The end of January heralds the end of the summer holidays for Australians. Australian corporate leaders have returned, or are returning, home from their northern hemisphere skiing trips and some may have ventured to the World Economic Forum in Davos, Switzerland. Once the Australian Open tennis is wrapped up, it is back to work for most. A new CEO appointment for Australia’s largest bank showed business has recommenced and CEOs are now reviewing the half-year results for their companies. Australia is again open for business.
During January, our politicians were busy with a strategic defence and trade trip to Japan. A restart for the Trans Pacific Partnership (TPP) was again on the agenda – with or without the USA. During my holiday in Thailand, the online news coverage of this event was extensive – well, at least on my online AFR. In passing, I note that our ABC is no longer able to network its news service (even on IView) to Asian countries – but you can watch live Australian horse racing with no problems! And yes, the internet connections in Thailand are outstanding for a supposedly third world country.


Your intrepid correspondent, exploring the wilds of Thailand
In the AFR, there was a significant editorial interview with Japanese PM Shinzo Abe, but the questioners dared not broach the subject of monetary policy. Unlimited QE by the Bank of Japan and the maintenance of negative cash rates is never an issue for either our economic journalists nor our politicians. A free trade agreement (FTA), free of tariff protections, is a noble quest – but only if the benefits are not diluted by excessively loose monetary policies. For many years, Japanese companies have borrowed for virtually no cost, while the BoJ manipulates the stock market to lower the cost of capital for its exporters. That is simply unfair for Australian companies competing against them in export markets.
Holidays are a great time to reflect on what is happening, and what is likely to happen during the year ahead; perhaps to consider both fake news and reality in a sober and quiet environment. Many use their holidays to immerse themselves in a novel or two to take their minds away from reality. Rather than fiction, I focused on the online news coverage and the many forecasts made by commentators for markets in 2018 (see our The View from last week). I also checked out hundreds of tables and charts (and even the odd cartoon) to see if any would give me (and you) a different insight into what is actually happening.

Source: Hedgeye
Apart from the “free trade” deals that are promoted mainly by countries (ex Australia) that either have or continue to print money, the next most covered financial news event was the US tax cuts secured by President Donald Trump.
In past editions of The View, we have predicted that a significant part of the tax policy of the Trump Administration would focus on the repatriation of profits by US multinationals. The new tax laws have delivered tax breaks in spades for US multinationals. Tax that should have been paid in the USA is now to be significantly forgiven in an attempt to encourage capital to flow back into the US. So is this US Government legitimising either tax avoidance or minimisation? Was this the door opener to allow the US to be “open for business” again? Rather than utilising illegal government industry grants, has the US Administration designed another way to help its export and import-competing companies?
The sanctioning of tax minimisation schemes would surely challenge free trade agreements that are appropriately drafted to stop protection that extends past simple trade barriers. Direct government assistance, in the form of tax breaks, excessively low interest rates and manipulated currencies are more corrosive of free trade than tariffs – but no world leader wants to acknowledge this point. Australia, the champion of free trade, seems oblivious to the anti-trade defences utilised by many of our friends and allies.
Context is everything and the reaction of Apple to the news of a massive tax break handed to it by President Trump was incisive. To quote columnist Bret Stephens in the AFR
“ Apple’s announcement that it will repatriate most of the estimated US$274 billion that it holds in offshore earnings is great news for the United States. Uncle Sam will get a one time US$38 billion tax payment. The company promises to add 20,000 jobs to its US workforce, a 24% increase, and build a new campus. Another $5 billion will go toward a fund for advanced manufacturing in America –  C’mon. what’s with the long face?”
It appears that Apple may well have been liable for $96 billion of repatriation tax but will now save about $60 billion in tax, which will partly be utilised to fund an investment back into its USA operations. But we wonder if that is Government assistance to help an export company? In our view, it explains why President Trump is against “free trade agreements” – because his policies won’t comply. However, once the tax cut is in place and the repatriation of profits has occurred, Trump will change his anti free trade stance and more so if pressure comes from China. As he stated in Davos – the US is open for business again – but give him a few more months of manipulation before he negotiates free trade.
Other companies with huge untaxed foreign profits that will avail themselves of the tax window (35% tax rate reduced to a one-off 8%) include Microsoft ($146 billion), Pfizer ($178 billion), General Electric ($78 billion) and Cisco ($71 billion). The US Congress’s Joint Committee on Taxation has estimated that US companies have about $2.6 trillion in untaxed offshore earnings and we can surmise that about $700 billion (50% more than the current annual US fiscal deficit) could be diverted from legitimate tax.
President Bush tried a similar strategy in 2004 when he reduced foreign sourced repatriation profits tax to 5%. The money came back and then left the US again in a type of cash-washing exercise that would make a casino or the CBA ATM network proud.
US corporations have not suggested that they will send the money back offshore again and the following table is a sample survey by Bank of America. Readers can decide for themselves if the answers are honest or fake!

Figure 3. How would the proceeds of repatriated earnings be used?
Source. 2017 BofAML Corporate Risk Management Survey
Offshore cash holdings that minimise tax are one side of the story. The next graph shows the ballooning US domiciled debt of Apple that grew over $80 billion in just 5 years. This debt was used to buy back shares and pay dividends. The interest on the debt was partly tax deductible in the US. Therefore the tax minimisation is much larger than is presented by many commentators. As tax was minimised, the US budget deficit blew out and the Federal Reserve implemented QE policies to help the US Government service its burgeoning debt. QE pushed interest rates lower and allowed Apple (and others) to borrow aggressively to generate ever larger tax breaks.
The reason for the long faces that columnist Bret Stephens noted was from people who saw the tax rort and understood it for what it was.
 

Figure 4. Apple’s US debt – 2013 to 2017
But before we are accused of being too negative, there are some real positives to come out of the Trump tax cuts and it would be churlish to ignore them. The Joint Committee on Taxation expects individuals and small businesses to save around $120 billion in tax in 2018 (compared with corporate tax savings of $83 billion). Real disposable personal income will accelerate as tax cuts are reflected in pay cheques in coming months and this will affect more than 80% of workers.
In the wake of the tax cuts, many companies have, somewhat unexpectedly, chosen to offer bonuses and other benefits to their staff. For example, Walt Disney is giving all 125,000 employees a $1,000 gift each, as well as investing $50m in an education program for its workers – both stated to be in response to the tax cuts (To put that in context, $1,000 is the equivalent of 1 month’s grocery bills for an average American family of four). Other companies have come up with different responses: Verizon said in an internal memo that it is giving 50 shares of restricted stock to full-time employees who aren’t executives. The amount will be calculated based on Verizon’s stock value on February 1. To date, more than 270 major listed corporates have announced programs to reward staff in some way consequent to the tax cuts, calculated to exceed $2.5 billion in value.
Thus it is no wonder that consumer confidence, the driver of two-thirds of US GDP, is performing so well.

Source: Strategas
Australia’s corporate leaders jumped on the opportunity and need for the Australian Government to cut our corporate rates. Given what the US has done and what others do, Australia must respond. If we do not challenge the unfair trade policies adopted by others, then we must also adopt them.
The motherhood statements below were fairly predictable, yet it was the comment by Qantas CEO, Alan Joyce, that was most telling. While Qantas has struggled to pay corporate tax for many years (mainly due to years of losses), he noted that many of his competitors don’t pay tax either, or are given highly favourable tax breaks through depreciation allowances.
 

Figure 6. What chief executives say about the corporate tax cut
Source. AFR
Free and open trade markets is a big issue. So too is the freedom of bond markets to properly reflect the relative economic risks of economies. Free trade and open bond markets go hand in hand, but at this point, the world is a long way from this.
This week saw continued weakness in international bond markets. Notably, the US ten-year bond yield breached 2.7% and the German ten-year bund yield jumped to 0.7%. German bunds are looking very likely to have broken their downward trend and are on the rise, like global bond yields the world over.

Figure 7. Germany 10-year bund yield
Source: Strategas
For a short period on Monday night (our time), German five-year bunds had a positive yield! German five-year bunds have had a negative yield for the last five years. Negative interest rates are starting to disappear and we expect this trend to accelerate over the coming year.
There is less red on this table than last year, and there will be less next year…

Figure 8. Global Rate Matrix
Source: Strategas
The upward movement in bond yields is beginning to bite those owners of negative yielding bonds. Bloomberg estimates that in January alone the market value of negative yielding bonds has dropped by $1 trillion across the world. Thankfully the bulk of these bonds are owned by the ECB and the BoJ. But what do they care – they bought them with printed money.
 

Figure 9. Market value of bonds with negative yields fall
Source. Bloomberg
The nonsense and manipulation of international bond yields are exhibited clearly in the following chart. Today the Greek Government can borrow two-year money at virtually the same rate as the US government.

Figure 10. 2-year yields, Greece vs. US
Source. Pension Partners
The world continues to endure a debt explosion. While some of the debt is overstated due to the tax breaks afforded US multinationals, there are a few clear trends to see.
Government debt has doubled over the last ten years, supported by QE policies. The financial sector debt has slowed dramatically since 2007, but it did implode during the GFC. Household debt has grown and, notably, Australia has grown its levels much faster than the rest of the world.
 

Figure 11. Global debt, by sector
Source. IIF, BIS, IMF, Haver
Our final chart is a reflective one. The only country that can really check the manipulation of tax breaks and the cost of debt by the US is its largest trading partner and creditor – China. As trade discussions continue and the risk of a trade war is threatened, the US needs to be careful. Today the US owes China US$1.2 trillion. However, this is less than the level of six years ago as China has halted its accumulation of USD Government debt. Indeed, China may well be using its US bond holdings as a tool to control the level of its currency.
 

Figure 12. China’s US Treasury Bond holdings, US$B
Source. US Treasury Dept., Bloomberg
While China has increased the level of its US bonds over the last year, can this be said to be positive for the US or negative? If there is a significant trade dispute, the more US debt held by the Chinese, the worse the negotiating position becomes for the US Government. That leads to the question – what does China think about the US tax rate changes? Perhaps a question for another day. 2018 is going to be an interesting year as the benefits and negatives flow from the US tax changes and the grinding rise in bond yields.