Wednesday, May 8, 2013

Levitational Tools
by Sinclair Noe

DOW + 48 = 15,105
SPX + 6 = 1632
NAS + 16 = 3413
10 YR YLD - .02 = 1.76%
OIL + .99 = 96.61
GOLD + 21.80 = 1475.40
SILV - .01 = 24.05

Another day, another record high. What's behind this? Nouriel Roubini weighed in from a conference in Las Vegas. Roubini is a professor at NYU and former Senior Economist for the White House Council of Economic Advisors, and notably, one of the few economists to anticipate the collapse in the housing market. Roubini identified the levitational forces, the forces lifting the markets, on “QE, zero policy rates, more money coming into the market, not just from the US, but from other economies” as the reason behind rising asset prices.

Roubini also said: "Growth is slow. Earnings growth is also slowing down. Top line and bottom line are not as good as they used to be, but margins are high. They could correct somehow over time.” His best guess is that it could go on for a couple more years.

Why two years? Roubini says: “recent data have effectively silenced hints by some Federal Reserve officials that the Fed should begin exiting from its current third (and indefinite) round of quantitative easing (QE3). Given slow growth, high unemployment (which has fallen only because discouraged workers are leaving the labor force), and inflation well below the Fed’s target, this is no time to start constraining liquidity.”

Let's take this a step further; with inflation running at about half the Fed's target, it might be argued the Fed has room to ramp up its already aggressive quantitative easing. The Personal Consumption Expenditures price index, or PCE, is the Fed's favored measure of inflation; it is currently at a 3 ½ year low of 1.0%. If the Fed target is 2%, with an upper limit of 2.5%, then they need to do more to move the inflation meter. Right now, they expect inflation to be lower than their target, and unemployment to be unconscionably high, so the Fed's own framework says that they need to take more stimulative action.
There is an argument that economic growth might pick up later in the year, but there are other arguments that we still haven't felt the full weight of the sequester. Government agencies may begin to freeze hiring more broadly, rather than just furloughing, and that will weigh on monthly payroll gains; government-dependent businesses will need to make greater adjustments.

Because money is a public monopoly, when the monopolist restricts supply by not running a sufficient deficit, it creates excess capacity in the economy, as evidenced by high unemployment. The downside is the deficit, which can result from lower taxes or increased government spending, whatever your politics prefers. But policies aimed at reducing the deficit are doomed to keep an economy depressed.

The Federal Reserve has already stated that fiscal policy is restraining growth and so the argument is not whether the Fed will exit QE anytime soon but rather whether the Fed will expand QE anytime soon. We're not hearing this debate but I think this is what the market is telling us. It might be nice to see some fiscal policy that could stimulate growth, but we know that Congress moves like a slow motion sloth unless it involves gutting the STOCK Act. You'll remember that they jumped at the opportunity to eviscerate key sections of the legislation that required disclosure of financial transactions by politicians and their staff prohibiting insider trading.

Americans for Tax Fairness, a coalition of 280 organizations, has "identified 10-year budgetary savings of $2.8 trillion simply by limiting or eliminating a plethora of high-income and corporate tax loopholes." Congress is busily revising the tax code as we speak but how many of those loopholes and other perks like credits and deductions do you bet will go away? Not many if the lobbying industry has anything to do with it.

Here's a quick and easy loophole that should be closed; remember last week, when Apple announced announced the largest corporate bond offering ever - $17 billion. And remember that Apple's balance sheet as of March 30 shows $145 billion in cash? Why would they borrow $17 billion when they have all that cash sitting around.

Apple may be lagging a little when it comes to technological innovation but they are pioneers in tactics to avoid paying taxes to Uncle Sam. To distribute the cash to its owners would force it to pay taxes. So it borrows instead to buy back shares and increase its stock dividend.

The borrowings were at incredibly low interest rates, as low as 0.51 percent for three-year notes and topping out at 3.88 percent for 30-year bonds. And those interest payments will be tax-deductible. Isn’t that nice of the government? Borrow money to avoid paying taxes, and reduce your tax bill even further. It's legal.

Apple can get away with paying little tax in the United States relative to the profits it makes, thanks to what is known as “stateless income,” in which multinational companies arrange to direct the bulk of their profits to low-tax or no-tax jurisdictions in which they may actually have only minimal operations. The United States, at least theoretically, taxes companies on their global profits, but taxes on overseas income are deferred until the profits are sent back to the United States.

The company makes no secret of the fact it has not paid taxes on a large part of its profits. They come right out and say they are generating significant cash offshore and repatriating this cash will result in significant tax consequences. Apple did pay about $6 billion in federal income taxes last year, but the borrowing scheme will help them avoid about a $9 billion dollar tax bill. There is something ridiculous about a tax system that encourages an American company to invest overseas rather than in the US.

Of course, we could close that loophole. Companies would owe taxes on profits when they made them. There would be, of course, credits for taxes paid overseas, but if a company made money and did not otherwise pay taxes on it, it would owe them to the United States. After it paid the taxes, it could move the money wherever it wished without tax consequences.

While big business is able to game the system, small business is being destroyed by it.  The Economic Collapse Blog reports “the percentage of Americans that are working for themselves has never been lower in the history of the United States.”  The decline in the number of startup jobs per 1000 Americans has dropped from 11.3 under the first President Bush, to 7.8 under President Obama. The percentage of new entrepreneurs and business owners dropped by 53 percent between 1977 and 2010. Entrepreneurs, who take risks, innovate and, when they succeed, hire people; small businesses, the backbone of the economy, seem to be being killed off in the US economy.  It does not portend well for the future.

The time to focus on jobs and inequality is now, but don’t hold your breath. The political agenda in Washington, DC shows no sign of even considering sensible policies. So, for now the best hope of economic growth comes from the Federal Reserve and their loose monetary policy, which will probably become super-loose, especially when faced with super-stupid fiscal policy. The Fed probably has some more tools in their tool-belt. They have room to be much more aggressive, just look at the example of Abenomics and the Bank of Japan. The real question is whether the Fed has any tools in their tool-belt that might actually spread the wealth beyond Wall Street. 

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