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Investment Commentary No.

265 August 24, 2009

Farewell America izers, as frequently stated in the Swiss media,

among others. It is astounding, and this is the
second interesting observation, how completely
1. A moral issue? naturally those who claim the moral high-ground
The agreement between the USA and Switzer- rush to join forces with the authorities and their
land under which Switzerland is to provide ad- financial requirements. At the risk of once again
ministrative assistance with regard to 4,450 UBS winding up certain specialists in business ethics,
clients suspected of tax fraud is, in our view, re- let us briefly recall the sort of tax authorities we
markable in three ways. Firstly, we note the way are dealing with, and the sort of state they serve: a
both parties are dressing it up in the aftermath of country that, over the last 60 years, has unques-
the battle. Everyone is talking of a “success”. The tionably been one of the most aggressive nations
IRS, the American tax authority, surely rightly, in the world. The USA has fought by far the larg-
for it has got what it wanted, namely access to a est number of wars, sometimes with, but mostly
large number of specific client names, combined without a UN mandate. It has broken the interna-
with persisting uncertainty on the part of all the tional laws of war, maintained secret prisons, and
others as to whether they are among those names. fought an absurd war against drugs, with serious
The UBS is happy not to have to pay another consequences both abroad (Columbia, Afghani-
fine, and to be rid of the heavy burden of legal stan) and at home (according to reliable sources,
proceedings. And the Swiss government regards it the tentacles of the narcotics mafia now reach
as a success inasmuch as from their perspective well into political circles). With breathtaking
the agreement preserves the rule of law and offers moral duplicity, the USA maintains enormous
the clients affected the possibility of legal re- offshore havens in Florida, Delaware and others
course to the federal administrative court. of its states. The moralizers have joined sides with
a nation that still makes extensive use of the
But there are also losers, of course. These are the death penalty, and that has a legal system under
people affected, who must now expect legal pro- which lawyers can get rich on the misfortunes of
ceedings against them as suspected tax cheats, their clients. Liability cases often end in verdicts
and who had, until relatively recently, been prom- with exorbitant damages, which makes business
ised that precisely this would not happen. Prom- activity extremely risky, for medium-sized enter-
ised by whom? By the bank concerned (among prises in particular. The moralizers provide intel-
others), which had generously interpreted and lectual support for a country that allows its infra-
intensively exploited an explicit gap in the 2001 structure to collapse, and then stuffs convicts into
“Qualified Intermediary” (QI) agreement; by the hopelessly overfilled jails, after what are not in-
supervisory authorities, which were fully cogni- frequently dubious proceedings. They fund a
zant of all this activity, but never questioned it; by nation that tolerates – or rather, causes – regular
the Swiss government, which only a few months crises in the global financial system that it man-
ago had spoken of the “brick wall” that foreign ages. A country whose underclass enjoys neither
authorities would encounter, were they to attack the benefits of an adequate education, nor a half-
Swiss banking secrecy – for example through way functional healthcare system; a country
fishing expeditions, such as an application for whose economic system is increasingly inclined to
administrative assistance against several thousand overconsumption, and in which saving and invest-
clients. Promises, connivance, a pretence of reso- ing have increasingly become alien concepts, a
lute behaviour – and now collapse. The appear- situation that has undoubtedly been one of the
ance of success conceals the reality of a breach of driving forces behind the current recession, with
trust. all its catastrophic consequences for the whole
Trust: is this the right word at all for something so world.
disgraceful as tax evasion, or even tax fraud? Those who wish to wield the sword of morality
Serves them right, these bloated capitalists, if they against tax evaders cannot avoid facing some
land in the dock! This is the position of the moral- critical questions with regard to the morality of

resource allocation. Were such questions to be Things are different under Anglo-Saxon law.
excluded, we would be left with nothing but the There is no forced heirship, so American inheri-
issue of just taxation, which also arises, as we well tance tax is levied on the “estate”; that is, the
know, when, in Sicily, one baker must make a physical goods, such as property, goods and chat-
contribution to the honourable society, and an- tels, and securities. If they are US securities, then
other not … It is more productive, particularly in they are liable to tax, regardless of the final domi-
matters of taxation, to leave morality aside, and cile or main place of residence of the deceased.
to take a non-judgmental view of tax liability, the US securities are basically defined as securities
meeting of obligations, and, if need be, the vari- issued in the United States, such as the stock of
ous forms of evasion, as givens resulting from the American companies like Apple, General Electric
prevailing legislation and its enforceability. or Pfizer and US funds and US bonds, in particu-
Which brings us to the third thing that seems lar Treasury bills. American inheritance tax law
remarkable. What exactly was the “prevailing makes specific reference to both US citizens (in-
legislation”? And what about its enforceability? cluding, particularly, US citizens resident abroad)
In 1996, the USA concluded a new double taxa- and “non-resident aliens”. These latter are for-
tion agreement with Switzerland, which, among eigners with no permanent residence in the
other things, regulated the conditions for adminis- United States; in other words, all non-Americans
trative assistance in matters of taxation. Switzer- in possession of US securities.
land agreed to provide assistance with regard to American inheritance tax rates are variable, with
“tax fraud and the like”. In other words, the ex- the top rate at 45 percent. Significant exemptions,
tension of the concept of “tax fraud” had long of over 1 million US dollars, are allowed for US
been pre-programmed; the USA had to wait for citizens; the limit for non-Americans is 60,000 US
its enforcement only until Switzerland had appar- dollars, unless there is a double taxation agree-
ently, and perhaps in reality, been driven into a ment setting a higher limit. For Switzerland, the
corner by the activities of the accident-prone limit is calculated on the basis of the double taxa-
UBS. In fact, truth to tell, we should have known: tion agreement of 1951, based on the proportion
Swiss banking secrecy with regard to the USA of the entire estate represented by the assets in
was well and truly relativized not in 2009, but the United States. To claim the allowance, the
already in 1996. “estate” – that is, in continental terms, the heirs –
What we need to do now, sine ira et studio, (and must disclose the entire, global legacy to the IRS.
putting aside all politically motivated window- On account of the IBM shares that he was so
dressing, all genuine, or merely nominal, moral attached to, the children of the late Hans Rüdi-
issues) is to analyze the situation, draw conclu- sühli of Melchnau must file with the IRS and
sions and, where necessary, act upon them. This is present a valuation of all other family assets.
exactly what we intend to do in what follows, by There is a remarkable lack of double taxation
taking a closer look at two important components agreements with the countries of Latin America,
of American tax law. And, surprise, surprise; the Asia and the Middle East. Mr Abdullah of Dubai,
next round of fiscal enforcement staged by the let’s say, a typical owner of treasuries, industrial
Americans will be devoted not to the American bonds and GM shares, is liable to American in-
super-rich, but to non-Americans who never in heritance tax on his decease. Not his problem, but
their lives had any intention of evading taxes. it may well become one for his 12 sons, Omar,
Yakub and all.
Or maybe not? For he had placed his securities in
2. Hans Rüdisühli and Muhammad Abdullah: an institutional structure, a trust or a company
liable to inheritance tax? domiciled on one of the Caribbean islands – and
To get some idea of how the inheritance tax of a institutions cannot die, can they? Indeed not.
foreign state can become a serious problem for However, the Americans are increasingly going
third parties, we need to start with a fundamental over to regarding such structures as look-through
difference between continental and Anglo-Saxon entities, and trying to get access to the bene-
inheritance law. On the continent, the view pre- ficiaries and their tax liabilities.
vails that the logical recipients of assets left by the Another common objection: it’s impossible any-
deceased are their descendants. Accordingly, way. How on earth can the IRS make the connec-
continental inheritance law provides for forced tion between a US security and a deceased for-
heirship, whereby a portion of the estate is legally eigner? The USA is not even capable of register-
required to be left to close relatives. Under such a ing its own residents, so how should it be able to
system, it is not difficult to see where any taxation control the rest of the world? Simple answer: it
of the inheritance should occur: with these heirs.

Investment Commentary No. 265 Page 2


doesn’t have to. Rather, American inheritance tax ment was, though, monitored by a special audit
law focuses on the executor. If there is no execu- following a process laid down by the US tax au-
tor, the role is fulfilled by the custodian bank, thorities. Our bank was among the signatories to
which is liable for the tax due. In order to exclude the agreement from the start and passed the sub-
this liability, the American custodians of foreign sequent audits, in 2002 and 2007, with flying col-
banks will go over to requiring their partners ours.
abroad to freeze the estate when one of their There are three definitions in this QI agreement
clients dies. that are of decisive importance: that of a US per-
Final objection: it was a dead letter for foreigners son, that of a US security, and that of a legal en-
anyway. Yes indeed. But with the revised provi- tity belonging wholly or in part to a US person.
sions of the Qualified Intermediary agreement, The definition of a US security is fairly unprob-
the USA will require the signatory banks to en- lematic, in that it is effectively determined by the
able an American auditor to control their compli- retention of the withholding tax by the custodian.
ance with the agreement, which entails giving The other two definitions, however, have caused,
such auditors access to all files, including client and continue to cause, almost insurmountable
data. This will create the means of directly linking problems for QIs, and thus generate considerable
US securities with non-American owners. Any- legal uncertainty.
one who believes that this will not soon result in Sadly, it is entirely unclear who actually counts as
obligatory reporting by the US auditor is as naive a US person and who does not. In addition to the
as those who failed to realize that “fraud and the clear case of US citizens resident in the USA, the
like” would eventually be interpreted to the al- American understanding of the category also
most unlimited advantage of the tax authorities. includes foreigners living in the USA, those in
An act passed in 2001 by the previous President possession of a social security card, holders of a
Bush envisaged a “sunset clause” for the then “green card”, US citizens not resident in the
controversial but reintroduced inheritance tax. USA, and also those who pass the so-called “Sub-
Unless extended, the Estate Tax would expire in stantial Physical Presence Test”. This “Presence
2010 and, if not reformed, come into effect again Test” has a particularly delightful design: it is
on 1 January 2011. The Obama administration is passed when someone has been in the USA for at
currently working not merely on an extension, but least 31 days in the current year and a total of 183
on making the law stricter with regard to recog- days over a period of three years; in the first year
nized loopholes. The possibility of further un- the days count for 1/6, in the second for 1/3, and
pleasant surprises can certainly not be ruled out. in the third year they are counted full. By this
definition, a student, perhaps Muhammad Abdul-
lah’s son Omar, who is doing an MBA at Har-
3. A “qualified extended arm” vard, very probably counts as a US person. The
Next, we need to look more closely at the already- problem is that the QI has to know whether he
mentioned Qualified Intermediary agreement. In does or not. For the agreement has turned the QI
2001 the USA introduced a new withholding tax into the extended arm of the American tax au-
system, with the aim of avoiding the complicated thorities.
and expensive reimbursement of tax levied on Even trickier is the question of how far the bene-
those not liable to taxation, and thus to give for- ficiaries of legal entities are liable to withholding
eigners easier access to the American capital mar- tax. Clearly liable, according to the text, are active
ket, and also of obliging US persons with securi- businesses; an American company holding securi-
ties deposited with intermediaries whose coun- ties in Switzerland, for example. Trusts, institu-
tries had no automatic exchange of information tions and foundations are exempt if they meet
with the USA to include all their US holdings in certain – naturally highly complex – conditions.
their tax declarations. This was done by imposing This was probably the trap in which the UBS
a withholding tax of 30 percent, which US persons clients were caught. Once the trap had closed, the
could avoid entirely by full disclosure, and non- American tax authorities shouted “Abuse, fraud
US persons could avoid in part or, depending on (and the like…)!” They set the trap themselves.
the double taxation agreement, entirely, by self-
declaration to the Qualified Intermediary. Matters become really awkward when an impec-
cably non-American legal entity suddenly be-
The 2001 QI agreement took account of countries comes “contaminated” by a US person. Let’s
with banking secrecy to the extent that clients assume that Mr Abdullah has named his son
could be assigned to their individual categories by Omar, as well as some of his other adult sons, as a
the QIs themselves. Compliance with the agree- beneficiary of his trust. As American tax law has

Investment Commentary No. 265 Page 3


turned him into a US person, Omar renders the 3. The “green book” seeks the compulsory im-
trust liable to tax, and when Mr Abdullah dies, position of withholding tax at 30 percent on
this may mean that the entire inheritance be- US securities held by non-American compa-
comes liable to US estate tax, possibly at 45 per- nies. Any reclaiming would have to be done
cent, for Mr Abdullah was extremely wealthy. by the company itself, and involve disclosure
Perhaps, and then again, perhaps not. But that of its ownership structure. According to the
doesn’t matter – the QI should have known. “green book”, exceptions would be possible
The QI agreement of 2001 already exposed all the for pension funds, listed public companies
signatory banks worldwide to significant legal and the like.
risks vis-à-vis the American tax authorities. Even 4. Also stipulated is the introduction of with-
without actively canvassing for clients in the holding tax at 20 percent on all gross revenue
USA, as the UBS did with Alinghi and by other from transactions via a non-QI intermediary
means, the mere fact that someone can mutate, and in a country with no double taxation
almost unnoticed, from a non-US person into a agreement or inadequate exchange of infor-
US person is an unacceptable situation. For the mation.
result can be an entirely innocent misdeclaration. 5. The “green book” envisages compulsory dec-
laration of transactions over 10,000 US dol-
4. Green book; red content lars involving US persons via a non-QI inter-
The Obama administration set out its intentions
with regard to various tax matters in May 2009, in 6. Notification to or recording by the IRS of the
a “green book” entitled “General Explanations of acquisition or foundation of an “offshore en-
the Administration’s Fiscal Year 2010 Revenue tity” on behalf of a US person is now also
Proposals”. In addition to the notion of forcing prescribed.
American businesses operating abroad to pay 7. Lastly, the involvement of an American audi-
more tax in America, the focus was on the exten- tor to monitor compliance with the QI agree-
sion of the “Estate Tax” and the tightening up of ment is envisaged. The report will have to be
the QI system. Essentially, the Obama admini- signed by this auditor.
stration is seeking to expand the application of This list of the intended amendments is not neces-
the QI system, and to plug all known and con- sarily complete, and may also contain minor inac-
ceivable loopholes. Seven significant changes curacies. What is clear, though, is that the USA is
deserve comment: attempting to exploit its almost unlimited position
1. The definition of a US security has been ex- of strength with regard to the international trans-
panded. In future, the QI system will also in- action systems (Swift, clearing systems, custodi-
clude equity swaps on US securities and on ans) and the fundamental attractiveness of its
securities lending. This should prevent US capital market to impose its ideas on the rest of
persons from entirely, and non-US persons the world. There is no question that signatories to
from partly, avoiding withholding tax by this new version of the QI agreement will need to
means of an OTC contract. According to the revise their business models for cross-border
“green book” the QI agreement is not (for wealth management, at least as far as US persons
the time being?) being expanded to cover are concerned. Both Swiss-style banking secrecy
non-US funds or derivatives that replicate US and the Austrian and Luxembourg versions, and
securities. indeed all Anglo-Saxon-style structures, whether
2. US persons are now required to report earn- managed from London, Dubai, Singapore or
ings and gross revenue from non-American Hong Kong, are called into question. As far as US
sources. This will extend the QI agreement to persons are concerned, the USA aims to abolish
cover the entire global financial universe, and cross-border business.
enforce disclosure by all US persons, in par- It might reasonably be observed that so long as
ticular those who, by not holding US securi- this really only affects its own citizens, the USA is
ties, had previously remained outside the QI absolutely entitled to do this. And to the extent
agreement. Should an intermediary wish to that it can exploit its position of power in the
remain outside the QI system, withholding world to enforce its intentions, we must – as we
tax at 30 percent is levied compulsorily, and have decided on as non-judgmental an analysis as
may only be reclaimed by the beneficiary, not possible – take note of this and adapt, or possibly
the intermediary. redimension our own business activities. The
concept of the “green book” is extraordinarily

Investment Commentary No. 265 Page 4


intelligent. The aim must have been “no way out” But that too is only part of the truth. A look at
– no loopholes. Sadly, however, the matter has who are the most important creditors of Amer-
not been properly thought through. The real ica’s highly indebted public finances reveals
problem lies not in the rigour of the law, but in something truly remarkable. It is the public au-
the lack of clarity about actual tax liability, and thorities themselves! A study by Sprott Asset
the resulting disproportionate effort required for Management, a Canadian asset management firm
monitoring and management. The enormously distinguished for its intelligent macroeconomic
expansive view of what constitutes a US person, analyses, showed that in 2008 over 4 trillion of the
and the potential, imperialist, expansion of inheri- total outstanding public debt of some 10 trillion,
tance tax liability to cover the whole world sub- or around 40 percent, was in the hands of so-
stantially increase the risk of investing in Amer- called “intragovernmental holdings”. These hold-
ica, and thus on the US capital market. This ap- ings include social welfare institutions, whose
plies for investors, but even more so for interme- assets, accumulated in order to be (halfway) able
diaries. While the old QI agreement put the to meet future liabilities, are invested in special
thumbscrews on them, the intended agreement Treasury debt instruments, known as “intragov-
will crush them in a vice. It is becoming clear that ernmental bonds”. In other words, the paying
it will be simply too dangerous to own US securi- recipient of, say, Medicare, the American health
ties, to hold them as a custodian for third parties, service, is an indirect source of finance for the
or to trade them as a bank. Treasury. Unusual, remarkable, or rather, alarm-
ing? Debtors are now simultaneously creditors.
5. The USA’s Achilles’ heel An unusual form of self-financing
4.3%1.2% 1.0% Ownership of US state debt
The sensibilities of their own capital market: this 4.6%
40.3% Intragovernmental holdings
is what the smart guys in the IRS have very 4.9%
probably failed to take into account. Their one-
sided regulatory proposals, focused on maximiz- 7.2%
ing the tax take, are based on the entirely unprob-
lematic and undisputed attractiveness of the USA 7.7%
as a place of investment for investors from all
Pension funds
over the world. We believe this assumption to be
Insurance companies
utterly wrong. Why?
Banks, savings banks
A glance at the USA’s debt situation suffices to
show that apart from oil, there is really only one Note: Figures as of 31 December 2008
element of strategic importance that the USA will
Source: Financial Management Service (Bureau of the United
need in the coming years: capital. The (declared) States Department of the Treasury). Ownership of Federal
public debt – national, state and community – Securities and Federal Reserve Statistical Release.
amounted to some 70 percent of GDP in 2008. These “intragovernmental bonds” are certainly
With the absorption of further debt in the wake of not assets of genuine intrinsic value. Were we to
the financial crisis, by 2014 the level of explicit consolidate both balance sheets – that of the
debt is likely to be significantly above 100 percent Treasury and that of the institution concerned – it
of GDP. By then the interest will have doubled would produce a tautologous situation that would
from around 10 percent of total public revenue to only not result in the total loss of value of the
around 20 percent, on moderate assumptions. social welfare trust’s assets if the Treasury were in
This is generally well known. What is generally a position to avail itself of the capital market to
less well known is that in the USA too, as in so an ever greater extent. So let us look at this abso-
many ailing European states, this explicit perspec- lutely decisive cash flow situation.
tive reveals less than half the truth about what has According to the Canadian study quoted above,
been implicitly promised by the state in the way the American Treasury had to finance new debt
of future benefits. Correctly accounted – that is, of 705 billion dollars in 2008. This was needed to
as probable future payment flows discounted to cover the budget deficit of 455 billion dollars and
present values – the picture would look a good a special deficit for the war in Iraq and Afghani-
deal bleaker. There are studies, such as the one stan of 250 billion dollars. New debt in 2009 will
by the Frankfurt Institute in November 2008, that amount to somewhat more than 2,000 billion dol-
reckon with a total level of debt for the USA of lars, with some 200 billion going to the Middle
up to 600 percent (!) of GDP. Eastern war chest and 1,845 billion to the “regu-
lar” budget deficit. This debt must be bought,

Investment Commentary No. 265 Page 5


financed, by someone. So how are the individual And nota bene: we have not yet discussed the
categories of creditors behaving? Number 2 in the quality of the growth. Over the last 15 years it
ranking of creditor groups are the “Foreign and has, as we know, increasingly come mainly from
International Holders”; that is, the total of all consumption and state expenditure; investment in
foreign creditors, including central banks, sover- the USA is extraordinarily weak. Far too little
eign wealth funds, private investors and so on. In potential for the future is being created.
2008 they bought some 560 billion dollars’ worth;
in this year so far, just 460 billion. In March and
April they were net sellers of government securi- 6. Rats leaving the sinking ship
ties. Other categories, such as pension funds, It can hardly be a coincidence that two of the
states, communities and investment funds, also most prominent and most successful American
seem to be tending to unload government paper investors, Warren Buffett and Bill Gross, chose
this year. This means that the usual sources of precisely the same moment to speak out very
finance for the American state are drying up. The clearly against their own domestic currency and
last hope of salvation comes from the Fed, which, against investments in US government securities.
with its quantitative easing programme for print- In an op-ed article in the New York Times on 18
ing money, is currently having to buy up to half August 2009, Buffett described the Treasury’s
the newly issued debt, month after month. current financing problems, with similar assump-
This will be OK as long as it’s OK. A Ponzi tions and observations to those of Sprott Asset
scheme, for that is undoubtedly what we are talk- Management, and lamented the necessity for the
ing about, goes on working as long as its growing Fed, as the lender of last resort, to intervene so
overindebtedness does not arouse any doubt extensively, by means of the printing press. In his
among the public as to the scheme’s continuing own words: “The United States economy is now
performance, and the flow of funds to the scheme out of the emergency room and appears to be on
is not significantly disturbed by other influences. a slow path to recovery. But enormous dosages of
As we know, Madoff’s scheme only collapsed monetary medicine continue to be administered
when individual creditors had liquidity problems and, before long, we will need to deal with their
and were obliged to withdraw funds. side effects. For now, most of those effects are
invisible and could indeed remain latent for a
Hopelessly in debt long time. Still, their threat may be as ominous as
Debt as % of US GDP
that posed by the financial crisis itself.” Buffett
Government fears high inflation, and consequently advises
350% States
Financial sector against the purchase of long-term Treasury bills.
300% Businesses
Households Bill Gross of Pacific Investment Management Co.
(Pimco), which manages the biggest bond fund in
the world, advises investors to sell dollar invest-
150% ments “before the central banks and sovereign
100% wealth funds do”. It’s time to take advantage of
50% the recovery of the US dollar to get one’s cur-
rency diversification in order. The somewhat
1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 strident commodities specialist Jim Rogers takes
Source: Federal Reserve. Flow of Funds Account. the same line, and also announces his new favour-
ite currency – the Chinese yuan. He is seconded,
We now believe that the combination of the US with a good deal more substance, by Hossein
tax authorities’ anti-capital-market plans with the Askari, a professor at George Washington Uni-
Treasury’s specific financing problems could re- versity. In a very readable article in the Asia
sult in such a situation. For the growth of debt Times on 6 August 2009, he also advocated a
alone would give sufficient cause for doubt as to global currency, which “would not be allowed to
performance. The figure above shows the long- be used to finance state debt or stimulation meas-
term development of overall US debt – that is, ures”.
public, household and business debt – compared
to economic performance. It is obvious that, for Without in any way wishing to overdramatize
about 30 years now, additional growth has only matters, we do believe that such signals should be
come at the cost of ever-higher debt. Today, taken seriously. In exactly the same way as it is
every dollar of growth comes with about 4 dollars inadvisable to ignore rats leaving a sinking ship.
of debt. For they often know the crucial aspects of the
ship better than the captain and the officers. The
least worst outcome that we expect for the USA,

Investment Commentary No. 265 Page 6


and for the Treasury in particular, is significantly own efforts. Those who produced too cheaply
higher financing costs for debt incurred in the were taken to court, big businesses were given
future. We calculate the medium-term contribu- blatantly preferential treatment, and property
tion by the American tax authorities to this added rights increasingly threatened. Without the exter-
expense, as a result of the “keep foreigners out” nal event of the Second World War, Roosevelt
strategy described above, at around 50 basis would have been numbered among the most un-
points. And this is precisely the Obama admini- successful American presidents of all time.
stration’s miscalculation. Their aggressive attitude The financial crisis has given momentum to anti-
to tax exiles will generate extra funds, perhaps capitalist, and thus anti-market forces in the USA
running into billions, but the price they pay will (and elsewhere). That promises little good for this
be exorbitant. An increase in the credit spread of part of the world, but it makes it somewhat easier
50 basis points on total public debt of over for investors to take their leave. Our bank is in
10 trillion US dollars represents increased costs of the process of recommending our clients to exit
50 billion per annum. The sums don’t work: to from all direct investments in US securities. This,
make up for this would require additional taxable on the grounds of the threat of inheritance tax
funds of some 2 trillion US dollars. coupled with the uncertainty as to whether one
might not, one way or another, be turned into a
7. Unattractive anyway US person.

Furthermore, the stupendous increase in Ameri- We do not deny that by doing this, we hope to
can debt is by no means a problem only for the significantly reduce the risk carried by our bank
Treasury, but affects the economy as a whole. The as an intermediary. Should we maintain QI status
state’s ravenous appetite for debt is preventing under the new, more rigorous conditions, we will
private borrowers from getting access to the avail- have so far reduced our holding of US securities
able finance. This is known as the “crowding-out that we shall effectively be spared most dealings
effect”. The aim of the Fed’s quantitative easing with these cumbersome foreign authorities. Inves-
policy is to counter this effect. At the same time, tors who need US exposure on diversification
distressed banks, and whole industry sectors, like grounds, can obtain it via non-US securities – the
car manufacturers, are being subsidized with “green book” explicitly excludes derivatives and
enormous sums, which ultimately must result in non-US funds from withholding tax. And as we
further distortions, and crass disadvantages for assume that we are not the only ones who will be
the unsubsidized part of the economy. pursuing a policy of exit from the American capi-
tal market, we expect that the range of non-US
This generally anti-entrepreneurial policy of dis- securities with American exposure will expand
couraging investment is further reinforced by significantly. This may be good news for Mr Ab-
wholly disproportionate efforts to intensify the dullah of Dubai.
regulation of small businesses. From the Wall
Street Journal, we learn that legislation already But then again, it may not. If this picture of a
exists in Washington that would impose reporting tautologous construct round the US Treasury is
obligations on small venture capital enterprises – correct, then we must at the very least be ex-
exactly those that have powered the rise of Silicon tremely cautious about nominal values. For
Valley – whose administrative burden would be Treasury bonds and bills would then be seriously
simply unsupportable. And this just because of overvalued, as would the US dollar itself, which
the concern that hedge funds, which, rightly or would naturally argue against all other US bonds.
wrongly, are felt to require greater control, might In our view, not even an engagement in US stocks
be able to operate in the guise of such venture is really worthwhile. Despite depreciation in the
capital companies. If Washington gets its way, this financial crisis, according to our calculations they
will mean the end for many small businesses with are still valued at around 12 percent above the
10 to 20 employees. long-term fair price, whereas European stocks are
undervalued by almost 17 percent. And these
In this economic crisis, the Obama administration calculations do not include the impact of any fu-
is making exactly the same mistake as its great ture increases in taxation or interest rates.
hero, Franklin D. Roosevelt, made in what is
quite wrongly regarded as the exemplary “New We live at a time of shifting power and influence
Deal”. Driven by Keynesian ideology and a belief in the world. Asia is on the rise, and Brazil too,
in the possibility of an upturn caused by appro- probably. Australia will catch on to their coattails,
priate state intervention, in the course of the and Europe may once more be able to position
1930s, Roosevelt deprived businesses of any hope itself within these countries’ recoveries. The USA
of being able to make money again through their will remain the unquestioned military power and

Investment Commentary No. 265 Page 7


also an enormous repository of debt and other why we are well advised to take a general farewell
problems. Because they are painful, and there of America. This will be painful, for the USA was
is always an inclination to shift the blame for once the most vital market economy in the world.
them onto third parties, redimensioning processes But for now, it’s time to say goodbye.
always harbour the potential for aggression. Switz-
erland is currently experiencing just this. But it
won’t end there. Potential aggression and eco-
nomic progress are mutually exclusive. Which is KH, 24.08.2009


Investment St. Gallen Bohl 17
Commentary No.Telephone
265 +41 71 242 50 00 Fax +41 71 242 50 50 Page 8

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