Donald Trump’s plans include measures to encourage US companies to repatriate $2.6trn in cash held offshore. Bob Swarup argues the policy could cause severe monetary tightening for the rest of the world.
Much has been written of Donald Trump and depending on one’s chosen political ilk, he may well be the Messiah or equally the second coming of Damien. This is not another emotional invective to add to the partisan cesspool. Rather, as befits this site, this is about cash, Trump’s plans for it and the very real potential consequences for us all who care about our own little monetary pools.
Amongst Donald Trump’s ambitious plans to boost the US economy and ignite US GDP, the cutting of US corporate taxes and the repatriation of the offshore cash pools held by US companies looms large and with good reason. Unlike many other countries, the US taxes corporate income globally, though companies can defer paying tax on any offshore earnings until they decide to repatriate that income.
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In an era of globalisation, the march of the multi-national and especially the rise of internet firms like Apple, Amazon and Google, whose businesses are agnostic when it comes to the lines of geography, the result has been a staggering growth in offshore cash pools. According to Congress’s joint committee on taxation, US companies have now parked a remarkable $2.6trn offshore to avoid paying taxes.
Trump’s plan is simple. Enact a tax holiday or amnesty, thereby persuading US corporates to bring much of that money home providing the US economy with a significant multi-trillion dollar stimulus. Financial markets have fallen in love with this notion, particularly as the Federal Reserve moves to raise interest rates nearly a decade on from the last financial crisis. Coupled with the broader tax cuts and increased infrastructure spending mooted by the Trump administration, we have seen a sustained Trumpflation rally since his election victory in November, with the wheels only wobbling recently as people fretted about the timing of it all.
Taxes go down. Domestic investment goes up. GDP goes up. What could possibly go wrong?
As it happens, quite a lot, especially when you begin to consider the second-order effects of the strengthening dollar that would inevitably arise from these policies, as capital flows and investment begins to gravitate towards the US.
The dollar is not the just the currency of the US but also the reserve currency of the world. Almost all global transactions are priced in dollars, for example the price of oil. Whilst outside the US, those cash pools nevertheless represent an invaluable source of liquidity for the rest of the global economy. At its most basic level, the rest of the world needs dollars to engage in global trade. Without a ready supply, global trade may stagnate or even decline, something few would want to add to the heady mix of protectionism already in the ascendant today.
More darkly, the global mountain of debt that almost brought the banking system and world economy to their knees in 2008 has grown to even more gargantuan proportions. Today, global debt is over 60% higher since before the last crisis and greater by $70trn, give or take a few trillion.
Central banks must shoulder a large part of the blame, as quantitative easing and the ultra-low interest rate environment it created over the last decade led to a hunt for yield that fed a dangerous debt addiction. Today, we have a world that is saturated with debt and where financial assets of every shade and stripe are expensive by any metric. This is a fragile system that is more, not less, vulnerable to shocks.
In this environment, a scarce and rising dollar is a significant source of strain. The Federal Reserve has already begun to raise interest rates and hinted at the future reduction of its bloated balance sheet, as it looks to start the long journey of unwinding QE. That is monetary tightening and for the rest of the world, will be expressed as a rising US dollar.
Much of the debt issued by emerging markets in recent years was dollar denominated, and more widely, alongside the offshore cash, there is an offshore pile of debt denominated in US dollars of about $10trn today. This debt pile requires dollars to service and eventually repay. A strengthening dollar makes that harder as more local currency is needed continually to service the same amount, eroding the credit quality of the borrowers.
Throw in a repatriation and the risk here is that you suddenly introduce a further sharp restriction in the supply of dollars globally. This would cause the dollar to rally hard, and the cost of accessing dollars for global borrowers would rise sharply. For the rest of the world, this is a far greater monetary tightening than anything their own central banks might have in mind.
In the end, this is only bad for economic growth and financial markets. A credit crunch in emerging markets could soon spiral out of control, while a rapidly strengthening dollar would also sharply increase input costs for individuals and companies, notably energy, straining those balance sheets.
We have a business cycle today that is mature, a global economy that is struggling for growth and a debt pile across consumer and corporate that is unparalleled.
This is not a strong position from which to fight contagion. Given the levels of asset prices, there is also the risk of turning sentiment as trust erodes.
What may seem an obvious win for the Trump administration may only make life difficult for the rest of us and eventually for the US as well. As we wade through the murky uncertainties of today, understanding and monitoring these distant currents will be critical to maintaining the security of what we have tomorrow.
Dr Bob Swarup is Principal at Camdor Global Advisors, a macroeconomic, investment and risk advisory firm focused on helping local authorities innovate to meet today’s unique challenges. He may be contacted at firstname.lastname@example.org.
*This article was first published on 19 April, 2017, and republished with amendments on 4 May following statements made on tax policy by the Trump administration.