Trapped Funds Myth: Foreign Cash Repatriation Boom in Reverse

The ongoing myth is that tax changes will ripple through the economy leading stronger growth and investment.

Trapped Funds Myth

Supposedly, Trump's tax changes and cash repatriation holiday will release funds trapped overseas and spur corporate investment, possibly to the point of overheating the economy.

The Reality

The reality is the cash is not overseas, and it's not really in cash form.

Investment boom? Forget about it.

Kitty Richards and John Craig debunked the "trapped funds" myth back in 2014 in Offshore Corporate Profits: The Only Thing ‘Trapped’ Is Tax Revenue.

Majority Leader Eric Cantor (R-VA) asserted that “encouraging businesses to bring overseas earnings back home to America will spur investment, economic growth and job creation,” while Cisco Chairman and CEO John Chambers and Oracle President and CFO Safra Catz wrote that “by permitting companies to repatriate foreign earnings at a low tax rate—say, 5%—Congress and the president could create a privately funded stimulus of up to a trillion dollars.”

That was a blatant lie by Cisco and Oracle. It was either a lie or ignorance by then Majority-leader Cantor.

In the real world, the money is often deposited in U.S. banks, circulating in the U.S. economy, and available for a wide variety of domestic investments. For nearly all practical purposes, that money is already here, being put to work in the U.S. economy.

To qualify as “offshore” for tax purposes, U.S. corporate money must be controlled by a foreign subsidiary, but it does not have to be invested abroad. In fact, for many corporations, these foreign profits already sit in Manhattan, in accounts in American banks. For example, as of last May, Apple had $102 billion in “permanently invested overseas” income not subject to the U.S. corporate tax. On Apple’s books, this untaxed profit is “offshore” because it is controlled by two Irish subsidiaries—even though these subsidiaries park their funds in bank accounts in New York. This $102 billion that has yet to be subject to U.S. taxation is already in the United States, not trapped in Ireland. Apple cannot use this money directly for American real estate acquisitions, dividends, share buybacks, or funding for operations in Cupertino, but the money is being loaned out in the American economy by American banks, funding American mortgages and small-business loans just like any other American deposit.

The drive to keep profits “offshore” for tax purposes may limit a parent corporation’s investment options somewhat, but domestic businesses and consumers still have access to multinational corporations’ foreign earnings. This money is not “offshore” economically, and it is not idle—it is already circulating in the American economy, being used for investments in American businesses and families.

While rules exist that prevent corporations from using offshore income as direct collateral for bonds issued in the United States, those foreign earnings drive down the interest payments that potential bond buyers demand in exchange for capital, allowing corporations to access cash at very low cost without repatriating untaxed earnings. Companies with large pools of unrepatriated earnings have favorable leverage and cash positions as a result of their unused cash. Those attributes result in high credit ratings and low—or sometimes even negative—borrowing costs. A company with $100 billion in cash on hand is a pretty low-risk borrower.

A corporation with lots of unrepatriated earnings does not have to repatriate those earnings to engage in domestic investment or payouts to shareholders. It can just borrow money for its domestic activities, and this borrowing is almost costless because creditors know that the unrepatriated earnings can be tapped at any time.

Apple has given us a great example of how this works. In April, the company announced that it wanted to begin a $60 billion share buyback program. The only problem? “According to analyst estimates, Apple has $145 billion of cash – but only $45 billion on hand in the US, and thus not enough to fully fund the share buy-back program,” Reuters reported. In theory, share buybacks and dividends are exactly what corporations cannot do with unrepatriated income. In practice, however, Apple was easily able to fund its buyback program without paying a dime of tax.

In April, Apple issued $17 billion in corporate bonds—the largest bond offering in American corporate history. The interest rate Apple paid on 10-year bonds was only 2.415 percent, or only 74 basis points above the rate on 10-year Treasury bonds that day. But that is just the sticker price. In fact, the interest on the bonds is then tax deductible—at a 35 percent corporate tax rate, the business-interest deduction covers 84.5 basis points of the borrowing costs, lowering the after-tax interest costs to 1.57 percent, or 10 basis points lower than Treasuries.

Tech Companies, the New Investment Banks

Financial Times writer Rana Foroohar earlier today proclaimed "The much-lauded overseas ‘cash’ pile is actually a giant bond portfolio".

She states "The largest and most intellectual-property-rich 10 percent of companies — Apple, Microsoft, Cisco, Oracle, Alphabet — control 80 percent of this hoard."

Her view, as explained in Tech Companies are the New Investment Banks is that large corporation will become the next target of voter rage.

B.R.E.A.M. (Bonds Rule Everything Around Me)

Financial Times Alphaville covers the story in B.R.E.A.M. (Bonds Rule Everything Around Me).

The Alphaville take is "The final effect of the US tax bill on corporate credit remains unclear, mostly because it depends on what companies do with the cash raised from selling their bond holdings."

Credit Suisse Analysis

The view that the repatriation of U.S. corporations’ offshore cash balances will lead to a stronger U.S. dollar and tighter money markets is wrong, in our opinion. It is wrong because offshore cash balances are in U.S. dollars already and are invested mostly in one to five-year U.S. Treasuries and term debt issued by banks.

The move from a global to a territorial tax system marks an inflection point in fixed income markets. The territorial system marks the end of corporations’ decades-long habit of putting surplus cash accumulating offshore into bonds. As the corporate bid for U.S. Treasuries and bank debt disappears, yields, swaps spreads and banks’ term funding costs could see upward pressure.

In a year where Treasury supply will increase significantly, that’s bad enough. But things can get worse: if corporate treasurers add to that supply by selling their roughly $300 billion hoard of U.S. Treasury notes, rates could move big. In fact, we believe this corporate “echo-taper” could be worse than the Fed’s taper…

That’s because we know that the U.S. Treasury will re-issue the Treasuries the Fed no longer buys as bills, not notes, and so the Fed’s taper won’t add a lot of duration back into the bond market. That’s not the case with the echo-taper.

All About Bonds

Steeper Yield Curve

If U.S. corporations buy back their reverse Yankee debt, that will involve the tear-up of €/$ cross-currency swaps. That, combined with our view that the increase in Treasury bill supply this year (on the back of the Fed’s taper and the Treasury normalizing its cash balances) will tighten the front-end, points to a steeper €/$ cross-currency basis curve.

$250 billion of this $475 billion is in U.S. Treasuries notes, which ain’t chump change: for example, if the top ten liquidated their U.S. Treasury holdings this year, markets would have to reckon with an “echo-taper” – $250 billion on top of the Fed’s scheduled $230 billion (we’ll return to the concept of echo-taper and its market implications in section six below).

No Investment Boom, No Buyback Boom, Just More Profits

There are numerous excellent charts in the Credit Suisse report. It's well worth a serious look.

The big beneficiaries of the tax bill are Apple, Microsoft, Cisco, and Oracle. They have a combined $500 billion in cash or equivalents, allegedly "held" overseas.

The bottom line, in sharp contrast to prevailing wisdom, is there will be no investment boom, no buyback boom, and no currency market disruptions no matter what the corporate liars and analysts say.

Instead, the tax repatriation boom is likely contributing to rising treasury yields, not rising wages or growth prospects.

Mike "Mish" Shedlock

Granted the cash now being in USD within the USA, repatriation through shifting direct ownership from foreign subsidiaries to US-based parent companies will have no impact upon financial markets (beyond the descriptions of what may happen to some swaps and to bond yields if there results a shift from bond investing) but the income from that repatriated cash will in future be taxable surely within the USA where it was not before.

“But American companies with foreign subsidiaries can’t legally use it to take over another American company or to pay dividends. “

But they can borrow to do both. With implied collateral in foreign earnings. Same effect, minus the usual subsidy to the usual leeching middlemen involved in the scheme.

@stuki this is speculation but i'm fairly sure they can't use the foreign subsidiarys' cashflow to pay back the borrowing

If it is good for the British and the Irish to have a low corporate tax rate, why is it not good for the US? I'm feeling cognitive dissonance.

And, we saw what happened to GE and GM when they became investment banks....

"...Instead, the tax repatriation boom is likely contributing to rising treasury yields, not rising wages or growth prospects." - Mike "Mish" Shedlock

I understand the argument that it could cause treasuries to rise - the biggest threat to the markets IMO -, but I feel like you're double dipping on the argument. If the repatriation isn't going to matter because 'the cash is not overseas (to begin with)', and is then kept in treasuries, why would it cause treasuries to rise? If corporations sell treasuries, pay the tax and repatriate the money, they are going to do something with the money. Some buy backs, some capital investment and, I guess, some could buy back treasuries. Some of the money is going to be invested in the economy and the money but, even if ALL of the money was just reinvested in treasures, that would be neutral with regards to yields. (I think Hussman, in particular, suffers from severe confirmation bias.)

So Apple buys back shares, the market goes higher, Americans feel the wealth effect and spend more money, GDP goes up.

So let me get this straight: mega-corporations with the lawyers and political connections to get away with the offshore games avoid taxes for decades/indefinitely, then buy mostly bonds with the money, extracting interest out of US taxpayers for those decades, while being able to keep the money in the US all the while? Yep, another scam. Cash repatriation was the only feather in the tax reform cap, now that's gone; it's all scams all the time; every string you pull comes loose.