InvestMacro

By Ino.com

– On September 30th, the United States Congress sent a bill to President Biden’s desk to avoid a government shutdown, at least until December 3rd. In the past, when the government has shut down or come close to a shutdown, similar to what just happened, we have seen market turmoil caused by the uncertainty surrounding the situation. However, even with that uncertainty removed temporarily until December 3rd, the markets may not have much breathing room since lawmakers still need to raise or suspend the debt ceiling before October 18th.

If the politicians in Washington can’t agree on the debt ceiling, the U.S. could default on U.S. debt, something that most market participants believe would be “disastrous.” However, the United States has never in its history defaulted on government debt. So, we honestly do not know what would happen if it were to happen. But, since U.S. Treasury bonds are widely considered “zero” risk and used as a benchmark or starting point to determine the risk of other alternative investment options if the government did indeed default, it would send shock waves throughout the market as other assets would need to be repriced based on their risk level when compared to U.S. Treasury bonds.

The uncertainty which would follow and potentially dramatic rise in interest rates across the board could and very likely would send the U.S. economy into a tailspin with the stock market falling and potentially a rise in unemployment. Some even believe that government spending in the forms of social security payments and bills owed to contractors would be suspended for a period of time while the U.S. Treasury determines what to pay and what not to pay. This would obviously hurt the overall economy as potentially millions of Americans would not receive social security checks and or paychecks if they work for a government contractor.

However, the long-term implications of defaulting would likely be the worst consequences. It is estimated that the U.S. Government gets a 25-basis point reduction in its interest rate because of the ‘perceived unparalleled safety and liquidity of the Treasury market.’ That discount on interest rates the government receives equates to roughly $60 billion in lower interest payments this year alone and more than $700 billion in interest savings over the next decade, based on the current U.S. debt amount. That means if the politicians in Washington can’t agree on something and the U.S. Treasury Department is forced to come up with creative solutions because it doesn’t have the funds to pay its bills, the U.S. taxpayer will be on the hook for a higher interest rate in the future.

So as an investor, how should you proceed over the next few days or weeks as this plays out?

Let’s talk about a few options you have at your disposal.

First, do nothing different and maintain the mindset that ‘this storm will pass.’ This is honestly the mindset that 99% of investors should take. If the stock market crash at the start of the pandemic, or the 2007-08 financial crisis, or the dotcom bubble (I’ll stop here), have taught us anything, it’s that the market will rebound and go higher than it was even just prior to the crisis. Long-term-oriented investors should literally just sit back and ride the roller coaster with their hands up (screaming is allowed but only in the confines of your own home) and let the market do what the market does. There is absolutely nothing wrong with this approach; you just need to be patient and keep a calm mind if the mayhem does hit.

Another option is that you could buy the market now, prior to the potential market-crushing event, with the thinking that some stocks have already been taken lower by some investors in anticipation of a big drop that they don’t want to be involved in. Then when the potential future market wrecking event doesn’t happen, stocks will bounce higher, and you will be sitting pretty. Finally, you could buy individual equities or ETFs that mimic the market, such as the Vanguard S&P 500 ETF (VOO), the SPDR S&P 500 ETF (SPY), which both follow the S&P 500 Index or the Invesco QQQ Trust (QQQ), which tracks the NASDAQ Index.

A third option is to buy a hedge in case the ceiling is hit, and we don’t have a solution from Congress, and the markets go haywire. Again, you would remain stable and hold all your current holdings and make no changes to those either before or after the crash occurred. However, before the crash, you hedge your long-term holdings and buy something like the Direxion Daily S&P 500 Bear 3X Shares ETF (SPXS), which is betting that the S&P 500 will go lower, or the ProShares UltraPro Short QQQ (SQQQ), which is an ETF that is betting against the NASDAQ Index or the QQQs. Another way of hedging would be to buy put options on the Vanguard S&P 500 ETF or the Invesco QQQ Trust themselves.

As I said before, 99% of investors should just sit back and watch the mess play out in Washington and do nothing different with their investors or portfolio. The 1% that may want to ‘time’ the market have a 50% chance of being right, so good luck. But what 100% of investors should do, is keep investing, no matter what happens over the next few weeks.

Matt Thalman
INO.com Contributor – ETFs
Follow me on Twitter @mthalman5513

Disclosure: This contributor did not own shares of any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.

By Ino.com – See our Trader Blog, INO TV Free & Market Analysis Alerts

Source: U.S. Default Could Be A Disaster

By Daniel Ofoe Chachu, University of Zurich and Edward Nketiah-Amponsah, University of Ghana 

Countries with abundant natural resources – gold, diamonds, crude oil– often fail to transform that advantage into favourable development outcomes. This is known as the natural resource curse. Countries like Nigeria, Angola and the Democratic Republic of Congo are often cited as examples.

Several explanations have been offered for the resource course. These include the lack of government accountability usually associated with large windfalls from natural resources relative to other sources of tax revenues. Others are an increase in the local currency against major currencies such as the US dollar, which makes it difficult for other sectors of the economy to compete globally. This is referred to as the Dutch Disease, named after the economic crisis that hit the Netherlands in the mid-1970s after the discovery of oil in the North Sea.

A related problem, but one that has received less attention, is the fiscal resource curse. It refers to the inability of a country well endowed with natural resources to generate domestic revenue from other sectors of the economy. For example, between 2000 and 2010, resource revenues in Angola stayed above 20% of GDP compared to a non-resource tax level of about 7% on average.

But the fiscal resource curse need not be a foregone conclusion for developing countries. A recent study finds tentative signs that China’s approach to trade with resource rich African countries might be the answer.

China has been offered bilateral infrastructure investment deals to resource rich countries. For instance, China “pays” for some of the commodities by investing in the supplier country’s infrastructure. This has been a common approach in several African countries, including Angola, Sudan, Nigeria and Ethiopia.

There is no consensus in the economics literature on the relationship between natural resource abundance and domestic revenue mobilisation. Nevertheless many studies suggest a tradeoff between revenues from the natural resource sector versus those from other sectors.

Our study investigated whether natural resource revenues displace non-resource tax revenues in developing countries. Its novel contribution is that it explores the impact of China. This is specifically about China’s extensive involvement (as a buyer) in the natural resource trade since joining the World Trade Organisation (WTO) in 2001.

Resource rich African countries do not have to fall victim to the resource curse.
Wikimedia Commons

Enter the dragon

We examined whether China’s entrance into the global trade has affected the relationship between natural resources and domestic revenue mobilisation.

We do not find consistent evidence of a negative relationship between natural resource revenues and tax revenue mobilisation from other sectors. The key implication is that natural resource abundance need not translate into a curse.

In our study we used a unique global dataset that separates domestic resource revenues and non-resource revenues. The database was developed by the International Centre for Taxation and Development. It is hosted by the United Nations University. We also used data from the World Bank’s World Development Indicators and the International Country Risk Guide.

We analysed a sample of 45 developing countries with data covering the period 1980-2015. More than half of these countries are African.

The period after 2001 was marked by growing commodity trade and rising commodity prices. These were triggered by China’s rising demand for crude oil and metals. For example, China’s global demand for metals increased to about 40% of total demand after 2001 compared to a paltry 3% before. Africa satisfied a third of China’s energy requirements.

This demand shock spurred natural resource exports, resulting in an increase in resource revenue growth.

The China shock

Without accounting for China’s role, we find that a negative relationship between natural resource revenues and non-resource tax revenues. In other words, developing countries don’t appear to raise taxes outside the resource sector when commodity prices are high and resource revenues are growing. But robust statistical analysis suggests that it’s not so simple.

If we take into account the “China shock”, there isn’t consistent evidence of a negative relationship between natural resource revenues and non-resource tax revenues. Our study finds that natural resource revenues could play a complementary role in raising taxes outside the natural resource sector.

On average, a percentage point increase in resource revenues triggers a non-resource tax revenues increase of about 0.3 percentage points for the countries and time period of study. However, the relationship is not strong, statistically.

A plausible explanation could be how developing countries take advantage of China’s demand for natural resources. In return for primary commodities, China offers a bilateral infrastructure investment strategy. This often compensates for the financial market and governance challenges that developing countries face. For instance, China “pays” for some of the commodities by investing in the supplier country’s infrastructure. This has been a common approach in several African countries, including Angola, Sudan, Nigeria and Ethiopia.

China’s development of infrastructure in these countries could be stimulating the growth of their non-resource sectors. Infrastructure is one of the key bottlenecks for private sector growth. In turn, private sector growth can help these economies diversify the economic base and increase non-resource revenues. Thus, increasing natural resource revenues need not displace sound tax policy. Tax revenue mobilisation in the non-resource sector need not suffer.

Concerns about opacity

The lack of a highly statistically significant positive relationship deserves comment. First, even if the China shock makes a difference, developing the capacity to tax in developing countries takes time. Moreover, one should not expect China’s natural resource trade model with developing countries to automatically guarantee favourable outcomes in every case.

Indeed, the burgeoning literature on China’s involvement in Africa paints a mixed picture. For example, despite the potential benefits of infrastructure projects, there are concerns with the opacity of Chinese contracts and the quality of the projects. Some governments also worry about the cost of natural resource-backed loans. Furthermore, many developing countries lack the capacity to manage infrastructure projects effectively.

Overall, our analysis shows that there isn’t strong evidence that natural resource revenues displace non-resource tax revenues. Investments in infrastructure in developing nations on the back of natural resource windfalls could help diversify economies and government revenue. This offers policymakers an opportunity to broaden the tax base and maintain a relatively stable tax rate. It also puts something in domestic revenue buckets even when the oil wells run dry.

About the Author:

Daniel Ofoe Chachu, Research Fellow, Institute of Political Science (Political Economy and Development Group), University of Zurich and Edward Nketiah-Amponsah, Associate Professor, Department of Economics , University of Ghana

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By Ronen Palan, City, University of London 

Many of the world’s richest and most powerful people are in the spotlight once more for using secretive tax havens and corporate structures to hide wealth and avoid paying taxes. The Pandora papers is the third in a series of huge leaks of documents to the media following the Panama papers in 2016 and the Paradise papers in 2017 – and little seems to have changed in the interim.

Those included so far in the new revelations include the leaders of the Czech Republic, Cyprus, Jordan and Ukraine, plus members of the ruling family in Azerbaijan and figures close to Vladimir Putin. In all, more than 100 billionaires are reportedly involved in the revelations, with transactions ranging from properties worth millions of pounds to slush funds and superyachts.

We asked Professor Ronen Palan, a specialist in offshore tax havens at City, University of London, about the story so far.

What are your initial thoughts?

I’m afraid I’m not surprised by these papers. There’s no evidence to suggest that the volume of transactions taking place through these offshore centres is declining, so the same financial structures that we heard about in the Panama and Paradise papers are still clearly being used.

It’s fascinating that so many of these people in the public eye must have known that eventually their activities would become common knowledge, and yet they opted for offshore secrecy anyway. I suppose any concerns may be overcome perhaps by greed and the knowledge that they will not be prevented from doing it.

In some cases we are talking about (illegal) tax evasion and in some cases it’s (legal) tax avoidance: the difference comes down to whether the people in question had fully notified the authorities in their home countries about the offshore structures they are using. In instances when I read that they are asked by the media to comment and they decline to respond, it creates the appearance that we are talking about evasion – although this remains unproven.

Why does the situation not appear to be improving?

Over the past 20 or 30 years, international regulation has focused on creating tools that allow tax authorities to ensure that taxpayers are not evading taxation. Systems were introduced that focus on “know your customer” or KYC – requiring people transacting in particular jurisdictions to fully identify themselves so that this information can be shared with other jurisdictions.

This essentially creates transparency so that you know who has money where, so that tax authorities can use this information to make sure that their citizens are not evading taxation. But while that can be effective in countries where the tax authority is operating independently of the government and politics, it’s not going to work in Russia or China or many other developing countries. It’s therefore not surprising to me that many of the revelations are about activities outside of the developed world.

But why hasn’t transparency forced tax havens to change?

It has brought about change, but some jurisdictions comply more than others. So you have got some British jurisdictions such as Jersey or the Cayman Islands that are much more transparent than they used to be. On the face of it, they can claim to be more regulated than, say, Denmark or Sweden.

But the professionals who have the expertise to create structures that enable tax evasion are still often based in these places, and they create structures with different layers that will be partly registered in these jurisdictions but partly in those with looser transparency rules such as the British Virgin Islands or Panama – following the letter but not the spirit of the law. This makes it very difficult to see what is happening and whose money is involved.

How do we improve the current situation?

The Pandora papers show we are reaching the limits of what can be done with data transparency. Unless we find ways to tighten the net, this won’t be the last leak of its kind. This is recognised at least implicitly by the OECD (Organisation for Economic Co-Operation and Development) and other international bodies in their increasing interest in going after the enablers, rather than just focusing on the tax evaders themselves.

Maybe it’s time to create something similar to what applies in medicine, so that, if enablers contravene certain standards, they can be prosecuted – even in countries who are not directly affected by their activities. If they went to such a country, they could be arrested on arrival.

Should we create a new international institution dedicated to stamping out tax evasion?

In practical terms, the three places that matter when it comes to creating international regulations are the US, EU and China. Unfortunately they are not agreeing with one another on much right now, so it will be difficult to reach an agreement about such an institution. Even if they did agree, they would be accused of imperialism by smaller countries, or of acting as dictators.

Of course, these three players would still need to agree on an initiative to really go after enablers, so you can make the same criticism of this strategy, but it is at least more modest in its scope and therefore potentially more realistic.

Are all these revelations actually helpful?

There’s certainly a danger of media saturation, in which the public knows about these kinds of activities and may be less interested by now. But we need to emphasise that the consequences are not going away: to run a modern state, it’s very expensive. To pay for a good education system, a good health system, properly functioning infrastructure and so forth, somebody has to pay for it.

If the rich are avoiding paying their share, somebody else is picking up the tab, and that’s either the poor or the squeezed middle classes. So if the public are tired of all this scandal, it doesn’t change the fact that they are suffering because of it.

About the Author:

Ronen Palan, Professor of International Politics, City, University of London

This article is republished from The Conversation under a Creative Commons license. Read the original article.