With the state of the US economy being one of mixed emotions, with good internal growth and yet ever suffering trade and current account deficits, the US could desperately do with a much needed shot in the arm. One of the main problems with the US growth pattern is that it is all debt financed, and a major imbalance in the trade deficit means that the US is leading itself even further into financial dependency on rival nations, who could theoretically call in the debts at any time. In addition to this we have a massive case of overstretch, with the Iraqi conflict. This is a campaign that is costing the $5bn on a monthly basis – equivalent to their current trade deficit increase from December 2004.
None of this looks like changing in the near future, and therefore none of it induces any level of confidence from the financial markets. The US currency has lost a third of its value against the euro over the last two years; the dollar’s fall is as much a result of simple economics as it is complicated fundamentals. The US is producing too little and spending too much.
The global business outlook is one of desperate uncertainty and traders and analysts alike are all but convinced that the dollar’s decline will continue well into 2005. A lot obviously depends on the US Congress with George ‘W’ entering his second term, getting the US economic house in order must be his priority. With the debts to Japan and China still rising and consumer spending also on the increase, interest rate decisions will be key in building global confidence. How the US manages its trade deficit will also be of immense importance.
Boosting Capital Inflow
One very stimulating piece of legislation designed to give the US a much-needed capital inflow boost is the introduction of the Homeland Investment Act – more correctly called the American Jobs Creation Act 2004, under which foreign earnings may be repatriated to the US at a low rate in a one-off tax break.
As with a lot of major corporations, it is often beneficial to leave funds offshore to avoid excessive tax implications. For years, American companies have indeed kept much of their offshore earnings in exactly that place – offshore. This was because the US tax code, which taxes US multinational companies on worldwide income, creates a disincentive for the repatriation of offshore funds. As a result, many large US multinationals have accumulated large amounts of income in overseas operations and have understandably been reluctant to bring that cash home.
The new legislation removes a huge impediment to bringing back offshore profits. The legislation provides US-based businesses with significant new investment resources, and it aims to accomplish this goal using the corporation’s, rather than the taxpayer’s, money.
The act allows US corporations to repatriate funds that are in excess of the average foreign dividends paid over the last three of five years at a more favorable tax rate of 5.25 per cent; in either the first taxable year for the firm (fiscal year 2005) or the last taxable year (fiscal year 2004) for the firm. This tax rate is a significant reduction from the current tax rate of 35 per cent. Whether or not a firm decides to repatriate their funds will depend upon whether they see more attractive investment opportunities with higher return rates abroad or in the US.
The bill introduced in the senate – the product of the efforts of a coalition of 20 or so US MNCs, among them Apple, Eli Lilly, Intel and HP – would give US MNCs a limited period of time during which they can repatriate those offshore funds without the usual tax effects.
The bill will have two main effects. On the one hand it is estimated that the bill will encourage the inflow of upward of $300bn in cash into the US, providing a much-needed ‘shot-in-the-arm’ to the anaemic US economy. The second effect would be to resolve a tax/treasury issue that’s been haunting US companies for years: how to bring back to the US cash that’s accumulated in other countries? That issue has become more visible lately, against the backdrop of weak US earnings and growing investor/analyst focus on cash and liquidity.
This legislation, for one year, removes the disincentive to invest in the United States, enabling US businesses to return up to $400bn of foreign cash to the US in the year following enactment. Among other things, these funds could be used to:
- Build new plants in the US,
- Buy equipment,
- Fund and conduct research in the US,
- Fund new ventures, and
- Create and retain US jobs.
The private sector will be able to do much more to stimulate the US economy when the barriers to using their offshore earnings are reduced.
Billions in foreign subsidiary income are invested and accumulating abroad instead of within the US where it is needed. The cash, which most experts believe would otherwise never make its way into the US, would provide an immediate stimulus to the US economy, “It’s the answer to my prayers,” commented the treasurer of one US MNC, upon hearing of the proposal, and echoing the sentiments of many US-based treasurers.
Many of the US companies and trade associations with funds abroad are greatly encouraged by the progress the US economy made in 2003 and applaud the actions taken by the Congress to make this progress possible. They also share the commitment to policies that will build on this recovery, and create a climate of strong job growth, capital investment and entrepreneurial innovation.
This would draw in hundreds of billions of dollars in private investment for the US economy, enabling US companies to rebuild at home and create new and better jobs within the United States.
It is anticipated this will achieve:
- More than 650,000 additional jobs in 2005,
- $75bn of deficit reduction in the first 5 years,
- Increased GDP, peaking at an additional 0.7 per cent – 0.9 per cent in 2005,
- Increased business capital spending, peaking at $78bn in 2005.
Given these anticipated achievements, this legislation has extraordinary potential to energize US economic growth and job creation, as well as to enable US companies to stay ahead of the curve and succeed in a worldwide economy.
Respite For The Dollar
This helps to alleviate two of the major factors grappling thedollar at this point – a weak labor market recovery and the growing current account deficit. The government’s goal is to encourage these firms to recycle their repatriated dollars domestically in investment opportunities, which will help boost jobs and overall economic activity. With anywhere between $200-400bn dollars expected to be repatriated, respite may be insight for the dollar.
But there are serious stumbling blocks. Funding the deficit is a major issue for the US dollar. With a current account deficit of approximately $500bn and growing, the US needs to continually attract capital to fund the deficit. According to the Treasury International Capital flow data, influx of foreign investments has been gradually shrinking.
Although the expected repatriation is between $200-400bn, only about 50 per cent of that is estimated to be denominated in foreign currency, which equates to a flow of approximately $100-200bn. Approximately half of that is estimated to be denominated in euros. The absolute number is pretty impressive and should be relatively positive for the US dollar. However, the only thing to keep in mind is that the flow will be dispersed over the course of a year. With $1.9trillion in daily turnover, the gradual repatriation could be absorbed into normal daily volume.
Ultimately even if it is difficult to quantify the amount of inflow expected from the legislation, it is at the very least dollar neutral to modestly dollar positive. The immediate effects in the dollar within the FX markets depend largely on whether the profits repatriated, are done available in dollars or that they have to be transacted from another currency, such as euro.
Impact From Capital Inflow
The effect of this money being returned via a cross rate, such as euro/dollar, would be huge, but not conclusive to changing the dollar sentiment. Such change would come from the impact on the US economy from the capital inflow. The funds repatriated back into the US would be reinvested, the increased business spending could provide the US economy with the stimulus that it needs to boost growth.
US Recovery Back on Track
According to a Calyon report, it is estimated that the creation of one job requires between $50,000 to $100,000 in business investment, so $200-400bn should be equal to over 4 million jobs. Although this is a rudimentary estimate that is certainly too optimistic, if the bill is successful in attracting inflow, not only will that boost the labour market, it would also eventually lead to increasing confidence and consumer spending. A stronger economy, a stronger labour market, could be just what the US economy needs to get the recovery back on track.