Trapped Funds Myth
Supposedly, Trump's tax changes and cash repatriation holiday will release funds trapped overseas and spur corporate investment, possibly to the point of overheating the economy.
The reality is the cash is not overseas, and it's not really in cash form.
Investment boom? Forget about it.
Majority Leader Eric Cantor (R-VA) asserted that “encouraging businesses to bring overseas earnings back home to America will spur investment, economic growth and job creation,” while Cisco Chairman and CEO John Chambers and Oracle President and CFO Safra Catz wrote that “by permitting companies to repatriate foreign earnings at a low tax rate—say, 5%—Congress and the president could create a privately funded stimulus of up to a trillion dollars.”
That was a blatant lie by Cisco and Oracle. It was either a lie or ignorance by then Majority-leader Cantor.
In the real world, the money is often deposited in U.S. banks, circulating in the U.S. economy, and available for a wide variety of domestic investments. For nearly all practical purposes, that money is already here, being put to work in the U.S. economy.
To qualify as “offshore” for tax purposes, U.S. corporate money must be controlled by a foreign subsidiary, but it does not have to be invested abroad. In fact, for many corporations, these foreign profits already sit in Manhattan, in accounts in American banks. For example, as of last May, Apple had $102 billion in “permanently invested overseas” income not subject to the U.S. corporate tax. On Apple’s books, this untaxed profit is “offshore” because it is controlled by two Irish subsidiaries—even though these subsidiaries park their funds in bank accounts in New York. This $102 billion that has yet to be subject to U.S. taxation is already in the United States, not trapped in Ireland. Apple cannot use this money directly for American real estate acquisitions, dividends, share buybacks, or funding for operations in Cupertino, but the money is being loaned out in the American economy by American banks, funding American mortgages and small-business loans just like any other American deposit.
The drive to keep profits “offshore” for tax purposes may limit a parent corporation’s investment options somewhat, but domestic businesses and consumers still have access to multinational corporations’ foreign earnings. This money is not “offshore” economically, and it is not idle—it is already circulating in the American economy, being used for investments in American businesses and families.
While rules exist that prevent corporations from using offshore income as direct collateral for bonds issued in the United States, those foreign earnings drive down the interest payments that potential bond buyers demand in exchange for capital, allowing corporations to access cash at very low cost without repatriating untaxed earnings. Companies with large pools of unrepatriated earnings have favorable leverage and cash positions as a result of their unused cash. Those attributes result in high credit ratings and low—or sometimes even negative—borrowing costs. A company with $100 billion in cash on hand is a pretty low-risk borrower.
A corporation with lots of unrepatriated earnings does not have to repatriate those earnings to engage in domestic investment or payouts to shareholders. It can just borrow money for its domestic activities, and this borrowing is almost costless because creditors know that the unrepatriated earnings can be tapped at any time.
Apple has given us a great example of how this works. In April, the company announced that it wanted to begin a $60 billion share buyback program. The only problem? “According to analyst estimates, Apple has $145 billion of cash – but only $45 billion on hand in the US, and thus not enough to fully fund the share buy-back program,” Reuters reported. In theory, share buybacks and dividends are exactly what corporations cannot do with unrepatriated income. In practice, however, Apple was easily able to fund its buyback program without paying a dime of tax.
In April, Apple issued $17 billion in corporate bonds—the largest bond offering in American corporate history. The interest rate Apple paid on 10-year bonds was only 2.415 percent, or only 74 basis points above the rate on 10-year Treasury bonds that day. But that is just the sticker price. In fact, the interest on the bonds is then tax deductible—at a 35 percent corporate tax rate, the business-interest deduction covers 84.5 basis points of the borrowing costs, lowering the after-tax interest costs to 1.57 percent, or 10 basis points lower than Treasuries.
Tech Companies, the New Investment Banks
Financial Times writer Rana Foroohar earlier today proclaimed "The much-lauded overseas ‘cash’ pile is actually a giant bond portfolio".
She states "The largest and most intellectual-property-rich 10 percent of companies — Apple, Microsoft, Cisco, Oracle, Alphabet — control 80 percent of this hoard."
B.R.E.A.M. (Bonds Rule Everything Around Me)
The Alphaville take is "The final effect of the US tax bill on corporate credit remains unclear, mostly because it depends on what companies do with the cash raised from selling their bond holdings."
Credit Suisse Analysis
The view that the repatriation of U.S. corporations’ offshore cash balances will lead to a stronger U.S. dollar and tighter money markets is wrong, in our opinion. It is wrong because offshore cash balances are in U.S. dollars already and are invested mostly in one to five-year U.S. Treasuries and term debt issued by banks.
The move from a global to a territorial tax system marks an inflection point in fixed income markets. The territorial system marks the end of corporations’ decades-long habit of putting surplus cash accumulating offshore into bonds. As the corporate bid for U.S. Treasuries and bank debt disappears, yields, swaps spreads and banks’ term funding costs could see upward pressure.
In a year where Treasury supply will increase significantly, that’s bad enough. But things can get worse: if corporate treasurers add to that supply by selling their roughly $300 billion hoard of U.S. Treasury notes, rates could move big. In fact, we believe this corporate “echo-taper” could be worse than the Fed’s taper…
That’s because we know that the U.S. Treasury will re-issue the Treasuries the Fed no longer buys as bills, not notes, and so the Fed’s taper won’t add a lot of duration back into the bond market. That’s not the case with the echo-taper.
All About Bonds
Steeper Yield Curve
If U.S. corporations buy back their reverse Yankee debt, that will involve the tear-up of €/$ cross-currency swaps. That, combined with our view that the increase in Treasury bill supply this year (on the back of the Fed’s taper and the Treasury normalizing its cash balances) will tighten the front-end, points to a steeper €/$ cross-currency basis curve.
$250 billion of this $475 billion is in U.S. Treasuries notes, which ain’t chump change: for example, if the top ten liquidated their U.S. Treasury holdings this year, markets would have to reckon with an “echo-taper” – $250 billion on top of the Fed’s scheduled $230 billion (we’ll return to the concept of echo-taper and its market implications in section six below).
No Investment Boom, No Buyback Boom, Just More Profits
There are numerous excellent charts in the Credit Suisse report. It's well worth a serious look.
The big beneficiaries of the tax bill are Apple, Microsoft, Cisco, and Oracle. They have a combined $500 billion in cash or equivalents, allegedly "held" overseas.
The bottom line, in sharp contrast to prevailing wisdom, is there will be no investment boom, no buyback boom, and no currency market disruptions no matter what the corporate liars and analysts say.
Instead, the tax repatriation boom is likely contributing to rising treasury yields, not rising wages or growth prospects.
Mike "Mish" Shedlock