Dust flux, Vostok ice core

Dust flux, Vostok ice core
Two dimensional phase space reconstruction of dust flux from the Vostok core over the period 186-4 ka using the time derivative method. Dust flux on the x-axis, rate of change is on the y-axis. From Gipp (2001).

Friday, September 2, 2011

The corporate structure of USA, Inc.--responses to the rise and fall of US confidence

This article was carried by Zerohedge, where it has attracted much comment. I would like to respond to a couple of the more interesting ones.

As for the head-and-shoulders "pattern"--yes, I had a feeling I might regret including it. But it sure attracted comments!

The two points of greatest interest to me were: 1) is it logical to expect the value of the "collateral" backing the US debt to be bid up to the point of rendering it solvent; and 2) what happens to my analysis in the event of a sovereign default?

Both of these points may be addressed if we look at the US as we might look at a corporation. The shares of the corporation trade on some sort of market as does its debt. Its shares are called "US dollars". Its debt is in the form of convertible debentures--to be exchanged for shares at some future date.

The problem is that unlike any other corporation, the convertible debentures are converted to a fixed number of shares, without reference to any external objective value. For instance, if company ABC floats debt in the form of a convertible debenture, the debenture would be valued in terms of something beyond the company's control (the dollar, for instance), and the conversion would be at, say, the closing price on the day before the date of conversion.

This is normally necessary, because if company ABC had stated to convert the debenture to a fixed number of ABC shares, we might imagine all kinds of shenanigans prior to the share conversion. ABC might carry out unnecessary, dilutive financings, or perhaps announce a 1000:1 split just before the conversion date. Reasonably informed investors know to stay clear of such issues.

USA, Inc. therefore has issued a large number of shares (just how many is a matter of some dispute) and has issued a number of debentures, which stand to be converted to an even larger number of shares. USA, Inc. lists a number of assets, including some 260 million ounces of gold. The assets have not, admittedly, been audited in some time, but let us ignore that for the moment. Unfortunately, USA Inc. is running a substantial deficit, necessitating the issuance of more debentures; and indeed has not turned a profit in a very long time. It is anticipated that USA, Inc. will need to continue to increase more debentures, in greater numbers each year, for the foreseeable future.

You should also note that the assets have not been pledged to cover the debt. As a matter of fact, nothing has been pledged against the debt but the future issuance of shares. These shares have no intrinsic value, only an imputed one. They pay no dividend and confer no voting rights (although they have been known to buy politicians). Although the market has been confident that these shares will continue to have value, in comparison to many objective measures, the imputed value of the shares has declined over the past century.

When confidence falls, the imputed value of the US dollar falls.The price of gold in US dollars rises as a consequence. Therefore the price of gold is rising not because the market is bidding up the price of gold to try to restore the US economy to solvency--the US dollar is being bid down.

As to the second point--under a sovereign default, USA, Inc. would simply refuse to honour some, or all, of its obligations. It might seem likely that the share price would rise, as USA, Inc. would have eliminated some or all of its liabilities. But would we expect to see a rising share price in an open market? If ABC company repudiated its debts, is it likely its share price would rise? Or would the market realize that a portion of the imputed value of a company's shares rests on the perceived honesty and integrity of its management, and revalue the shares accordingly.

The shares of USA, Inc. have an imputed value, which is dependent on the market's perception of the future prospects for the company as well as the honesty and integrity of its management and employees. The assets of the company are not pledged against either its shares or its convertible debentures. You should invest accordingly.

No comments:

Post a Comment