ECB Cuts Rates when Stock Markets are at Record Highs

The ECB took Financial markets by surprise when it announced a 0.25% cut in its core interest rate on Thursday. Most analysts, including yours truly, expected rates to remain as they were and indeed few expected rates to ever dip below the 0.50% rate announced earlier this year. It is obvious the ECB is less than impressed with the limp growth being experienced in the Eurozone, and with inflation running at a meagre 0.7%, the European economy is in danger of slipping into a Japan-like decade of economic stagnancy and deflation. Indeed we can say we are already half way along that road.

But is the ultra accommodative policy of the ECB enough to help Europe reverse course? Experience elsewhere would suggest not. Japan's lost decade occurred at a time when the Bank of Japan kept interest rates close to zero, printed money at will and facilitated a carry trade that saw the Yen kicked around in currency markets. Despite the exhaustive efforts of the Bank, apart from exporters, there was very little economic uplift in Japan's domestic economy and the country has spent the best part of twenty years in a deflationary rut.

So can Mario Draghi & Co. avoid the economic chasm that so engulfed Japan for much of the past twenty years? We are five years in and thus far the omens are not good. The ECB and the Eurozone are running out of options and unless European consumers begin to find work and find the propensity to spend, then stagnation will become denigration and to déja vu we are doomed.

Given the German influence within the ECB and its strong resistance to quantitative easing as a method of economic stimulation, the Eurozone is highly unlikely to follow the same path as Japan, the US and the UK in rolling out the printing presses, simply to appease the flawed political lines of economic argument. One thing we have learned over the past five years is that quantitative easing has had minimal positive impact on real economies across the world and it has merely acted as a tool by those at the top end of the financial tree to stoke the fire in financial markets.

Since the economic collapse five years ago, virtually the only place where we have seen inflation, and indeed heightened inflation, has been in stock markets, commodity markets and in a range of other financial instruments. Indeed many of the increases in these markets are hyper inflationary and are totally out of synch with consumer experience and with the normal rules of economic supply and demand. To be fair there are two very real contributory factors leading to the growth in major stock indices, one being that the lack of credit on the ground has squeezed out a huge chunk of the SME market in favour of cash-rich conglomerates, and the other being that sustained growth in the developing world has hugely benefited multinational PLCs.

However there remains a huge disconnect between the growth in stock markets as against GDP growth in the real economy which suggests financial markets are due a very significant correction downwards. Investors in stocks should not take the ECB move on Thursday as a positive sign for the medium-term outlook for stocks. The ECB is not the line of either first or last defence for financial markets in the same way the Fed acts as the great protector of Wall Street. And with ECB rates at a level under which there is no scope, when the trap door opens under the weight of inflated stock markets, there will be little to nothing the ECB can do, even were it as inclined as the Fed to intervene.

Apple, Google and the Tax Holidays on Offer in Ireland

Much has been written in the past two weeks about apparent anomalies in the tax regime in Ireland and the ability of two of the biggest corporations in the world – namely Apple and Google, to exploit these anomalies to their advantage, i.e. to avoid paying taxes to the tune of Billions of dollars, to any tax authority, anywhere, for many years. Neither company has broken any law, rather, both have jumped on the incredibly generous tax laws which operate in Ireland, a country that enables large multinationals to register their entities in Ireland while not having to be tax resident there, nor indeed tax resident anywhere.

There have been many vocal objections within Europe in recent years to Ireland’s lowly corporation tax rate of 12.5% which is significantly lower than the EU norm. However, despite the protestations, Ireland managed to convince the Troika during the bailout talks 2.5 years ago that Ireland had to retain this tax rate to ensure the sustainability of existing business operations from multinationals in the country, a sector that currently provides upwards of 150,000 jobs in a county with a population of around 4 million people. The fear was that if this tax rate was increased significantly, it would trigger an exit of multinational firms from the economy, and further depress an already stuttering economy, thus exacerbating the country’s already dire debt problems.

However, the Apple and Google story really has nothing to do with Ireland’s corporation tax rate. Even if the corporation tax rate were 35% (as in the US), this would not have made much difference to the actual tax take Ireland would have netted from either company, as Apple and Google only pay nominal tax in Ireland, reported as being just 0.05% and 0.14% respectively of total income channeled through their Irish entities. The tax anomalies that exist in Ireland permit a company to register there, but if the entity is managed from outside the Irish jurisdiction, it can be deemed to not be tax resident in Ireland, thus the corporation does not have to pay tax to the Irish State for the operations of these companies. In the case of Apple, three of the Group’s main revenue generating companies are registered in Ireland, but are tax resident in Bermuda, where there is no tax. Using this arrangement, Apple managed to restrict its overall tax liability across the globe in 2011, to just 1.9% of the Group’s income. Apple is a US conglomerate with its Headquarters in Silicon Valley, and given the corporation tax rate for American registered companies is 35%, it is easy to see why certain people in charge of the legislature in the US might get quite exercised on this issue.

Similarly, in the UK, the House of Commons were informed two weeks ago, that Google Ireland paid tax of just €70 Million on sales of €47 Billion between 2005 and 2011. Google’s sales in the UK were channelled through its Irish company and Google essentially paid no tax in the UK on UK sales. Google availed of the same tax loophole as Apple, whereby it funneled revenues from non-Irish operations through Irish subsidiaries which although registered in Ireland, were not deemed tax resident in Ireland. The funds then made their way to a Bermuda registered Google company, to avail of the 0% tax rate on offer there. The House of Commons committee subsequently branded Google ‘devious’.

So who is to blame for the tens of Billions of dollars in lost tax revenue? It is hard to blame the companies themselves directly, as ultimately the function of corporate companies is to maximise the wealth of their shareholders. There is an argument that both Apple and Google come up short in terms of displaying corporate moral responsibility, whereby they have deliberately avoided paying their fair share in tax contributions back to the economies that contributed most to their success. However most corporations will generally operate within the legal parameters set for them, and if the legal parameters come up short, and this provides an opportunity, then most companies will take such an opportunity if it helps it to preserve and grow its wealth for shareholders.

The Irish Government has been at pains over the past week to state Ireland is not a tax haven and that the government does not do deals with companies on the tax liability a company must pay. However the fact is that Ireland deliberately operates an accommodative policy surrounding legal registration and tax residency and this accommodation is used by scores of multinationals to avoid paying tax in other jurisdictions. This has nothing to do with the low corporation tax regime already operating in Ireland. Apple and Google between them provide about 6.000 jobs in Ireland and these jobs are obviously deemed more important to the country than the very significant tax revenue the country could earn from both companies, and indeed from other multinationals, were these companies forced to pay corporation tax on all earnings channeled through all their Irish registered entities.

The European Union could introduce a rule that all companies registered in the European Union are automatically liable for tax at the tax rate applicable in the jurisdiction in which the company is registered, closing off the Irish loophole that permits a company to be registered as a legal entity in one country, while being resident for tax purposes in a separate jurisdiction. Of course the EU, US and other major governments could also determine that, for tax purposes, IP has to be registered in the country of origin of the IP, as opposed to being registered in some remote island and thereby by proxy, this would force large multinational companies like Apple and Google to radically rethink their policy in relation to corporate responsibility and tax and their overall economic contribution to all society.

Bob - May 27th 2013

Jamie Dimon's Two Fingers to Governance

What is going on at JP Morgan Chase?

Despite the multiple scandals that has plagued the broader Banking sector in recent years and the more recent 'London Whale' trading scandal, where JP Morgan blew billions of dollars of investors money, JP Morgan Bank has spectacularly demonstrated its inability and reluctance to embrace strong leadership and transparency by voting down a proposal to separate the key corporate roles of Chairman and CEO. As to why this proposal needed to go to a vote by shareholders in the first place, says a lot about Jamie Dimon's own personal agenda within the Bank and his rather alarming indifference to best practices in governance. What is he afraid of? What has he got to hide? Why does he not want to be accountable to anyone within the Organisation?

Even undergraduate students that study business studies and corporate governance will know the critical importance for the separation of the CEO and Chairman roles in an organisation. The Board's job is to oversee the performance of management and to hold management to account. How can the Board carry out this function if the Chairman of the Board happens to also be the Head of Management (CEO). Given the Chairman sets the agenda for Board meetings and is the most powerful and influential person on the Board, how can the Board function in any meaningful or effective manner, if the Chairman also happens to be Management's chief representative and defender on the Board.

The fact a publicly listed Bank the size of JP Morgan Chase is even allowed to retain a CEO and Chairman as the same person does not say much for the regulatory authorities in the US. In many countries this would be a breach of governance practice and the Bank would be expected to provide an explanation in its Annual Report for the breach, and to provide details on what it is doing to rectify the transgression. Many of the failings of international banks during the financial crisis had to do with core governance failures and the failure of Boards to rein in management, when risks in the sector began to escalate.

JP Morgan Chase may well argue that it outperformed and outlasted most of its competitors during the Banking crisis, but that does not give Mr Dimon a license to be answerable to nobody and to both manage and govern the bank as he sees fit. If he is truly proud of the job he has done, he would be open to transparency and accountability, and welcome a non-executive Chairperson to evaluate his performance and to report back independently to the Bank's shareholders. Ultimately one has to ask what is the role of the non-executive Directors on the Board of the Bank and if these Directors believe it enhances their corporate reputations to sit on such a dysfunctional Board structure. How effective can the Remuneration Committee be if a member wishes to question the remuneration package afforded to Jamie Dimon? Dare they strike it down? They can hardly revert to the Chair for guidance, or support.

The number one requirement in good corporate governance practice is the separation of the CEO and Chair roles. Any organisation that fails this simple test is a long-term recipe for disaster and should be seen as a significant risk for would-be investors. JP Morgan Chase is an Institution where strong ego wins out over strong governance. Step clear!

Bob - May 22 2013