Home' Trinidad and Tobago Guardian : June 22nd 2014 Contents SBG20 INTERNATIONAL
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt JUNE 22 • 2014
Investors lulled into believing that low interest rates
would last forever got a cold dose of reality this month.
First Mark Carney, governor of the Bank of England,
told an audience in London that rates could rise "sooner
than markets currently expect."
Then America s Federal Reserve, which like the Bank
of England has kept rates near zero for more than five
years, signaled its intention to keep them there at least
until next year. However, it too faces ever-louder calls,
including some from its own officials, to abandon that
Advocates of fast action worry that leaving rates near
zero for too long will cause inflation to accelerate in both
countries. They also fear that, even if prices stay quiescent,
too much cheap money for too long is inflating asset
bubbles whose eventual popping will create another
These worries are not unfounded, but they are exag-
Start with inflation. At 1.5 per cent in Britain, the
lowest rate in four-and-a-half years, and 1.6 per cent
in America, it is below the 2-per cent target of both
countries central banks. Of course central bankers should
fret not about today s inflation but about tomorrow s,
and the vigor of Britain s recent growth means that the
country s spare capacity is disappearing: Unemployment
has dropped to 6.6 per cent from 7.8 per cent a year
ago, but there is no pressure on wages.
In America the price picture is even more benign.
The slack is greater, and inflation has been below target
for two years. As in Britain, meager pay rises give no
hint of a wage-price spiral.
What about financial instability? Froth is certainly
evident. In Britain the main exhibit is home prices, which
have surged by 10 per cent in the past year, overtaking
pre-crisis levels. Household debt also is on the rise.
In America the appetite for risk is most obvious in
the fixed-income market. Loans to highly leveraged
companies this year are on track to match last year s
record-breaking US$1.1 trillion. A third of these loans
lack the usual covenants that ensure that borrowers can
repay the money.
These excesses are worrying, especially given the
wretched history of the 2000s, when the Fed stood by
as an enormous housing bubble inflated. Nonetheless,
higher rates are the wrong response to the latest signs
of excess, for three reasons.
First, the excesses are still small, compared with those
that brought down the global economy in 2007. Britain s
housing bubble is limited largely to London. In both
Britain and America, banks sit on thicker cushions of
capital and liquidity, making them less vulnerable to any
downturn in asset prices.
Second, central bankers and their fellow regulators
can treat financial excess far more surgically today by
using "macroprudential" tools rather than the blunt
instrument of interest rates.
The starting point with mortgages is usually limiting
loan-to-value and debt-to-income ratios, while allowing
some flexibility for the riskiness of various borrowers.
Canada, for instance, is stricter with buy-to-rent investors
than with homeowners. Banks also can be compelled
to hold more capital and liquidity against risky loans.
To the extent that macroprudential measures slow the
growth of assets, debt and wealth, they delay the need
to raise interest rates, ensuring that safer loans remain
cheaper for longer.
Third, the danger of raising interest rates to dampen
asset prices is much bigger now than it was 10 years
ago, because rates are near zero. Premature monetary
tightening could push the economy back into recession
and turn inflation to deflation. The result would be to
send interest rates back to zero for even longer.
To be sure, macroprudential controls are untested.
Applied too roughly, without allowing for the credit-
worthiness of borrowers, they too could be fairly blunt.
Still, they are a better first line of defense against bubbles
than simply raising interest rates. The Economist
America is a land of immi-
grants, but some of its
biggest companies are
eager to emigrate, driven
abroad by high tax rates
and America s "world-
wide" system of taxation, which grabs a share
even of their foreign profits.
The preferred method of exit is the "tax
inversion," which uses a cross-border merger,
generally one that also has some sort of
industrial logic, as a pretext for reincorporating
in a more tax-friendly place. Medtronic, a
maker of medical devices, is the latest and
largest firm to change its nationality in this
The combined group will be domiciled in
low-tax Ireland, the official home of its merger
partner, Covidien. Medtronic s executives
will stay in Minneapolis, however, and Covi-
dien s will remain in Mansfield, Mass. Covi-
dien, then part of Tyco, left America for
Bermuda in 1997 before moving to the Emer-
ald Isle in 2009.
The deal thus involves an inversion with
a "foreign" firm that has itself already inverted,
a sort of "inversion squared."
This will be the 15th transaction of the
latest inversion wave, which began two years
ago. Such deals are particularly popular with
health-care and energy firms. Pfizer s recent,
abortive bid for Astrazeneca, which may yet
be revived, would have been a blockbuster
of the genre. According to Bloomberg, a busi-
ness-information provider, close to 50 Amer-
ican companies have flown the coop since
tax planners hatched the idea in the 1990s.
Medtronic s planned inversion is less about
reducing the per centage of profits that it
pays in corporation tax, which will be only
slightly lower after the union, than about
freeing some of the US$20 billion in foreign
earnings that the firm is loth to bring home
because Uncle Sam would grab 35 per cent
Medtronic has borrowed heavily at home,
rather than repatriate foreign earnings and
trigger extra tax payments, to finance share
buybacks and dividends. With this deal it
can use its foreign cash both to reduce its
debt and to finance the acquisition itself,
engaging in "hopscotch" transactions that
funnel cash from non-American subsidiaries
to the Irish holding company, skipping the
American layers, says Edward Kleinbard of
the University of Southern California in Los
Wall Street analysts applaud this sort of
intra-group shuffling, because it makes capital
deployment more "flexible," typically boosting
the share price. Another advantage is that
in the future the group s American arms will
be able to issue debt, use the proceeds to
pay dividends and take an interest deduction
that is not taxable in America under its tax
treaty with Ireland.
America has tried several times to stop
companies from fleeing abroad through tax
inversion, with limited success. Rules intro-
duced a decade ago required the foreign part-
ner to be worth at least 20 per cent of the
combined group. That helped stem the out-
flow of firms inverting with shell companies
in tax-free Bermuda and the Cayman Islands,
but it left American multinationals with var-
ious options for mergers with smaller firms
based in places with low corporate taxes,
such as Britain, Ireland and the Netherlands,
as long as the target firms had some employ-
ees and offices---"substance," in tax-speak---
in those countries.
Bills introduced by Congressional Democ-
rats this year have proposed raising the 20-
per cent threshold to 50 per cent. In other
words, the foreign partner would have to be
as big as the American one for the inversion
to stand. The change would be applied
retroactively, from May of this year.
Were the bills to pass, this latest deal would
be blocked, because Covidien investors will
own only 30 per cent of the new entity. This
is unlikely, though, since the bills will not
win the Republican votes they need unless
they are part of a broader tax reform.
Still, inverting companies are taking no
chances. Medtronic s agreement with Covi-
dien gives it the right to cancel the deal if
Congress rewrites tax laws in a way that
deems the merged group an American tax-
There will be more reincorporations,
regardless of what happens in Washington.
A group of Walgreen shareholders is pushing
the drugstore chain to redomicile in Switzer-
land, for instance. Intercontinental Hotels of
Britain reportedly is being stalked by an
American bidder seeking to invert. Companies
have grown more creative in getting around
new rules, for instance by structuring deals
as private buyouts to dodge curbs on inver-
sions carried out by means of a public offer-
ing.Tax lawyers already have gimmicks up
their sleeves in case the Democrats 50-per
cent rule does pass. An American firm can
keep its stake below half, even if its partner
is smaller, by taking a chunk of cash in return
for the reduced stake, as Mondelez Interna-
tional is doing in a linking of its coffee division
with Douwe Egberts, a Dutch rival.
Lawmakers are likely to find that simply
trying to prevent inversions only leads to
more cat-and-mouse games with corporate
tax planners. It would be better to reduce
the incentive to leave America by cutting its
corporate tax rate to around 25 per cent, par-
tially paid for by hacking away the current
thicket of corporate allowances, and moving
to a "territorial" system that taxes only
domestic profits, as most other countries do.
Among other benefits, this would encour-
age American firms to bring home their for-
eign profits to invest them in America. Until
then inversions will remain on boards agen-
das. With so much at stake---each per cen-
tage-point cut in Medtronic s tax bill adds
US$60 million to its bottom line---the temp-
tation is simply too great.
@2014 The Economist Newspaper Ltd.
Distributed by the New York Times Syn-
The inverse logic of
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