The 111-Point Market Sell-off Jude Wanniski January 14, 2005

The financial press is universally attributing yesterday afternoon’s market collapse to a slightly higher price of oil and disappointment over earnings. The real reason is a number of bureaucrats at the U.S. Treasury Department. Treasury Secretary John Snow was actually better than usual yesterday as he made the rounds explaining that the current-account deficit is the result of faster growth in the U.S. than in the rest of the world. But meanwhile, his underlings were releasing a 40-page report outlining the uses to which multinational corporations repatriating profits from abroad can put that capital. In a serious dimwitted blow, the funds cannot be used to buy back stock or to pay higher dividends, and only in certain special circumstances will they be able to pay down lawsuit judgments with the funds.

The market had been down a bit when the report was released at 1:30PM, but as it was read and digested, equities unraveled across the board with a fast finish. If there had been an economist worth his salt at Treasury, he might have explained to the tax division that when it refuses to permit the market to direct new capital flows to their highest and best uses, they will be forced into uneconomic uses. When Congress passed the repatriation bill in the lame-duck session in November, it specified that the funds coming back to take advantage of a one-year 5.25% corporate tax, reduced from the maximum rate of 35%, had to have the after-tax remainder invested at home. It left it to Treasury to decide the details and until the report came out, it was still assumed companies would be allowed to buy back their own shares, although it was being assumed companies could not pay out higher dividends if they did not have good uses for the capital. Both should have been permitted, which would have allowed funds being directed by management committees of the multinationals to be directed by the market to younger companies in need of capital, companies with little or no footings abroad. Instead, the big guys will be able to use the funds to increase advertising budgets and to buy other U.S. companies. 

The legislation House Ways & Means Chairman Bill Thomas and Senate Finance Chairman Chuck Grassley spent two years working on to produce this capital inflow was battered enough by Democrats and rust-belt Republicans before it got to the President’s desk. But the Treasury regulations take another big bite from its benefits and we can expect a good bit of the huge capital pool sitting outside our borders will remain there. Companies who would have automatically repatriated to buy back stock will have second and third thoughts and keep available funds invested abroad where there are obvious economic uses. The next step would be for them to sell themselves to foreign entities, a la Chrysler becoming Daimler-Chrysler, to escape the good intentions of Treasury policymakers. 

The one side "benefit" of the Treasury regulation, then, will be a decrease in this fresh capital flow, which will mean a slightly lower deficit on current account. Remember a capital inflow is the flip side of the current account deficit, as the only way foreign capital can make its way to the U.S. is if more goods and services are exported to the U.S. than are exported from the U.S. to the rest of the world. If we attribute the 1 percent sell-off in equities to the one-time disappointment in these Treasury regulations, we can come up with a tidy sum of wealth squashed in the process, perhaps more than $100 billion. The man in charge at the tax division, Eric Solomon, is "the acting deputy assistant secretary for tax policy," a rank not much higher than the janitor's. 

Because nobody else seems to have noticed the connection, I will send this brief to Chairmen Thomas and Grassley in Congress, to the White House political staff, to Allan Hubbard at the National Economic Council, and to a number of Treasury officials who might get through to Secretary Snow.  A hundred billion here, a hundred billion there, and pretty soon you are talking real money.