New highs in stocks...

It's a simple question: do new all-time highs on the Dow Jones Industrial Average indicate that our country is no longer in danger of the End of America scenario I've outlined over the past several years? I'll do my best to answer that question objectively in today's Friday Digest.

Yes, it's difficult to look at your own predictions objectively. Doing so has been especially hard on my pride lately. I gave myself an "F" on our most recent Annual Report Card because of the boneheaded timing of my bank-stock recommendations – which later, of course, soared to new highs. (The latest stress test results, which were announced today, prove my analysis of a year ago was right on the mark.)

For those of you unfamiliar with my End of America hypothesis... the idea is as simple as it was controversial. To summarize, I believe that America's mounting debts (particularly our runaway federal government's debts) will cause our creditors to abandon the U.S. dollar. They will do so not in a deliberate effort to sink our economy, but in an effort to hedge their exposure to the inevitable inflation that must result as America prints trillions of dollars to repay its debts.

In this scenario, the U.S. dollar would lose its standing as the world's reserve currency, causing a cascade of further financial, political, and social problems, including a massive devaluation of the dollar. It is a serious question to ask what the 46 million people who depend on food stamps would do if, suddenly, a crisis left the government unable to feed them.

To many people, such questions seem radical or only meant to inspire fear. That's not why I wrote them. Nor is this scenario what I hope will occur. Instead, as when I wrote about the inevitable bankruptcy of General Motors and the inevitable failure of Fannie Mae and Freddie Mac, I believe I am merely pointing out the obvious. What I hope is that by drawing attention to these very serious financial problems, we can avoid the worst outcomes.

Today, for the first time in human history, the entire global economy relies on a paper currency – the U.S. dollar – which is not linked or backed up by any reserve commodity (such as gold). Around the world, roughly 60% of all bank reserves are U.S. dollars. Our leaders and our bankers greatly admire the dollar's remarkable financial flexibility. Its standing as the world's reserve currency permits America's leaders to do what no other country in the world can do: legally print money to repay debts. As long as this system remains in place, there is no limit – none whatsoever – to America's credit.

When this system was created following World War II, America's reputation was such that no one believed that we would ever become a net debtor to the world. At the time, we were the world's largest creditor (by far). It was greatly in our best interest to maintain a firm and stable value of the dollar, so that our loans would be repaid in sound money.

However... the power to rack up unlimited debts quickly corrupted our political system. In less than 50 years, we went from being the world's largest creditor... to being a net debtor... to being the world's largest debtor... to being the largest debtor in history. With access to this kind of unlimited credit, our Federal government – whose total budget during peacetime had historically been well below 5% of GDP – grew like the magic beanstalk to nearly 25% of GDP.

As a result, today, the U.S. dollar – which remains the foundation of the world's financial system – is little more than an "I.O.U. nothing." The U.S. Treasury has no realistic ability to ever repay the holders of its notes in sound money, not with total current debts that exceed the United States' GDP. And that's not including our government's unfunded liabilities, which exceed the value of every liquid asset of every country in the world.

So... what will happen next? As long as we retain our status as the world's reserve currency, we will continue to have every incentive to go further and further into debt and to finance these massive obligations with our unique printing press. I believe we will continue to exploit this system until it collapses. Remember, the dollar is purely a paper (or a digital) abstraction. It is not tied to any firm or fixed value. There's literally nothing to prevent us from continuing to borrow trillions every year.

This unbelievable power seems like a miracle to our leaders, who undoubtedly believe that by cutting more slices into the pie, they're creating a bigger pizza. I suppose they haven't fully considered the downside to such a system, however. If confidence in the dollar were to fail, what on earth could be used to stop the panic? There are no reserves. There is only more paper. Perhaps that's why the Department of Homeland Security is buying millions of rounds of ammo and thousands of tanks.

Since I began writing about the End of America scenario, there have been plenty of signs that I'm right and that the world is turning away from the dollar. Our two biggest economic rivals, China and Russia, have begun buying enormous amounts of gold and other strategic commodities and assets all around the world. They're using their dollars as quickly as they can to hedge their enormous exposure to the U.S. dollar.

They've also negotiated trade agreements that allow them to exchange goods without using dollars. Dozens of other countries have done the same, reducing the use of dollars around the world.

For the first time since 1971, central banks are again net buyers of gold. This is a run on the dollar. It has already started. Credit-ratings agency Standard & Poor's downgraded U.S. debt in response to these moves and the federal government's continued runaway spending. Many major corporations have begun to use China's capital markets to sell bonds denominated in China's renminbi, rather than sell dollar-denominated bonds in New York. This reflects a growing investor interest in other, safer currencies.

Finally... there have been large (and sometimes violent) public demonstrations protesting any effort to reduce the government's spending or to cut entitlements.

In many ways, I would argue that my End of America warnings were right... and that this process is currently underway. But... in the most important way of all... my prediction has been totally wrong. I believed that as America continued to rack up trillions in new debt, and as it continued to finance these debts by using the Central Bank to buy its notes and bonds (aka quantitative easing), our creditors would flee the U.S. bond market, causing interest rates to soar.

That hasn't happened. Instead, the U.S. Treasury bond market has rallied, almost continuously. Whether that's because the Fed continues to buy all the excess paper or not, I've been wrong about my predictions of a bond-market collapse... at least, so far.

The real test of my hypothesis will come when the Fed stops intervening in the market and when, eventually, it must begin to sell some of the bonds it holds to reduce the inevitable inflation its vast expansion of the money supply will cause. Today, speculators from around the globe have a nearly foolproof way to make money: they merely front-run the Fed's bond-buying operations. The same thing will be true in reverse, too. When the Fed begins to sell the trillions it holds in U.S. Treasury bonds, the world will try to sell first. When that happens, you could see a global run on the dollar.

But if that were likely, would stocks really be trading at new highs? I would argue that the new highs in the stock market are actually part of the problem I'm describing. You see, as the dollar loses value, it causes the nominal price of stocks and the nominal amount of earnings to go up. In short, a weaker dollar is one path to a higher stock market. But it's not the path to prosperity or wealth. It's just a sign of more dollars in the system.

For proof of this, let's look at some data points that describe our economy today versus nearly six years ago, when we were last at these levels on the Dow. By the way, I've deliberately chosen to examine specific, real-world prices as often as possible, because I have no faith in the official government statistics.

What did energy cost six years ago?

This is the one area where America's economy has clearly seen a drastic improvement. The discovery of massive new energy supplies in America is the one thing that could realistically save us from our debt crisis. We're now producing more liquid fuel than Saudi Arabia. That hasn't been true since 1992. As a result, the cost of energy in our economy has fallen significantly.

Back in 2007, a gallon of propane cost $1.54. Today, it's only $0.84, a 45% decline. A barrel of oil cost $98 in 2007. Today, it's trading for $90. But gasoline has gone up. A gallon of gas (wholesale) in 2007 was $2.39. Today, it's $2.85. Why has gas gone up? Mostly because of political restrictions on building new refineries… but also because most of the existing refineries are designed to process sour crude, not the light, sweet crude we're producing domestically. And since the crooks in Washington won't let companies export crude oil, these markets can't be put into better balance.

What did food cost six years ago?

Corn is the most important food crop in America. Back in 2007, government efforts to build a domestic ethanol industry (which led to dozens of bankruptcies) sent corn prices soaring to around $4 a bushel – a price most farmers couldn't believe. (That's what happens when you decide to burn 40% of the domestic crop in an insane effort to make gasoline out of food...) Today, corn sits at $7 a bushel, 75% more expensive than it was six years ago. And we're still stupidly using food as a fuel.

What were wages six years ago?

The federal minimum wage at the beginning of 2007 was $5.15 per hour. Today, it's up 40%, to $7.25 per hour.

How much was real estate?

Real estate – where the previous credit bubble was focused – has seen price declines. The average home in Miami Beach, for example, cost $370,000 in the fall of 2007. Today, that figure is $294,000. On the other hand... rents – which were not directly connected to the big credit bubble – have gone up. A typical two-bedroom, two-bathroom apartment in downtown Atlanta, between Buckhead and Midtown, cost $1,075 per month in 2007. Today, it's $1,350 per month. That's a 25% increase.

How much were domestic-manufactured goods?

One of the best examples of the decline in the purchasing power of the dollar is domestic-manufactured items. The Ford F-150 is the bestselling vehicle in the United States. Ford is an iconic American company... and it didn't take a bailout in 2009, either. The base F-150 model retailed for $18,275 in 2007. Today, it retails for $23,670, a 30% increase.

I'd argue that the real-world data shows pretty clearly that the value of the dollar has fallen by a substantial amount. I'd estimate between 20% and 40% of its purchasing power has been erased. But of course, there are other measures that matter, too.

For example, how has the dollar fared against other currencies? Actually, since 2007, it has strengthened against both the yen and the euro – as those currencies have seen even greater purchasing-power losses. What about gold? Gold has gone from $832 per ounce to around $1,500 per ounce. That represents an enormous decline in the dollar's purchasing power.

As the dollar has fallen, our debts have continued to grow – at a faster and faster pace. Total U.S. federal debt has gone from $9 trillion in the fall of 2007 to more than $16 trillion today. That's an increase from 65% of GDP to more than 103% of GDP.

The total debt in our economy has grown from $55 trillion to more than $58 trillion. Meanwhile, the government continues to take up more and more of the credit in our economy. Likewise, as a percentage of GDP, federal government spending has grown from 19% of GDP to more than 24%. States spend another 15% of GDP on top of this, pushing government in all forms to more than 40% of GDP. Forget about the U.S. becoming France... we're already there.

In summary... don't regard new highs in the stock market as a sign that we're out of the woods when it comes to the serious problems we face because of our runaway government spending. Instead, I think the collapse in the purchasing power of the dollar is making stocks appear to be worth more, because their prices, in nominal terms, have gone up. In reality though, all that's happening is that the dollar is falling in value.

I'd love to hear your thoughts on the matter. Send your comments to me personally here: feedback@stansberryresearch.com.

New 52-week highs (as of 3/7/13): ProShares Ultra Biotech Fund (BIB), Berkshire Hathaway (BRK), WisdomTree Japan Hedged Equity Fund (DXJ), iShares Australia Fund (EWA), iShares Insurance Fund (IAK), SPDR International Health Care Fund (IRY), PowerShares Buyback Achievers Fund (PKW), ProShares Ultra Health Care Fund (RXL), ProShares Ultra S&P 500 Fund (SSO), Anheuser-Busch InBev (BUD), Pepsico (PEP), Johnson & Johnson (JNJ), Automatic Data Processing (ADP), Cisco (CSCO), Ericsson (ERIC), Chicago Bridge & Iron (CBI), American Financial Group (AFG), Alleghany (Y), and Cheniere Energy (LNG).

In today's mailbag... one reader talks wine, and another is confused. Send your notes to feedback@stansberryresearch.com.

"Back in about 1975 I had a half bottle of the best claret (or any other red for that matter) in my life at a local restaurant owned by a wine collector. I remember that it was a Chateau St Emilion (Grand Crus) but cannot remember the year (1968?). It was so exceptional that it inspired me to study up on wine and oinology, and to even try my own had at a WA state claret (pinot noir) with some limited success in the late 1970s.

"A lot has happened to 'domestics' since then and US wines have won international acclaim; some from WA and OR as well as CA. I am much older now and appreciate a good soft red (heartburn) on occasion, but that memory still stays with me." – Paid-up subscriber Joe Granger

"So. Here we are. March of 2013. Two years after the 'End of America' was predicted by you. And with Komrade Obama at the head of our government. Clearly, a terrible President. A disaster for our country. So you say. And what are the conditions of our country, under the leadership of this terrible Kenyan Socialist?

"A booming stock market. Do stock buyers fear that the future of America is collapse and ruin? Then why do they buy stocks??

"Low inflation. Is Bernanke a 'fool' for 'Printing money?' Then why is inflation low?

"High corporate profits. Is Komrade Obama an enemy of Capitalism? An enemy of the corporation? Then why are corporations doing so well?

"Low interest rates. Is our debt 'out of control?' Is the National Debt 'choking us?' Then why are interest rates so low?

"Our US Dollar. Has the world 'lost faith in America.' Will they abandon the US dollar and flee to China? Then why is our US dollar and economy still among the strongest in the world? Why is oil still denominated in dollars and there is not the slightest hint that any oil producing nation would do otherwise?

"Oh please, Mr. Stansberry... can you explain these things to us? Cause your views and reality seem to be diametrically opposed. Which confuses me. And I don't like to be confused." – Paid-up subscriber Mark Kesler

Porter comment: I'd say today's Digest should clarify my position.

Regards,

Porter Stansberry
Miami Beach, Florida
March 8, 2013

Editor's note: Today, we present the second part of Porter's essay about former Major League Baseball player Lenny Dykstra and how his downfall relates to economics... You can read Part I of this essay here.

Keynesian economists and their friends in politics believe the key to the economy is simply giving it a boost any time things slow down: a little more credit... a little more inflation... a little more government spending. In theory, it always works, because adding demand to the economy results in a greater supply of useful things. Too bad that's not what actually happens.

In reality, trying to add aggregate demand to the economy always leads to disaster because people inevitably do something stupid once you give them too much credit or too much money... like making loans to a washed-up ballplayer trying to start a magazine for ex-jocks, or building 40,000 condos in a year in Miami... or making loans to subprime borrowers with no down payment and no income verification. I could go on, but you get the point.

And when you give Congress a bunch of money to dole out, the results are even worse. The money ends up in places like Alaska, simply because the state's senator happens to be in control of appropriations. (How else would you explain NASA's headquarters being built in Huntsville, Alabama?)

In other words, far from being a machine governed by logical, Newtonian physics, a real economy is more like chaos in motion. Guys like Dykstra muck the whole machine up.

The Austrian economists (so-called because their best-known leaders Ludwig von Mises and Nobel Laureate Friedrich Hayek emigrated from Austria after World War I) saw this human problem – the Dykstra Effect, if you will – coming. They didn't believe economics was a hard science at all. People, they noted, aren't machines. And since economies are merely the sum of an endless number of individual human choices, then economies couldn't be machines, either.

The Austrians saw the study of economics as being a question of human action. They realized you can't accurately model economics because you can't accurately predict human actions. People do irrational things all the time – with money and everything else. No one in his right mind should have given Dykstra a job picking stocks, let alone giving him tens of millions of dollars to start a magazine. But it happened.

Therefore, if you decide to create a bunch of money or credit out of thin air and push it into the market, you can't know what people will do with it. Will they build productive factories and new technologies... or will they make loans to condo flippers, subprime mortgage firms, and Lenny Dykstras? You can't know. But the Austrians did understand when bad investments – what they called "malinvestments" – were most likely to happen: when credit was expanded beyond savings.

It's common sense applied to macroeconomics. You tend to be a lot more careful with your hard-earned dollars than with other people's money. When there's more of "other people's money" available in the entire economy, the more likely the Dykstra Effect becomes. That's not because of any careful accounting or algebra. It's human nature.

Therefore, more money and more credit (the Keynesian prescription for a better economy) doesn't work. It may provide a short-term boost – but it will also lead to far more malinvestment and far bigger problems down the road when the bills come due.

And there's another cost, too – one that's very, very difficult to measure...

The more the Austrian economists studied human action, the more they realized that for the full potential of human actions to be realized, people had to be free to enjoy the fruits of their labors. The more taxes, regulations, and inflation (another form of taxation) the Keynesians forced on people to steer the economy, the worse the whole thing ended up working, because people had less and less incentive to work hard or try their best.

Thus, the Austrian economists prescribed a whole different kind of medicine to "fix" an economy. They told the government to get out of the way. Cut the size of government. Reduce the number of laws. Eliminate restrictions to personal liberty. Provide strict property rights. Enforce contracts. Provide a sound (inflation-proof) currency. Don't attempt to steer anything – just get out of the way and allow human action to flourish.

You might think, judging by the results of the 20th century, the debate between these two economic camps is over. Clearly, the Austrians won. Economies where the government simply got out of the way – places like Hong Kong – have become incredibly prosperous, despite a complete lack of natural resources. And places that implemented varying degrees of Keynesian planning have suffered correspondingly poor economic results – even places, like the Soviet Union, that have abundant natural resources.

You could think about the Soviet Union as being at one end of an economic-freedom index and Hong Kong at the other, with the U.S. as somewhere roughly in the center. When you plot out all of the world's economies like this, the matching growth in real per-capita GDP over the last 50 years lines up almost exactly. The smaller the government sector as a percentage of GDP, the wealthier the country becomes, in real terms.

And yet, despite all the obviously correct reasoning and the real-world experience, nobody can seem to get rid of Keynesian economic planners, who continue to call for bigger and more expensive government programs to manage the economy. So when the great credit bubble burst in 2007, what happened? The government decided to mount one of the greatest Keynesian efforts of all time. Now, a dozen different programs are pumping money and credit into the economy – all created out of thin air, either by the Federal Reserve, the U.S. Treasury, or Congress.

Whether the government can spend its way out of a credit collapse is yet to be seen. But we know for certain its efforts will result in inflation, higher taxes, lower productivity, and enormous malinvestments.

– Porter Stansberry with Sean Goldsmith