Up To $100 Billion Annual Revenue Potential From the MAC

CDJPA Research Note #4

By Jeff Ferry, CPA Research Director

CPA advocates the Market Access Charge (MAC) as an innovative tool to address systemic dollar overvaluation due to excessive demand from the international capital markets for dollar-denominated assets.

The MAC, which would require congressional legislation, would be a small tax levied on the purchase of every dollar-denominated asset by a non-US person or entity. The MAC would raise substantial revenue for the benefit of the US Treasury. This paper estimates the annual revenue potential of the MAC to be in the range of $19 billion to $100 billion.  The estimates in this paper should be regarded as preliminary indicative estimates and not firm forecasts.

We began by using Federal Reserve data to estimate the current outstanding holdings of US assets by non-US entities. Federal Reserve data shows that as of March 31, 2018, non-US entities held a total of $18.6 trillion worth of US securities (see Table 1). The total is dominated by US equities, accounting for $7 trillion, US Treasury bonds at $5.6 trillion, and corporate bonds at $3.5 trillion.

We exclude real estate and foreign direct investment from this initial analysis because while both types of investment reach significant totals, transactions are typically infrequent. We also exclude interest-bearing bank accounts and loans by American banks to foreign entities. There is no available data breaking out interest-bearing bank accounts from noninterest-bearing. In addition, the transaction volume in these categories is not easy to estimate. We plan to include these assets in a future analysis.

Table 1: US Securities Held By Non-US Entities ($ billions)

We divided the major holders of these dollar-denominated assets into three groups: foreign central banks, sovereign wealth funds, and private investors. These groups have different interests and objectives. Foreign central banks hold international assets as part of their responsibilities to manage national domestic monetary policy and international financial policy. In general, sovereign wealth funds target long-term asset appreciation. Private investing institutions have a range of objectives but in general they target income and capital appreciation in the short and the long term.  According to the US Treasury, foreign central banks and related public institutions held $6.2 trillion of US government debt as at June 2018. Based on examining some published reports by sovereign wealth funds, we estimate that 50% of their total assets or $4 trillion are in US securities. Private investors account for the remainder. Table 2 shows our estimate of the assets and share of each group.

Table 2: Major Non-US Institutions Holding US Securities

Turnover rate is the key variable that determines the value of a fund’s transactions each year. A turnover rate of 100% means that in a year a fund carries out transactions worth the full value of its assets. Investing institutions show a wide range of turnover rates. Typically, a conservative institution might show a turnover rate of 10%-20%, while an aggressive fund might show turnover of 50% to 100%. Very aggressive hedge funds can reach turnover rates of many hundreds of percent, but these are rarely disclosed publicly.

All three types of institutions regard their fund management strategies as confidential and disclose few details. Foreign central banks do not disclose how they manage their reserves. But we can gain limited insight from the information they do disclose. For example in its 2017 annual report, the European Central Bank stated its total assets as of Dec. 31, 2017 were 414 billion euros, equivalent to $496 billion. The majority of that was held in European securities for intra-European monetary policy purposes. The ECB’s foreign exchange holdings totaled€47.5 billion ($57B), of which €36.2 billion ($43.4B) or 76% was held in dollar-denominated assets. The ECB described its objectives this way:

“The ECB’s foreign currency reserves are mainly invested in securities and money market deposits or are held in current accounts…The purpose of the ECB’s foreign currency reserves is to finance potential interventions in the foreign exchange market. For this reason, the ECB’s foreign currency reserves are managed in accordance with three objectives. In order of priority, those are liquidity, safety, and return. Therefore, this portfolio mainly comprises securities with short maturities.” (From ECB Annual Accounts 2017, pg. A8)

Foreign central banks are typically managed conservatively. The ECB discloses that 62.8% of its foreign currency denominated securities have maturities of under one year, meaning there is a steady stream of securities that mature and must be rolled over.  Other central banks such as those of China and Japan are generally viewed as holding large volumes of US Treasuries, primarily in longer maturities, which would lead to lower turnover rates. We therefore estimate a turnover rate of 30% in foreign central bank US assets. Just as illustration, these will typically be transactions in which a bank sells one type of Treasury bill or bond and buys another one, to replace a maturing security, or to take advantage of moves in the yield curve or adjustments to the average maturity of its portfolio. On top of these transactions, which do not change its overall exposure to dollar assets, central banks will also change the mix of currencies held within their foreign exchange portfolio. For example, the international financial experience of the first eight months of 2018 has been the tribulations of emerging economies (Turkey, Venezuela, Argentina) suffering foreign exchange crises, leading to increased demand for the dollar. As major participants in these markets, foreign central banks may have moved to increase their investments in dollar assets to position themselves to gain from the dollar’s appreciation.

Sovereign wealth funds pursue a broader range of objectives with a general long-term perspective. The world’s largest sovereign wealth fund is Norway’s, with $1.06 trillion in gross assets. China Investment Corporation is second with $941 billion in assets. According to the Sovereign Wealth Fund Institute (SWFI), oil and gas related funds account for 54% of the total 2018 assets of $8.02 trillion held by sovereign wealth funds. The remainder, termed “Non-Commodity” by the SWFI, are mainly funds that have arisen as a result of persistent trade surpluses. After China, the largest non-commodity sovereign wealth funds belong to Hong Kong, Singapore, Dubai, and South Korea.

A view of sovereign wealth fund strategy can be gleaned from the annual reportof GIC, the larger of Singapore’s two sovereign funds, with assets of $390 billion.  GIC held $133 billion or 34% of its total assets in US investments as at March 31, 2017. GIC says it “focuses on long-term fundamentals rather than on short-term market price gyrations…long-term investing is not a rigid buy-and-hold approach,” but instead is “underpinned by the discipline of distinguishing price from value. If an asset’s price persistently exceeds its fundamental value, we would tend to sell, and vice versa, even if it sometimes means going against current market sentiment.” (GIC Investment Report for the Year 2016/2017, pg. 12)

GIC does not disclose turnover rate. We estimate a conservative turnover rate of 15% for sovereign wealth funds.

Private investing funds are a much more diverse group, ranging from conservative insurance companies to aggressive hedge funds. Non-US institutional investors do not typically disclose their turnover rates. To gain some insight, we looked at the turnover rates of US-based mutual funds, which do typically disclose turnover rates. Table 3 shows the turnover rates of some of the largest US mutual funds. Based on the data in Table 3, a turnover rate of 30% seems an appropriate estimate for the non-US private investing sector.

Table 3: Leading US Mutual Funds, Turnover Rates

Next we combine our estimates of turnover to produce an estimate of total annual transactions in US securities by non-US entities. The total value of all transactions is $4.36 trillion. Note that although the private investor sector accounts for less than half of the market value of foreign-held US assets, because of its higher turnover rate, it accounts for just over half of the total transaction value. This suggests it exerts greater influence over the value of currencies than the other two sectors. This analysis does not take into account the spot and future foreign currency markets, which are not liable for the MAC tax. Those markets are large and also exert strong influence over foreign exchange values.

Table 4: Annual Transaction Value of US Securities Transactions by Non-US Entities

Next, we apply the Market Access Charge (MAC) to our estimates of transaction value. We look at three illustrative rates, a MAC of 0.5%, 1% and 2%, which could be chosen by the Federal Reserve, the body charged with setting and managing the rate in the current draft bill. The primary purpose of the MAC is to discourage foreign investment in US assets as a means of driving the dollar down towards its trade-balancing equilibrium. In the medium term, we expect the MAC will reduce the total foreign holdings of US securities significantly below the 2017 level of $18.6 trillion. However for the purposes of this analysis, we assume that level does not change. As a transaction-based tax, another effect of the MAC should be to reduce the frequency of transactions and therefore the annual transaction value subject to the MAC., To illustrate that effect, we include scenarios in which transaction volume falls by 25% for each of our selected MAC rates.

The results are in Table 5.  The estimates show that the MAC would produce annual revenue for the US Treasury ranging from $19 billion at the lower end up to $100 billion at the high end.

Table 5. Estimates of MAC Revenue

Conclusion

Our analysis shows that a Market Access Charge applied to foreign purchases of US financial assets could produce revenue for the US Treasury in the range of $19 billion to $100 billion.  This range of estimates demonstrates that the MAC will produce significant revenue, which can be used to benefit US citizens and taxpayers in a wide variety of ways, at the discretion of Congress and the President. A unique feature of the MAC is that it is only paid by foreign entities. No American will ever be liable to pay the MAC.

It must be emphasized that this is a preliminary estimate. We plan to pursue further work to refine these estimates. The addition of more MAC-liable assets could change the revenue estimates. Further study of each sector of foreign holders of US assets is required to better understand their investing behavior. In addition to refining our estimates, further study will enable us to better understand the likely impact of the MAC on investment patterns and movements in the dollar exchange rate.