Is the Global Financial Order Shaking or Shifting?
The introduction of the FACTA is resulting in a further erosion of the US dollar in its role as the world's reserve currency. A reserve currency (a.k.a. anchor currency) is the currency held by a country's central bank as foreign exchange reserves to be used to settle the country's international financial obligations. The US dollar has a history of being the most important reserve currency but it is not the only one used by governments: others assets commonly used are IMF SDRs (Special Drawing Rights), the euro, the pound sterling, and the yen.
For quite some time various governments around the world have been debating the value of the US dollar in light of the fiscal deficit and debt of the United States and how these serious fiscal concerns affect the position of the US dollar as the world's reserve currency for international trade settlements.
That these discussions are leading to concrete actions could be evidenced by the fact that more and more trading partner countries are setting in place financial, contractual infrastructures to avoid the use of the US dollar. China has signed agreements calling for the use of yuan when trading with Germany, Russia, and India; Saudi Arabia and other oil producing states in the Middle East are gradually moving from only dollars-for-oil exchanges to accepting other currencies and gold.
In addition, during the 6th BRIC forum held on July 15, 2014 in Brazil, a long-anticipated document was signed to create the new BRIC Development Bank, with the respectable initial capitalization of 100 billion US dollars (equivalent). The launch of the BRIC Development Bank is seen as a first step to break the dominance of the US dollar in global trade, as well as dollar-backed institutions such as the International Monetary Fund (IMF) and the World Bank, both US-based institutions.
And now, the FATCA US regulation (refer to the newsletter of January 2014 for more information) is triggering a movement of aversive actions against the US dollar, moving from governments to companies to individuals. FATCA was signed into law on March 19, 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act and became active on July 1, 2014. Since that time, participating foreign financial institutions (FFIs) are required to annually provide the US Internal Revenue Service (IRS) with names, addresses, and account details of all American account holders with assets over $50,000. This includes US citizens, those with dual citizenship, and permanent residents (those holding American "green cards"), who we will refer to in this newsletter as "US-related clients." If these individuals conduct any kind of financial activity in a foreign country, they must be identified and reported. Otherwise, the IRS will impose a whopping 30 percent withholding tax on all US dollar payments going to the FFIs that fail to track and report the activity.
For illustrative purposes, consider this hypothetical scenario: A client of a foreign country's bank fails to inform his bank (a FFI under FATCA) that he is a US green card holder. Once this is discovered by the US correspondent bank with which this foreign bank is working, to be in compliance with FATCA and avoid trouble with the IRS, the American bank would start withholding 30% on all payments going to the client's bank. However, in order to avoid sending full payments when they shouldn't, American correspondent banks, to avoid being penalized for not withholding payments, have started to withhold the 30% on all payments to FFIs and then let the foreign banks and their clients sort it out with the IRS as to who should get a re-imbursement for funds erroneously withheld. Clearly, this is an undesirable and costly burden of proof placed upon the FFIs and their US-related clients.
If US financial institutions only held back payments when FFIs failed to notify them properly, FFIs could invest in systems and software for segmenting, tracking, and reporting their US-related account holders to make sure they almost never failed in reporting them. However, once the US FIs started withholding payments preemptively, FFIs increasingly are refusing to accept US-related clients who fall under the jurisdiction of FATCA. As mentioned in our newsletter of May 2012, HSBC Holdings Plc (HSBA), Deutsche Bank AG, Bank of Singapore Ltd. and DBS Group Holdings Ltd. (DBS) have all admitted to turning away US-related business. UBS, the world's biggest non-US private bank has recently announced that it would discontinue offshore accounts for clients under the jurisdiction of FATCA; it seems a cost-benefit analysis of FATCA does not favor maintaining US-related clients. Considering the role of the US dollar as a global reserve or anchor currency, one could assume that almost all banks located all over the world, in one way or another, are currently conducting transactions in US dollars and as such will be affected by FATCA. Over time, these smaller FFIs may follow the example of the big institutions.
To add to the problem, FATCA is making it very difficult for US-related clients to transfer funds and invest abroad because American financial institutions are acting to protect themselves as well. One of the largest banks in the US, JP Morgan Chase, recently introduced a new policy limiting monthly outgoing international transfers to $50,000 USD on small business checking accounts. It is anticipated that other smaller banks will soon follow suit.
In conclusion, it can be said that the FATCA regulation is increasingly revealed to have been a poorly conceived policy, as it is showing itself to be a financial double-edged sword that cuts on both sides. On the one hand, it has had the effect of reducing the attractiveness of US-based clients for FFIs and on the other hand limiting the possibilities for US citizens to transfer funds abroad. These dual negatives are further threatening the supremacy of the US dollar as the world's reserve currency. One can foresee that if the negative effects of FATCA continue, there could be a general consensus among the central banks of governments around the world to select one or more other currencies as their reserve currency and the status of the US dollar and American economic supremacy in the world will decline even further. The FATCA could be an example of reaching out too far and falling off the cliff!