I: OW O V 11_1
1T
The Fantastic Dollar Premium
By NICHOLAS DAVENPORT
MY subject this week is madly technical, but it is so important for the investment world that I must try to make it readable, especially, I hope, for those Members of Parliament who blindly vote on very complicated pieces of finan- cial legislation which they do not understand. It concerns the investment dollar, more usually called the premium dollar. This is the currency a UK resident has to acquire in order to buy American, Canadian, European or other non- sterling securities; he has to acquire it from a pool replenished by sellers of such securities by UK residents. In the past it has usually com- manded a premium over the official dollar rate ranging from 1 per cent to 10 per cent-it was 9+ per cent only last October-but in the last few months the premium has been bounding up and last week touched 21 per cent. At the moment of writing it is around 20 per cent. This is equi- valent to devaluing the £ to $2.33 for overseas investment purposes. Foreigners who are not aware of our strange financial rules may be sur- prised to see that British investors are willing to pay a premium of 20 per cent to invest their money outside the country.
Of course, the jump in the investment dollar premium does not mean that investors are ex- pecting an early devaluation of the £. There is a special technical reason for the rise. The Chancellor last April dried up some of the special sources of supply of currency for the investment dollar pool and simultaneously increased the demand for it. Previously the proceeds of wills and gifts from abroad came into the pool : now they go into the official reserves. Previously, business people adding to their direct investment abroad could often get official exchange by apply- ing to the Treasury : now they have to go to the investment dollar pool. Finally, Mr. Callaghan decreed that any investor disposing of dollar or other non-sterling securities must sell 25 per cent of the proceeds at the official rate of exchange; that is, give up the premium. At the time the premium was about 10 per cent, so that this was regarded as a capital levy of 2f per cent. Now that the premium is 20 per cent, it becomes a levy of about 5 per cent. And if the investor is switching one security for another simply in order to improve the quality and maintain the size of his dollar portfolio, he has perforce to buy 25 per cent of the selling proceeds at the prevailing high premium, thus adding to the cost of his port- folio as well as to the demand for investment dollars. It is small wonder that the premium has been pushed up to 20 per cent.
I might mention in passing that a separate property investment pool has been created for those who wish to buy houses abroad. Into this pool are paid the proceeds of the sale of property abroad by UK residents. We must assume that it is the change in weather and not the change in government which has caused the demand for houses in foreign parts to increase. But who would have expected the property in- vestment dollar to go to a premium of 30 per cent? For those whose winter health demands a house in a warm climate it seems a heavy penalty to pay for survival.
But to go back to the important Budget changes. One of the Chancellor's good intentions was to discourage investment abroad which had previously been accorded too favourable a tax treatment. (As he said, we treated a British in- vestor in the United States better for our tax purposes than we treated a British investor in our own country.) If the balance of payments has to be restored to surplus by the end of this year, on capital as well as trading account, it is essential to restrict the massive outflow of capital for direct investment. Of course, to restrict port- folio investment abroad would have no effect upon the official reserves as it is carried out through the investment dollar pool, but the Chan- cellor reasonably supposed, I imagine, that he would achieve both his objectives by the revo- lutionary tax reforms of his Finance Act.
Both direct investors and portfolio investors overseas have lost valuable tax advantages. Especially the latter, who lose about 30 per cent of their previous grossed-up income. The loss of
this revenue jam, the return to a realistic invest- ment test of straight dividend yield, less 15 per cent withholding tax, should have sufficed to persuade most portfolio investors not to run after American equities yielding around 21 per cent, but to sell and bring the proceeds home to buy British equities yielding 51 per cent or more.
But alas! the clever device of stealing 25 per cent of the dollar premium has completely upset investment morale. This capital levy has so in- censed the British portfolio investor that he will do everything in his power to avoid bringing money home for investment in this country. He will argue passionately that there is no profit in British equities when he really means that there is no sense of equity in the Inland Revenue. He has persuaded himself that American equities are the only true index of capital growth in the Western capitalist world. He feels that the exact- ing of a levy on this one particular form of portfolio investment which has hitherto brought great gain to the 'invisible' income of our inter- national payments account is an act of victimisa- tion which must be resisted. And resisted it is. For how can one explain a dollar premium of 20 per cent if there is any sizeable flow back of money from our dollar portfolios now esti- mated at $4,000 million?
If the British portfolio investor abroad will not dis-invest, then the demand for premium dollars from the businessmen making direct in- vestments abroad will inevitably drive the premium up further--perhaps to 50 per cent or even more. Thus, for the sake of the 25 per cent premium grab, foreign portfolio investment has become completely distorted. Would it not be better for Mr. Callaghan to say that while he has to drive the businessman to the dollar pool for direct investment he must suspend port- folio investment abroad entirely? If, however, he would like to see dis-investment of portfolios abroad, he should abolish the 25 per cent levy and let the premium fall away to zero. When it reaches zero or a discount, then dis-investment will work directly to the advantage of the official reserves.
It is interesting to see that the Treasury ex- perts advised Mr. Callaghan that the 25 per cent levy would bring in about £50 million ($140 million) in a full year. In nine months of 1965 the investment trusts dis-invested to the extent of $96 million, but this was before the dollar premium became distorted. You would think that with an investment dollar premium of 20 per cent and with Wall Street looking danger- ously 'toppy,' there would be a rush to bring
money home, but it is the maddening thought of handing over a quarter of that huge premium to the Treasury—a potential $200 million on a $1,000 million dis-investment—that makes the managers of these dollar portfolios as stubborn as a foreign mule. And oh so jealous of their Irish brothers who are allowed a free once-and- for-all switching by a more compassionate and understanding government.
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