By Porter Stansberry

Thursday, December 18, 2008

The world's leading economy, the United States, has become fantastically indebted at every level.

Entire industries exist today purely because of the widespread availability of easy credit – a trend that has ended. U.S. consumers have refused to save any significant portion of their earnings for more than a decade. This trend was unsustainable and has also come to an abrupt end.

As I've covered previously, fueling the debt and consumption binge in America were phony insurance schemes (AIG's bogus default swaps), record high levels of mortgage debt, and global investors (primarily Asian) buying American mortgage paper. In the most basic analysis, China and Japan lent us endless sums of money so we could keep buying their exports. America's real estate bonds became the world's collateral, supporting ever-greater amounts of borrowing.

This global game of credit expansion has come to a crashing halt because the creditworthiness of American consumers and financial firms collapsed. In the dark days of September, October, and November, we witnessed a synchronized margin call, where credit of all types was called in. Any asset liquid enough to generate cash was sold.

Consider the folly of the AIG "bailout." The government has been shoveling money through AIG's front door, only to see it immediately leave out the back door en route to Goldman Sachs to cover an unknown amount of credit default losses. Or witness the charade of General Motors' "bailout." GM hasn't earned a profit in almost a decade. It owes, by my reckoning, close to $80 billion. The amount of overcapacity in the car industry is extreme. GM has more than 6,000 dealers in the U.S., compared to less than 2,000 for Toyota and Honda. Congress might as well light its $20 billion on fire.

With a currency and a budget process totally untethered to any reality, nothing limits the amount of foolish spending Congress can (and will) authorize. Something about the scene reminds me of watching King Kong flail at his tormentors on the top of the Empire State Building. Our government is the most powerful in the world. It controls the world's only reserve currency – meaning it is the only country in the world that can print money to cover all its debts, bar none. And yet, for all of this power, King Kong is still doomed.

We are witnessing the end of the paper-dollar standard.

Like every experiment with paper money in history, our dollar will be destroyed in an all-out attempt to paper over deficit spending, bad investments, and war debts. Says legendary investor and monetary expert Dennis Gartman:

The U.S. deficit for the two months of the fiscal year to date now stands at a record $401.6 billion, compared with the most recent official budget estimated for the full fiscal year of a deficit of $481.8 billion. This is a shockingly large number, and even we, who usually pay little if any heed to the deficit, find it both awe inspiring and terribly, terribly depressing as a tax payer.

Federal spending is now up 48% over last year. I hope for your sake you understand this is completely unsustainable. At some point, America's creditors will balk.

In addition to the Treasury's vast increase in spending, the Federal Reserve has opened the monetary floodgates. Says another legendary investor and gold bug, my friend John Doody: "The Fed's actions kicked into high gear in Sept-08 as its Total Assets have soared +143% to $2,109 billion, reflecting money pumped into the banking system."

The massive expansion of the Fed's balance sheet has come via the purchase of an alphabet soup of toxic assets from the money-center banks (read "Citigroup").

By the end of November, the Fed had purchased almost $900 billion worth of questionable assets. It also increased its lending to banks (and, for the first time ever, brokers) to more than $700 billion, up from a mere $481 million in November 2007. The result has been a truly fantastic expansion of the Fed's total assets, from less than $900 billion to more than $2.1 trillion.

What you must understand is these assets form the basis of our currency. As the Fed's balance sheet expands, so does the lending capacity of the money-center banks. At the moment, they're not lending, but sooner or later, these resources will find their way into the economy. (The money will most likely be recycled back into Treasury bonds.) This huge increase to our money supply and the inevitable huge stimulus spending plan by the Obama administration position our economy for cataclysmic inflation beginning at some point in 2009.

It is difficult to know what impact these changes will have on stocks, but I believe, in general, they will drive up prices. In addition to buying the world's best businesses (the Cokes, Intels, and Microsofts of the world), I believe you should have hedges in place for the coming devaluation of the dollar.

In other words, you should be buying gold: plain, regular bullion gold coins. I'm currently holding about 10% of my net worth in gold coins. Buy as much as you can afford... and do it soon. Tomorrow, I'll explain why the premium we have to pay for physical gold is so high right now... and why I believe it's going higher.

Good investing,

Porter

Further Reading:

The End of the Paper-Money Experiment

Why You Must Immediately Bet on Inflation

Market Notes

PUT THIS ETF ON YOUR WATCH LIST IMMEDIATELY

There's an unlikely defensive sector appearing on our watch list these days... biotechnology.

Investors use the "defensive" label to describe businesses that enjoy steady demand for their products... like food, cigarettes, and utilities. The thinking goes, you want to own these sectors when the economy stinks. Their profits should hold up better than a shoe retailer or hotel chain. But speculative biotech stocks as a safe haven? Let's see what the market says...

The market in this case is the price of the S&P Biotech ETF (XBI). This fund has big holdings in the 10 or so large biotechnology companies with viable products bringing cash in the door. As you can see from today's chart, this ETF is actually higher than where it was two years ago. You can't say that about oil, real estate, retail, food, transportation, Internet, gold, infrastructure, or financial stocks.
When an asset holds steady during a worldwide liquidation, we put it in the "I probably want to buy this" category. That's where we have XBI right now.

I Hope for Your Sake That You Read This

Market Notes

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