How The Foreign Laundromat Trashed the U.S. Economy
Economics / US Economy Apr 02, 2011 - 05:39 AM GMTBy: Andrew_Butter
I was looking at Vietnam recently. Apparently the streets are paved with gold and so I’m going over next week to check that out, but I’m getting more confused by the minute.
On one hand (supposedly) FDI is pouring into Vietnam, on the other hand, you read in the Financial Times that the Vietnamese are sending their gold jewellery to Switzerland to be melted down and turned into ingots to be stored in a vault (outside Vietnam). Or converted into a “hard” currency…although there again, there is a bit of a debate going on these days about where you might find one of those?
On reflection, that makes sense, “foreign” money in Vietnam and in many developing countries (India and China for example); get’s a much better deal, particularly with regard to the risk of confiscation, than home-grown wealth (unless of course you have connections). On (more) reflection, it’s the same deal in USA.
Here is a statistic everyone knows, “50% of the earnings of S&P 500 Companies are made outside America”.
That’s good news Eh!?
“Can-do” American corporations bravely ventured abroad to earn money so they could bring it back home to buy…apple-pie for mom…an SUV for Melanie…plus enough military ordinance to keep the loved ones “safe” from any imaginable threat, and of course to pay for the “luxury” of the most expensive medical care in the world!
Err…well, as the diplomat said, “Good News…Up to a point”.
The point is how much of that money got “lost” on the way back; or more to the point, laundered out of the watchful gaze of the IRS and the Tort Lawyers?
This is how it works.
You have assets in USA that make money, plus more relevant to the modern world you have “intangible value” like a brand (Coca Cola), or intellectual capital (Apple).
Assets as in “things”, are much easier for tax-men and tort-lawyers to confiscate, than “intangibles”. You don’t “amortize” those like you do computers, machinery etc, “strictly” in accordance with what the tax-code proscribes, and you can’t carry them away with a writ any-more than you can cut out a pound of a man’s flesh without spilling a drop of blood.
In fact, managed properly, that stuff usually goes up in value over time, that’s the reason Intel and Apple can put blow-your-socks-off new products on the market; they have both the brand (people trust their new products), and they also have the intellectual capital to come up with new ideas. Or in case you are Microsoft, which hasn’t had an original idea in its life, to re-package other peoples ideas.
In essence, the beauty of that “intangible” stuff is it’s devilishly hard for the tort and tax lawyers to get their claws into it.
So here’s an idea, you let your manufacturing capability in USA get run down to nothing, and you allocate all the losses you can muster to that part of your enterprise, and eventually you “sadly” close it down, and gratefully “take the hit” on the part of the balance sheet where the “hard” stuff is located. There are plenty of good reasons to loose money in an enterprise in America and plenty of ways to do it, like you can charge the old factory, for the R&D you will spend building a new one in China.
Then you borrow money in USA collateralized by your intellectual property and your brand. Why in USA? Well the US government (particularly the pork-chop Congress), and its agents such as the Fed and Fannie and Freddie, have been subsidizing borrowing for years. So the Land-of-the-Free-Lunch was and still is by far the cheapest place to borrow in the world, and the cherry-on-the-cake is that if you play your cards right, you can get a tax-break on the interest you pay.
Then you invest that (borrowed) money in a more “friendly” environment (as in tax-and-tort-free Zones), to buy spanking new equipment and build a new factory.
If you want to be very clever you set up a JV or an off-take deal with people who own the easily confiscated stuff. You put in equity (you call it equity – even though it was borrowed in USA), plus you put in the intellectual capital (impossible to value), and the other guys puts in the land and the (cheap) labour, and pays off whoever needs to be paid off to make sure “order” is maintained.
And of course the agreement you have is written up in a mind-bogglingly complicated five-hundred page document in some obscure language like Ancient Latin or Sanskrit. On top of that you arrange the financial year to coincide with the local horoscope, just in case some enterprising tax-inspector or tort-lawyer decides to fly in to try and do a bit of confiscation, in which case you can say “sorry mate, but our financial year ends in two months time, come back after you have read and inwardly digested our Articles of Association”.
All you need is a good lawyer plus a Big Four Accountant. The accountant is the key; I know that because once it was the “Big Five” and back-then I worked for Number Five (Arthur Andersen). Managing those sorts of scenario, was one of their core businesses. Just for the record I got fired from that job for sending an e-mail to the QA jerks in Switzerland, saying that a senior partner was a FFFFFF crook. That was five years before ENRON blew and back then, even thinking such a thought was considered to be totally “outrageous”; everyone told me I shouldn’t have been so “emotional”, particularly my wife.
This is how that sweetheart deal played out:
You won’t find that chart anywhere, but the numbers aren’t hard to find, they are in black and white on the BEA website under “International Transactions”.
Starting from the top:
Red Line:
That’s the total U.S. Foreign debt outstanding which includes “Official” obligations (i.e. to other sovereign states (Line 57)), plus sales of U.S. Treasuries to “non-official” punters (Line 65), plus sales of “U.S. securities other than U.S. Treasuries” (fondly referred to as “Toxic Assets” by some people, as in TARP (Line 66)).
There is a “doom & gloom” story going around saying that America owes $4.5 trillion to foreign governments and that’s a very-bad-thing…well sorry to be a killjoy, but that’s not even the half of it, America as a whole owes just under 100% of its annual GDP to foreigners, that’s about 25% of all the money America as a whole has borrowed at this point in time.
That’s quite a lot of money, by way of comparison the estimated “mark-to-market” value of all the commercial real estate in USA right now is $3.5 Trillion down from $6.5 Trillion at the height of the bubble.
The Blue Line:
That’s the “Good News”, add up all the money Americans have shipped abroad since whenever, and that adds up to almost as much as it owes, and that’s just “book value” not counting any re-invested profits or growth in the value of the assets that were bought.
So theoretically, if the “Aliens” asked for their money back, America (as a whole) could liquidate their assets abroad and pay their debts!!
Phew, and that makes a mockery of all the hysteria about Debt to GDP ratios in USA, when 25% of the debt is “covered”.
Well perhaps more than covered, which is where I’m going (below). Notice how about $1 trillion of FDI got repatriated when the credit crunch hit, presumably used to pay back debts that couldn’t easily be rolled over, and how that affected the total foreign debt line (that’s important).
The Orange Line:
That’s how much income got generated by the investments Americans made outside America, cumulative since 1960. Great Return on Investment...more on that later too.
The Purple Line:
That’s direct investment as opposed to buying bonds and stocks in companies, nice steady line, and no blip when the credit crunch hit.
What intrigues me is this:
First off, the way the foreign debt got piled on (money coming in) is sort of mirrored by the way that Americans invested money abroad (money going out). As if America was a sort of Laundromat, money comes in, gets “cleaned” and then it goes out again.
Except in most cases the “collateral” for the debt was assets in USA, as if American borrowed money, putting up their US assets, so they could get the cash to invest abroad.
The other thing that’s weird is the “Return” on investment.
Just to explain, that chart shows the nominal yield on the “book value” (i.e. the cumulative amount of FDI going out”, as in “income” that came back to USA thanks to that investment.
Notice how when the credit crunch hit, magically, the repatriated “income” surged, which is funny since the whole world was supposed to have been in dire straights. Yet in spit of that “income” on the investments abroad, went up 40%.
WOW!! That sounds too good to be true. Or perhaps there was money standing-by ready to be liquidated, as in profits that the IRS and the Tort Lawyers didn’t know about?
That sounds more likely.
Translating that into English, it often makes more sense for Americans and American corporations to make investments outside of USA, and to create jobs outside of USA, because the chances of American money, getting “confiscated” in America, is much higher than it is outside America.
Hence the Laundromat, the system in America is weighted towards low taxes for individuals, particularly rich individuals, and low taxes on things like gasoline (compared to anywhere else in the world that imports so much oil), plus occasional government efforts to “stimulate” the economy by subsidising borrowing.
Yet corporate taxes are high and corporations suffer from a perception that they “exploit”, and are thus fair-game.
Get on the wrong side of the US “system” and you can discover insanity on a monumental scale, from McDonalds getting successfully sued for selling hot coffee to a lady who put it between her legs in her car, and then braked, or one I will never forget reading about, of how a 13 year old entrepreneur got caught selling dope out of the back window of his grandmother’s house, and the judge seized the house and threw the kid; and the grandmother out on the street. Yet it’s OK to burn a Koran when you know that will incite violence, because that’s Free-Speech.
That sort of insanity prevails throughout America, apparently the federal tax code is 70,000 pages, and everyone is paranoid about Tort-Lawyers. Remember the Toyota recall, when it was discovered that a dozen or so “senior citizens” had pressed the wrong pedal, and the head of Toyota got hauled up in front of the US Congress for a public spanking.
Great TV, but there again, try following where the money goes when that sort of thing is commonplace.
So, US corporations take advantage of the subsidized debt, and invest it abroad (thank you very much); that way they can avoid punitive taxation, and punitive regulation.
How more of that is going to help America grow its way out of the hole it dug for itself, is less than clear.
By Andrew Butter
Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe; currently writing a book about BubbleOmics. Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.
© 2011 Copyright Andrew Butter- All Rights Reserved
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