By Mike Dolan
LONDON (Reuters) – Investment barriers have long been taboo among U.S. policymakers, for fear that a mere mention could spook the world’s biggest financial market. But the idea of taxing or frustrating inward investment is now being openly discussed by investors as Donald Trump’s sweeping economic agenda rewrites all the rules.
The macroeconomic worldview that underlies much of the president’s agenda is based on international trade accounts and zero-sum rivalry.
If the U.S. is running large and chronic deficits in goods, so the thinking goes, then it must be because trading partners are systematically undervaluing their currencies against the dollar to uncut American business, suppressing their domestic consumption and, in the process, “stealing” U.S. manufacturing jobs.
These countries then plow the savings created by these huge trade surpluses back into U.S. assets. And that, in turn, pushes the dollar’s value higher, lowers the U.S. cost of capital and enables Americans to consume ever more overseas goods.
Tariffs on imports, Trump’s economic weapon of choice during his first month back in office, are one way to push back against this perceived global slight against American workers.
FLIP-SIDE OF COIN
But there’s an obvious flip-side to this view.
America’s large and rising current account deficit, which captures U.S. net trade flows in goods and services as well as net investment income, has to be matched by an equal and opposite capital account surplus to balance the nation’s books.
These cumulative capital surpluses have been driving the dollar higher for years, juicing American’s stock portfolios and reducing U.S. businesses’ cost of capital.
At last count, the net international investment position (NIIP) – or the net overseas holdings of U.S. assets less U.S. ownerships of non-U.S. securities – was a mind-boggling $23.6 trillion, roughly 80% of annual U.S. GDP.
As Societe Generale’s Kit Juckes wrote last week: “President Trump doesn’t like the size of the US trade deficit, but would he be happy to see the savings that finance that deficit go home?”
CHICKEN OR EGG?
This national accounts approach suffers from the ‘chicken or egg’ syndrome, of course.
It’s not at all clear which comes first – U.S. ‘exceptionalism’ in market scale, growth, innovation and liquidity, which attracts foreign capital, or the flood of capital itself, which results in a chronically overvalued dollar that makes U.S. exports uncompetitive worldwide?
But either way, the Trump team’s current plan for dealing with the issue – taxing imports – is flawed for two key reasons.
First, tariff threats have, thus far, mostly lifted the dollar even more, exaggerating the trade competitiveness problem.
The second problem is that import tariffs do little to address the relentless demand for U.S. assets – the other side of this equation.
To deal directly with that, some experts think you might need to “throw sand in wheels” of cross-border flows, a phrase coined by Yale economist and Nobel Laureate James Tobin almost 50 years ago when positing a “Tobin tax” on currency transactions to tame capital flows.
TOBIN OR TOBIN?
To be sure, Trump officials have not yet started publicly discussing capital controls – or taxes on foreign investment. But economists and investors sympathetic to the administration’s policies are freely batting around the option.
Currency hedge fund manager Stephen Jen at Eurizon SLJ wrote last week that taxing inward investment would be preferable to tariffs if the goal is to raise revenue, as tariffs would never bring in enough revenue to be a true alternative to income tax.
Jen suggested that widening the scope of taxation to international capital flows – in effect a ‘Tobin tax’ on currency transactions – could widen the potential ‘external’ revenue base to 50 times that of the trade in goods.
“There are, of course, obstacles and trade-offs in such taxes on capital flows, but in our view, they are no more daunting or negative than those associated with import tariffs.”
Conceivably, a fractional tax could be the sweet spot if the administration is focused primarily on raising revenue. Applying Tobin’s idea of a 0.0005% tax on currency transactions in a global market that turns over $7.5 trillion every day could raise huge amounts of revenue and likely wouldn’t reduce the transactions or flows.
But is raising revenue really the goal of the Trump administration or is it altering supposedly “unfair” trading relationships? If it’s the latter, then the capital controls would necessarily need to be disruptive to be effective.
And they could be very disruptive indeed. Even the possibility that the U.S. would think about deterring overseas investment could be devastating in an already frothy market. Not only might the dollar fall sharply, but it could take the entire U.S. stock and bond market with it.
So capital controls are an obvious option if Trump truly seeks to upend the global balance of trade – but they would also be the nuclear option.
The opinions expressed here are those of the author, a columnist for Reuters
(by Mike Dolan, editing by Deepa Babington)
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