A few years ago, while I was trawling for information about financial risk and where it might be held, I had a fascinating conversation with an economist of the US Treasury’s office of Financial Research. The economist advised me to look at the debt offerings and corporate bond purchases being made by the largest, richest corporations, such as Apple or Google. In a low interest rate environment, with billions of dollars in yearly earnings, these high-grade firms were issuing their own very cheap debt and using it to buy up the higher yielding corporate debt of other firms.
In the search for both higher returns and for something to do with all their money, they were, in a way, acting like banks, taking large anchor positions in new corporate debt offerings and essentially underwriting them the way that JP Morgan or Goldman Sachs might. Since such companies were not regulated like banks, it was difficult to see exactly what they were buying, how much they were buying, and what the market implications might be. Still, the idea that cash-rich tech companies might be the new systemically important institutions was compelling.
This is why I have been poring over a new Credit Suisse report that both confirms and quantifies this idea. Economist Zoltan Pozsar has forensically analyzed the 1Trillion US Dollar in corporate offshore savings parked in liquid assets, a fortune that he likens to China’s foreign exchange reserves, not only because of its market-moving size, but the idea that both fortunes were created by a “macroeconomic crime”-mercantilism in the case of China, and tax arbitrage for the corporate hoard.
The largest and most intellectual property-rich 10% of companies -Apple, Microsoft, Cisco, Oracle, and Alphabet- control 80% of this hoard. Their earnings come mainly from IP that can be easily moves across borders. Their offshore savings went around 100 Billion US Dollar in 2008 to 700 Billion US Dollar by 2016. And according to the report of Credit Suisse and their calculations, most of that money is held not in cash but in bonds. Indeed, half of it is in corporate bonds.
The much-lauded overseas “cash” pile held by the richest American companies, a treasure that Republicans cited as the key reason they passed their ill-advised tax “reform” plan, is actually a giant bond portfolio. So what does this mean? Many significant things. But let us start with the obvious, which is that bonds are first of all not cash. If companies are to bring back those overseas earnings and invest them in growth enhancing projects in the US, as Donald Trump keeps promising us they will, they would have to sell their bond stash. If so, this would impose serious implications on interest rates. Consider that the Federal Reserve is starting to deleverage its own balance sheet. Now, add in the corporate “echo-taper”, as the Credit Suisse report puts it, and you have got a heck of a lot of bonds in the market, which is bound to move the interest rate needle up, perhaps more quickly than is currently expected. We recently saw the effect that even mild change in interest rate expectation can have.
Rising interest rates would also have a huge impact on the debts of America, especially with the new 4.4 Trillion US Dollar plan for next year, which includes a proposal for 200 Billion US Dollar in new infrastructure spending over the next decade and an already by Mr. Trump signed two-years spending bill that includes a big increase in defense and domestic programmes which are included in the new budget proposal. The move towards freer spending coincides with growing market anxiety over the prospect of rising interest rates and the wisdom of injecting fiscal stimulus into an economy at or near full employment. The 10-year Treasury bond trading at four year lows, reflecting investors nervousness that the Federal Reserve may need to put a break on an overheating economy.
Although Republicans control both houses of Congress, Mr. Trump has sought to blame Democrats for the 1.2 Trillion budget deficit next year that will result from last week’s two-year deal. But in the spending plan for fiscal 2019, the White House abandoned a pledge, included in its first budget last year, to close the deficit within a decade. Instead it said its new plan would see the budget in deficit until fiscal 2039. It also laid out growth forecasts that many analysts believe are overly optimistic, predicting 3% growth in real gross domestic product that the White House said would help reduce the US debt burden in the long term. The centerpiece of Mr. Trump’s budget is the 200 Billion US Dollar plan that the administration wants to use to spur 1.5 Trillion US Dollar in spending on roads, bridges and energy infrastructure. Like last year’s budget, it also calls for big increases in defense, and cuts for civilian agencies such as the state department and Environmental Protection Agency. Such cuts have also proved unpopular with Congress, which controls the federal purse. Another point to consider: the real economic growth impact of this spending scenario would be minimal. Corporate treasures have already said that the bulk of repatriated funds will be used for mergers and acquisitions, dividends and share buy backs, not building factories or raising wages.
Such share buybacks will be good for whoever owns such of those stocks but not much else. As we believe that financial fortunes will be made and lost as this cycle plays out over the next couple of years liquidate at least 50% of your stock portfolio and build our cash would be our recommendation as most of the deal making of interest would probably be done by 2020, when the next presidential election could shift rules yet again. Yet nothing accordingly to us in the real economic growth picture would change. We believe that we are still in the last stages of a recovery cycle, with flat productivity and demographics, and due for a slower, not faster, growth in the next few years.
In fact, the new Republican tax plan is likely to exacerbate that divide, by making it even easier for big companies to move money around. The shift to the territorial system means that US business won’t have to play the game of issuing debt to buy debt any more. They will just move money where they like. In the context of more trade protectionism and pushback against immigration, this could lead to further discontent with globalization, if you define it as the free movement of goods, people and capital. So in our opinion, the US is embracing protectionism on the one hand, and tearing down liquidity silos on the other. If people continue to feel the game of the globalization is rigged against the little guy, you can bet on more political populism.
This time around, the target of voter rage will not be the big banks, but the world’s largest and richest corporations. Just as, say, the Rothschilds went from being merchants to merchant bankers when they had enough cash on hand, so rich corporations especially tech firms have become the financial engineers of our day. Let us all just hope the companies’ boards are thinking about all that comes with it as the responsibilities and the impact could be huge.
