Outlook: The Fed can't afford to hold on much longer

Where's the tax?; Mining stocks
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The Independent Online

If not now, then when? Both Japanese and US interest rates were left on hold yesterday, with few clues given by either by the Federal Reserve or the Bank of Japan as to when they might start rising again.

If not now, then when? Both Japanese and US interest rates were left on hold yesterday, with few clues given by either by the Federal Reserve or the Bank of Japan as to when they might start rising again.

In the US, inflation remains subdued, on the official numbers at least. As long as the employment data looks as weak as it is, there's no reason to believe the Fed would want to upset the incumbent President's re-election hopes by jacking up rates. This is less a policy stance dictated by political bias, as one which by convention leaves policy neutral in an election year unless there are very good economic reasons for doing otherwise.

Yet the case for acting now grows stronger by the day, and the Fed is almost certainly only piling up problems for itself for after the election by delaying as long it has. The same is not yet the case in Japan, where continuing price deflation dictates that rates can be left at zero for a good deal longer before action becomes necessary.

Even so, there are signs that American policymakers are starting to lose patience with Japan's efforts to pull itself out of more than a decade of economic stagnation. In pursuit of this aim, the zero interest rate policy goes hand in hand with massive foreign exchange intervention to keep the yen depressed against the dollar. Last week, the Federal Reserve chairman, Alan Greenspan said the Japanese recovery was reaching a stage where large scale intervention may no longer be necessary.

Japanese press reports meanwhile suggest that the Bank of Japan is becoming decidedly nervous about the extent of the intervention, which in the first two months of this year has reached massive proportions. The upshot of all this may be that the turning point, both for interest rates and the currency markets, may already be quite close. The Fed will hold off raising US rates as long as it credibly can. The Bank of Japan can afford to wait a bit longer, but more positive economic news may soon bring the era of massive Japanese currency intervention to an close. The tectonic plates are beginning to shift once more.

Where's the tax?

Not many companies would nowadays publicly trumpet the view once expressed by Lord Hanson that directors are under a fiduciary duty to their shareholders to avoid as much tax as they possibly can. Indeed, even Lord Hanson might shrink from such politically incorrect opinions if he were still running a big company today.

Yet according to the Treasury, that's what corporate Britain and many wealthy individuals are still practicing, and in ever growing numbers too. The Chancellor is determined to do something about it. Representatives of the big four accounting practices were summoned into the Treasury last week to be told, "ease off or face the music".

It may already be too late. Business leaders are braced for a root and branch crack down on tax avoidance in today's Budget, with the possible introduction of sweeping anti-avoidance measures of the type used in the US and Australia. At the same time, a legion of different avoidance loopholes will be closed.

The Revenue's response to avoidance has hitherto been characterised by the gentlemanly practice of closing loopholes as they become apparent. A certain amount of avoidance would be tolerated, and the game became simply that of staying one step ahead of the taxman. On the view that if the guy next door is doing it, you'd be a mug not to, the tax avoidance industry has mushroomed in recent years, to the growing alarm of the Treasury, which believes widespread avoidance is one of the reasons tax has been falling short of forecasts.

One of the reasons is pressure on corporate profits. When profits are falling, chief executives look for savings wherever they can find them. Tax is a primary target. Just as important, in the hunt for extra sources of revenue, all the big accountancy practices have hugely expanded their tax advice departments.

Many tax avoidance schemes have been marketed much more widely and aggressively than they were in the past, when they would tend to be much more hush, hush affairs, kept for the benefit of perhaps just a few favoured clients, hidden from public view so as not to alert the Revenue. Post Enron, the situation has got worse still, with the big practices increasingly resorting to tax avoidance income to fill the gap left in their books by the enforced removal of management and IT consultancy functions.

Yet there is a third reason, which the Treasury would much rather we all ignored. The Chancellor would deny it, but the truth of the matter is that a disproportionately large part of the extra burden of taxation that Labour has imposed on the nation has fallen on business. This is where the great bulk of Labour's "stealth" taxes have arisen. As the tax burden grows, the temptation to engage in elaborate tax avoidance grows with it. Furthermore, the growing complexity of the tax system has only encouraged clever accountants, lawyers and investment bankers to find ever more ingenious ways circumnavigating it.

The American system of anti-avoidance obliges accountants to register a tax avoidance scheme with the Internal Revenue Service together with the client the moment they start charging for it. This acts as a powerful disincentive to tax avoidance, as the client is immediately at risk of becoming a target for IRS inquiries if he pays for a tax avoidance scheme. An alternative is a general rule against avoidance of the type that exists in Australia, where a business purpose has to be demonstrated for any scheme that attempts to reduce tax.

The problem the Chancellor has got is that like everything else in business these days, many tax avoidance schemes are international and cross border in nature. That makes it much more difficult to make anti-avoidance measures work. He also speaks with forked tongue on these issues. The Chancellor preaches tax competition between nations in Europe, but he's against the use of legitimate techniques to reduce business taxation when this hurts his own coffers. He preaches against tax avoidance in the UK, but he's against attempts by the European Union to produce a common method of profit recognition so that member nations can more easily crack down on tax avoidance through transfer pricing. Tax avoidance is not as black and white an issue as it sometimes seems.

Mining stocks

Time was when most respectable British newspapers used to employ "mining correspondents", and no, they weren't paid to write about the coal industry. The London stock market's once thriving mining sector all but disappeared in the 1980s, laid low by anti-apartheid boycotts, corporate governance concerns and growing industry fragmentation.

Now it's back and thriving as never before. There are no fewer than five mining stocks in the FTSE 100 and another two pushing at its door. In part that's because two of South Africa's leading mining companies, Billiton and Anglo American, decided to switch their primary listings to London in the late 1990s. More recent interest in the sector has been driven by the extraordinary rise in commodity prices, which in turn is down to China's rapid industrialisation.

Yet still Britain's growing mining fraternity struggles to win space on the business pages. Chip Goodyear, chief executive of BHP Billiton, provided a mild flurry of interest yesterday with a management reorganisation which saw one of his top executives, Mike Oppenheimer, head of the coal division, thrown overboard. In most FTSE 100 companies, this would have produced acres of analysis and comment. Not so for BHP Billiton.

This is largely because mining companies are not British businesses at all, but foreign ones merely based here. That's good for Britain, and good for British investors, who gain an exposure to industries that would otherwise be completely off their radar screens. Regrettably, I still won't be advertising for a mining correspondent anytime soon.

jeremy.warner@independent.co.uk

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