Our latest warning about U.S. government debt

If you're not really familiar with the fiscal problems of the U.S. government yet, I urge you to read today's Digest carefully – and immediately.

But before we tackle our country's debt and spending problem, here's an update on the bubble in China's economy we've been following closely for several weeks. The Bejing-based magazine China International Business recently interviewed Zhang Xin, CEO of SOHO China, Beijing's largest commercial property developer. Zhang believes there is a real estate bubble in China. And she says her company is selling its properties as quickly as possible:

[O]ther than Qianmen [Street] in Beijing, which is the only project we decided to hold long term, our strategy for today is to sell everything we have. The real estate business should really be looking at rental yield... But, because of where China is with asset bubbles, people want to buy the assets regardless of whether they can be leased out or not.

People just want to hold [property], even if it is empty. Prices are too high, rent is too low... so our strategy is to sell everything. We see ourselves very much as a manufacturer. We buy land, we build, and then we sell. And the asset bubble has compelled us to be even more of a manufacturer.

There is currently RMB 20 trillion ($2.9 trillion) of new money circulating in China, and "it all finds its way to real estate," Zhang said. She says the real estate bubble will continue as long as the Chinese government maintains a relaxed monetary policy. Her company will continue to build and flip until the music stops.

 To support Zhang's statement of rising prices and falling rents, look at the below chart from real estate brokerage Colliers International. Rental prices for every apartment sector are plunging.

Short Report editor Jeff Clark saw a short-term top forming in the Chinese market and told his readers to short China on January 6. Weeks later, they were sitting on a triple-digit gain. Then Jeff followed up with two more triple-digit winners. Short Report readers are making an absolute fortune this year.

He expects the trade to return at least 100% over the next two weeks. I wouldn't bet against him. I've long believed the company he's shorting is doomed to bankruptcy. To access Jeff's latest trade, click here...

New highs: Berkshire Hathaway (BRK), Burlington Northern Santa Fe (BNI).

In the mailbag... Angry about InterOil and feedback on the Private Wealth Alliance. Send us your praise... or blame: feedback@stansberryresearch.com.

"I wanted to let you and Ken McGaha know I appreciate the feedback you gave me. I realize that it seems like a big expense for me to get into the Alliance today since I'm just starting out, but I try to view things with a long term perspective and it was a no brainer to me. Your response made 'Momma' happy and I've just signed up for the Private Wealth Alliance! I will be letting my subscription to another newsletter service expire. Here's to a prosperous future!" – Paid-up subscriber Don Wilde

Porter comment: As all of our Alliance subscribers would tell you, there's no better way to get more out of Stansberry Research for less than by signing up for a lifetime subscription arrangement. These offers are truly win-win. You become our long-term sponsor, which allows us to focus on what we do best – researching investments. And the longer you stay with us, the less you end up paying.

Also, our recent offer for Private Wealth Alliance, our most affordable lifetime membership, ends tomorrow. To learn more, click here.

"I have emailed you twice and maybe three times last week for an update on InterOil. I was very upset that, as a subscriber, I was not allowed to listen in on your much-hyped phone call regarding the stock unless I took another subscription to another of your firm's newsletters. You are not responding to my emails regarding Interoil. I took your subscription because of the hype, bought the stock because of your research.

Porter comment: This is an important issue, something I want all of our subscribers to understand.

First, please know: We do not respond to e-mails regarding securities or investments. We cannot do so for lots of good reasons, including important legal reasons. The SEC forbids us to speak or communicate directly with any subscriber in regard to recommended investments. We are not your broker or your money manager. We are only allowed to publish our research broadly. Individual communications are out of the question.

Now... about the InterOil issue in particular. A little background for subscribers not familiar with recent events... We have been covering a very speculative and risky oil and gas exploration company – InterOil. Our first report on the stock went to our Resource Report subscribers, who were given all of the key facts and access to our full report, based on a trip to the company's new gas well in Papua New Guinea.

We spent a substantial amount of money to send our analyst and the famed Texas wildcat oilman Cactus Schroeder to the drill site, halfway around the world. Both men were extremely impressed with the site. They reviewed the geology (seismic data and drill results) and the engineering. Our analyst, Matt Badiali, recommended the stock, based on the enormous potential of the discovery, which he believes will be one of the largest ever made.

The story, however, is a lot bigger than our report. There are several other big investors on Wall Street who think the stock is a fraud. That's a serious allegation – one we had an obligation to investigate in detail.

In order to learn more about the situation, we invited InterOil to participate in our monthly conference call service, called Off the Record. They agreed. We also invited famed oil and gas investor Rick Rule to join the call, and, perhaps most importantly, we were able to persuade the company's most vocal critic, Barry Minkow, to join us too. (Minkow is a former conman who now makes his living exposing financial frauds. Most of the big investors who are shorting InterOil have relied on his research.)

Our intention in organizing the call was to provide a service to interested investors – in an independent way. What we want to discover is the truth. If we had uncovered anything unusual or new during this call, we would have alerted our Resource Report subscribers that Matt Badiali was changing his rating on the stock.

But that's not what happened.

Our conference call was excellent – probably the best I've ever listened to. I think all of the parties made excellent points. Our experts were all in agreement InterOil has discovered a huge amount of natural gas. They all agreed there's a very high likelihood a large amount of oil will also be discovered and, if that happens, the stock should certainly see its share price increase by a large amount.

Barry Minkow raised several interesting questions about the company's corporate governance – none of which seemed significant to me. On the other hand, he admitted he was impressed with our analysts' due diligence. It was clear to me Minkow is unfamiliar with the junior oil and gas sector and the company's press releases – which he took as being too promotional – are actually standard practice in this industry.

I thought we'd done a great job for investors and everyone would be pleased we organized the call. But instead... a funny thing happened. Lots of our subscribers were mad at us for giving Minkow an opportunity to speak. And lots of folks seemed to believe our coverage of the situation meant the stock would immediately go higher. Folks seem to believe it is our responsibility to "make" the stock go up. Or at least our fault that we didn't do enough "cheerleading" on behalf of the company.

I find all of the criticism absurd. Our job isn't to boost the share price. Our job is to uncover all of the facts and present them to you in a thorough and honest way. And that's what we did. We told you what we discovered. We told you what we think it means and introduced you to various experts who gave you their opinions, too. Rather than hide from the company's critics, we gave them the same opportunity – to show you what they know.

So... what will happen with the stock? No one knows, of course. If InterOil finds a lot of oil in addition to its big gas discovery, I think shares will likely go much higher. If it doesn't, Minkow's criticisms of the company's promotional press releases will probably drive down the stock. That's life.

And those are the risks every investor faces when they buy an oil exploration stock. We can't change the risks by reporting they exist. And if you don't understand that, you're too naïve to be buying these kinds of stocks.

One final point... If you only want to hear the InterOil side of the story... if you're not interested in what independent experts or the company's critics have to say... you can listen to a free conference call being hosted tomorrow by Morgan Stanley. To listen tomorrow at 10:30 a.m., dial 877-415-3180 in the U.S. or 857-244-7372 internationally. The passcode for the call is: 30525805.

We will be listening to what InterOil says on this call. But... we'll be listening with experienced analysts who we've paid to analyze this situation on our behalf. Don't forget: This call is being organized by an investment bank, whose job it is to sell securities on behalf of InterOil.

I'm not saying Morgan Stanley won't do a good job or won't be honest... but its approach is different than ours. It makes millions selling stocks and bonds to investors who may, or may not, make money buying those same securities. That's why Morgan's call is free. Our calls aren't free because we think there's a good business to be made in helping people evaluate these kinds of opportunities objectively. If you want to listen to our call, click here.

Regards,

Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
February 1, 2010

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What OBAMA!'s Budget Doesn't Mention
By Porter Stansberry

Nobody likes bad news.

A few years ago, I got in hot water by insisting General Motors was bankrupt. Supporters of the company (whether investors or unionized employees) got mad at me and said I was exaggerating. They rightly pointed out GM was still servicing its debts and was still owned by its equity holders. Thus, technically at least, GM wasn't bankrupt.

In order to avoid any unnecessary litigiousness, I began to write in parody, pretending to be the chairman of General Motors and warning of the company's impending bankruptcy. One of the few ways you can still speak unpleasant truths in America is by using – or pretending to use – humor. That's why, for example, Chris Rock and Bill Cosby are our most poignant commentators on race relations and why John Stewart is perhaps our most insightful news commentator.

Meanwhile, the bankruptcy of General Motors was far from a laughing matter.

GM had no conceivable way to repay its debts. It was even borrowing money to pay for the interest expense on its existing debts.

Monitoring the company closely between 2006 and 2009 taught me quite a bit about willful self-deception. Here are the three key traits I look for now in companies facing major financial stress...

No. 1. There's never any real tally of the total amount owed. GM used byzantine accounting to hide the truth of its deteriorating fiscal condition for nearly 20 years. It was impossible for any outside analyst to get an accurate, consolidated account of GM's total debt.

No. 2. None of the company's "turnaround" plans include any efforts to actually repay principal amounts owed.

No. 3. The company's spending is out of control. In GM's case, it was also rife with fraud and absurdity – like, for example, its jobs bank where people were paid not to work.

If you don't know how much you owe, if you make no attempt to ever repay your debts, and if your spending is out of control, there's no way to avoid bankruptcy. In retrospect, these facts seem so plain and obvious. But who else was warning about GM? No one.

I bring this up to you today because the exact same things are now true about the United States of America.

We don't know how much we owe. We don't have any plan to repay our debt. And our spending is still completely out of control...

OBAMA! has sent a new budget to Congress. It contains several provisions that will make people unhappy. Taxes are going up on the rich. They're going up on private-equity firms and hedge funds. They're going up on oil and gas companies. And they're going up on multinational companies.

These new taxes are what you'll see people arguing about. They are what the politicians will complain and campaign about. Nobody wants to pay the costs of government, so that's the easy sell. But the taxes aren't the real problem with OBAMA!'s budget...

The real problem is that government spending is literally out of control.

The government is going to reduce its so-called "discretionary" spending by a grand total of $200 billion. Only about $1.4 trillion of the government's $3.8 trillion budget is discretionary. The rest is legally required, thanks to unfunded entitlement programs, like Medicare. So right now, far less than half of the government's annual budget can legally be restrained.

Meanwhile, there's no accurate tally of the government's debt. Supposedly, we owe around $12 trillion. This number is so large that it is meaningless. What does it really mean? According to the IRS, almost 143 million people filed tax returns in 2007 (the most recently reported year).

Of these people, roughly 96 million paid something in taxes – even one penny. Thus, technically, you could say there are basically 100 million taxpayers in the United States. Dividing the total debt ($12 trillion) by the number of taxpayers, you can see our total debt is actually $120,000 per taxpayer. How many people do you know can afford an additional $120,000 in debt?

And the truth is, the $12 trillion figure is only a down payment on our actual debts.

For example, nobody really knows how much more money Fannie and Freddie will require. (My bet is $500 billion each – or $1 trillion.) On Christmas Eve, when no one was looking, Congress approved unlimited funding for the two national mortgage banks.

And that's far from the only "off-budget" item. We have committed to fighting two civil wars – in Iraq and Afghanistan. The costs are likely to be $50 billion or so next year alone. How much over the next 10 years? Maybe $1 trillion? Or maybe more. And there's a new "jobs package" that's estimated to cost $76 billion next year with another $25 billion to bail out cash-strapped state governments.

Even if you only looked at the dollar amounts that have been budgeted today and you ignored all of the rest of the growth of future entitlement spending, you'll discover that we actually owe something around $20 trillion right now.

And if $20 trillion is the real number, then the amount owed by taxpayers is actually $200,000 each. Of course, that's if you're counting all of the taxpayers. Most people, though, pay almost nothing in taxes. Unless you're earning more than $50,000 per year, you're not really contributing to the tax receipts. Roughly 50 million folks are in this category. These people pay less than 10% of all income tax receipts. So you shouldn't count on them to repay much, if any, of these debts – they can't.

What's the real per-capita number? My best estimate – just on the money we actually owe today – is $400,000 per taxpayer. At a reasonable (6%) rate of interest that's $24,000 each – just to pay the interest on these debts each year. How many people do you know that could afford $24,000 a year in higher taxes? How many people can afford additional debts of $400,000?

My point? Our government is bankrupt – right now, today. Sure, it might still have access to the credit markets. And yes, since it owes dollars, it can always simply print more. I realize the government can't go bankrupt they way GM did. Our bondholders won't end up getting title to our national parks and the strategic petroleum reserve. No, that's not going to happen.

What will happen?

I can't say for certain. But here's what I know: It's not a good idea for the world's largest debtor and the world's strongest military power to go broke. Bad things happen in democracies when the government goes broke. At the very least, our creditors will demand much higher interest rates and abandon the use of our currency. That's going to devastate our standard of living.

These facts and figures should cause you to wake up and think about what you're doing with your savings. Here's a hint: Don't save dollars. And don't count on whatever the government has promised to you, whether it is a retirement or medical care. The government is bankrupt. It won't be able to deliver.