By Michael Every of Rabobank
Now THAT'S escalation!
What a relief that a Russian troop withdrawal and an explanation short of Iran targeting Israel’s nuclear reactor mean the near-term risk of Hot War is removed,…and we can get back to focusing on Cold War (as more bipartisan US anti-China legislation races through Congress). Let’s forget about military experts concluding that because Russia left its military hardware right next to the Ukrainian border it can complete a new build-up within days, and far less visibly; and that the risk of an Iranian attack on Israel remains. Let’s look just at markets, eh?
Even there, we see remarkable pushing of boundaries. The ECB left rates on hold as expected; stressed negative rates stimulate the economy (?!); maintained QE levels; pushed the PEPP envelope as its latest weapon; and mentioned they are looking at the exchange rate too in terms of what inflationary/deflationary signals it sends – so hardware left near that frontier too. Just take a step back, please, and consider that what was once a simple rate decision is now negative rates + QE + PEPP + an eye on EUR. And yet they are still losing the battle towards 2% CPI. What secret super-weapon would be next, one wonders?
More importantly for markets, US President Biden launched another stimulus package. No, not the USD1.9 trillion bill that already went through; and not the USD2.25 trillion infrastructure bill than redefines social spending as infrastructure, and is planned to be funded by higher corporate taxes; instead, a new USD1.5 trillion spending bill aimed at helping American families (via universal pre-kindergarten, expanded subsidies for child care, a national paid leave program for workers, and free community college tuition) to be funded by raising capital gains tax from 23.8% to 39.6% for those earning more than USD1 million, alongside a matching top marginal income tax rate of 39.6% (up from 37%). The 3.8% tax on investment income to fund Obamacare would also stay, meaning a top rate of 43.4% for some (and higher in New York). Moreover, this tax apparently includes the sale of inherited art and property --again aimed mostly at the rich-- and would be retroactive to cover 2021, so if it passes, selling now won’t help avoid it.
Obviously, US markets sold off anyway, and there was a rush for safety as US 10-year Treasury yields dropped below 1.54%. The message which echoed in the press and social media from Wall Street to Silicon Valley was clear: “Reflation, please: but not redistribution!”
Will this measure pass? It’s unclear with the current make-up of Congress, just as it is for the USD2.25 trillion infrastructure bill. Yet presuming the latter is rammed through ahead via reconciliation, then it is technically possible the same mechanism could be used for tax-hikes in 2022, meaning we would potentially be less than a year away from a huge US step away from financialization and towards a somewhat more European-looking economy.
The irony is that both Wall Street and Silicon Valley went all-in to get President Biden elected, and two elections in a row have seen the guy they put in the White House lead US policy in a direction they don’t like at all. From Trump, it was America First, protectionism, anti-globalisation, anti-China, and anti-Big Tech. From Biden, it’s still anti-China, high taxation – and possibly anti-Big Tech as well. After all, anti-trust Linda Kahn is now nominated for the FTC. Moreover, whispers are flying Treasury Secretary Yellen will slap an 80% tax on crypto assets. Talk about putting down the Doge, making Bitcoin worth just a bit, and sending Ethereum into the ether; and again, what an irony – death via taxes, the two eternal truths Silicon Valley seems busiest trying to avoid.
As I have mentioned before, we no longer have an Overton Window in the US: it’s wall-to-wall, floor-to-ceiling glass. As such, Wall Street and Silicon Valley are perhaps going to have to live with the same “disruption” -- and loss of income -- that US workers in most other fields have experienced at their hands for decades. One can already hear the pearl-clutching. Wall Street might move to Miami to save a few percent on taxes, but can it fight the current political momentum from both Republicans AND Democrats? Silicon Valley will have a tantrum, and there may be threats to work in China instead: but ask Jack Ma about how that is working out.
So what’s the global angle? Expect more pearl-clutching from some. Yet also consider the US, despite its dysfunctional political system, has showed in two successive elections that it can produce transformative outcomes, and at some point this Hegelian process is going to find a synthesis that works for it. How are other countries doing on that front, the EU and Japan in particular, or even China - where is their long talked-off, much-needed property tax?
Yes, there will be voices screaming the US will see net capital outflows. Near-term, yes, perhaps. However, to where? Where looks better in terms of growth prospects, with a queue of multi-trillion US stimulus packages now being lined up? Crucially, however, the US does not need foreign capital. It has household savings among the wealthy at a record high, piles of (big) corporate cash, huge government spending, and a central bank willing to back whatever is needed for social equity. It also has the world’s reserve currency – and with an 80% tax on crypto, it will stay that way.
Furthermore, recall the counterpart to a capital account surplus is a current account deficit. As such, if the US sees a lower capital surplus then it will get a lower current deficit too, and there are only a few ways this can *logically* work:
US unemployment will go up, reducing US demand,…which is possible given how radical these changes are, but also seems illogical when seeing huge Made-in-America stimulus packages for those with the highest marginal propensity to consume; or
We get more balanced US growth, and with more local, not foreign, production. In other words, stopping capital inflows into the US can act in the same way as a trade tariff.
Yes, this could be via a lower USD, forcing painful savings-investment imbalances back onto the rest of the world, including the EU, Japan, and China. Then again, given there will still be global demand for USD for trade and to service piles of Eurodollar debt, and there will be less opportunity to earn said USD by selling to the US, what do you think that says about where the USD could trade – and with no crypto rivals?
Now THAT’S escalation…in thinking – Happy Friday!