Rockefeller Treasury Services, Inc. Analytics | 10 of February

Posted 10 February, 2017

Trump is still dominating the headlines. This time market players are relieved that it’s a promise of tax reform that is egging on the reflation trade, and not something negative for the economy and markets.


In fact, Trump is pulling back from the trade war expectation he himself built. Trump told Chinese leader Xi that the US will respect the One China policy (after goring it as stupid and incomprehensible). He also indicated that he will not be talking about currencies or currency manipulation in the meeting today with Japanese PM Abe. Trump already won that one. Quartz reports “Ahead of his trip the Japanese prime minister asked business leaders to come up with a tweet-friendly figure for planned investment in the US.” And the poor guy has to put up with Trump’s garish lavishness, more suited to Middle East potentates than the far classier and deliberately restrained Japanese.


Before getting too happy about tax reform, we need to be wary of a true debate disclosing the dirty little secret—that US companies don’t actually pay 35%. After all their deferrals and other loophole exploitations, it’s more like 12-15% and as we all recall from the 2008 election, some big names pay no tax at all (General Electric). Never mind—everyone’s eye glaze over the minute you say “corporate tax reform.” Trump and the Plubs can tell as many lies as they like and nobody will notice because they will all be snoozing. Besides, we have not a single study indicating that a lower tax rate will raise capital spending or create jobs. We may get a repatriation deal as during the Bush years, with an estimated $2.6 trillion available. This had a minor but noticeable pro-dollar effect at the time (2004), although in the end, the 843 companies repatriated only $312 billion, or about a third of what was available offshore.


The WSJ reported in 2011 that the 2004 “repatriation tax holiday” was a total failure. “The 15 companies that benefited the most from a 2004 tax break for the return of their overseas profits cut more than 20,000 net jobs and decreased the pace of their research spending… The failed tax policy “cost the U.S. Treasury $3.3 billion in estimated lost revenues over 10 years and led to U.S. companies directing more funds offshore.”


The companies spent the windfall on stock buybacks and executive compensation. And “With the exception of Pfizer, the 10 companies that repatriated the most money after the 2004 tax break have stashed increasing funds offshore every year since the 2004 tax break, the survey noted.” So, the tax reform idea is considered pro-business and that’s generally good, but the only real winners are the stocks where buybacks can be expected with some confidence. Some researchers somewhere are busy finding out exactly which companies those are.


Across the pond, politicians are running the table, too. The number of articles about Brexit is truly aweinspiring. Bloomberg has one today saying PM May is antagonizing European to the point of no return—i.e., no deal at the end of the two-year process in 2019. Yikes! Europeans have the stance that the UK must be punished for leaving and can’t end up better off after Brexit.


The May White Paper plan involves a trade deal with Europe not all that much different from what EU membership conferred, although with the added complication of the ability to get separate deals on a country-by-country basis. This is anathema to the pan-European ideal that did, after all, start as a customs union. Europeans see it as threatening the existence of the “European idea.” They are not wrong. Europeans are also offended by threats to withhold security cooperation or to cut taxes to wildly favorable levels, not to mention declining to pay for European budget items passed since Brexit. Europeans are starting to see May as Trump-like. And they are gathering their forces (aka teams of experts), which seem bigger and better-organized than the May team.


And finally, how much should we worry about foreigners cutting back on ownerships of US paper? The WSJ reports “Foreigners are steadily pulling back: As of November, for the first time since 2009, less than 30% of the $20 trillion market for U.S. government debt was held overseas, according to the latest official data, released in January, from the Treasury Department and Federal Reserve. In the U.K., it is now 27%, compared with a record of 36% in 2008. In Germany, it is 49%, down from a peak of 57% in 2014.” Note we get the TICS report next Wednesday.


Many managers are required by their own rules to hold dollar and top G3 currency assets on the basis of various metrics (market share, etc.). But UBS chief economist Donovan notes “You create an environment where yields are manipulated lower by captive investors.” This is an important shift. But if even the captives are demoralized by crummy rates, they also have a problem finding alternatives. The WSJ has a separate story on how French yields jumped on the LePen rhetoric of leaving the eurozone (and conceivably defaulting). They are now looking more like Italy and Spain (if not Greece). But “In terms of Ms. Le Pen’s chances, at best they’ve risen to negligible from nonexistent,” according to poll analysis.


Politics: The Appeals Court decision against Trump is dollar-favorable, if unmeasurably so. The dollar, and before the dollar, the UK pound, is a reserve currency not only because of economic size and military supremacy, but also because of the rule of law over the rule of men and the law upholding property rights and individual rights against the rights of the state. Lesser countries expropriate private property (France vs. the banks) and assert the state is always supreme over any individual (Russia, China). It’s not going too far to say the rule of law is the core underlying reason investors and merchants choose the dollar.


The FT headline “Trump rhetoric sets stage for constitutional showdown.” Well, no. Plenty of presidents have tangled with the judiciary, although not so rudely and offensively. Roosevelt tried to pack the Supreme Court. Nixon said he was above the law. Even Obama, a constitutional law professor, locked horns with the judiciary. Defining the borders of executive authority is an on-going process. It’s only a “showdown” if you think any single decision is final and permanent and the law is a zero-sum game.


The entire world knows by now—the three-judge Appeals Court upheld the restraining order on the Trump executive order which sought to halt immigration by refugees and people from seven countries while intending to favor non-Muslims. The legal commentaries all note that the government’s case was very badly prepared and presented even more badly. The court might have allowed the seven-country aspect if the government had only presented one shred of evidence of national security need and not just that it was the opinion of the so-called president. If Trump were willing to admit error, the Justice Dept could go back and re-draft that part and it would likely pass muster—courts do defer to the executive on national security but do need some evidence, which can be presented to the judges alone, outside the public eye.


The big Trump loss was the court making special note that the president is, indeed, “reviewable.” Every 10th grader learns about constitutional checks and balances. Trump doesn’t know as much as a 10th grader. The Justice Dept lawyers should have known better. And the Trump lawyers tried to correct the green-card error mid-case, saying the order should have exempted them and others with valid visas. But an Executive Order can’t be modified by the Justice Dept. It can be modified only by another executive order.


Two points: first, words matter. Legal procedures matter. Second, Trump is not a dictator. You can bet his first response to the restraining order was “how do I fire these judges?” Somebody needs to tell him that the three branches of government are equal. He is not the only star on the stage. But he tweeted— so dignified--he will go back to court, either the original lower court or the Supreme Count. Respectful acceptance is not in his nature but most observers think it’s a prerequisite for the office.


Public Policy Polling reports that 65% oppose a Muslim ban (to 22%). A majority (53% to 43%) think Trump is doing a lousy job. A majority think he should release his tax returns (58% to 31%) and sever ties with his businesses as the law requires (62% to 27%). As for who is more credible, 52% choose the New York Times over Trump (37%). Even the comedy show SNL has more credibility (48% to 43%). Those who would impeach is equal to those who would not (46%). A majority (64%) agree Trump should not be able to override the courts. But among Trump voters, 51% think he should. This shows once again that Trump voters are the uneducated, uninformed, and misinformed. Good thing they are a minority.


Good thing we have a Constitution, although it’s too bad some jurists are purists who try to interpret the constitution as the founders would have. These purists forget the constitution considered slaves as 3/5 of a “person,” gave no vote to women, and other social and cultural stances of several centuries ago, But guys like Jefferson were modernist. Jefferson invented a ton of cool stuff, including a pen that would make a duplicate copy while the original was being written and the rolling, rocking office chair. Who is to say he would not approve of privacy rights or gay marriage or anything else? The constitution was devised to be a living document—that’s why we have the ability to amend. It should live in the 21st century, too. And most of all, the judiciary deserves respect, Gore v. Bush notwithstanding.


Big Tidbit: We are always intrigued by demographics, which sometimes underpin big economic trends without being obvious. Lacy Hunt, in the Fourth Quarter Hoisington Report reprinted by Mauldin yesterday, names a slew of influences on the US and global economy and ends with some alarming data on “eroding” demographics. The US is starting to look like Japan….


“Weak population growth, a baby bust, an aging population and an unprecedented percentage of 18- to 34-year olds living with parents and/or other family members characterize current U.S. demographics, and all constrain economic growth. Moreover, real disposable income per capita is so weak that these trends are more likely to worsen rather than improve.”


Real disposable income has fallen over the past 10 years to a negative 1%. See the chart. It’s an odd calculation method. Sneaky use of data? We don’t know, but probably not.
“In the fiscal year ending July 1, 2016, U.S. population increased by 0.7%, the smallest increase on record since The Great Depression years of 1936-1937 (Census Bureau). The fertility rate, defined as the number of live births per 1,000 for women ages 15-44, reached all time lows in 2013 and again in 2015 of 62.9 (National Center for Health Statistics). The average age of the U.S. reached an estimated 37.9 years, another record (The CIA World Fact Book). Population experts expect further increases for many years into the future. For the decade ending in 2015, 39.5% of 18-to 34-year olds lived with parents and/or other family members, the highest percentage for a decade since 1900, with the exception of the one when new housing could not be constructed because the materials were needed for World War II.”


And “Over time, birth, immigration and household formation decisions have been heavily influenced by real per capita income growth. Demographics have, in turn, cycled back to influence economic growth. If they are both rising, a virtuous long-term cycle will emerge. Today, however, a negative spiral is in control. In the ten years ending in 2016, real per capita disposable income rose a mere 1%, less than half of the 50-year average and only one-quarter of the growth of the 3.9% peak reached in 1973. In view of the enlarging debt overhang, which is the cause of these mutually linked developments, economic growth should continue to disappoint. There will likely be intermittent spurts in economic activity, but they will not be sustainable.” As a result of demographics and other factor, pent-up demand is exhausted.


This sounds about right. The baby boomer generation is anti-materialistic now and downsizing like crazy. The youngsters are shunning fabulous garage and Craigs List sales of antiques (in favor of fewer things overall and shiny plastic things when they do acquire stuff).


By now everyone has seen the George Carlin rant about “stuff” from 1986. This demographic work means the Trump economy faces a severe headwind. Tax deals and trade deals cannot create disposable income out of whole cloth, can they?

 

By Barbara Rockefeller

 

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