Beating an idea into submission...

Beating an idea into submission... A major link between Europe and the U.S... How I know Italy will default... Why gambling will be THE growth industry of the next decade... Opportunity in Miami... Another 'gimme more' liberal in the mailbag... Life's big lesson...

At the risk of beating our poor, long-suffering subscribers into intellectual submission, I want to hammer home one particular point this week. (As you hopefully realize by now, I'm writing all the Digests personally this week.)

What's the message? We are in the midst of a global, financial collapse. Let me be clear about what I mean. The underlying basis of the world's economy – the U.S. paper-dollar reserve system – is breaking down. It's collapsing, just as all other previous paper systems have… and for the same reasons…

Paper money allowed excessive debts to be created. Eventually, these debts could not be serviced – as we saw in the collapse of Fannie and Freddie, AIG, GM, and now, major European sovereign borrowers. Upon facing a collapse, the world's political leaders have opted to "print" money rather than restructure the debts. They are willing to sacrifice the value of the world's reserve currency in exchange for what they believe will be financial stability.

The stability, though, is a mirage. The ongoing inflation will cause new and unexpected problems, leading to more and more intervention, and still more inflation. We are in the earliest stages of this crisis, which could take a decade or more to play out.

Until the world's economy returns to a sound currency (which I believe will be centered on gold), the challenge for investors is to survive. The current environment will make it difficult for most people to simply retain their existing standard of living.

The ongoing inflation is massive, global, pervasive, and nearly impossible to forecast. For example, the Fed has announced it will stop its current money-printing campaign on June 30. But declines in mortgage-security prices, weakness in the U.S. economy, and more trouble in European sovereign debts suggest the Fed may soon have to launch another round of quantitative easing. It's impossible to judge when the Fed will return to the market, but it will have a profound impact on assets prices in every market around the world. How can we, as investors, manage this politically driven volatility?

The U.S. dollar has served as the basis of the world's economy since 1971, when Nixon took the U.S. off the gold standard permanently. The U.S. was so confident in its position at the center of the world's economy, it even allowed its citizens to begin buying gold bullion on January 1, 1975. Gold, the feds implied, was no longer money – nor would it ever be money again.

Paper money is a vast improvement over gold – in theory. It allows for full capitalization of long-term and illiquid assets. It permits unlimited financial support for the world's banking system, which in turn reduces the amount of capital banks must hold in reserve. Most people don't realize the impact this has on the banks.

During the real gold standard of the late 1880s, banks on average held more than 30% of their assets in reserve. By 1971, with the advent of a global paper standard, U.S. banks held less than 10% of assets in reserve. As a result, banking became much more profitable. The risks were passed along to the taxpayers and the holders of the currency.

Putting the paper dollar in the center of the world's economy also allowed other risky experiments with money and credit – for example, the euro. Take Italy, for example…

It should be obvious to anyone who has visited the two nations that Italy cannot compete with Germany on a currency-parity basis. Manufactured products drive both economies. And yet Italy hasn't had a current account surplus since the euro was introduced in 1998. Since that time, its current account deficit has grown larger every year. In other words, for the past 13 years, Italy has run larger and larger trade deficits and borrowed increasingly more capital from abroad than it has invested.

And since that time, Italy's economy has barely grown at all, with a 10-year GDP growth rate of less than 1.25%. Rather than restructuring its economy to compete more effectively with Germany, it has borrowed more money every year, almost all of it held at the federal level. Obviously, this isn't a winning strategy, and it's not sustainable. Sooner or later, it will lead to a massive collapse. Credit-rating agency Standard & Poor's explains the dynamic this way…

It's only a matter of time before Italy defaults. Every rational economist in the world knows this already. And yet... what's being done about it? Nothing. Banks continue to extend credit and pretend something will change. This kind of willful risk-taking is only possible in a paper-money world. Everyone knows that… sooner or later… the Fed will bail Europe out.

Why? Here's one good reason. According to a report published yesterday by the credit-rating agency Fitch, 10 of the largest U.S. prime-rate money-market funds hold half of their assets in U.S. dollar-denominated bonds issued by European banks. Italy is the world's seventh-largest sovereign debtor.

What should you do about these risks, which are sitting out in plain sight? You've got two choices…

You could choose to speculate. You can trade, long and short. You can attempt to profit from the various ups and downs of this paper-money economy as it spirals ever closer to its inevitable failure. Today, for example, you'd want to short China and Australia, as their massive credit boom comes to an end.

You might want to buy distressed European debt issues, as you can count on an eventual Fed bailout. You might short low-quality commodity stocks, as the second half of this year is likely to see a slowing global economy as both China and the U.S. Federal Reserve pull back from the markets.

But all these ideas are risky. Conditions will certainly change, and they may change quickly. If you're nimble, you could do well. But if you're not prepared when the trend turns, you could get crushed.

This environment is horrible for genuine investors and savers. Safety requires a large allocation to gold, as it is the one asset sure to remain in a bull market for the duration of this period. That's why we insist you keep your eye on the "only chart that matters." It's a constant reminder of what's actually happening in the world... as currencies are debased, time and time again, in an insane attempt to cover up economic reality.

What else might do well during this period of intense currency instability? Gambling. Yes, that's right. As people around the world come to distrust currencies and their financial institutions, they will turn to gambling. Its booms have always coincided with severe currency collapses. And I believe we're seeing that right now, on a global basis.

Most interesting to me is the potential for gambling to come to Miami. I have written about this idea several times over the years, and I've invested millions of my own dollars in the expectation that Miami would eventually become one of the world's greatest gambling destinations.

It's starting to happen. The world's largest casino company, Genting Berhad, is spending $236 million for a 14-acre site on the water in Miami. The company plans to invest $3 billion in a casino-resort on the site. Says Genting Berhad CEO KT Lim: "I believe Miami is destined to become one of the greatest global cities in the world. With planes now able to fly nonstop from Singapore and Hong Kong, Miami will soon connect Asia with the Americans."

More about the opportunities available in a world gone mad tomorrow...

New 52-week highs (as of 6/21/11): Forest Laboratories (FRX) and McDonald's (MCD).

In the mailbag... cheers from our subscribers. Plus, yet another "gimme more," liberal, big-government, bloodsucker writes in. Rather than reply to this guy, I'm just going let you take him on. Send your replies here: feedback@stansberryresearch.com.

"Your response to the subscriber suggesting that you are saddling the poor with more taxes was great. I don't know overall numbers, but I ran a volunteer tax office this last season and out of just over 2,000 returns, found that the average family did not pay taxes, they got money back, though. One taxpayer of personal note made over $30k and paid about $3500 in taxes... tax return amount... $8,000. That $8,000 did not include any homebuyer credit, education credit, or anything that related to the government trying to encourage productive behavior through financial carrots...

"Aside from politics and taxes, I am not in complete agreement with all that you say, but you sure do know what you're talking about, and given a few more years experience I might find myself agreeing more and more often." – Paid-up subscriber Zion Hallenbeck-Charleston, SC

"Porter – I enjoy reading your analyses and newsletters every day. Other subscribers like Bill Burdette are also enjoyable to read. Enjoyable and comical. Given the crisis our Great Country and the world is in, these snippets of laughter are needed. It is quite obvious that while people might have the great instinct to want to learn and look at things through a different prism, the harsh reality is that the majority of folks have become hypnotized or even brainwashed by the talking heads and BS they hear in the mainstream sp(n)ews media.

"Unlike myself, Mr. Burdette actually 'sounds' intelligent with his words, but his ideas are ludicrous and evidence that he is listening to your analysis, but is not 'hearing' it... that could be said for at least 50% of the population because they keep voting for the same 'solutions' I apologize for getting political, but as I stated earlier, we all need a little comedy relief. Thanks again for your great work." – Paid-up subscriber Lenny

"I find all your pieces well researched and thought out presenting facts from all sides to come to logical decisions regarding investing. Your comment about the 50% paying taxes and a flat rate is spot on. People who have 'skin in the game' tend to make more informative decisions about what they need and want in life. Everyone should pay taxes of some sort so they understand that nothing in this life is free, especially not from the Federal Government.

"I have been on both sides of the coin in the 90s paying much more than I am making now in taxes, so I see the big picture. As a final comment there is an old adage that 80% of the work is done by 20% of the people, 80% of sales come from 20% of your customers and so on the 80 20 rule. My wife says the problem today is the country is run by the 80%, and most have no skin in the game." – Paid-up subscriber Jim Motley

Porter comment: Your wife sounds like a very wise person.

"How about the income earners over $130,000 not paying their fair share. They don't contribute anything to SS over the $130,000 threshold. Handled the same way as the Fed does with treasuries? What about wall streeter's paying capital gains on what should be income? The parks used to be free as well parking to take a hike. Moving violations, parking fees, fishing licenses, could go on and on regarding fees that have all been regressive. It takes me a week of earnings to pay a speeding ticket while you work less than five minutes to pay the fine. Many other fees have been loaded onto the middle class.

"I'm starting to believe you are from the class without class. Rich, nepotism, cronyism and entitlement. If we were all like you, who would clean the streets, feed the children or house the homeless. I'd really like to see how well you would have done with your career if you were born in Somalia. All Americans contribute to your success. To have the whole you have to support the parts. You won't allow this feedback to be published... because your rich and it doesn't serve your interest. See how this rich thing is perpetuated?" – Paid-up subscriber Kris

Porter comment: No, I'm not going to reply because it would be a total waste of time. If one of my subscribers has the patience to try and teach you anything about the government's budget (like the difference between Social Security contributions and taxes) or basic economics, I'm happy to give him the opportunity. I wish you the best, Kris. You have a painful lesson to learn: No one owes you anything. The good news is, once you really absorb what that means, you'll enjoy life a lot more.

Regards,

Porter Stansberry

Baltimore, Maryland

June 22, 2011