Thursday, March 09, 2006

On the declining value of US gift certificates

Gift certificates can be a great or horrible gift depending upon the issuing store.

If the certificate is from a store you frequent, or would like to, it's worth its value in cash.

If the certificate is from a store you know has nothing for you, it's worth less than cash to you, unless you can work out a swap with someone who wants those particular goods sold by the store in question.

The worst kind of gift certificate, it seems to me, would be one from a store at which you wanted to shop, only to find out that they kept removing merchandise from the shelves each time you went to buy it. I wonder if the US$ is behaving a bit like this worst kind of gift certificate.

Decades from now, I'll bet economists will be scratching their proverbial heads trying to figure out why the rest of the world went on a US$ reserve buying spree, all with approval from the issuing country, beginning slowly in the late 80s and accelerating rapidly as the 90s progressed. I'm assuming these economists will be viewing our time with the benefit of hindsight, in full awareness of the effects of the resolution process we have yet to experience.

I can remember when US$50B in reserves was quite a bit. In 1986, Japan had only US$42B. They currently have more than US$800B. That's a lot of gift certificates.

The Bank of Taiwan has a page which lists the growth of reserves over time for quite a few nations. You can see Japan's reserves grow, particularly once Rubin at Treasury and Sakakibara at the MoF rescued the US$ in 1995-6.

You can see the effects of the lesson of the Asian Crisis. Having convinced themselves that the reason for the crisis, or at least reason for an inability to mitigate its effects, was a lack of US$ Reserves, Asian Central Banks went on a buying spree. S. Korea had US$34B in reserves prior to its crisis, they currently have over US$200B. That's a lot of gift certificates to accumulate in 10 years.

China, Russia and the Middle East are also accumulating gift certificates at a rapid pace. More troubling, they are constantly learning that some items on display are not for sale.

China tried to buy Unocal in July of last year. Their efforts were rebuffed. The value of those gift certificates in China fell. Interestingly, the $ price Gold broke to new highs in the weeks following China's decision to drop their bid for Unocal.

The UAE has now bought P&O but may not be able to take control of the US ports. If the House rebuffs the UAE, as they are saying, the value of the gift certificates in the UAE will fall.

When next you read some economist claiming that imbalances don't matter remember these deals. When a nation runs a trade deficit it can either sell equity assets or debt, which in the case of the US, is really just a swap of fewer gift certificates for more gift certificates in the future-a delaying tactic. Let me repeat, for emphasis, the sale of US debt to foreigners is really just a delaying tactic-a swap of their gift certificates now for more later.

The fewer equity assets for sale, like Unocal, or the ports' operations, the less valuable the gift certificates become, particularly as the only convertibility guarantee for these certificates is for US$ denominated debt, something the rest of the world has been paying off quite rapidly over the past half decade.

I'm not arguing that Congress should or should not approve the deal. I'm merely pointing out the risks of the imbalances which are the driving force behind the need to sell assets to foreign companies. The nation has three choices: 1) radically curtail credit, slash government expenditure and deflate the equity and real estate bubbles 2) sell its equity assets and become Buffett's sharecropper society 3) not sell them and hasten inflation's manifestation in the goods markets.

If Congress kills this deal and raises the debt ceiling, the effect of which has reduced debt monetization since early this year, I would expect to see the inflation trade come back in full force.


ps That was fast, according to CNN, Dubai Ports will transfer US port operations to a US entity. Assuming this isn't some corporate shell game, such as the UAE opening a shell company in the US to shield its ownership from clear view, the gift certificates are already shrinking in value.