Of Trade and Capital: A Tale of Two Strategies
Beyond tariffs, capital flow tools are critical to reshaping America’s economy.
By Michael McNair, CFA, analyst and fund manager at a large U.S.-based institutional asset manager focusing on macroeconomics and global trade dynamics
It was the best of times for Wall Street; it was the worst of times for working-class Americans. For decades, Americans watched with growing concern as real wages stagnated, jobs disappeared overseas, and once-thriving industrial towns slipped into decline. Economists assured us this was simply the price of progress—America had moved up the value chain, beyond manufacturing, into a service-driven economy. Meanwhile, our trade deficits widened, our industrial base hollowed out, and government debt soared—trends that have persisted despite varied policy efforts across multiple administrations.
But what if we’ve been going about fixing what ails our economy all wrong? What if these seemingly separate economic challenges actually share a common cause—one that tariffs alone cannot address?
The Trump administration appears to recognize that trade challenges require a more complex approach. A dual strategy is emerging: tariffs to urgently decouple critical supply chains from adversaries, complemented by capital flow tools, such as a capital flow tax and foreign currency reserve accumulation, that target the source of persistent trade imbalances.
The Trump administration’s dual strategy represents the most sophisticated approach to trade in generations. While tariffs are grabbing headlines, capital flow measures may ultimately prove even more transformative in rebuilding American manufacturing strength and rebalancing the U.S. economy.
The Balance of Payments Framework
Most discussions of international trade focus only on the exchange of goods and services. However, this view captures only half the picture. When money crosses borders, it does so in one of two ways: either buying things (trade flows) or buying financial assets (capital flows). These two flows are inextricably linked through what economists call the balance of payments, which can be expressed in a simple but powerful equation:
Trade Account* = Capital Account
Any change in one side of the equation must be matched by an equal and opposite change in the other. When a Japanese pension fund uses its trade earned dollars to invest $1 billion in American tech stocks, U.S. net exports must decrease by $1 billion—despite this transaction having no direct connection to trade in goods and services.
This framework reveals why conventional efforts to reduce the U.S. trade deficit have largely failed: they target only trade flows while ignoring the far more powerful role of capital. Today’s global financial daily currency transactions dwarf goods trade—often by a factor of 100—making capital flows not just a response to trade imbalances, but a primary driver of them. Tariffs and other traditional trade tools address only one side of the equation; lasting change requires incorporating capital flow measures into policy, recognizing that real leverage lies in reshaping how foreign capital moves into U.S. financial markets.
Why America Needs Both Tariffs and Capital Tools
Economists may wince at tariffs as clumsy instruments for balancing trade, but they serve a vital purpose beyond economics: protecting America’s national security through forced decoupling from hostile supply chains.
The uncomfortable truth is that America’s industrial base has become dangerously intertwined with our primary geopolitical rival. Nearly every critical manufacturing sector—from pharmaceuticals to electronics to defense—depends on Chinese inputs. It’s a strategic vulnerability that could prove catastrophic in a conflict. Our trillions in defense spending becomes worthless if adversaries control the components needed to conduct and sustain military operations.
After decades of complacency, we’ve painted ourselves into a dangerous corner. We now have only less bad choices: either endure supply chain disruptions under controlled, peaceful conditions today or suffer potentially catastrophic supply chain failures during a hot war when our economy is under maximum strain.
Tariffs are certainly disruptive, but that disruption serves a vital purpose: forcing companies to rebuild resilient, secure supply chains before a crisis makes orderly transition impossible.
The Economic Case for Capital Flow Tools
While tariffs address security concerns by urgently decoupling U.S. supply chains, capital flow tools directly target the economic distortions driving imbalances. The administration appears to be developing three primary tools:
The U.S. Sovereign Wealth Fund (SWF), which functions as a mechanism to create outward capital flows from the United States, reducing upward pressure on the dollar and making U.S. manufactured goods more competitive.
Reinstating the 30% foreign withholding tax on interest income, which existed until 1984. This policy would make U.S. financial assets less attractive to foreign investors, particularly central banks, reducing capital inflows that drive dollar strength and the trade deficit.
Potential capital controls using the International Emergency Economic Powers Act (IEEPA), which grants the president broad authority over international transactions in response to national security threats.
The administration isn’t just talking about rebalancing trade, it’s assembling the tools to actually do it.
The Withholding Tax: Balancing the Scales
America stands alone among major economies in giving foreign investors a tax advantage over its own citizens. This isn’t just unfair, it’s self-defeating. Reinstating the 30% withholding tax on foreign investments would correct this imbalance while generating massive benefits.
To start, it’s worth noting that this isn’t radical policy, it’s restoration of American normalcy. Until 1984, foreign investors paid this tax just like everyone else. We abandoned it over outdated concerns about tracking international money flows in the digital age—specifically, fears that foreign investors could easily conceal ownership through complex intermediaries and nominee accounts, making proper tax collection difficult.
Second, this policy would generate trillions in revenue, drawn entirely from foreign holders of U.S. Securities rather than domestic taxpayers. For private foreign investors, this wouldn’t necessarily increase their total tax burden. For example, the average statutory top personal income tax rate in Europe is 42.8%. Therefore, European holders of U.S. securities would simply pay 30% to the U.S. government and the remaining 12.8% to their home country. The lost revenue would be borne by foreign governments. Given that most foreign jurisdictions already impose similar withholding taxes on their securities, they would have limited grounds for retaliation. The U.S.’s large negative net international investment position further constrains potential retaliatory measures.
Third, this approach precisely targets a significant driver of our trade imbalances: foreign central banks that currently pay no taxes while accumulating massive U.S. holdings. These institutions deliberately hoard dollar reserves well beyond what’s needed for legitimate currency management, creating artificial capital outflows that mathematically force trade surpluses with the United States. This strategy is effective precisely because these central banks deliberately target their reserve accumulation toward markets like the United States that don’t respond in kind and allow unrestricted capital inflows without reciprocal access or countervailing measures. Yet if we introduce a tax on these holdings, these central banks have no superior alternatives to Treasuries, with European bonds yielding just 2.5% and Japanese bonds a paltry 1.3% compared to our 4.5%. Even if they wanted to sell, no other market has the depth to absorb their massive holdings. Rather than triggering a wave of liquidation, such a policy is more likely to incentivize higher consumption in surplus countries—reducing the trade and savings imbalances that create the need for reserve accumulation in the first place.
Finally, this approach offers strategic flexibility through America’s network of tax treaties with over 60 countries. These agreements allow Washington to selectively reduce tax rates for allies while maintaining them for adversaries and countries using mercantilist policies: the U.S. tax code states that later laws won’t override existing tax treaties unless Congress specifically indicates such intent. This creates powerful leverage to build coalitions for broader economic realignment.
The 30% withholding tax isn’t just good economic policy, it’s the restoration of basic fairness in a system that has been tilted against American interests for too long.
Addressing Common Misconceptions
Critics claim targeting capital flows would spike interest rates, crash markets, and starve America of essential foreign investment. History and economics tell a different story.
Goods, not capital: Dollars entering the United States must either purchase our financial assets or our products. There is no third option. Therefore, every dollar a foreigner spends buying American stocks and bonds is a dollar not spent buying American goods and services.
In fact, those U.S. financial assets represent claims on future U.S. production. Thus, when foreign central banks and investors purchase trillions in Treasury bonds, they’re essentially deferring their consumption of U.S. goods and services to some unspecified future date. Rather than letting foreigners continue accumulating these future claims on U.S. output, the Trump administration’s goal is to see those claims exchanged for current production, creating jobs and higher incomes for Americans today.
That’s why threats to ‘dump US Treasuries’ aren’t threats at all—they’re promises to buy more American exports! If foreigners sold $1 trillion in US bonds, those dollars would ultimately flow back to purchase $1 trillion in American-made goods and services.
Capital flow tools aren’t about restricting trade—they’re about redirecting foreign dollars from Wall Street to Main Street. And that’s precisely what America’s manufacturing heartland has needed for decades.
“America Needs Foreign Capital”: Despite what some critics may imply, America doesn’t face a capital shortage—our banks, markets, and investors already have ample resources to fund every worthwhile domestic investment. Foreign capital flooding into Treasury bonds and stock markets doesn’t enable additional investment that couldn’t happen otherwise.
Instead, it simply replaces what domestic investors would have funded anyway, while simultaneously forcing a corresponding trade deficit that reduces demand throughout the economy. We don’t need Chinese savings to build American factories, we need those dollars to purchase American-made goods.
America’s investment drought stems from insufficient demand, not insufficient capital. And that demand shortage is directly linked to the persistent trade deficits created by those very capital inflows.
“Higher Interest Rates Are Inevitable”: Critics argue that reduced foreign buying of U.S. bonds would decrease demand, inevitably driving Treasury yields significantly higher. This misunderstands how bond markets work. Treasury yields aren’t a purely free market; they reflect expected Fed policy rates plus a small “term premium”—the extra yield investors demand for holding longer-dated bonds. Any pressure on yields from reduced foreign buying would only affect this modest premium.
More importantly, the Federal Reserve holds the power to counteract any unwanted yield increases through bond purchases or “Operation Twist” operations (which does not increase the Fed balance sheet). Any interest rate spike would represent a Fed policy choice, not an inevitable outcome.
Finally, when foreign capital inflows decline, there’s a proportional, corresponding reduction in U.S. debt issuance. If America consumes 100 widgets but only produces 80, we must finance those extra 20 widgets by selling financial assets to foreigners. If foreigners reduce their purchases of our assets, it forces an increase in production relative to consumption, reducing our net borrowing needs.
“Markets Would Collapse”: When European nations liquidated U.S. securities equivalent to 15% of GDP during the 1914 crisis, markets initially declined. Yet within two years, the Dow was up 40%, and earnings were up 150% from pre-crisis levels. Why? Because the dollars previously channeled directly into financial markets first passed through the real economy, supporting stock valuations through dramatically improved corporate earnings rather than merely increased buying pressure. When foreigners stopped buying financial assets and instead purchased U.S. goods and services, these dollars increased American incomes and stimulated a manufacturing boom. This boom created a virtuous cycle: rising corporate profits improved market fundamentals, while higher domestic incomes gave Americans greater capacity to invest domestically.
Redesigning a Broken System
America stands at a crossroads in global trade. For decades, we’ve operated within a system that has failed to function as designed, creating dangerous economic vulnerabilities, and hollowing out our industrial base.
The principal goal of a properly designed global trading system is to allow for temporary trade imbalances, but it should contain mechanisms that automatically reverse those imbalances over time. Under the gold standard, relative inflation rates served as the primary rebalancing mechanism. Later, the Bretton Woods system introduced flexible exchange rates to provide a smoother, less painful way to correct trade imbalances.
But countries have gamed the system so that exchange rates haven’t been allowed to adjust properly to rebalance global trade. America is the only nation in history to run large, persistent trade deficits for over four decades—all while simultaneously seeing its currency appreciate by 350%. This defies fundamental economic principles: where persistent deficits should trigger currency depreciation and automatic rebalancing. The only explanation for this paradox is that the direction of causality has reversed: it’s not American consumption driving our deficits; it’s inelastic foreign demand for American financial assets forcing those deficits upon us.
The persistent imbalances that have occurred over the past 40 years are, by definition, the sign of a broken global trading system and why the administration is justified for wanting to redesign it.
While a strong dollar has its advantages, it’s entirely different to allow the currency to become so overvalued that it suffocates America’s tradable goods sector. This overvaluation has arisen precisely because other countries actively prevent the dollar from depreciating naturally and blocking the currency adjustments that would ordinarily rebalance global trade flows. Far from attempting currency manipulation, the administration’s goal is simply to allow the dollar to fluctuate freely and fulfill its intended economic role: correcting persistent imbalances and restoring competitiveness to U.S. manufacturers.
* The technical identity is: current account = capital account, but we are using “trade account” for simplicity.