A pause for inflation

A pause for inflation... "Deficits don't matter"... Bailouts all around... Stansberry Stadium... More houses?... We get an "F"...

We begin this week by taking a break from current events. We pause for inflation. And perspective...

It is as though Mr. Market has Alzheimer's disease... or a very poor education in history. We see U.S. Treasury bonds moved to new highs last week. Mr. Market, terrified by the risks of private bankruptcy, opted for the relative "safety" of public insolvency. He seems to have forgotten all the great inflations begin with pyramiding government obligations...

In America at least, the tradition of papering over a financial crisis began in 1690. The colonial government of Massachusetts couldn't pay its soldiers in bullion. They'd returned, defeated, from a raiding expedition to Quebec. Angry and hungry soldiers are dangerous – much like subprime homeowners facing foreclosure or union workers facing unemployment. To silence the mob, Massachusetts politicians promised to pay them, despite that the soldiers had lost the battle and the government had no money with which to pay.

The solution? Paper money, of course. 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: 1) The notes would be redeemed in gold or silver from tax revenue in a few years and 2) Absolutely no more paper notes would be put into circulation. Trust us, the politicians explained. Gold, they said, is only a "barbaric relic." Ha, ha, ha...

Only six months later, the printing press would be turned on again. Yes, papering over debts felt so good and had such a wonderful impact on the economy, these pioneers of inflation issued an additional 40,000 such notes. One of the leading Puritan legislators of the era was famously quoted saying "Deficits don't matter." But as this second, much larger wave of paper hit the market, merchants began to have doubts. They began to favor bullion, leaving the paper with only about 60% of its previous purchasing power. So the colony moved to buttress its value by force – a tactic copied later by such illustrious leaders as Richard Nixon and Robert Mugabe.

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. These tactics caused more fear and began the inevitable process of bad money forcing out good money. Spanish silver coins, which had circulated widely in the colonies, began to disappear. (You'll recall the same thing happened to silver dollars in the 1960s... and seems to be happening now with gold bullion.) The disappearance of bullion led to still more printing. In 1716, Massachusetts issued another 100,000 notes – these backed by a "land bank." Then in the 1740s, the colony more or less turned on the printing presses for good. 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, Massachusetts had turned its promise to repay in specie (gold and silver coins) into a farce: Its 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 in 1751 outlawed the issue of any currency not backed by gold or silver.

Three hundred years ago, it took 60 years for our paper money to be destroyed. We seem to be getting better at it. Nixon officially took America off the gold standard in 1971 – 37 years ago. This weekend, America's money printers promised to "lend" more than $7.4 trillion to rescue the financial system – half the value of everything produced in the U.S. last year. And where will the money come from? Not from mines. And not from our savings – we have none. Where will it come from? The Federal Reserve, whose balance sheet has more than tripled in just two months.

Our prediction? OBAMA! will become the biggest money printer in history. Bailouts all around. Meanwhile, more and more force will be required to maintain the value of the dollar. Bullion – gold and silver – will disappear. These events will take time to unfold. But they're guaranteed to happen. History doesn't lie.

Citigroup, facing an imminent breakup or sale, received $306 billion of government guarantees for troubled mortgages and toxic assets over the weekend. The bank will also get another $20 billion cash injection from the Treasury, in addition to the $25 billion it received last month under the Troubled Asset Relief Program (TARP). In return for the $326 billion bailout, the U.S. government will get $27 billion of preferred shares paying 8%.

We've noted companies that buy naming rights to professional sports stadiums often falter after the sponsorship. In August, we warned you Citigroup was spending $400 million to put its name on the new Mets stadium in New York.

Homebuilders are jumping on the bailout bandwagon, asking the government for a $250 billion stimulus package called "Fix Housing First" and arguing that markets won't recover until home prices bottom. The homebuilders' proposal would offer buyers a tax credit equal to 10% of the home's value, up to $22,000, nearly triple the $7,500 credit Congress offered buyers earlier this year. Builders say the earlier credit didn't work because it wasn't enough and it had to be repaid. Builders also want subsidies on 30-year, fixed-rate mortgages for government-backed "conforming" loans, which are currently around 6.2%, to bring rates down to 3% for buyers in the first half of 2009 and 4% for those in the second half.

The homebuilders will be sadly disappointed to discover that for all of his power and willingness to help, not even OBAMA! can reverse the law of supply and demand. You cannot cure a glut of homes by building more new homes.

My own Put Strategy Report inspired a few of the other editors at Stansberry Research to use the technique in their markets. No one is having more success than George Huang, one of our biotech analysts...

George just notified his subscribers: "This morning, Alpharma's (ALO) board came to its senses. It accepted the $37 per share buyout offer from King Pharmaceuticals (KG). Alpharma shares jumped 6% on the news, but we fared even better… Last week, we sold Alpharma January 35 puts (ALOMG) for at least $4 per contract. Most of you were able to fetch the same contracts for more than $4 throughout the week. The acquisition deal will close by the end of the year. So the January puts we sold will expire worthless. We will pocket the full $4, or $400 per contract. Considering the $700 in margin requirement per options contract, we will make approximately 57% in just six weeks..."

Nice work, George. To learn more about George's trading service, the S&A FDA Report, click here. We're currently offering the service at a big discount.

New highs: nyet.

In the mailbag... We get an "F" – because we don't all say the same thing. How have we let you down, dear subscriber? Let us know: feedback@stansberryresearch.com.

"I have to say that as of late, the Stansberry team help in these trying times gets a grade of 'F'... Your subscribers pay good money for extra help and advice which lately is as schizophrenic as the markets themselves. Ferris says 'Don't abandon the market' while telling us 'Bottoms don't feel this good,' Clarks says 'Scalp some quick trades,' or 'This is a once in a life time opportunity' then later says, 'The best thing you can do is to do nothing.' As of late, every day a new piece of advice comes in that adds to the confusion, 'Insiders indicate stocks are going up,' 'Volatility indicates stocks have more downside,' 'Stocks are cheap,' 'Minimize your risk and wait for the uptrend.' I understand that each analyst is entitled to his own opinion, and in fact that is what I send my hard earned money in to you guys for independent thought to help me make better market decisions. However, at this point I could turn on CNBC and get the same Bipolar analysis for free... I expect a higher standard of solidarity and collaboration from the Stansberry Research team. If the market continues to fall and S&A provides nothing more than disparate and conflicting views, you may end up lumped in with the discredited and dying equity culture." – Paid-up subscriber Matt Berzins

Porter comment: I don't tell my analysts what to write. And they wouldn't work for me if I did. I hold them accountable for the advice they offer. I also compete with them in our annual portfolio reviews and for position in the Top 10. We're honest and open about when we've been right and when we've been wrong. Our intelligence, independence, and rivalry leads to a disparity in our opinions from time to time. You won't get solidarity from us – at least not intentionally. And if you got it all the time, you'd only know we're not any good at what we do.

"You are always mentioning Jim Rogers and his savvy investing. I am wondering has he lost his ass on his commodity investing like most of us. Can't imagine that he could be setting the world on fire." – Paid-up subscriber Harold Hubbell

Porter comment: It's easy enough for you to track at least some of Jim Roger's investments. He has an index fund for his portfolio, the Rogers International Commodity Index. By the end of October, it had fallen 29% for the year. Of course, it's up 213% since inception in 1998.

"Can you share the process for running quick screens to locate overleaveraged REITS?" – Paid-up subscriber Sedberry

Porter comment: Many online sites – including Yahoo, Morningstar, Barron's – make such products available. But if you know how to read a balance sheet, you could simply look at any REIT with more than $1 billion in market cap, and you'll have plenty to choose from.

"I grew up in a GM town (Janesville, Wisconsin). The plant employed 5,000 and now it's closing. Used to be the most profitable (Yukons, Tahoes, Suburbans) before the dollar died and gas went nuts recently. I worked there 2 summers ('85 and '86) during college. One of my jobs was third shift dusting and sweeping in the paint area. Took me an hour and a half to do an 8-hour shift. We had nooks and crannies everywhere to play cribbage and euchre, watch TV or sleep. Got bumped to 2nd shift after 3 weeks when a lifer found out about the cush job. GM's nickname then was Generous Motors. That was 20+ years ago. How the hell did it take SO LONG for leviathan to crash and burn?" – Paid-up subscriber LAF

Porter comment: Until the spring of 2005, GM was an investment-grade credit. I believe it has borrowed more money, in total, than any private company in history. The reason it survived for so long with such poor results? One word: debt.

"I have sent you a couple of e-mails. I ask questions. You don't respond. Yes, I have paid money for your services, so I think I might get the courtesy of a response. I am just an average Joe that tries to gain knowledge that I can use to make money in the stock market. Only problem that I have is that the market already beat me up and stole the money. Now if I have your attention or if I have shamed you into reading the rest of this, I will repeat my question. You of all people are in touch with organizations that invest huge sums of money in businesses. Am I right? Or at least you know of MLP's that do this very thing right. I have my finger on the pulse of a company wanting start up money. They are not sophisticated people. They just have found a market for a simple product that will pay an investor 15 to 20 times their investment. They are wanting three things. A building and two pieces of equipment for manufacturing and finishing their product. Once that is in place they will get a designation from the SBA that will guarantee a contract from the U.S. government {it is a law!}. The smallest of which are about 100 Million a year conservatively speaking. There is no one else pursuing this. So there is no competition. But the demand is enormous. Now, will you call me and I can give you details or is there a MLP that you know that needs to invest in a company and get a huge return. Either way is fine. I just know you guys are in the know about these things and I want to see this thing take off." – Paid-up subscriber Kip

Porter comment: While we spend a good amount of time reading the e-mails we receive, we do so to learn how to improve our products and what kinds of information our subscribers are seeking. We publish the notes we find unusually insightful, unusually critical, or, every now and then, unusually ignorant. We do so because we know most people are reading the mailbag for entertainment. In regards to your friends looking for capital, we receive lots of such requests. And we never get involved. If the company isn't already publicly traded, we have no interest. The only exceptions are with people we've had a long relationship with – folks who have a great track record of success.

Regards,

Porter Stansberry

Baltimore, Maryland

November 24, 2008

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