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Two Strategies for Prospering During Inflationary Times

By Porter Stansberry
Saturday, February 2, 2008

Our politicians' propensity to spend money they haven't got goes back a long, long time...

In 1690, the colonial government of Massachusetts faced a fiscal crisis. Its soldiers were returning, defeated, from a raiding expedition to Quebec. The treasury had no funds to pay the soldiers, because the colony expected the campaign to be profitable: The soldiers were to loot the French.

Angry and hungry soldiers are dangerous. The Massachusetts politicians promised they'd be paid, even though the colony's coffers were empty. Unfortunately though, the colony's credit was also tapped out. No one would lend the government the funds it required – 7,000 British pounds.

So, pioneering a tradition in U.S. politics, the leaders of the colony simply printed up 7,000 paper notes. On behalf of these notes, the politicians made two solemn promises: The notes would be redeemed in gold or silver from tax revenue in a few years' time... and absolutely no further paper notes would be put into circulation. "Trust us," the politicians said. "Gold is only a barbaric relic."

You can guess what happened to these promises.

Less than six months later, the colony's leaders decided the first issue of paper money had gone so well and had such a positive impact on the local economy that they should issue an additional 40,000 such notes. Once again, they promised the notes would be redeemed in gold or silver and they promised no further notes would be put into circulation.

As this second, much larger wave of paper hit the market, merchants began to significantly devalue the notes versus genuine bullion, leaving them with only about 60% of their previous purchasing power. When the market began to reject the fiat paper as a fraud, the colony reacted with a strategy that would later be copied by such illustrious leaders as Zimbabwe's Robert Mugabe: It moved to buttress the notes' value by force. The government decreed its paper was legal tender – at par – for all debts and granted a 5% premium on the notes for all tax payments.

Such tactics worked... for a time. But as always happens when one currency is artificially propped up over its intrinsic value, the bad money forced out the good. Spanish silver coins, which circulated widely in the colonies, began to disappear.

Meanwhile, the politicians treated each of the following crises with more of the same money medicine. In 1716, another 100,000 notes were issued – these backed by a "land bank." Then in the 1740s, the printing presses were more or less permanently turned on. Paper money in circulation soared from around 300,000 notes to more than 2.5 million.

All of this money sloshing around the world helped power one of the greatest speculative manias in history – the South Sea Bubble. It also caused the price of precious metals to soar. The free market price of silver, which had once stood at par with the notes, ended up 10 times higher. In about 60 years, the Massachusetts politicians had turned their promise to repay in specie into a farce: Their notes were now worth 90% less than face value.

Fed up with the constant economic booms and busts of a paper standard (always followed by yet another, still larger issue of paper money), the King of England finally outlawed the issue of any currency not backed by gold or silver in 1751.

Given our exit from the gold standard roughly 40 years ago, the constantly increasing money supplies in the United States, and the relative financial standing of our government – I think a gradual decline in the purchasing power of the dollar is a sure thing. Higher precious metals prices are a lock. None of these debts will ever truly be paid back. They will be refinanced, postponed, and inflated away. That work is already in progress.

While owning precious metals is probably the safest way to profit from inflation, owning high-quality, capital-efficient businesses is even better. As Warren Buffett figured out, corporate "goodwill" increases in value along with tangible assets during inflation, and, unlike asset-rich companies, goodwill doesn't require any additional capital investments to maintain. Goodwill is the value of a business that doesn't reside on its balance sheet... things like trademarks, brand names, and customer lists.

One of my favorite businesses along these lines is Anheuser-Busch (aka Budweiser). Budweiser is vertically integrated to a degree without peer among widely distributed consumer product companies. Plus, the strength of Budweiser's brand – which has owned a majority of the U.S. beer market since 1954 – ensures it can continually pass along cost increases to consumers. No matter how bad the mortgage mess gets, a large segment of the U.S. population will continue to drink Budweiser. (No wonder Buffett owns more than 35 million shares of the stock.)

It's true, Anheuser-Busch is not the kind of stock that will make 100% in a year... or even 25% in a quarter. Instead, it's like a World War II battleship – a slow-moving, but irresistible, force.

If you agree with me that the U.S.'s debt burden will be gradually inflated away, you'll want to make sure you have a substantial portion of your wealth in precious metals and high quality businesses like BUD. With this strategy in place, you'll do just fine in the coming years.

Good investing,

Porter Stansberry

Market Notes


We have a negative real interest rate right now. When real interest rates are negative, the price of "stuff" rises faster than the interest rate on cash deposits.

Economists calculate real interest rates by subtracting inflation from nominal interest rates. Today, three-month Treasury bills have a nominal yield of 2.08%. In 2007, inflation ran at 4.10%, as measured by the Consumer Price Index (CPI). Therefore, real interest rates are -2.02%.

Negative yields are a big disincentive to saving money... It's why gold... and real estate... do well when rates are negative. This is the real stimulus plan of the U.S. government.

Tom Dyson

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