by Ambrose Evans-Pritchard
September 9, 2017
Donald Trump’s appetite is whetted. He knows that American companies have stashed trillions of dollars overseas in what amounts to the greatest cash reserve in the world.
Apple has $257bn parked abroad beyond the reach of the Internal Revenue Service. Alphabet (Google) has $126bn, Microsoft $84bn, Cisco $68bn, and Oracle $59bn. The US Bureau of Economic Analysis estimates that total retained earnings outside the country have mushroomed to $4 trillion.
The President is determined to lay his hands on this money, or at least to divert it back into the US economy. The latest briefings from Washington suggests that the White House is preparing ‘mandatory’ action as part of his tax reform, unlike the previous voluntary attempts to lure back money through tax holidays.
If Mr. Trump succeeds, these repatriated capital flows will have a volcanic impact on the US dollar, Wall Street, and the global financial system, with big winners and big losers.
Companies leave the money abroad because US corporate tax rates are the world’s highest, touching 39% in some US states. Their overseas subsidiaries pay (lower) taxes in host countries – very low for Apple in Ireland. The residual US liability is triggered only if profits are sent home.
John Shin from Bank of America says a big chunk of this cash is in other currencies. The funds would have to be converted on the exchange markets.
When this happened following the ‘tax holiday’ in 2005 it caused the dollar index (DXY) to rocket by 15% over twelve months, reversing the secular dollar slide of the era. This time the sums are much larger, the tidal force that much greater.
Mr. Shin’s survey of 300 companies found that half kept at least 80% of their overseas money in foreign exchange, an astonishingly high number. The Congressional Research Service thinks just 46% is in US-denominated assets.
Technology giants undoubtedly hold more in dollars but the implication is clear: there may be a stampede into US currency, whatever Mr. Trump says about the virtues of a weak dollar. He would be overwhelmed by his own policy. Whispers of a trillion dollar conversion are doing the rounds.
Mr. Shin discovered that most companies have no plans to invest repatriated funds in the real economy – as Mr. Trump hopes – but rather for “paying down debt” (65%), “share repurchases” (46%), or “M&A” (42%).
This is worth pondering. A $4 trillion flood would cause US corporate debt issuance to dry up and would – ceteris paribus – send Wall Street equities into a parabolic rally akin to the dot.com blow-off in 1999.
Normally one might wish to batten down the hatches at the current late stage of the economic cycle, but the politics of Mr. Trump’s Washington make the denouement of this cycle wildly binary.
It would be very bad news for those on the wrong side of the global dollar trade. David Bloom from HSBC says that repatriation could have seismic effects even if the money is already in US currency abroad.
Shifting it to the US for other purposes would drain dollar liquidity from offshore markets, tightening the supply of oxygen for corporate credit in Asia, Latin America, and the emerging world. The bigger the volume, the greater the risk of repeating the 2013 ‘taper tantrum’ that shook the emerging market.
The nagging worry is that this could gather force just as the US Federal Reserve pulls the trigger on ‘quantitative tightening’ and starts to unwind its $4.4 trillion balance sheet, draining yet further dollar liquidity.
And not to be forgotten, the US Treasury will have to rebuild its cash balance from near zero to a $500bn target once the federal debt ceiling is lifted this Autumn. This too is a form of tightening.
We have the potential for a perfect dollar storm – a Hurricane Harvey in the exchange markets – ripping through a global financial system that has never been more leveraged to the US dollar.
Yet currency analysts and hedge funds are mostly positioned for the exact opposite. They have written off meaningful action from the White House on tax reform this year, betting on a slow, relentless slide in the ‘Trump dollar’.
Nomura expects the euro to reach $1.40 over this cycle, arguing that the dollar’s fortunes are moving from “feast to famine.” It says the muscular Obama dollar peaked in 2015 and the “multi-year downtrend” is underway.
Didier Saint-Georges from Carmignac sees the end American hegemony altogether as Mr. Trump fritters away US leadership. “The dollar is under threat. We are witnessing something unprecedented: a convergence of economic and political factors severely questioning the US dollar’s status as the world’s dominant global currency,” he says.
My own view is in polar contrast. America remains the scientific superpower. There is no challenger: Europe is in demographic decline; China has failed to grasp the nettle of reform under Xi Jinping and may slow to 2% growth rates by the early 2020s.
Needless to say we have to get through September and October of this year first. It is always possible that querulous Republicans will cause a the federal government shutdown. The House Freedom Caucus may block efforts to raise the $19.8 trillion debt-ceiling before the money runs out in mid-October, precipitating a technical US default.
What that would mean is anybody’s guess. “A shutdown combined with failure to raise the debt limit would likely be more catastrophic to the economy than the 2008 failure of Lehman Brothers,” says Standard & Poor’s.
Amid all the noise, the “big six” congressional leaders have been working with the US Treasury and the White House to thrash out a package on tax reform. Outlines will be circulating within weeks. The drafting is being left to the House Ways and Means Committee and the Senate Finance Committee. Mr. Trump has learned his lesson from the health care debacle.
Failure to repeal Obamacare is no template for the battle over tax reform in any case. The issue has different contours. It is easier to cut taxes than it is to solve the Rubix Cube of US health care.
While the Republicans are prone to ideological fist-fights, they control both Congress and the White House and will be held to harsh account in the 2018 mid-term elections if they prove incapable of converting a monopoly of power into legislation. The Republicans need an ‘easy win.’
By November markets may have moved on from today’s Trumpian dramas to a radically different narrative: an impending cut in federal corporation tax from 35% to 20% or so, and middle class tax cuts across the board. Mr. Trump is already on the campaign trail pushing his reform.
“If we’re going to keep momentum going and allow the economy to truly take off as it should, it is vital that we reduce crushing tax burden on our companies and on our workers. This is more than just tax reform. This is tax cutting,” he said this week.
The President too needs an easy win. If he secures what he wants – or anything like it – the stimulus effects will turbo-charge a US economy already hitting a labor shortage and capacity constraints. The Fed will have to slam on the monetary brakes. The international financial system will rock violently on its dollar axis.
Write off Mr. Trump at your peril.