Sun Ra - Column for 12/5

News you can Use

Cant columns can be many things: erudite, incisive, or funny; blathering, incoherent, or boring; all of the above. However, I'm going to try something relatively uncommon today, and write a Cant column that could possibly be useful.

Useful columns are not unheard of. We've had, for instance, recipes. But this column is going to proffer the reader (gasp) financial advice.

To be sure that credit goes where credit is due: the research and the numbers here are my own, but the original idea comes from my wife.

As you are doubtless aware, the United States runs a massive trade deficit. We buy more products from other countries than they do from us. This tendency has been around for quite a while, but has become significantly more pronounced of late.

One of the "natural" economic reactions to a trade deficit is currency fluctuation. In order to buy foreign products we need foreign money, which means we must trade our own money for the foreign currency in question. Since we are buying more foreign products than foreigners are buying our products, there is more demand for foreign money than there is for our money. And so, the value of the dollar should be diminishing.

This is precisely what we have seen over the last five or so years. Back in 2000, the Euro purchased around eighty-five cents. A British pound would buy you around a dollar and a half.

As one would expect, dollars became cheaper. At the beginning of this year, a pound Sterling would purchase a buck eighty eight, one Euro, a dollar thirty three. But then something strange happened.

As the year wore on, the dollar stopped becoming cheaper. It actually became more expensive. As of November 25th 2005, a Euro only purchased one dollar seventeen cents; a pound, one dollar seventy one (and a half).

Now, the trade deficit hasn't improved. In fact, it's gotten worse. So what's up?

The "Jobs Creation Act" of 2004.

One of the features of this law (featuring the typical Orwellian naming scheme so beloved of Republicans) was a provision which allowed American corporations to repatriate foreign earnings to their American headquarters at a reduced tax rate - for one year. That is, during 2005 only, American companies can be paid dividends by their foreign subsidiary companies and pay a tax of 5.25% on those earnings, rather than the usual 35% corporate tax rate.

This has led to a one-time flood of cash into the U.S.

How large a flood?

No one is certain how large it will be exactly, but already it has reached hundreds of billions of dollars. Some estimates:

You get the picture.

And you can already realize the rest. All this money moving back into the United States means that suddenly there is demand for American dollars. Which has been moving the exchange rate in the other direction.

To give you an idea of the scales involved, here is a chart of the U.S. trade deficit in 2005. Note that the average is somewhere around $58 billion a month. So for the whole year the U.S. trade deficit will be in the neighborhood of $600-$700 billion dollars.

Thus, the repatriation of profits is a heavily offsetting factor. And is why during 2005 the dollar has actually, and surprisingly, gained in strength.

And on January first, 2006, it's all going to come to a screeching halt.

My advice: buy foreign denominated assets in December. The largest rate of profit repatriations will be in December, because it's the last chance and we all know what human nature says about waiting until the last minute. During December, the dollar will be as strong as it's going to get.

We own a house. Our largest single asset by far can only be denominated in dollars. Everything else, every blot of liquid cash, we're converting into foreign assets. I would advise you to do the same. ADRs, mutual funds with foreign holdings, foreign bank deposits... anything that represents a fixed amount of a foreign asset. As soon as those billion dollar cash flows back to the U.S. stop, the inexorable pressure of the record trade deficit will resume. Or strike back, depending on how dramatic you want to be.

Next week: so, the dollar crumples like a wet tissue. What will that mean?

Columns by Sun Ra