Donald Trump is on a mission to bring factories back home. The U.S. president’s “America First” trade policy is intent on unravelling the sprawling web of international supply chains that has reconfigured the global economy over the past three decades and – according to him – hollowed out American manufacturing. His latest attacks include threatening Apple (AAPL.O), opens new tab with a 25% tariff if it fails to make iPhones in the United States, and raising the levy on imported steel and aluminium, opens new tab to 50%.
Yet the golden age of globalisation went well beyond offshoring manufacturing to exploit cheap labour overseas. The painstaking construction of a global commercial order under international law also encouraged a spectacular flourishing of tax, regulatory, and financial arbitrage. If “America First” means reversing globalisation along these other dimensions as well, the consequences for investors will be even more momentous than Trump’s trade war.
Start with tax. Over the past few decades, U.S. companies have become adept at shifting patents, intellectual property and other valuable bits of their businesses offshore. Brad Setser of the Council on Foreign Relations has demonstrated, opens new tab that the tax-driven shuffling is now so egregious that it shows up in the U.S. balance of payments statistics. In 2024, American multinationals reported earnings of $300 billion in seven low-tax jurisdictions – Bermuda, the Cayman Islands, Ireland, Luxembourg, the Netherlands, Switzerland, and Singapore. That’s six times what they made in seven of the world’s largest economies combined.
Setser singles out pharmaceutical giants as the most adept of the arbitrageurs. In 2022 eight of the largest U.S. drugmakers booked only $10 billion of profit on $214 billion of revenue in their home market – a paltry margin of less than 5%. Contrast that with the $90 billion of profit they extracted from $171 billion of revenue – a hefty profit rate of more than 50% – in various more lightly taxed regimes.
This epidemic of arbitrage has fattened firms’ profit margins and filled the treasuries of low-tax jurisdictions at the expense of U.S. taxpayers. Where companies have moved physical production offshore, they have also left American workers behind. In Trump’s first administration his flagship fiscal bill – the 2017 Tax Cuts and Jobs Act – attempted to close this loophole by taxing companies’ overseas earnings. Ill-conceived exceptions meant the move backfired and made the arbitrage even more prolific. Setser quips that it should have been called the “Tax Cuts and Irish Jobs Act”’So, this is really a wealth transfer from poorer Americans to richer Americans.
Another defining feature of globalisation has been the ability of companies, particularly in finance, to shift activities to more favourable regulatory regimes. The industrial-scale transfer of life insurance policies by U.S. insurers to offshore jurisdictions – a process known as “ceding reserves” – provides a timely example.
Such liabilities are less burdensome in jurisdictions such as Bermuda, which has looser capital requirements than those demanded by American regulators. That allows U.S. insurers to crystalise a profit when the transfer is effected and free up balance sheet capacity. Since 2019 more than 10% of all America’s life insurance reserves – some $600 billion in total – have decamped to Bermuda alone, Moody’s
Once again, the benefits of the cross-border reshuffle have flowed both to the coffers of overseas governments and to the owners of the companies doing the offshoring. In this case there’s been another important consequence too. Leading private credit providers such as Apollo Global Management (APO.N), opens new tab and KKR (KKR.N), opens new tab have been among the biggest pioneers of the wheeze, both acquiring offshore life insurance operations. The resulting captive funding has helped drive their prolific growth.
If the Trump administration cracks down on these tax and regulatory arbitrages, investors can take some simple precautions. They can shun Big Pharma on the assumption that the industry’s supernormal margins will compress. They can avoid private credit providers in the expectation that funding will become more expensive. They can also short tax havens and lightly regulated jurisdictions in the anticipation that the golden geese will be flying home.
If Trump takes on the third area of arbitrage money managers will have fewer places to hide. This is the edifice of international finance underpinned by the U.S. dollar. In a recent lecture, opens new tab, Hyun Song Shin of the Bank for International Settlements explained how, before 2008, liquidity in international markets was supplied by so-called shadow banks issuing private credit instruments. That architecture imploded in the Great Financial Crisis and has been replaced by a system in which international credit money is synthesised out of U.S. Treasury bonds using the market for foreign exchange swaps. This new financial alchemy operates on an epic scale: around $8 trillion of Treasuries held overseas supports FX swaps with a face value of $60 trillion.
Many would argue that the rampant demand for U.S. government debt this new system generates is a benefit for Uncle Sam: part of the “exorbitant privilege” of issuing the world’s reserve currency. The Trump administration disagrees. In April Stephen Miran, chairman of the White House Council of Economic Advisers, described, opens new tab the U.S. as an unrewarded financial Atlas carrying the rest of the world on its back. “The U.S. provides the dollar and Treasury securities, reserve assets which make possible the global trading and financial system”, he said. Today, the U.S. is providing a “global public good” for free. In future, the rest of the world should be compelled to “pay their fair share”.
That may sound far-fetched, or just impractical. But the sweeping tax and spending bill recently passed by the U.S. House of Representatives includes a provision that allows the U.S. government to tax foreign investors in American assets. This proposed levy, included in Section 899 of the bill, could potentially allow Trump to attack capital flows in the same way that he has targeted the trade in goods.
That should make investors nervous. Given that the Committee for a Responsible Federal Budget estimates, opens new tab that the same bill would boost the budget deficit by a third to $2.3 trillion, it should worry the U.S. Treasury Department too. Cracking down on international tax and regulatory arbitrage is one thing. Cracking up global finance as we know it would be quite another. If that happens, it won’t be just officials in Ireland and Bermuda who will be fretting. It will be those in Washington as well.