European Tax Havens - Assignment Example

PART A (50% of total marks) Q1 - The market system is based on supply and demand and thus provides a natural means of price regulation for commodities. One aspect that can alter this relationship is speculation. For example, in market cornering such as happened on ‘Silver Thursday,’ when the Hunt brothers tried to corner the international silver market: Silver Price History: 1792 to 1999 (Silver Coin Values, 2010) “The Hunt brothers believed that inflation would result in silver becoming a haven, just like its more expensive cousin, gold... Bunker foresaw at least a tenfold increase in the price of silver as a result of the plummeting real value of the dollar, so he and his brother began to buy up physical silver as well as future contracts. Instead of closing out contracts with cash settlements, a common procedure on the commodities market, the Hunts took delivery on silver. They then stockpiled this silver and used their large cash reserves to buy up even more futures. The billions in demand triggered the rise of silver to more than $50 per ounce.” (Beattie, 2010) If speculation can have this much of an impact on the price of a fixed commodity – and the silver price plummeted when the Hunt brothers’ market corner was toppled – then the market cannot be totally reliable for an egalitarian distribution of resources. In this instance, a small minority with excess capital reserves could easily create massive market movements in price. It is the same with any commodity if a large capital interest takes hold in the sector and accumulates not from the need of supply, but based on speculation, then the aspects of banking and finance can come to determine even the price of coffee and tea. A free market based upon supply and demand and a free market fueled by speculation may not function in the same manner in determining market prices. If one reviews the ability of a group of brothers like the Hunts to move prices in silver, what could a nation-state, for example, accomplish if it were to try to monopolize a sector of commodities, or accumulate from a perception of scarcity. One example of this would be the Chinese State-owned and financed oil companies or loans being given to businesses by State-sponsored banks to buy commodities like copper, driving up the price. Q.2 - In free market economics, government interference and influence in the economy is rejected, in favor of the pure dynamics of supply and demand being determinant in driving prices, investment, capital flows, and other aspects of trade, manufacturing, and business activity. In this theory, the market operates naturally and freely when government does not interfere. However, in practice the modern nation-states manages sovereign economies with trillions of dollars in assets, and their budgets allocate billions in capital flows according to the political will. “The Guardian and the Institute for Fiscal Studies present the ultimate guide to how central government spends our money – and how it has changed since last year.” (Datablog, 2010) The above chart shows the distribution of the £620bn UK national budget in 2010, where the tax money is committed to by department and sector. As government becomes more invested and active part of the economy, the removal of money through the cutback in services impacts the economy. The reverse is also true – how the government invests money in the economy through its programs and expenditures impact the economy. Thus, in allocating resources, governments have to be cautious to “create a positive investment climate” with the organization and public distribution of capital expenditures, taxation, and social programs. Central Banks function in a similar manner as sovereign governments with regard to the impact of their policies upon the economy outside of the control of market forces. Thus, the policy of a central bank must also be tailored to “create a positive investment climate”. The reason for this is that in economic competition between nations, central bank activity can determine capital flows, especially through setting interest rates, currency levels, and exchange rates at a State level. Governments and central banks that create a positive investment climate for international capital can reap the benefits of local economic stimulation, as was first the case with the four “Asian Tigers / Asian Dragons” and later the BRIC countries. As the World Bank writes: “Investment is needed to replenish assets used up in production and increase the total capital stock. Without investment there would not be sustainable economic growth. On average, 21 percent of the world output is invested for production purposes. In East Asia and Pacific investment averages 34 percent of its output. But high rates of investment alone do not ensure rapid economic growth.” (World Bank, 2007) “Between 1990 and 2004, foreign direct investment in the developing countries increased tenfold, from $21 billion to $211 billion (in current dollars).” (World Bank, 2007) This chart from the World Bank illustrates the large amounts of capital that creating a favorable investment climate can attract for a region, and the economic results of stimulation. In this context, however, it is also to be remembered that when altering the economic climate through public expenditures, that those influences to the economy can also help to stimulate investment, but may also have consequences if withdrawn. Scarce resources, in this example represented by foreign capital investment in developing countries, are potentially attracted to a region on free market fundamentals or through government incentives, both which can quickly change impacting corporate policy. Developing nations reap the reward of GDP growth and wider economic prosperity through employment deriving from foreign investment, and thus governments may enact incentives to attract investment that are not sustainable long term, or base social programs on tax income from economic activity that is not sufficient, and acquire national debt that is non-sustainable. Q3 - In the example of the United Kingdom, maintaining London as a global financial centre is of primary importance to the country. However, unless global finance views London and the UK favorably in terms on investment, capital will continue to flow to other countries, creating new jobs, social dynamism, and tax revenue abroad. Conversely, if the UK fails to attract new foreign investment, and capital flows to other global financial centres for investment management, then there is the risk of loss of jobs, social stagnation, and more debt in government. One main aspect of this involves tax rates. If one global location offers a lower rate of taxation, than basing business there may be a good investment for cost savings, especially if there are other favorable factors to recommend the region. Similarly, high taxation rates on individuals and corporations can discourage both foreign and domestic investment. “Over the past few months prime British companies and high earners have reportedly threatened to pick up sticks and relocate to Switzerland to avoid rising taxes. From April, a 50 per cent tax rate for those earning more than £150,000 (SFr242,000) comes into force. Britain, which for years appeared to encourage personal wealth, is now being described as a ’hostile environment’ for the rich. Banks and hedge fund firms have been the main focus of reports about potential company relocations. But at the beginning of March, the chemical manufacturer Ineos announced it was thinking about shifting its global headquarters from England to Switzerland for tax purposes. Britain’s largest privately held company believes the potential saving for the business would be quite significant.” “We estimate a saving of €450 million (SFr650 million) on tax charges between now and 2014 by relocating,” Ineos spokesman Richard Longden told swissinfo.ch. “This would enable us to reinvest within the business and improve our long-term competitiveness.” (Littlejohn, 2010) Taxation rates in England encourage financial companies and investment management groups to locate in Ireland, Switzerland, Hong Kong, and Dubai, rather than London, in order to enjoy favorable taxation rates. “Andorra, Austria, Campione DItalia, Canary Islands, Cyprus, Ireland, Madeira, Monaco, Spain & Yugoslavia” are among countries that seek the same international business investment as the UK, but do so by offering businesses a low or non-existent tax rate. (LLL & BBG, 2002) Thus, reducing personal and corporate taxation rates, and with it downsizing government, could help to encourage investment in the UK. PART B: (50% of total marks) - Q1: Oil Price Forecast: Developments in geopolitical events have historically created the largest and most abrupt price shifts in the price of oil, though there is evidence that the supply and demand relationship internationally is changing on fundamentals related to peak oil. Global consumption patterns are also changing, with an increase in demand for crude oil coming from the BRIC countries of Brazil, Russia, India, and China. Of the BRIC countries, Russia and Brazil represent two of the world’s most dynamic new oil producers, and have reserves that are still undeveloped in vast quantities in comparison to India and China, both of which are relatively limited with regard to domestic natural crude deposits. China’s oil industry has focused on acquiring global assets related to oil exploration and production in order to meet demand in the Chinese domestic economy. This increases the demand-side globally in an environment where some industry analysts suggest that oil reserves and production are decreasing. Related to this is an increase in exploration and production costs in harder to exploit crude reserves that increase the price of the final product. Damage from weather and accident, such the Katrina hurricane and as the recent off-shore drilling disaster that polluted the Gulf of Mexico can also affect oil prices unexpectedly. Finally, war in the Middle East can erupt suddenly and at any time, with Israel attacking Iran being a serious geo-political risk along with the flare up of conflict in Iraq, Afghanistan, Pakistan, Syria, Yemen, and Lebanon. War risk is not limited to the Middle East, and could also affect oil prices by rising up in production regions like South America or Africa, though the risk is considered less. In general, risk management in regard to hedging or tracking oil prices over the next decade will be challenging because of the complexity of the geo-political environment. Oil Consumption (most recent) by country (Nationmaster, 2010) The above chart shows the U.S. economy first in representing about 25% of global demand. In 2007, the Chinese economy accounted for around 9% of global demand, and the Japanese economy 6%. The Indian economy by comparison only represented 3.2% of global demand for oil. As industrialization, the rise of the middle class, and increased number of automobiles with developed roads proliferate in the developing world through economic progress, the demand for oil is expected to increase globally. In the same manner, if the U.S. and E.U. economies begin to grow and expand considerably, the price will rise through increased demand. The development of speculation sectors in the investment communities of the industrialized nations can also drive prices, as noted above. “Exxons 2004 yearly report on energy. It shows the amount of new discovery and production that is needed to keep up with consumer-demand in the next decade.” (Peak Oil Centre, 2004) This chart shows the problem that is highlighted by Peak Oil theorists, namely that current known oil reserves that are in production are in decline regarding the number of barrels of oil they produce per year. In addition to this, new oil reserves are not being discovered at a rate significant enough to replace declining fields. Taken together, this represents the market environment for peak oil, combined with emerging market demand. The wildcards in the peak oil contingencies are related to new discoveries, increased efficiency in production, and discoveries that improve efficiency on the demand-side. Tar-sand oil is an example of oil exploration with higher processing costs that becomes viable when oil prices rise. In the same manner, alternative energy technologies also receive a greater impetuous when oil prices are high. These factors can contribute to a reduction of demand, but historically have not done so thus far. “2009’s ‘economic risks’ included a fall in the US dollar, asset price declines, and underinvestment in infrastructure, all of which reduced the demand for, and price of, commodities. Most advanced economies were simultaneously in recession reducing growth prospects in emerging markets due to lower demand for export goods. Panic was a clear feature of the systemic financial crisis, highlighting the need for better market foresighting. Global growth is expected to remain below potential in 2009 and 2010.” (CFP Funds, 2009) The heat map above shows some of the geo-political risks associated with commodity trading in relation to ‘strength of global impact’ factored by expected frequency of occurrence or ‘risk probability’. Listed as medium risk scenarios are U.S. military adventurism, nuclear proliferation, and international terrorism. A higher risk or more probable scenarios can be seen in extreme weather problems, Chinese geo-political activity, further global economic stability, and dollar exchange rate fluctuations. All of these can impact oil prices unexpectedly in the future. “Narrowing technological advantage” is listed as highest probability of risk- in this context, for Western nations and businesses vs. the developing world, which can reduce margins and profitability for businesses in a competitive global market while also improving standards of living in former colonial nations. In summary, all of these are aspects of geo-political and natural disaster risk that could and likely will impact oil prices in the near future, in combination. However, predicting the occurrence or timing of these incidents is extremely difficult. In the same manner it can be difficult to predict future oil prices because of all of these variables. Few predicted the economic collapse in 2007-8 in the Western banking system related to the mortgage and real estate meltdown. The effects of contagion in this crisis and the degree to which equity and commodity markets moved together worldwide suggest that economic factors other than peak oil and geo-political risk can play a factor in determining oil prices. “10-year commodity price chart for Crude oil - Units: U.S. dollars per barrel – Category: Energy Compiled by mongabay.com using figures from World Bank Commodity Price Data.” (Mongabay, 2010) The ten year chart of oil reflects a possible bubble or spike that comes from speculation, or it may be a spike that presages peak oil. The Saudis are said to be happy with a price of around $78 per barrel, and as leading producers in OPEC and the world the Saudis determine greatly the extent of the oil price. “Saudi Oil Minister Ali al-Naimi told reporters at an OPEC meeting in Quito: ‘$70-$80 is a good price.’" (Bakr & Bronstein, 2010) Oil at $88 a barrel is currently $10 over the Saudi target, and thus could fall again to the low of $70-$72 as a lower limit or base. It is unlikely that oil will fall below this price per barrel barring depression or extended recession in the global economy. More significant for the price of oil as a hard commodity is the relation of the price to currency exchange rates of the Euro and Dollar, as well as the relation of these currencies to the price of gold. “Gold has been a good leading indicator of non-energy industrial commodity prices, and it appears that the rally in both isnt over yet.” (Grannis, 2010) The Saudis continue to favor a price of $70-$80 per barrel officially for oil as OPEC policy, and as such, this should be determinant in pricing. However, the price of oil tracks geopolitical risk, as well as inflation / deflation in global economies. If the Euro and Dollar both become debased in real terms through quantitative easing, national debts, etc., and as this is represented in the price of gold, then crude oil prices should also follow gold in appreciating. Similarly, a stronger dollar policy by the U.S. could decrease prices in accordance with other factors, but this seems unlikely. Oil is generally traded in dollars so the dollar to gold ratio also determines price. Peak oil and increased demand primarily from China, India, and other developing countries places pressure on limited supplies. In this context, a lower trading range of $70-$80 per barrel is seen as the expected price based on OPEC pricing, but that this is also to rise with currency debasement and nation-state sovereign default pressures, as in Greece, Portugal, Ireland, etc. However, deflationary factors could also overrule the inflationary State bank response if economic recession continues. A Chinese real estate collapse and economic contraction in China would impact demand significantly. Another war in the Middle East would surely push oil over $120 per barrel. Thus, a close monitoring of geo-political events is required in oil trading, and these news cycles have a huge contemporaneous influence on market pricing. Speculation fueled by ETF vehicles of investment also impact price. In summary, the prime determinant of oil prices is the rate of global GDP growth, related to peak oil limitations in production. Geo-political risk rarely changes these fundamentals of supply and demand, despite their headline effect on prices in the international oil market. Sources Cited: Bakr, Amena and Bronstein, Hugh (2010), Saudi still favors $70-$80 oil, OPEC holds supply, Yahoo News, Published 11 Dec. 2010, viewed 14 December, 2010, . Beattie, Andrew (2010), Silver Thursday: How Two Wealthy Traders Cornered The Market, Investopedia, Web, viewed 14 December, 2010, . CFP Funds (2009), Commodity Compass Synergy – Oct. 2009, The Currencies and Financial Products Performance Fund Limited, PDF, viewed 14 December, 2010, . Datablog (2010), UK public spending by government department, 2008/09, The Guardian UK, Web, viewed 14 December, 2010, . Grannis, Scott (2010), Crude Oil and Gold Reach New Nominal Highs, Seeking Alpha, Web, viewed 14 December, 2010, . ‘Lectric Law Library (2002), European Tax Havens, The Lectric Law Library & Baltic Banking Group, Web, viewed 14 December, 2010, < http://www.lectlaw.com/filesh/bbg31.htm>. Littlejohn, Andrew (2010), Swiss offer firms haven from British tax hikes, Swiss Info, Published Mar 18, 2010, viewed 14 December, 2010, . Nation Master (2010), Energy Statistics > Oil > Consumption (most recent) by country, NationMaster.com, Source: All CIA World Factbooks 18 December 2003 to 18 December 2008, viewed 14 December, 2010, . Peak Oil Center (2004), Facts and Data, Resource Depletion, Web, viewed 14 December, 2010, . Silver Coin Values (2010), Silver Charts, Silver-Coin-Values.com, Web, viewed 14 December, 2010, . Williams, James (2007), Oil Price History and Analysis (Updating), WTRG Economics, Web, viewed 14 December, 2010, < http://www.wtrg.com/oil_graphs/oilprice1947.gif>. World Bank (2007), Atlas of global developments, World Bank Publications, Web, viewed 14 December, 2010, . Read More