I've been thinking about the fate of the U.S. dollar for a long, long time. The U.S. dollar is truly an amazing edifice. You might not have spent much time thinking about how unusual it is, but there's never been a paper currency so widely accepted around the world. And consider this: Thanks to the U.S. dollar's status, the U.S. government is the only one in the world that can pay for all of its debts with a paper currency only it is legally allowed to print. What do you guess the odds are our politicians will so abuse this privilege that they lose it? I think it's a lock – the best, most certain bet in all of global finance.
Officially, our paper standard began in 1971. It's approaching four decades of service. In that time, its purchasing power has fallen by close to 90%. And yet, amazingly, our creditors continue to accept it – primarily because its exchange value doesn't normally fall by more than a few percentage points each year. But... it's getting long in the tooth. And the abuse it has taken lately – $1.75 trillion in "quantitative easing" – can't inspire our creditors with confidence.
What might knock the dollar off of its perch? Well, my guess is the same kind of things that have ruined every other paper currency in history. The big problem with paper money is bankers and politicians inevitably go too far with it. On a commodity standard, like the gold standard, the bankers and politicians have to use a conservative reserve ratio – like say 20% – because creditors expect them to produce bullion on demand. But with paper money, this natural restraint is absent. Without it, government and banks can use whatever amount of leverage they deem prudent.
And they always go too far. Like Fannie Mae, which was leveraged more than 70 to 1. Or Bear Stearns, leveraged 50 to 1. Or the U.S. government itself, which now owes foreign creditors roughly $2 trillion over the next year, continues to run annual deficits in excess of $1.5 trillion, and only has about $500 billion in exchange reserves to cover its funding needs in the event of a credit crisis.
Here's what I'm thinking. The global banking sector still faces big problems. JPMorgan says more than $40 billion of losses are coming from Eastern Europe. Nobody has figured out who is going to pay the $5 billion the Icelandic banks lost to British and Dutch depositors. Several big European banks haven't been marking their portfolios to market since 2008. If they did, they'd be insolvent.
Bad commercial real estate loans will probably result in more than 500 bank closures in the U.S. over the next 18 months. That will require an additional $500 billion in FDIC funding. The FHA will need a similar amount to cover the bad mortgages it has underwritten. And a similar amount will be needed to cover Fannie and Freddie's debts. Meanwhile, the number of foreclosures continues to grow, up another 6% last month.
If you combine these pressures on the U.S. dollar with a few good trade disputes, you might see some real fireworks. A trade war between the U.S. and China, for example. The U.S. Senate seems eager to label China a currency "manipulator." In reply, the Chinese might decide to label us "bankrupt." Foreigners now own roughly 50% of our government's debts. If they come to doubt the stability of the dollar (and they should) and dump our bonds, you will see the largest economic crisis in history.
Is this a real risk? Well, China continues to sell Treasury bonds, dumping about $5 billion worth last month. Paul Krugman – the left-leaning New York Times columnist and Nobel Prize-winning economist – says you have nothing to fear if China dumps our bonds because the falling value of our currency will make Chinese goods more expensive, providing a lift to U.S. manufacturers.
Krugman is insane. According to the same logic, we should all burn our houses to the ground because that will give homebuilders a lift and solve our unemployment problem. It is truly an irony of humanity that we seem unable to learn and remember even the most obvious and basic truth of economics.
Short-selling wiz Jim Chanos reiterated his bearish sentiment toward for-profit educators at a New York investment conference this month... "We're still as bearish as we've ever been," he said. "The value proposition for the taxpayer guaranteeing the student loans to questionable institutions offering a questionable education is ultimately bad policy."
The fundamentals for these companies continue deteriorating, but the stocks have more than doubled in the past two years. Below is a two-year chart for industry giants Career Education (CECO) and ITT Educational Services (ESI).
The bearish argument against these for-profit educators is simple – schools are expensive (tuition can exceed $30,000 a year) and the benefit for graduates is small. They're often left with a large debt load and few job prospects. Plus, the government has become these companies' largest customer. Roughly 80% of Career Education's $1.84 billion in annual revenue comes from federal loans and grants (up from 63% in 2007). The number is 86% for Apollo Group (up from 69% in 2007).
Chanos believes when the government realizes what a bad value proposition these for-profit educators are and withdraws funding... look out below. We're not so sure. We can't remember a single bad idea the government didn't love – especially if it was expensive, had the backing of a lobby, and led to votes. State closures of community colleges are pushing more and more students into for-profit universities and trade schools. Enrollment has increased around 20% a year for the last two years (more than double the pace from 2001-2007).
On the other hand, here's what might cause these companies real trouble: bad loans. The for-profit educators have also ramped up lending to their own students to replace the void left by student-lending giant Sallie Mae. And the loan terms are ridiculous. One loan for nearly $14,000 came with a $7,327 "finance charge" and a 13% interest rate. Career Education and fellow for-profit educator Corinthian recently told investors they set aside half the money allocated for private lending to cover anticipated bad debts.
How can you make money with a 50% default rate? With lots of upfront fees. Besides, these companies have to make the loans because federal requirements say at least 10% of tuition money must come directly from students or private sources. That's pretty crazy, isn't it? Lending money you know you'll never get back, just so you can convince the government to do the same? Only in America... the land of the "free."
Consol Energy, one of the country's largest coal miners, announced it will buy Dominion Resources' natural gas business for $3.48 billion. We've been covering Big Oil's natural gas buying spree in the Digest because we believe it is one of the biggest trends of this decade. Oil is becoming more expensive and more difficult to find, while natural gas is abundant and laughably cheap. Plus, the current administration is undoubtedly going to stymie coal use in lieu of a cleaner natural gas.
We've urged you to read February's PSIA to learn what we think is the safest natural gas stock you can purchase (zero debt and an almost 8% yield). If this latest news from Consol doesn't spur you to buy natural gas, we're giving up on you. However, if one of the country's largest coal producers spending billions of dollars to diversify into natural gas strikes you as an important development in the gas markets, you can click here to sign up for PSIA and get my recommendation.
Also, the March issue of PSIA, published last Friday, describes our new favorite short opportunity – a company in an obsolete industry that spends all of its earnings servicing its huge amount of debt.
CBS's 60 Minutes aired a great interview with Michael Lewis, author of The Big Short, and Dr. Michael Burry, the one-eyed hedge-fund manager we covered previously. While promoting his new book, Lewis discusses the "mass hysteria" that took place on Wall Street leading up to the subprime crisis. And Burry, the first person to buy a credit default swap on mortgages, discusses why he was one of the only "10 or 20 people," according to Lewis, who foresaw the impending doom. You can watch the video, in two parts, here.
Jeff Clark is the only trader we know who can consistently make money trading naked options. And his recent trading streak has been amazing. So far this year, he's closed trades for the following gains: 88%, 93%, 106%, 100%, 73%, 126%, and 69%. Jeff has without a doubt produced the greatest returns for our subscribers in 2010. And if you're not reading the S&A Short Report, you're missing a great opportunity. Just hitting on a couple of Jeff's trades can make your portfolio for the entire year. If you've ever been the least bit interested in options, Jeff is the guy you have to read. And we're currently offering his service at a huge discount. But only until midnight tonight. If you decide Short Report isn't for you, we'll happily refund your subscription fee. To sign up, click here...
We doubt this will matter much to you, dear subscribers... but just for the record, we'd like to update a very old, long-running debate we once had with our good friend Mark T...
Mark is a senior executive at a big, national retail chain. He has been our unofficial advisor in the retail space for many years and served in that capacity officially on our editorial advisory board. Back in 2003, we had a long debate with Mark – some of you might even remember it – on our (now defunct) message board over the value and attractiveness of Tommy Hilfiger shares.
At the time, Hilfiger was a beaten down stock, and we wrote about it as an example of a stock so cheap you could buy it without taking any real risk. It was trading for around $500 million at the time. We believed it was worth at least 100% more and predicted it would be bought out. About two years later, the company sold itself at auction to Apax Partners (a London-based, private-equity firm) for $1.5 billion. Today, Bloomberg reports Phillips-Van Heusen will buy Hilfiger for $3 billion. Assuming you could have held your stake in the firm, you would have earned nearly 500% buying the stock in 2003. That's roughly 70% per year. That's not bad. And it's a great reminder why it's so valuable to buy branded, high-margin businesses when no one else wants them...
New highs: Washington REIT (WRE), Hershey (HSY), Visa (V), McDonald's (MCD), Enterprise Partners (EPD), Markel (MKL), TimberWest Forest Corp (TWF-UN.TO), Longleaf Partners (LLPFX), Sequoia Fund (SEQUX), Altius Minerals (ALS.TO), Sprott Resources (SCP.TO), Akamai (AKAM), Steak 'n Shake (SNS), Carpenter Technology (CRS), MAG Silver (MVG), Westmoreland Coal (WLB).
More praise in today's mailbag... Send your notes here: feedback@stansberryresearch.com. We read every one.
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Porter comment: We hope justice prevails, too... but based on what we've experienced in the courts so far, we're not optimistic.
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Porter comment: Inside Strategist is not only the highest-quality investment newsletter we currently publish, it is also the best value we offer. If you're an active investor, it is the first publication of ours you should read. I know if you try it, you'll make more money trading stocks and never unsubscribe. So for the next week or so, I'm offering you a chance to get it for only $50 per quarter. That's about $4 per recommendation. Nothing we publish is more affordable. To try it, click here.
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
March 15, 2010