January 17, 2007
2006 was a year when ‘liquidity’ became the most important word for the financial markets. Moreover, with foreign stocks booming and emerging market spreads falling to record lows (compared to US Treasury bonds), 2006 either marked a key turning point in global capital/financial market distribution patterns, or a repeat of the hot money inflow/outflow crisis’s that have plagued emerging market economies in the past. With this in mind, two important questions leading into 2007 are 1) Does a boom in places like China and India portend a bust, and 2) Will the US reaffirm its safe haven status during the next financial crisis or not? Liquidity driven investment minds want to know…
Unfortunately this is where the positive side of the story ends. Since its first quarterly report more than a decade ago, USAT has posted 45-quarterly losses in a row. Taking both longevity and consistency into account this is stunning record of losses, and with $2.7 million in interest expenses being logged over the last 4-quarters it is not as if the trend of losses can be easily reversed (Excel Financial Highlights).
As you might suspect shareholders have not exactly been pleased with the company’s performance: From a reverse-split adjusted high of more than $500/share in 1999 USAT is trading at less than $7/share today. Yet despite the losses it is not as if USA Technologies is about to go under. Rather, since inception the company has been extremely adept at attracting new funds on a regular basis, most recently closing an $8.4 million deal of common stock and warrants.
The reason USA Technologies continues to attract new funding is because the company has an attractive story to tell - growth! And while there are few other enterprises that have proven as capable of losing money on such a consistent basis as USAT, there is perhaps one.
USA less the T
Founded in 1776, the United States of America was quietly reorganized into a subsidiary of the US Federal Reserve in 1913. The country is in the business of providing services and collecting taxes from its stakeholders (or citizens). If not enough taxes are collected to cover expenses, which is the case more often than not, the government simply borrows money to pay the bills.
Not obligated by GAAP, the BEA estimates Gross Domestic Product quarterly, and the US Treasury provides a daily snapshot of what it believes to be the Nation’s ‘Debt To The Penny’. As for the interest expenses associated with the debt, rates generally follow the yield on the 10-Treasury bond, or the country’s largest and most followed debt issue.
US debt is worrisome not only because of its sheer size - $8.6 trillion! – but also because it is growing at a faster rate than GDP. Indeed, almost any debt-to-GDP configuration you care to make over the last 25-years paints a startling image of unsustainability.
Hand-and-hand with debt growth concerns is the fact that interest payments, which at $400+ billion annually are currently running at approximately 3.37% of GDP, could increase dramatically if interest rates rise. Other things being equal, a 1% increase in the 10-year Treasury bond yield equals a $86.7 billion increase in annual interest expenses.
Obviously these assumptions are static and could prove inaccurate. For that matter, there is the issue of what numbers to use when making statistical forecasts. For example, President Bush recently touted that the government deficit for the 2006 budget year, which ended Sept. 30, dropped to a four-year low of $248.2 billion but in the’ 2006 Financial Report of the US Government’ (which follows GAAP - PDF) the 2006 deficit was $449.5 billion. Confused? Don’t be, at least not until you turn to the question of unfunded liabilities, which by the Treasury’s math puts future debt obligations above the $50 trillion mark! In other words, as unsustainable as the growth/debt/interest expense situation may appear, future government promises make for an even more uncertain tomorrow.
How does the US sustain its seemingly reckless spending habits? With the largest economy in the world, the US is afforded many advantages in the financial marketplace, most importantly being able to print unbacked [by gold] paper currency that the rest of the world is essentially obligated to absorb to secure their own interests. Cocksure that USD hegemony is a perpetual advantage, current Fed Chairman, Ben Bernanke, made the following statement more than 4-years ago: “the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
Are the times a-changin'?
In 2006 London took the crown from New York as financial capital of the world, the majority of emerging markets and many developed market equity indices outperformed the US, precious metals continues to boom, and the largest IPOs came out of China. Also of note is the fact that academics, foreign central bankers, and OPEC continued to tinker with the idea of euro-backed world in 2006 and that the concept of one Asian currency took steps, albeit small ones, towards becoming a reality. To reiterate, these types of trends suggest that 2006 either marked a key turning point in global capital/financial market distribution patterns, or a repeat of the hot money inflow/outflow crisis’s that have plagued emerging market economies in the past. Assuming the boom in places like China does not turn to bust, the ‘key turning point’ in question is simply as follows:
The point when investors start to regard non-USD assets as being equally safe/attractive as USD assets.
If this point really did arrive in 2006, the timing for the US could not be any worse.
“The net social insurance responsibilities (scheduled benefits in excess of estimated revenues) indicate that those programs are on an unsustainable fiscal path and difficult choices will be necessary in order to address their large and growing long-term fiscal imbalance. Delay is costly and choices will be more difficult as the retirement of 'baby boom' gets closer to becoming a reality with the first wave of boomers eligible for retirement under Social Security in 2008”. 2006 Financial Report of the United States Government
Conclusions and 2007 Speculations
While the US dollar remains the glue that keeps the global financial markets together, trends in 2006 suggest that the declining premium investors are willing to pay for US assets may be permanent. This is the case not only because it is widely believed that the US’s balance sheet is likely to turn even more precarious in the future, but also because investor’s have grown increasingly comfortable investing more of their capital in the international markets. As a quick example, Trimtabs estimates that US investors pushed $150 billion into international stock funds last year versus only $30 billion in US stock funds.
Suffice to say, if equity chasers ever become more comfortable speculating in say ‘China Technologies’ instead of ‘USA Technologies’, Mr. Bernanke or his successor would become considerably less cocksure. Keeping in mind the ominous debt/dilution story at USAT, there are costs associated with printing US dollars (i.e. as investors place less value on each new US currency unit the purchasing power of each dollar declines), and these costs could be severely magnified if legitimate investment/currency alternatives to those made in America were available. Can inflationist US monetary policies continue without jarring consequences if capital no longer places a premium on US assets? (Perhaps sensing greater interrogation of its printing policies down the road, Bernanke’s Fed stopped releasing the M3 during 2006. Needless to say, and without knowing the actual numbers (shadowstats), the ‘excessive liquidity’ in the marketplace tell us that the US money stock, like debt, is growing at a faster rate than US GDP.)
Given the contrarian expectation that the liquidity-driven bliss of 2006 will not be maintained in 2007, the lesson to remember is that while liquidity dilutes, excessive liquidity plants the seeds that inevitably destroy. Thus, the question is once the period of creative destruction starts will capital migrate into USD, Euros, gold, or other? Unsure of exactly when the reckoning days will arrive, lets just say that the best outcome for the US is that the growing investor attraction to non-USD interests proves to be a temporary infatuation.