Escolar Documentos
Profissional Documentos
Cultura Documentos
AGAIN
SUMMARY
INTRODUCTION
This article looks at two topics covered on the White House website: improving
employment and economic growth through tax reform and renegotiating trade. This
article first looks at the impact of high valuations on future returns, why economic
growth has slowed over the past several decades, that entitlements set in motion
during high growth periods are unsustainable during slow growth, the direction and
impact of debt, why companies are moving abroad, the impact of tax reform and
fiscal stimulus, the importance of trade, and likely reforms. The topics are complex
so I draw heavily on research from many sources. Hopefully, I got most of this right
and apologize for any errors.
The base case for the next decade is provided by the Congressional Budget Office
(CBO) Outlook. [I]n CBOs view, there is a two-thirds chance that the average
growth rate of real GDP will be between 0.7 percent and 3.2 percent over the next
five years. The CBO projects that the Federal Funds rate will rise to 1.8 percent by
the end of 2018. Interest rates on the 10 year treasury are estimated to rise to 3.4
percent by the end of 2020. The budget deficit will increase to $1T (trillion) by 2024.
Federal debt held by the public will increase by $9T. The increase is due mostly to
Social Security and Medicare and higher interest rates. The CBO sees that the rising
debt will cause increased spending on interest payments, reduced total saving in
the economy, fiscal responses will be less effective and increases the risk of a fiscal
crisis. (Source: An Update to the Budget and Economic Outlook: 2016 to 2016 by
the Congressional Budget Office, 2016)
The International Monetary Fund has raised the U.S. economic growth forecast by a
half a percent to 2.3% this year and 2.5% next year based on expected tax cuts and
increase infrastructure spending. Both the IMF and World Bank warn that restrictive
trade policies may negatively impact global growth. (Source: A Shifting Global
Economic Landscape: Update to the World Economic Outlook by Maurice Obstfeld,
The World Post, 2017).
DEFINITIONS
Current Account: consists of the balance of trade, net primary income or factor
income (earnings on foreign investments minus payments made to foreign
investors) and net cash transfers that have taken place over a period of time.
Capital Account: (also known as the financial account) reflects net change in
ownership of national assets.
Source: Wikipedia
The relationship is the Current Account = - Financial Account = Savings
Investment
Balance of Payments: The Current and Capital Accounts make up the balance of
payments. The sum of the balance of payments should be zero.
Net International Investment Position (NIIP): a nations stock of foreign assets
minus its foreign liabilities and the value of overseas assets owned by a nation
minus the value of domestic assets owned by foreigners. NIIP includes overseas
assets and liabilities held by a nations government, the private sector and its
citizens. A negative NIIP figure indicates that a nations foreign liabilities exceed its
foreign assets, while a positive NIIP figure indicates that its foreign assets exceed its
liabilities. These may be the result of claims on assets instead of loans.
Source: Investopedia
Gross Domestic Product = Consumption + Business Investment + Government
Spending + Net Exports
The next chart shows that Quantitative Easing (QE, green) increased reserves
balances held at the Federal Reserve. Interest rates on government bonds in the
U.S. paid less than in the Eurozone (Spread between U.S. and Euro Area, blue) which
put downward pressure on the exchange rate (red) for the dollar. QE has been
unwinding, interest rates paid on government bonds is now higher in the U.S.
relative to the Euro Area and the exchange rate has been rising for the past couple
of years. The higher exchange rate makes U.S. exports more expensive.
My Investment Model shows signs of improvement since mid-2016. The Fed targets
are in range for unemployment (below 5%) and inflation has risen steady (now
above 2%). The economy is growing slow and steady with the 2016 Q4 first
estimate of real GDP at 1.9% YOY. The NY Fed forecasts 2017 Q1 growth to be 2.7%.
I built my Investment Model to vary my allocation based on the business cycle. It
uses 29 main indicators consisting of nearly 100 sub indicators. My minimum stock
allocation is set to 20% and the indicator has increased over the past six months
from 20% to 45% as the economy shows signs of improvement. I remain cautious
until the euphoria of the Trump win fades.
SECULAR MARKETS, VALUATIONS AND INTEREST RATES
Vanguards 2017 Global Economic and Investment Outlook states their belief that
without the driving force of demographics and consumer debt growth that 2%
GDP reflects current long term growth prospects. Vanguard's outlook for global
stocks and bonds remains the most guarded in ten years, given fairly high
equity valuations and the low-interest-rate environment. We continue to believe
that global bond yields will not increase materially from year-end 2016 levels.
Vanguard estimates the risk of Recession or Stagflation in the short term to be 30%
with a 35% probability of a cyclical acceleration. (Source: Vanguards 2017 Global
Economic and Investment Outlook)
Gary Shilling recently said on Bloomberg television that the Federal Reserve has
been overly optimistic about economic growth and raising interest rates. He expects
that there will be massive stimulus but that it will take a couple years for it to be
approved, implemented and have an effect. (Listen to Gary Shilling: Fed Will Fall
Short of Rate Targets on Bloomberg)
I put the next chart together to look at historical growth trends in productivity and
the real economy by decade. Both have been declining post-WWII. Tax reform, trade
policy and stimulus will not fully reverse this 70 year secular trend. There will be
short term cyclical spurts.
The economies of the world are slowing along with the U.S. as shown below. S&P
500 companies get about 45% of their revenue from outside of the US. Slow growth
outside of the U.S. is negative for the U.S. over the long term.
Source: World Bank, Gross Domestic Product for World [NYGDPMKTPCDWLD], retrieved from FRED, Federal Reserve
Bank of St. Louis; U.S. Bureau of Economic Analysis, Gross Domestic Product [GDPA]; chart shows
[NYGDPMKTPCDWLD] - [GDPA]
From 1986 through 1999, while world GDP growth was slowing in the low single
digits, real world foreign direct investment grew nearly 18%. About 90% of U.S.
exports and imports flow through a U.S. multinational corporation with nearly half of
the U.S. trade occurring between affiliates of the same multinational corporation.
(Source: Foreign Direct Investment Behavior of Multinational Corporations by
Bruce A. Blonigen, NBER, 2006)
Marc Levinsons Extraordinary Time: The End of the Postwar Boom and the Return
of the Ordinary Economy describes the 1960s and 1970s as characterized by post
WWII boom, high regulation, high taxes, ending of the Bretton Woods Agreement,
switching to floating exchange rates, OPEC oil embargo, high inflation, and low debt
levels. One term he applied during that time period is of the Welfare State where
high taxes needed to support social programs enacted in better times were
assumed to last. He makes the point that during certain time periods, factors such
as technology or education have improved productivity, but these circumstances
are not due to temporary stimulus. These booms are largely the result of the private
sector which take many years for new technologies to impact productivity and
cannot easily be influenced long-term by governments. Mr. Levinson says ordinary
performance more accurately describes our current slow growth than secular
stagnation. (To listen to a Financial Sense podcast with Marc Levinson click here:
Marc Levinson on An Extraordinary Time: The End of the Postwar Boom and the
Return of the Ordinary Economy, Sources: Every U.S. President Promises To Boost
Economic Growth. The Catch: No One Knows How, and Why the Economy Doesnt
Roar Anymore).
Demographics
The U.S. population growth was high following WWII, but has fallen in half. This will
contribute to slower growth and the return to ordinary performance. Increasing
immigration restrictions will have benefits, but also adds to the headwinds through
less population growth and reducing the availability of low cost un-skilled labor.
Population Growth and Birth Rate
The world population growth rate peaked in 1962 at 2.1%. The projected growth
rate in 2100 is expected to be near zero. (Source: World Population Growth). Since
population growth is a primary driver of economic growth, it will slow.
Arable Land per Person (hectares per person)
The next chart shows investments and research and development as a percent of
GDP. R&D increased until the early 1960s, declined in the 1970s, received a boost
in the Technology boom and has declined afterwards. Investment increased as a
percentage of GDP until the early 1980s and has since declined. There was a
temporary in R&D increase during the Technology and Housing booms.
Investment and R&D
Income Inequality
The slower U.S. growth since 1973 has been accompanied by rising income
inequality and by a stagnation of middle class incomes. The reasons often cited for
income inequality are pro-capital tax reform, declining high paying jobs such as in
manufacturing, decline in labor unions, opportunities brought about by new
technologies, fiancialization, globalization including increased competition and
immigration of low skilled workers, shifting from low-skilled jobs to higher skilled
jobs such as information technology, rising historical real estate and stock market
returns.
(Source: Income inequality in the United States, Wikipedia)
Globalization
The Bretton Woods system of fixed exchange rates constrained nations to maintain
balanced trade. When it ended in 1973, exchange rates were allowed to float. The
chart below shows the Current Account/GDP (blue) compared to the trade weighted
dollar (red, inverted scale). The recovery from the 1981 global recession and U.S.
budget deficit led to higher interest rates (through 1984) to attract capital. The
result was a 40% rise in the dollar exchange rate from 1980 to 1985. This helped to
increase the trade deficit. (Source: The United States Trade Deficit, by U.S.
Department of State, 2016)
Education
Education levels have been increasing for many years and will not have the same
strong impact on productivity as it did post WWII. The next chart shows that
employees with some college has grown from 52% as a percent of the work force in
1992 to 68% currently.
Employment by Education
The Future of North American Trade Policy: Lessons from NAFTA conducted by
Boston University with participants from Canada, Mexico and the U.S. found that,
Since 2000, however, North American manufacturing has shown a
competitiveness problem. The region as a whole has lost more than one-
quarter of its manufacturing jobs, and the downward trend predated the
current recession. The report also found that NAFTA has done little to create jobs
and stem the migration of people.
The chart below came from the Pardee Center Force Report on NAFTA. It shows that
there has been a decline in manufacturing jobs across the region, lending credence
to the claim that automation is the cause of much of the loss of jobs or that the
North American Region has lost jobs to overseas countries.
Manufacturing Employment, NAFTA Region
Ben Bernankes quote from April 2010 in The Seeds of Destruction is worth
repeating:
To avoid large and unsustainable budget deficits, the nation will ultimately
have to choose among higher taxes, modifications to entitlement programs
such as Social Security and Medicare, less spending on everything else from
education to defense, or some combination of the above. These choices are
difficult, and it always seems easier to put them off-until the day they cannot
be put off any more.
Below is the projected revenues and outlays for social security. Large increases in
outlays will start this year. Benefits will have to be reduced around 2029 unless
something changes. They estimate that Social Security and Major Health Care
Programs as projected will grow from 10.4% of GDP in 2016 to 12.6% in 2026.
(Sources: Financial Sense: The Imminent Multi-Trillion Dollar Surge In Social Security
& Medicare Costs by Daniel Amerman and Congressional Budget Office)
To put this in perspective, social security, Medicare and Medicaid, and other social
benefits have grown from 5% of GDP in 1960 to 15% now and as the previous CBO
chart shows, are expected to continue growing to 2030.
Navarro and Hubbard favor increasing growth to reduce the burden of social
benefits. They suggest exempting capital gains, dividends and interest for
individuals from taxes and allowing corporations to expense capital investment to
reward saving and capital investment. They argue that reforms to structural
imbalances of overconsumption, underinvestment, and excess government
spending and chronic trade deficits can improve long term growth that will increase
the rate of growth as an alternative to those suggested by Mr. Bernanke.
To resolve the Social Security spending gap, they propose changing the index used
to index benefits from wages to prices because wages typically rise faster than
prices. The Wage Index used by Social Security has increased at an annual rate of
4.58% from 1955 to 2014 while the Consumer Price Index for All Items has
increased at a 3.76% rate. They also propose raising the retirement age to reflect
the longer life span. As shown below, the percent of the workforce aged 55 and
older has doubled in the past 16 years. People work longer because they are able
to, want to, or have to.
Navarro and Hubbard propose shifting the focus of the Affordable Care Act from
expanding coverage paid for with increased taxes to cost containment. Instead of
fee-based reimbursement they propose support focused on lower-income individuals
and less support for the more affluent. Another key focus is to shift from expensive
employer provided insurance programs to using pre-tax dollars for the consumer to
be more sensitive to health care spending. Health Savings Accounts seem to
accomplish at least part of this as a tax-advantaged savings account for high
deductible health plans.
The Congressional Budget Office lists 115 ways to reduce the deficit. Over a half
trillion dollars of potential savings over the next 10 years are listed for Social
Security including using alternative measures of inflation for indexing, index to
average prices instead of earnings, reducing benefits for new beneficiaries, and
eliminating supplemental benefits. Other options are to convert assistance for
lower-income people into smaller block grants to states, eliminating concurrent
payment of retirement pay and disability compensation to veterans and tightening
eligibility for the Supplemental Nutrition Assistance Program. To reduce
discretionary spending, the CBO lists reducing the military, funding for the
International Affairs programs, eliminating Head Start and the space programs. To
increase revenue, the CBO lists imposing a 5% Value-Added Tax (VAT), limiting
itemized deductions and deductions of state and local taxes, imposing a greenhouse
gas emissions tax, increasing payroll and social security taxes, taxing financial
transactions and increasing excise taxes. (Sources: Congressional Budget Office and
The Cost Of U.S. National Debt by Jeff Klearman, 2016)
I believe the solution to entitlements lies in encouraging more savings as discussed
in the next few paragraphs. The 401(k) was created in the Revenue Act of 1978 to
supplement retirement. By 2013, there were 89 million participants with $4.5T in
assets. David Dayen points out that the gradual retirement of workers receiving
defined-contribution plans instead of defined-benefit plans is a slow moving time
bomb because people are not saving enough. (Source: The Retirement Revolution
That Failed: Why the 401(k) Isnt Working, by David Dayen, 2016)
Monique Morrissey wrote a great article analyzing retirement savings plans. The
chart below shows the reliance on social security for low income people 65 and
older and the importance of working longer and having higher savings for higher
income people. (Source: The State of American Retirement by Monique Morrissey
at the Economic Policy Institute, 2016)
Saving for retirement is a lifetime of choices for many people such as working
overtime, going to college, participating in savings plans, increasing their savings
rate, taking that vacation, buying that latte instead of brewing a cup at home,
buying a new or a second car, changing jobs, or going to the lounge after work.
Reasons often given for not saving for retirement are not making enough money,
saving for college, expectations that social security will cover retirement costs,
expected lower expenses in retirement, lack of knowledge of investing, its too late
to start, paying off debt, there is plenty of time to start, my employer doesnt offer a
plan, my parents died young, planning on working longer, being too busy,
expectations of inheritance, expectations of successful career, reliance on home
equity, dire expectations of the economy, current spending desires, expecting
employer plans to suffice. AON Hewitt conducted a study of savings plan in 2014.
Savings plans with automatic enrollment have a participation rate of 85% while
plans without automatic enrollment have a participation rate of 62%. Nearly a
quarter of the participants have borrowed on average nearly 20% of their balance.
(Sources: 2014 Universe Benchmarks Measuring Employee Savings and Investing
Behavior in Defined Contribution Plans by AON Hewitt and Americans dont save
enough. Is this how we change their minds?, by Allison Schrager, Quartz, 2016)
AON Hewitt offers suggestions on how to increase participation, savings rates,
investment returns and final savings. These include more automatic enrollment,
increasing the contribution to receive the employer matching contribution, adding
the Roth option, and increased target communication to participants. To improve
investment returns, they advise reviewing the fund options, providing advisory
services, and providing lifetime income options. They also advise limiting access to
the funds through loans. I favor the Australian system which invests 9.5% of wages
into individual accounts.
DEBTOR NATION
Since 1982, Federal Total Public Debt has risen from $1T to nearly $20T now as
interest rates on the 10 year Treasuries fell from 15% to under 2% in 2016. Interest
payments on this debt have climbed to $350B (FRED). Because of lower interest
rates, interest payments have fallen from 15% of Government Total Expenditures
down to 7.5%. As interest rates normalize closer to 4% the cost of interest
payments is going to rise competing with other expenditures.
The Net International Investment Position to GDP ratio and current account to gross
domestic product are measures of borrowing constraint.
There have been at least 73 companies that have moved headquarters overseas
since 1983. Since the start of 2000, 59 companies have moved headquarters
abroad. Of the 38 companies with revenues shown, this represents $750 billion in
revenue. Fifty-six of these companies have moved to Bermuda, Cayman Islands, or
Ireland. (Source: These are the companies abandoning the U.S. to dodge taxes, by
Danielle Douglas-Gabriel, The Washington Post, 2014)
Referring to tax laws for international companies, President Obama said, A lot of
its legal, but thats exactly the problem, its not that theyre breaking the law. Its
that the laws are so poorly designed. The U.S. top corporate tax rate is 35 percent
compared to 20 percent for Britain and 12.5 percent for Ireland. In addition, U.S.
based companies are taxed on global profits when they repatriate the money home.
This has resulted in over two trillion dollars in cash accumulated overseas by U.S.
multinational companies. (Sources: Obama administration cracks down on
companies moving abroad for lower taxes and Burger King-Tim Hortons deal: 5
questions answered, U.S. Companies Are Stashing $2.1 Trillion Overseas to Avoid
Taxes, Whats Driving American Firms Overseas)
Average and top tax rates can be misleading. There may be tax loopholes that
reduce the taxes that fall in the top tax brackets. However, high tax rates impact
the more profitable companies. Lance Roberts points out that according to the
Government Accountability Office the average tax rate paid by U.S. corporations is
about 12.5% even though the top rate is 35%. When state and local taxes are
added, the average taxes paid by corporations is 16.9%. (Source: 3 Things: Policy
Hopes, Puppies And Rainbows, by Lance Roberts, Seeking Alpha, 2017).
The chart below shows that Federal tax receipts on Corporate Income as a percent
of profits and as a percentage of national income has been declining since the
1950s. The trend upward since 2009 matches what is reported by the companies in
the table above for S&P 500 companies.
Of the cash held overseas, Goldman Sachs and others point out that about 45% of
corporate cash is used for stock buybacks and dividends and a tax repatriation will
likely increase these purchases. The remainder would likely go to acquisitions, R&D
and capital investments. Secondly, less than half of the two trillion dollars is likely to
be repatriated with the rest used to finance overseas operations. Some analysts
believe that tax holidays encourage these companies to relocate outside of the US.
The profits of offshore subsidiaries can be invested in U.S. treasuries and corporate
stock without being repatriated. Without a tax holiday, U.S. firms are now
repatriating about a $100B per year. (Sources: Goldman: How Corporations Will
Spend Their Huge Piles of Overseas Cash, Repatriation Tax Holiday Would Lose
Revenue And Is a Proven Policy Failure, Offshore Corporate Profits: The Only Thing
Trapped Is Tax Revenue
The U.S. has a high top corporate rate, but as shown below, corporate taxes as a
percentage of GDP in the U.S. have been lower than the average of the OECD
countries since the 1980s. Again, the difference is narrowing since 2009. Notice the
tax reforms of the 1980s reduced the U.S. tax burden on corporations.
Source: OECD
As a starting point for discussing taxes, the following chart shows the sources of tax
revenues. Corporate income taxes are small compared to personal taxes and state
and local taxes. Total U.S. tax is 26% of GDP compared to 34% for developed
countries. The U.S. collects 48% of its revenue on income and profits compared to
34% among developed countries which tend to use taxes on goods and services (ie
sales and VAT taxes) more than in the US. (Source: Tax Policy Center). The average
combined payroll tax (employee and employer) rate in the U.S. is 15% while the
combined rate in the OECD was 23% percent. The total tax burden for U.S. workers
is 31.7% compared to 35.9% for the OECD countries. (Source: Tax Foundation)
Ben Bernanke recently wrote, referring to potential fiscal stimulus that, its not
clear that the near-term macroeconomic effects of fiscal changes will be large, even
if major legislation passes. He points out that much of the proposed tax cuts will
benefit the wealthy and not likely to benefit growth of consumption. He adds that
higher interest rates and stronger dollar will have an adverse effect on fiscal
changes. (Source: The Fed and Fiscal Policy, by Ben S. Bernanke, Seeking Alpha,
2017)
John B. Taylor argues that discretionary countercyclical fiscal stimulus is not very
effective and may actually be destabilizing. Instead he argues that higher economic
growth requires tax, budget, regulatory and monetary reform. He states there have
been fiscal stimulus programs implemented in the 1970s as well as in 2001, 2008/9
and 2012 including federal transfers to the states for infrastructure building, tax
rebates, income tax cuts and financial aid for home buyers. Economic performance
during these time periods was disappointing. (Source: A Turning Point in American
Fiscal Policy: Fiscal Stimulus or Structural Reform? by John B. Taylor, 2016)
The chart below shows two models that estimate the impact on GDP of a permanent
increase in government purchases equal to 1% of GDP showing a wide discrepancy
in methods. Taylor believes that temporary stimulus may have a short-term boost to
the economy without promoting sustainable recovery while leaving the economy
with more debt. He analyzes the effect of cutting government spending including
entitlements to reduce the debt to GDP ratio and implementing cutting personal and
corporate tax rates. Dr. Taylor concludes, Recent experience with fiscal
stimulus programs in the United States raises considerable doubts about
the efficacy of such programs in practice.
Dr. William McBride reviewed 26 studies about the impact of taxes on economic
growth. Almost all found a negative impact of higher taxes on growth. Corporate
income taxes are the most harmful followed by personal income taxes consumption
taxes and property taxes. He finds taxing higher incomes at higher rates reduces
investment, risk taking, and entrepreneurial activity since a large share of these
activities are done by high income earners. He believes that long-term growth is
highly impacted by tax policy. As an examples, an IMF study found that a 1% tax
increase reduces GDP by 1.3% after two years and reducing corporate income taxes
1% raises annual growth by 0.1 to 0.2%. (Source: What Is the Evidence on Taxes
and Growth? by Willian McBride, Tax Foundation, 2012)
State and Federal taxes (blue) have been falling as a % of GDP, but federal revenue
shortfalls are made up with the budget deficit (red). Yet, as shown previously, long-
term real GDP growth has slowed from 4% to 2%. Part of the success of the 1981
Reagan years through to the Tech Bubble was due to corporate bond rates falling
from 13% to 7% by 1999, federal debt increasing from 31% to 64% by 1995,
Household debt to Disposable income increasing from 66% to 95% by 1995, and the
top tax rate falling from 70% to 33% among other factors such as de-regulation.
Effects of Income Tax Changes on Economic Growth states that the net impact of
tax rate cuts on long-term growth is small and if they are not financed by immediate
spending cuts will probably increase the budget deficit. The authors say that
reforms that improve incentives, reduce existing distortionary subsidies, windfall
gains, and avoid deficit financing will have the largest effects. A fair assessment
would conclude that well-designed tax policies have the potential to raise economic
growth, but there are many stumbling blocks along the way and certainly no
guarantee that all tax changes will improve economic performance. (Source:
Effects of Income Tax Changes on Economic Growth by William Gale of the
Brookings Institution and Tax Policy Cent and Andrew Samwick of Dartmouth College
and NBER, 2014)
Rudolf Macek studied the impact of taxes on economic growth in OECD countries
from 2000 to 2011. He found that government spending reduces economic growth,
probably due to crowding out and to unproductive spending. He concludes that the
corporate tax is most harmful followed by personal income taxes and then by social
security contributions and finally by the value added tax. (Source: (The Impact of
Taxation on Economic Growth: Case Study of OECD Countries by Rudolf Macek,
Review of Economic Perspectives, 2015)
Davide Furceri and Georgios Karras believe that there is strong agreement about the
effect of taxes on economic growth while the exact mechanisms for this is less
understood. They estimate that from 1965 to 2003 using 26 OECD economies that
increasing taxes lowered long term GDP per capita by -0.5% to -1%, but the effect is
much larger on investment. (Source: Tax Changes And Economic Growth: Empirical
Evidence For A Panel Of OECD Countries by Davide Furceri and Georgios Karras)
In a report prepared for Tax Policy and the Economy, Alberto Alesina and Silvia
Ardagna make the case that there is relatively little known about the impact of fiscal
multipliers for tax cuts and spending, but that the topic is politically charged.
Economic growth does decrease debt to GDP levels rapidly. They find that tax cuts
are more expansionary than spending increases in the cases of a fiscal stimulus and
for deficit reductions spending cuts are much more effective than tax increases in
stabilizing the debt and avoiding economic downturns. (Source: Large Changes in
Fiscal Policy: Taxes versus Spending, by Alberto Alesina and Silvia Ardagna, NBER,
2009)
The chart below shows that lowering top marginal tax rates and effective tax rates
on capital income has not stemmed the decline in net savings of the past 60 years.
Tax Rates and Labor Force Participation
(Source: Tax Rates and Economic Growth, by Jane G. Gravelle and Donald J.
Marples, Congressional Research Service, 2014)
The chart below shows the relationship between Federal fixed investment and real
GDP. It may be the right thing to do, but the relationship is either not strong or
requires time for the effects to be realized.
The Congressional Budget Office produced a working paper which describes the
accuracies and limitations of estimating multipliers for fiscal spending. The table
below lists estimates for the American Recovery and Reinvestment Act of 2009.
Purchases by the Federal Government and infrastructure spending will have the
largest effect followed by transfers to individuals and the tax cuts to lower and
middle income people. Tax cuts for higher income people, extension of First-Time
homebuyer credit and corporate tax provisions would have the lowest multiplier
effect. (Sources: The Fiscal Multiplier and Economic Policy Analysis in the United
States by Charles J. Whalen and Felix Reichling, Infrastructure Spending and the
Fiscal Multiplier by Anika Khan at Wells Fargo and The Fiscal Multiplier: Econ 101)
TRADE
This busy chart puts investment and trade into perspective. There is nearly $4T of
foreign direct investment in the U.S. and foreigners own $6T of Federal Debt. Gross
Domestic Investment is $3T per year. Exports are $2.3T per year and imports are
$2.7T per year for a trade deficit of about $0.4T. The Federal Deficit is close to $0.6T
per year. At the turn of the century, $1U.S. would buy 8.3 Yuan compared to 6.7
now, making imports from China more expensive.
Below, the trade deficit is added back to GDP growth reflecting how small a percent
of GDP it is.
The current account (red and blue) is compared to the exchange rate. For the past
couple of years, the exchange rate has been rising and the current account deficit is
becoming larger.
Multinational Corporations, Mobile Capital and International Taxes
Ernst & Young analyzed more than 5,000 business investment announcements in
2015 accounting for more than $166B in investment and 400 thousand new and
retained jobs in the US. Top investment trends are a resurgence of automotive
manufacturing outside of the upper Midwest, development of New Yorks Tech
Valley and continued attractiveness to foreign investors ($36B or 22% of the
investments monitored). The largest investments were in natural gas-related
industries and New Yorks Tech Valley. Green growth and headquarter facilities
also saw considerable growth. Projects costing less than $10M created slightly more
than half of the jobs. Taiwan, South Africa, Germany, Austria, Japan, Canada,
Denmark, Netherlands and China, listed in decreasing order, each invested more
than $1B. E&Y cites the stronger dollar as a possible deterrent to foreign
investment. (Source: 2016 U.S. Investment Monitor, by Ernst & Young LLP)
Multinational and transnational companies make up a significant amount of foreign
assets and sales. In 2013, the U.S. companies in the top 100 global multinationals
owned nearly $2T in foreign assets. Much of the imports and exports between
countries is done through intra-corporate sales between the parent and/or affiliate
businesses. The largest U.S. multinational (2013 data) is General Electric with
$331B in foreign assets and foreign sales were 53% of its total sales. Oil companies
Exxon, Chevron, and Conoco had $460B combined. Technology companies Apple,
Microsoft, IBM, Hewlett-Packard and Google had nearly $300B in foreign assets.
(Source: The Worlds Top 100 Non-Financial TNCs Ranked by Foreign Assets, 2014)
In 2014, 10% of importers were multinational companies which accounted for over
75% of imports. There were over 400,000 companies importing or exporting with
20% of the companies both importing and exporting. Large companies (6% of the
84 thousand companies that import and export) represented 73% of the imports.
Multinational manufacturing firms that both import and export accounted for
approximately half of the total imports. (Source: A Profile of U.S. Importing and
Exporting Companies, 2013 - 2014, by Glenn Barresse, Benjamin Shelak, Ramon
Pineda or Sherri Ewing, U.S. Census Bureau News, U.S. Department of Commerce,
2016)
Estimates of the intrafirm trade as a percent of total trade are subject to
measurement error tracking trade across borders. The estimates of intrafirm share
of total trade range from 35% to 50%. (Sources: Globalization and trade flows:
what you see is not what you get! and An Overview of U.S. Intrafirm-trade Data
Sources)
The following figure is an estimate of the share of intra-firm imports compared to
total imports leading up to the financial crisis. The share of intra-firm transactions in
trade between the U.S. and other OECD (developed) countries is much higher than
in emerging economies. Low labor costs does not appear to be the primary driver of
foreign direct investment. Over 55% of the imports from Mexico are estimated to be
intra-firm while over 35% of the exports to Mexico are estimated to be intra-firm.
High income taxes are an incentive for multinational firms to estimate higher costs
of imports in order to have lower profits subject to higher income taxes. The U.S. tax
code is burdensome enough, and these multinational firms must deal with tax
systems of more than one country raising administrative costs. (Source Intra-Firm
Trade Patterns, Determinants and Policy Implications by Rainer Lanz and Sbastien
Miroudot, OECD Library, 2011)
Mr. Zucman created the figure below showing the share of U.S. multination firms
profits from tax havens. He then estimates that the share of tax havens in U.S.
corporate profits has climbed to nearly 20% (2008 -2012). He estimates that the
percent of U.S. equity market capitalization held by tax haven firms and individuals
to have risen from about 2% in 1980 to 10% by 2010. The amount of wealth held by
foreigners in Switzerland was over $2T in 2014. Mr. Zucman estimates that
8 percent of the global financial wealth of households is held in tax havens and is
increasingly being concentrated with ultra-high net worth individuals. In 2010, the
U.S. Congress enacted into law the Foreign Account Tax Compliance Act to compel
foreign banks to disclose accounts held by U.S. taxpayers.
There appears to be a significant increase in corporate profit shifting over the past
several years. The loss in tax revenue may be over $100B per year. The cost of tax
evasion of individuals using foreign tax havens is estimated to be between $40B
and $70B per year. The Hiring Initiatives to Restore Employment (HIRE) Act and the
Stop Tax Haven Abuse Act focus on reducing individual tax evasion. One of the
problems is that the U.S. does not withhold tax on many types of passive income
paid to foreign entities. A list of tax haven countries compiled from the OECD, IRS,
and Government Accountability Office lists is shown below. (Source: Tax Havens:
International Tax Avoidance and Evasion by Jane Gravelle, Congressional Research
Service, 2015)
The countries in the list above with a GDP of $25B or more plus the Netherlands
account for 40% of earnings but only 4% of rest-of-world GDP indicating that they
have a disproportionate share of earnings given their small economies. Five of the
10 countries with the most foreign multinational profits had effective tax rates
below 12% while the other 5 including Mexico had effective tax rates in excess of
23%. The cited report lists policy options for tax reform.
Intrafirm transfers comprise part of imports and exports and affect the domestic
content. Below, I show the U.S. direct investment by country. Most U.S. investment
has been going to tax haven countries such as Ireland, Luxemberg, Netherlands,
Switzerland, and Cayman Islands. Very little direct investment goes to countries
with large trade deficits like Mexico and China.
This chart shows the strong correlation between the dollar and oil prices during the
past 16 years. The relationship between interest rates, the dollar and oil prices often
has a countercyclical effect on monetary policy.
The Trade Imbalance with Mexico and China
Mexico and Canada are the largest trading partners of the U.S. Net exports are
balanced with Canada.
U.S. Imports and Exports with Canada and Mexico
Trade began increasing dramatically a few decades ago. Gross Domestic Product per
capita is high in the OECD developed countries, in particular the U.S., with the rest
of the world including China and Mexico much lower. China is not a wealthy country
and with state owned enterprises, its national goals of employment often over-ride
market driven goals.
Mexico is the second largest export market for the U.S. after Canada. Mexico has a
balanced current account with about $425B in both imports and exports. The U.S.
merchandise trade deficit with Mexico is $58B, mostly (32%) due to vehicles and
parts. Mexico imported $23.8B of motor vehicle parts from the U.S. in 2015. The
U.S. services surplus with Mexico is about $10B. The stock of Foreign direct
investment from the U.S. into Mexico was $93B and from Mexico into the U.S. is
$17B. The economic growth rate of Mexico is comparable (fluctuating between 2 to
4%) to that of the U.S. for the past 30 years. (Source: U.S.-Mexico Economic
Relations: Trends, Issues, and Implications, by M. Angeles Villarreal, Congressional
Research Service, 2016)
The OECD estimates that the import content of Mexico and Chinas exports is about
32% as shown below. Domestic content is over half of the value for manufactured
goods. (Source: What is Made in America? by Jessica Nicholson and Ryan Noonan,
U.S. Department of Commerce, 2014)
Domestic Content of Exports
SOURCE: OECD, 2011
David Dollar writes in Brookings 2016 Election that Trade with China has led to
the loss of American manufacturing jobs, reduced real wages for semi-skilled
workers, and devastated some communities dependent on low-end manufacturing
jobs. Mr. Dollar points out that the U.S. has nearly balanced trade with the
countries in the proposed Trans-Pacific Partnership which does not include China.
These are more open economies and the U.S. has $1T invested in the TPP partners
which is 15 times more than in the closed China markets. He suggests policy
options to place restrictions on China investing in the U.S. because of Chinas
restrictions and closed markets. He adds that imposing tariffs on imports from China
will send those jobs to other developing countries instead of them returning to the
US. He suggests using the TPP as an incentive for China to reform, China is not one
of the negotiating countries, and it would be hard for China to meet TPP standards
because it would require the country to open up its trade and investment and
adjust other regulations. (Source: The Future of U.S.-China Trade Ties, by David
Dollar, Brookings, 2016)
A large part of the high growth rate in China has come from pegging their currency
rate to the dollar as shown below. Since 2015, China has attempted to weaken the
yuan against international currencies. The goal is to make exports more
competitive. In 2016, the yuan became part of the International Monetary Funds
special drawing rights (reserve currency) along with the dollar, yen, pound and euro.
The chart below shows that imports from China amount to nearly 4% of U.S.
consumption.
The House Ways and Means Social Security Subcommittee introduced the Social
Security Reform Act of 2016 in December (Source: Social Security Reform Act of
2016)
The Act proposes:
In Headwinds for the Trump Economy, Robert Kahn and Steven A. Tananbaum,
point out that the Tax Policy Center estimates that the cost of President Trumps tax
plan could increase the federal debt by $7.2T over a decade, while Paul Ryans A
Better Way has more modest tax cuts mixed with spending cuts that are more
neutral on the deficit. They suggest that stronger economic growth can cover up to
a half percent of GDP of the increase in the deficit by increasing revenues.
According to Kahn and Tananbaum, academic and policy studies question the
effects of tax changes on economic growth in agreement with Marc Levinsons
assertion. Increased deficits are likely to increase upward pressure on interest rates
as the markets are currently anticipating which will have a dampening effect on
growth. (Source: Headwinds for the Trump Economy at the Council on Foreign
Relations, 2016)
Wells Fargo described in the Global Chartbook, In October, our full-year GDP
forecast was 2.2 percent for 2017 and 2.2 percent for 2018. Postelection, those
figures are unchanged. The big impact from the election is less about the actual
projected growth rate and more about the increased variability of potential
outcomes given the increased policy uncertainty.
CONCLUSION:
Trade and employment is more complicated than the U.S. is just being inundated by
cheap products that rely on cheap labor to displace American jobs. Low savings
rates in the U.S. and the high savings rates in some countries impact the exchange
rates making U.S. products more expensive. U.S. consumers have purchased
inexpensive products at the expense of savings which has shifted jobs overseas.
Multinational corporations and high net worth individuals take advantage legally or
unethically of tax havens. Corporate and trade reforms including transparency
should occur to correct this trend. Trade tariffs will be counter-productive and hurt
consumers and many employees and businesses.
DISCLAIMER:
I am not an economist, investment advisor nor investment professional. This
material is for informational purposes only and should not be construed as
investment, legal or tax advice. Investors should do their own research or seek the
advice of investment professionals.