ACCORDING to President Donald Trump, money is pouring into America from abroad. The tax reform he signed into law in December means American firms can no longer defer paying taxes on profits left sitting in foreign subsidiaries. The change has led to some uplifting headlines. Apple said that it would make a one-off tax payment of $38bn relating to its past accumulation of $252bn in foreign earnings. Presumably, it will now start to bring this cash home. “Huge win for American workers and the USA!” tweeted Mr Trump. Yet despite the prospect of large-scale profit repatriations, the dollar has been strangely weak of late. Since the start of November, when tax reform began looking likely to pass, the greenback has fallen by about 3%. What is going on?
Start with the fact that repatriations are mostly not true capital inflows. An analysis by Zoltan Pozsar of Credit Suisse finds that, as of March 2017, American corporations had amassed around $2.2trn of earnings in overseas subsidiaries. About half was tied up in illiquid investments such as local firms and factories. Most of the rest—the money that could “come home”—is already in dollar-denominated assets.
Take Apple. In its most recent annual report, it said that its $252bn was “generally based in…dollar-denominated holdings”. According to Mr Pozsar, Apple holds more Treasuries and other government securities than Bank of America does. The same is true of Microsoft. Repatriation makes these funds available for distribution to shareholders, but neither increases demand for dollars nor sharpens the incentive to invest in America. In fact, argues Mr Pozsar, if firms start selling bonds, it could lead to tighter credit.
Even if repatriation is a damp squib, however, America can expect capital inflows in 2018. They will be needed to plug the hole tax cuts have made in the federal budget. Tax reform will increase borrowing by $1.1trn over a decade, according to official projections. In 2019 America’s budget deficit may surpass $1trn, or 5% of GDP. Someone must lend the government this money. American households are unlikely to do so. In December the personal-savings rate was just 2.4%. So the government will probably borrow more from abroad. In other words, the current-account deficit, as well as the fiscal deficit, will rise.
The implication for the dollar of these “twin deficits” is ambiguous, says Zach Pandl of Goldman Sachs. Should the Federal Reserve raise interest rates to stop tax cuts from overheating the economy, America’s bonds will automatically become more attractive to foreigners. The dollar should rise as investors take advantage of higher returns, as when Ronald Reagan cut taxes in the 1980s. Alternatively, foreigners might be enticed to buy American bonds by the prospect of a cheap currency with room to rise. So if the Fed refrains from tightening in response to the fiscal stimulus, the need for more external financing could explain a cheaper greenback today.
The current value of the dollar seems to reflect a mix of both effects, says Brad Setser of the Council on Foreign Relations, a think-tank. Good economic news elsewhere, particularly in Europe, has made investors think twice about where to park their funds. Yet the dollar remains relatively strong by the standards of the past decade, reflecting America’s higher interest rates. On February 27th Jerome Powell, the Fed’s new chairman, told Congress that the outlook for the economy had strengthened since December, in part because of the fiscal stimulus. Markets took this as a sign that the Fed might raise interest rates four times in 2018, rather than three, as previously expected, and the dollar rose.
Capital inflows are awkward for Mr Trump. He has promised to cut America’s trade deficit, which, as a matter of national accounting, goes hand in hand with borrowing from abroad. His best hope is thatgrowth and more domestic saving keep the twin deficits down, at least as a share of GDP. If not, capital flooding into America may not be something he should cheer.
Japan still has great influence on global financial markets
IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.
“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.
This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.
One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).
But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.
Tokyo storm warning
These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.
Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.
What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.
Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.
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