size and the political willingness (for now) to absorb such large financial flows (and the UK cannot do this without sharing the burden with the US anyway). . . . . As for your question regarding putting the investment to good use, read Michael's February 2015 post on Syriza and the French Indemnity of 1871-73 --it explains things (IMO) in a brilliantly coherent manner, and the historical perspective gives some "distance" for easier absorption. .. . . Just a thought.
Interesting reads, particularly the Syriza post. Thanks for sharing! The Syriza post quite nicely articulates the questions that I had, esp part 2 (Assumption 2 -- Spain was in "control" of what it could do with the inflow of funds): To quote: " ... This might be true, of course, if there were such a decision-maker as “Spain”. There wasn’t. As long as a country has a large number of individuals, households, and business entities, it does not require uniform irresponsibility, or even majority irresponsibility, for the economy to misuse unlimited credit at excessively low interest rates..." What I don't quite understand is if this same observation holds true for the US: 1) Is there any data on the amount of capital flowing from China and other foreign countries into the US, and for buying what kinds of assets? My intuition is that it cannot just be treasuries, because the US govt is that single "decision-maker" that could simply choose to not have large auctions and huge federal deficits in the first place. The auction results indicate that they are not 100% filled, so there's more demand for treasuries than what the US govt can consume. 2) If historically, large capital flows have not ended well (depression) for the countries at the receiving end, is the US also going to suffer the same fate? Or is US, being the largest economy of the world, somehow different because they can absorb all the capital and put it to "productive" use?
Hmm...I believe that your last question makes an incorrect assumption--the point is that the US is *already* suffering from the capital inflows, and preventing them will cause the US to benefit as a whole (although the financial sector will suffer, that will be more than offset by net non-financial gains). . . . . Let's see if I can do Michael's argument justice without the equations: Inflows only benefit a country it brings innovation or if enables the recipient to fund productive investment needs that cannot otherwise be funded. Otherwise, net capital inflows cannot increase productive investment. Since productive investment cannot rise, either unproductive investment must rise (which is the default response to unneccessary capital inflows, but is unsustainable) or US savings must fall. The decline in savings comes via either an increased debt burden or a rise in unemployment or a combination of both. . . . . . As with all wealthy countries, the US can fund all of its productive needs domestically. Therefore, the additional capital inflows are generally not put to productive use and are thus causing either higher US debt burdens or higher US unemployment than would otherwise be the case. . . . . . . . As an aside, Michael previously stated that the US could, in fact, improve its use of capital by investing in infrastructure such as roads and only isn't doing so out of political dysfunction. I don't think he has ever explained how he knows that there is a lack of infrastructure spending (the roads in the US are far nicer than those in Canada, for example), but since the US chooses not to fund such infrastructure, I guess that China could keep its model going a bit longer and generate some goodwill by building US and UK roads and bridges (my offbeat thought of the day...)
Claire, you got Mike down pretty good.
Thanks Claire. Do you have data/reasoning for this claim "As with all wealthy countries, the US can fund all of its productive needs domestically"?
Yes, excellent job, Claire. As to Infrastructure, they have mentioned extensively, prior to GFC, and after, there was a lot of discussion coming out of the Investment banks of the "need' for, starting at 40 trillion to 125 trillion in infrastructure (the latter number towards 2015). Not just in US, then, Summers and others, got on kick of discussing LaGuardia vis a vis any numbr of new airports built globally. Around me, they never stop doing infrastructure, roads and bridges pretty good, think that roads become ever more populated and expect any limits, less due to funding, then shutting down major thoroughfares, limitations to ability. With that said, a lot of light rail could be forced in metro areas, but would people use. Further, suspect a heck of a lot of soft and hard infrastructure is needed, and that states and regions have many potential projects envisioned. But timing to economic necessity might be difficult. There are several new towns cropping up around me, plans for shopping and roads. When ask when, they are 9 years out, not sure they would want to expedite, even if could. (Actually, I am really impressed with these new "towns"; the progression of development, slowly, is superb Whenever Id rive through them, really smart and live-able with exercise path's and families walking neighborhoods with open spaces, and sport fields, dog runs, really, really well-developed relative to 40-50 years ago.) There is a sort of fetishism that can be imagined of too much development under constrained time-frames of recent "miracles"
Thanks for the reply, CStevens. My understanding is that by saying that there is a shortage of infrastructure, Michael really meant that the productivity of the US economy would increase if this infrastructure is built. I am willing to believe him (lol--especially since it's not my money on the line), but I guess I don't understand how to make the link between the increased infrastructure and increased productivity (Is there an even simplified model somewhere that says that for every $X put into infrastructure, the US economy will increase by $Y until a total of $Z has been put in, at which point the money will become unproductive/speculative).
Dear Michael, I can't wait to hear your thoughts on Carney's suggestion of a new monetary system - looks very Bancor like. I am shocked that this suggestion is coming out of the BOE this soon. Thought it would take another crisis.
Given all of Michael's previous analyses, I am actually more surprised that this came from Carney instead of from the US itself--I always assumed that the US would be leading the charge out of the current system. I am not sure why the rest of the world would benefit form this, though--at lest not in the immediate future.
Needless to say, Nick and Claire, I agree with Carney, and I assume the reason he supports something that is mainly in the short-term interest of the US and against the short-term interest of the rest of the world is that he is farsighted enough to see that it is in everyone's long-term interest. The US cannot keep playing this role, and it is much better that we agree now to redesign the system than that we wait until the US drops out or is forced out chaotically (although I don't think anything should be done under Trump's leadership).
This may be a silly question, but can the US even continue to accommodate the current level of capital inflows for another five years? Wouldn't a more aggressive timetable be preferable?
You can look at the U.S. Net International Investment Position (NIIP). It is basically the sum total all past trade deficits, adjusted for value. When a country's NIIP gets past about 60% of GDP, bad things tend to happen. USA's NIIP is currently at about 50% of GDP. If current trends continue, in five years NIIP will be sitting at pretty close to 70% GDP...
Assuming that the ~$500bn current account deficit gets reduced linearly over the five years, that's still an additional $1.5tr in capital inflows. Maybe that's not overly significant for a $20tr economy(??)
Michael, But Is QE not already effectively a Tax on excessive Capital Inflows. The purchasers of bonds are not getting a real market return on lending money, since the market is being distorted to compensate for 'a manipulated current account market'. ? Regards Phil
But they have been, essentially QEing themselves, so should the US really accommodate the worlds excess printed "savings" while they use these to divert trade, even if they weren't?
A couple of other thoughts (this may be obvious to finance professionals, but please bear with me). . . . (1) If interest rates turn negative, why would governments not issue as much debt as they could and use the proceeds to buy up all of the callable bonds that they have issued over the years? . . . . (2) Why would they also not issue as many long-dated zero-coupon bonds as possible? . . . . (3) If they issue enough zero-coupon bonds at negative rates, is that not equivalent to the mechanism that Tammy Baldwin and Josh Hawley are proposing through the Fed, but without requiring legislation or a five-year transition period? . . . . . . I don't think I have invented anything new or brilliant, btw--just trying to understand where the flaw in my reasoning resides.
Claire. I'll tell you where the flaw in your reasoning is: YOU ASSUME THAT THE FEDERAL GOVERNMENT MUST BORROW TO OBTAIN THE FUNDING TO RETIRE PRIOR DEBT. As the MONOPOLY CREATOR of currency, and the ability to impose obligation, the federal is never in the position of being forced to borrow her own currency. The government issues debt for other reasons.
Exactly, Yok. And it is tiresome how this is assumed away. The responses will be more of the old drivel, or "Yeah, but's", where frankly the "other reasons" that you are mentioning, could be viewed in positive or negative lights, but these become more stressed, regardless as to whether one imagines maniacal actors or benevolent intentions, simply, the system needs a reset. Thanks for stating this clearly. And yes, Claire, as you state, but this is more of system extension beyond point of utility and how it has evolved, and is want to continue, speaks to inertia in the policy community, group-think, and lack of vision. The real consideration in all of these things, is what is actually being delivered globally. We have the spread of advanced material capabilities to state and non-state actors, many with historical or imagined grievances, and we do little more than tinker. Now is time for Fed to be far more creative than they have been. Of the pervasive receipt and development of capabilities, we need help a lazy Idealism yield to more practical and pragmatic philosophical horizons to strengthen the foundations from which our core values can extend. I think this is a confusion, that tempts one to imagine that within the stoa of Finance, there exists something, that you are not sure if getting right, or that of others imagining weakness, or things we need do, can't do, of rising and falling and so many other obfuscations of the discourse. Sorry, Westerners, the benevolence within your societies, has caused you to lose sight of the real world, talking yourself into "as the progenitor" of many problems, and you need to realize, in this puzzle, you might not be the thing to be feared, and in terms of the development of Social SYSTEMS, Finance is but a part, it now need be right-sized.
Yep--that's it. Old thoughts die hard :).... Thanks.
Although it doesn't explain why the government can't use zero-coupons as a substitute for the bill Baldwin-Hawley bill proposed...
Claire. I'm sorry. I don't know anything about the Hawley Baldwin Bill. But I'm glad you appreciate my commentary.
I like the idea that the Fed is given more monetary powers to act independently given the political impasse in congress. I like the idea that Fed don't just mandated to keep inflation and unemployment in check. They should be given powers to keep the economy in balance like not too much consumption or debt etc
Mike, what ever happened to the book you were writing?
Now's the time. It would work great. That's why the left will Never entertain the idea, much less pass a bill.
Au = Gold, Si = Silicon, O2 = commonly found form of oxygen, as atmospheric gas.
The rates were negative and yet the US continue to attract foreign capital. Wasn't these negative rates that possibly induced lowered return expectations some form of a broad based tax and if so anything observed along the lines of articles in terms of rebalancing?
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