We might think that a bill looking to accomplish such things as improving the trade deficit would seem like a fine idea indeed. We need to look behind the rhetoric though.
There are a lot of people that look at America’s massive trade deficit and see this as a harm or at least lost opportunity, and wish we could do something to improve the situation.
President Trump is certainly one of them, and this is the main driver behind his passion to work out a better trade deal with China and other countries, and he actually sees the trade imbalance as other countries preying on us. These perceived injustices should therefore be remedied, and this is what tariffs seek to do as well as other forms of protectionism.
The United States Senate now has a bill before them called The Competitive Dollar for Jobs and Prosperity Act, which is seeking to join the battle by having the Federal Reserve set a taxation rate on foreign acquisitions of American assets over $10,000. The goal here is to seek to weaken the U.S. dollar to the point where we will see the trade deficit reduced, allegedly leading to more prosperity for Americans.
If the effect of this is to actually improve prosperity for Americans, then it would be hard to argue that this would not be a good idea, at least from the perspective of Americans. If this helps America but hurts foreign persons, the U.S. government is supposed to be acting in the interest of its people, and if it hurts people who live in other countries but helps Americans, that would be a completely reasonable political solution.
It wouldn’t even matter if such a thing hurt the world economy overall, as long as the American economy was advantaged by this. Some may argue that Americans should not be biased toward Americans but governments may be expected to favor their own residents, which is what they are supposed to be doing anyway when they promote protectionist policies, and other governments may act to protect the interests of their own people in turn.
If it turns out that an idea that is supposed to promote American prosperity actually reduces it instead, then the idea would surely not be a good one, even if it benefits certain sectors of the country such as exporters.
Exporters do not have the national interest at heart, as their focus is on their own companies, but our elected officials are supposed to be promoting the overall welfare of Americans and not benefit certain ones such as exporters at the expense of the people in general. In order to justify whatever intervention that we choose, we do need to establish that it is for the overall good of the country.
For This Bill to Make Sense, This Needs to Help, Not Hurt
We therefore need to examine what effect this bill would have on the country overall, and not just be satisfied with platitudes such as a trade deficit being bad and reducing it being good, or a strong dollar being bad and a weaker dollar being better. We have to actually start by examining whether these assumptions are even valid.
This bill clearly is a protectionist strategy, and it seeks to dissuade foreign entities from purchasing American assets, including American securities. The fact that this applies to securities as well as real property and other investments is something that we have to be particularly careful with as this in itself is a pretty dangerous idea.
Weakening the U.S. dollar is another move that has some pretty significant ramifications, depending on the effectiveness of such a bill if it ever becomes enacted. The plan here is to make it more expensive for foreigners to invest in America or lend them money, resulting in their doing less of this and this placing downward pressure on the dollar because it is now less in demand.
When we leave the amount of this taxation open and only subject to the goal of bringing down the value of the dollar enough to meet the bill’s objectives, this gives this bill great power and it will then be able to shut out a lot of investment and lending from abroad, and knock the value of the dollar down quite a bit. This is not a small measure by any means and has the potential to enact some big changes, and therefore it is even more important that we actually know what we are doing before we unleash such a monster upon the world.
Our currency is presently allowed to float against other currencies for the most part, although we do rely on the Fed to enact policies which do serve to strengthen or weaken the dollar, which are the things that the Fed does in the course of managing our economy.
When they put up interest rates, this serves to strengthen the dollar, and when they cut interest rates, this weakens it, relative to other currencies that is. Interest rate hikes constrict our economy and interest rate cuts serve to expand it, and that’s the main purpose of this interest rate manipulation. It is not the Fed that manipulates the currency this way, the market takes these moves and does what markets do where supply and demand of the dollar is affected accordingly.
This actually does not serve as a direct manipulation but instead looks to change business conditions whereby our currency floats higher or lower alongside other currencies as a result of these changes. It is actually important that we not interfere with the dollar’s value directly because this creates market inefficiencies, given the efficient route is to let the market itself decide this.
The effect of this proposed tax, like all taxes, would result in a constraining effect upon the U.S. economy, as taxes take money out of the economy. We might think that this should not matter since it takes money out of the hands of foreigners, but to the extent that they still invest, the amount of taxation is no longer invested. To the extent that the tax scares them away, the entire amount that would have been invested in our country is lost.
If the goal here is prosperity, having less investment does not lead to more, it leads to less, every time in fact. If we restrict this to the point where the loss is sufficient to reduce the value of our currency enough to change our balance of payments significantly, we’re talking about some huge losses in investment indeed.
These moves also need to be put in context, as our particular situation matters a lot as far as how this is to play out. The first and perhaps most important thing to realize is that America is a net importer, and the net effect of devaluing the dollar will mean a lot of money leaving the American economy for elsewhere, something we do not want and should never pursue on purpose.
China, on the other hand, China, being a big net exporter, benefits from a weaker domestic currency, as the country will benefit on a net basis from getting more money for their exports over their imports costing more. If America was a net exporter like China is, devaluing the dollar on purpose would have some clear benefits, but the opposite is the case.
Proponents of this bill would argue that the weaker dollar would cause us to move away from imports, and while this would result in higher prices for these now domestically produced goods, this would result in job creation where the economic benefits would offset the higher costs.
This Bill Would Attack and Deteriorate the American Economy on Several Fronts
There is a lot wrong with this though, starting with the fact that we already have full employment. If we are to benefit from all these new jobs, we have to wonder who will fill them. If the unemployment rate were high, 10% for instance, then we may be willing to essentially have the 90% who are working subsidize the employment of the other 10% by paying more for things, but without this problem, we end up with the costs without much benefit at all, making this clearly a bad bargain.
This also assumes that the difference in productivity between the imported goods and domestic goods is small, such that a weaker dollar could swing things in the favor of the domestic goods being more efficient. This isn’t the case at all though.
The big disparity here is the cost of labor, which is much cheaper in the countries that we import a lot from, and this is the reason why they are available so cheaply. We can impose a 25% tariff on these goods and still have them cheaper. The average daily wage of a factory worker in the U.S. is $176. In China, it is about $27. Other countries offer even cheaper factory labor, and in Vietnam for instance it’s only $6 a day.
Putting the dollar down a bit isn’t going to even touch these disparities. This will not create jobs, it will actually cause a loss of jobs, as people will just pay more for imports and have less left over for domestic spending. This is not the road to greater prosperity, it is instead the road to insanity.
America does compete very well in certain sectors, particularly those involving a lot of expertise and training that you can’t just round up a bunch of very low paid factory workers and pull off. Wherever we benefit now, we will continue to regardless of this bill, but in the areas where we are way behind, we’re far too behind with our much higher costs for all of this to provide any real benefits.
We therefore have all the costs of this, more of our dollars leaving the country due to more needed to pay for what we import, and while we will get back more for what we now export, the net result will look pretty ugly indeed. We just have to look at our net outflows and multiply by how much the dollar will be devalued to arrive at the additional cost, and we can then get an idea of just how crazy intentionally devaluing the dollar would be.
We also need to consider what effect our restraining foreign investment would have. This would put bond prices down and elevate our cost of borrowing by selling treasuries, and making it more expensive for people to buy them will do this. We are fortunate that so many people prefer the dollar and our treasuries as this allows us to borrow more cheaply and that’s not something we should want to undo unless we’ve taken leave of our senses.
We should also understand that investment in general strengthens our economy as this is one of the most basic principles of economics. Wanting to restrain investment at all, whether by foreign or domestic entities, does not make sense.
It seems that if you just focus on this one thing, our trade deficit, to the exclusion of everything else, and have a distorted view of things like how the trade deficit plays out, we can end up with some pretty strange ideas indeed, and ones that are pretty harmful to the economy indeed if we have the wherewithal and desire to think about these things enough.
There are some who actually see the very low wages in some countries as our exploiting these other countries, although in economic terms this involves a flow of value from the less economically prosperous to the more prosperous, ourselves. Watering down these benefits from manipulating our currency just ends up harming ourselves.
We should not wish to even reduce this trade deficit as long as it results from free market activities which gravitate toward overall efficiency. If we insist on meddling with this, we at least need to be clear about who is going to pay the price, and in this case, it is us.