Republicans Deal Blow to American Investors as Foreign Investors Win

The Hill just published my new essay on one of the perverse effects of the GOP tax plan. Republicans insist that their deep cuts in corporate rates will produce waves of new investment, mainly from abroad. That’s very doubtful – but if it did happen, it would also drive up the dollar’s value against other major currencies by about 10 percent. Here’s the rub: the currency changes would exact a $1.6 trillion windfall loss from U.S. investors holding foreign stocks and bonds -- $220 billion from retirement savers holding mutual funds invested abroad. But foreign investors holding U.S. stocks and bonds would reap windfall gains of $2.2 trillion! I have copied the full text here.

Last week, House Republicans produced a tax bill that elicited howls of protest from realtors, homebuilders, small business advocates, officials from high tax states, universities, museums, and Democrats. To fund huge tax cuts for businesses, the bill also includes a number of careless cruelties aimed at the families of Americans with chronic illnesses and disabilities, children in cash strapped schools, and even orphans. The bill seeks to end deductions for large medical expenses, tax credits for teachers who pay for their own school supplies, and a tax break for families that adopt children.

One set of winners and losers, however, is buried in the bill’s secondary effects. If the White House storyline about the proposal’s economic impact is accurate, the biggest losers will include U.S. retirement savers and all other American investors holding foreign stocks and companies. The biggest winners, after the children of billionaires, will be foreign investors who own U.S. companies, factories, stocks and bonds.

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The reason lies in the bill’s second and third order effects. Under the Trump administration’s rosy scenario, the deep cut in the corporate tax rate will attract billions of dollars in new investments, mainly from abroad. But if that comes to pass, an unavoidable effect will be an 8 percent to 10 percent jump in the value of the U.S. dollar against the euro, the yen, and other major currencies.

Here’s the rub. If the tax changes lifts the dollar 8 percent to 10 percent against the euro and the yen, the value of European and Japanese owned investments in the United States will rise 8 percent to 10 percent with it. Similarly, if major currencies fall 8 percent to 10 percent against the dollar, the value of all U.S. owned foreign companies, stocks and bonds also will fall 8 percent to 10 percent, including the international mutual funds held in the retirement accounts of millions of Americans.

These currency effects would produce huge windfalls. According to the United Nations, foreign individuals and companies currently hold nearly $6.4 trillion in direct investments here. That covers all foreign owned subsidiaries, factories, and buildings in the United States. The Treasury Department reports that foreigners also hold nearly $6.2 trillionin American stocks, or about 25 percent of all U.S. equities, and more than $10 trillion in long term U.S. corporate and government bonds.

All told, foreign investors hold real and financial assets in the United States worth $22.6 trillion. An 8 percent to 10 percent increase in the dollar’s value would produce a windfall gain of $1.8 trillion to over $2.2 trillion for those foreign investors, which would be at least the cost to U.S. taxpayers of the entire cut in corporate taxes over 10 years.

Here’s the equally bad news for U.S. retirement savers and other investors with foreign holdings. The United Nations has reported that Americans and U.S. companies hold about $6.4 trillion in direct investments abroad. Moreover, the Treasury Department has shown that Americans also own nearly $7.2 trillion in foreign stocks and more than $2.4 trillion in long-term foreign government and corporate bonds.

All told, American investors hold foreign real and financial assets worth about $16 trillion. An 8 percent to 10 percent decline in the value of foreign currencies against the dollar would mean windfall losses of $1.3 trillion to $1.6 trillion for the U.S. owners of those assets. If just one-third of the $7.2 trillion in U.S. owned foreign stocks are held by mutual funds, which in turn are held in U.S. retirement accounts, those retirement savers would lose nearly $192 billion to $240 billion.

These effects are baked into the economics of exchange rates. In response, the House Republican tax bill’s advocates may counter that it will boost growth here, and then the increase in imports will moderate the dollar’s rise. But if the tax changes so spur faster growth, another result would be more foreign purchases of U.S. stocks and bonds, which in turn would offset the currency effects of higher imports.

All of this leaves us with two scenarios. Under the first, the bill boosts investment as promised, which leads to huge windfall gains for foreign investors holding U.S. assets and huge losses for American retirement savers and investors holding foreign assets. Alternatively, the bill fails to boost investment and merely delivers huge windfall gains to wealthy shareholders and children of the very rich, which ordinary Americans will ultimately pay to offset or finance trillions of dollars in additional deficits.