on January 5, 2009.
No civilization has ever paid all of its debts.
British historian Niall Ferguson, author of many books, including, most recently, The Ascent of Money, pointed out in the Financial Times the other day that previous civilizations, including the ancient Hebrew civilization described in the Bible, understood this basic principle of finance. (Ferguson, The Ascent of Money: A Financial History of the World (Penguin 2008); Financial Times, Dec. 19, 2008.)
Every few years there had to be a crash or some other cataclysmic event that would wipe out debts and allow the economy to start from a clean slate. The ancient Hebrews canceled all debts every 50 years by a royal decree called "jubilee." Lenders got wiped out, but what was called "the Lord's release" was regarded as for the general good.
Now, by contrast, lenders control all of the levers of power -- that did not change with the presidential election -- and they don't want to be wiped out. They've asked us to believe that what is good for them is good for us.
We don't have a liquidity crisis. We have a debt overhang. Ferguson explained:
Excessive debt is the key to this crisis; it is the reason we are confronting no ordinary recession, curable by a simple downward adjustment of interest rates. It is the reason we still have to fear, if not a second Great Depression, then very likely the biggest recession since the 1930s. . . . We are witnessing a real-time experiment with not one but two theories about the Depression.
A debt overhang means a lot of that debt will have to be written down. It will have to be written down to zero in some cases, and in the case of houses, it will have to be written down to the value of the collateral. It also means that there is no amount of money that can be created to restore the lost imaginary paper wealth. It's gone, and the creditor class will have to take the hits.
The Federal Reserve either does not understand this, or, like so many incoming and outgoing government officials, it is completely in the thrall of the creditor class. The Fed is so busy creating money and taking in bad assets that it is a wonder that the dollar is not worth about 12 centimes. This, Ferguson explained, is an exercise in the monetarist view of the Depression -- the notion that the problem then was liquidity.
Moreover, the Fed itself has become "a public hedge fund," in Ferguson's words, with holdings of more than $2 trillion and capital of less than $40 billion, giving it inadequate capital and 50-1 leverage against a portfolio of other people's garbage. The Fed is now letting hedge funds borrow from it, in the hope that they will buy depreciated paper and pump up prices. It's a bad precedent, letting unregulated offshore entities borrow, in the service of a fool's errand, propping up asset prices.
Meanwhile, the Treasury Department and Congress, anxious to prop up share prices and stimulate demand, are taking the Keynesian view of the Depression -- the idea that the problem was lack of demand. Ferguson takes a dim view of this. "Is it really plausible that the cure for excessive leverage in the private sector is excessive leverage in the public sector? Might there not be a simpler way forward?" he asked.
That simpler way forward, Ferguson suggested, is more radical reduction of debt. Mortgages may yet be written down to the value of the collateral, as Congress considers giving power to bankruptcy judges to write down mortgages on primary residences. Called "cram down" in bankruptcy vernacular, this power was rejected in last fall's bailout bill, but now one in six mortgages is under water. And it has become blindingly obvious that the voluntary approach to mortgage modification has not worked. (Want to crawl under a rug? Ferguson's predictions for 2009 are even scarier. Financial Times, Dec. 27, 2008.)
Eventually, taxes will have to go up to pay for all this Keynesian stimulus. Today's topic, however, is tax reduction. Creativity in the American business sector is so great that no matter what the macroeconomic problem, American business will adapt its arguments to present tax reduction as the solution.
So multinational companies are busy in Washington peddling their favorite tax reduction nostrums newly fluffed up as cures for the asserted liquidity crisis. They are arguing that section 965, the provision allowing a one-time, low-rate repatriation of foreign profits, should be revived to provide big companies with liquidity and prop up their share prices through buybacks.
The idea is to add it to a stimulus bill. Earlier this year, the Senate Finance Committee rejected an amendment that would have revived section 965 in the 2008 stimulus bill. Now, with a 2009 stimulus bill coming (and expected to be a Christmas tree), a lot will depend on procedure. If Finance has to approve the tax provisions in a markup, as is the normal procedure, cooler heads may prevail. But if normal procedures are not followed and the stimulus bill is rushed directly to the unpredictable Senate floor, a section 965 revival may have a chance as a floor amendment.
The proponents of section 965 renewal are members of the Business Roundtable, chiefly Oracle and Eli Lilly. Their horses in the Senate are likely to be the same pair as last time out: Finance Committee member John Ensign, R-Nev., who also happens to be the chief Republican fundraiser in the Senate, and Sen. Barbara Boxer, D- Calif., the chief Democratic sponsor in 2004. The Roundtable has commissioned economist Allen Sinai of Decision Economics to make a study promising that a repatriation tax holiday will have miraculous economic effects.
This article looks at the previous experience, the Sinai study, and the related question of intangibles migration. Reviving section 965 is a bad idea in light of previous experience and intangibles migration. As the record shows, the principal effect of another repatriation holiday would be to reward multinationals for shifting income out of the United States to low-tax jurisdictions. And no amount of lobbyist-funded promises of liquidity and growth and job creation will change that.
Moreover, the hand of Congress may be forced on international tax reform by the actions of important trading partners that just happen to be the last bastions of worldwide taxation with the credit method of double tax relief, namely Japan, Britain, and Canada. Britain and Japan are on track to change to dividend exemption systems in their next budgets.
If any one of these three changes to a quasi-territorial system, the United States will be even more of an outlier than it is already. This would mean that a temporary holiday for drug companies that put intangibles in tax havens would be an unwise distraction. Competitiveness means being on the same system as the trading partners, not making the rewards greater for the already flush.
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