Not another Friday Digest...
On Fridays, when I write the Digest personally, I prefer to focus on one topic, so I can flesh it out more fully. You won't be surprised to see that I'm writing about the ongoing sovereign debt crisis – again. In today's Digest, I'll explain why I don't think there's any way out of this crisis without a complete collapse in the U.S. Treasury market. That's an outcome almost no one else expects.
As always, a brief word of warning... Most subscribers complain about the Friday Digest because it's usually longer and more complex than the other e-letters we publish. In fact, Mondays continue to be "refund day" at our offices. Life has taught me many, many times that no good deed goes unpunished.
But I am a complicated and stubborn man. I remain dedicated to giving you the information I'd want if our roles were reversed. That's why I continue to write these things, even though doing so appears to cost me a few million dollars a year in refunds.
Considering the things I've written below, I wouldn't be surprised to see a record number of refunds hit us on Monday. Nor would I be surprised to see the Justice Department knocking on my door. I have a feeling the government can't afford to let me write this stuff much longer. Anyway, here goes nothing...
To understand where we are now, you have to start with a clear understanding of money and credit. Most normal people never have to think about these ideas. But... during a financial crisis... you won't have any idea what's really happening unless you understand a few basics of economics. Please bear with me while we cover a few fundamentals. Understanding these concepts will make it easy for you to see how much trouble we're in right now.
Credit is money that's been borrowed. In a healthy economy (one with sound money, like gold), credit is limited to savings. That only makes sense, doesn't it? How could you borrow something that someone else hasn't already put aside for the purpose of lending?
Of course... saving is hard. Most people would prefer to have the benefits of credit without the effort of saving. And that's what they vote for in democracies. Thus, we have modern economics, which is based on a simple lie: That you can safely expand credit in excess of savings.
But, of course, you cannot create wealth from a printing press. Doing so causes price inflation, asset inflation, a credit collapse – or a mix of all three. Everyone knows this. And yet it seems the entire global political class remains dedicated to pretending otherwise.
When credit is expanded far enough in excess of savings, you get a collapse. It happens every time. It shouldn't surprise anyone. Sooner or later, creditors look around and begin to ask themselves a critical question: Can these debts really be financed? Will I ever get my savings back? If credit has been expanded radically beyond savings (as it has in the U.S.), the answer is invariably no. That's what S&P was warning about two weeks ago. And that means credit will be harder and harder to get in the U.S.
Currently, the total-debt-to-GDP ratio in the U.S. is almost 400%. (Total debt is the combined federal, state, municipal, corporate, and individual debt in the U.S.) Crushing debt loads have already destroyed the real estate market and led to an economic decline. For now, the government has stepped up to replace the private borrowing and spending. As a result, we're now spending close to half our GDP merely on interest and government taxes. This simple fact should give everyone a reason to worry about the future of our country. Spending half your production each year on the government and interest payments doesn't leave much to live on or invest for the future.
In Europe, the problem is a bit different... and slightly more technical. Most of the debt in Europe is held by the big banks, not the sovereigns. Look at just two French banks, for example. Credit Agricole and BNP Paribas have combined deposits of a little more than 1 trillion euro. But they hold assets of 2.5 trillion euro. Those assets equal France's entire GDP.
And those are only two of France's banks. Right now, the tangible capital ratios of these banks have fallen to levels that suggest they are probably bankrupt – like UniCredit in Italy and Deutsche Bank in Germany. BNP's tangible equity ratio is 2.85%. Credit Agricole's tangible equity ratio is 1.41%. (UniCredit's is 4.42%, and Deutchse Bank's is 1.92%).
These banks have long been instruments of state policy in Europe. They've funded all kinds of government projects and favored industries. Making loans is far more popular with politicians than demanding repayment for loans. As a result, these banks are left with nothing in the kitty to repay their depositors. If there's a run on these banks (and there will be), how will they come up with money that's owed? No one's saying. (But I'll tell you in a moment...)
The numbers are similar across most of Europe's biggest banks. And the money that's owed is staggering. The reason the market fears these debts so much is that there's no clear mechanism to increasing the money supply enough to paper them over, as there is in the U.S. As strange as it may seem, investors prefer the U.S. Treasury market precisely because they know there's nothing to stop the Fed from buying as many Treasury bonds as the market wants to sell. On the other hand, in Europe, there's no guarantee whatsoever that the ECB will continue to buy the sovereign bonds – and there are even rules that explicitly forbid the ECB from financing bank bailouts.
What's the end game? How will this huge mess be sorted out? The essential problem is there's too much credit and too little money. So a lot more money is going to be created. Let me explain why I'm so sure this will happen...
Twice in the last week, I've heard someone describe gold as "just another fiat currency." James Altucher said this in our discussion about gold on Yahoo Finance (which followed our previous debate.) And I also heard some clown on CNBC make the same claim. To these folks, gold is in a bubble because it's become so overvalued against the other fiat currencies. It's amazing to me how little knowledge there is on these topics. Gold isn't a fiat currency at all. In fact, it's the only form of money that's not a fiat currency.
I enjoy offshore fishing. I have a relatively modest center-console fishing boat. I like it because it's really fast and I can get across to the Bahamas quickly, which is my favorite place to fish. But to get there in a reasonable amount of time, I need calm water. My wife is always surprised that I can tell the surface conditions of the ocean just by looking at the sky. I know because the ocean is the mirror of the sky. While you might not be able to "see" the waves in the sky, waves are caused by wind. You just can't see the wind.
The same thing is true about the price of gold and the stability of fiat currencies. Gold is the mirror of the world's paper currency system. The price of gold doesn't reflect the intrinsic value of the metal – which is almost unchanging over time. It reflects the relative value and volatility of paper currencies.
The people who are arguing that gold is overvalued are not looking at the right numbers. They ought to be looking at Europe's banks. They ought to be looking at the amount of short-term obligations that are sitting on the U.S. Treasury's books. The price of gold is reflecting the likelihood that the world's sovereign nations decide to bail out Europe's banks and paper over the U.S. Treasury debt. Here's how it will happen...
Two great depositories of the world's bad debt are Europe's banks and the U.S. Treasury. Europe's banks will need trillions of euro (yes, trillions) to regain safe capital ratios. And the U.S. Treasury will need trillions of dollars to refinance its upcoming repayment schedule. Both will be accomplished by the actions of the U.S. Federal Reserve. Step one will be the extension of swap lines to the European Central Bank (ECB) by the Federal Reserve, which will allow the Fed to buy between $2.5 trillion-$5 trillion worth of "riskless" ECB notes. These notes will allow the ECB to bail out Europe's banks, which will in turn begin to buy U.S. Treasurys to repair their capital ratios.
The big unknown in this scenario is whether or not the Germans will approve this massive inflation. I can't know whether they will go along or not. But several of their biggest banks need a bailout, which leads me to believe they will eventually get on board. Whatever the final details, the goal is clear – a massive increase in the size of the Federal Reserve's balance sheet and a correspondingly huge increase in the world's money supply. And that's what you're seeing when you look at the prices of gold and silver.
How will we get from here to there exactly? I can't know. It may be done piecemeal, one quantitative-easing program and bank bailout at a time. Or it might happen with some kind of grand new compromise – a kind of Bretton Woods II solution. But just remember where we must end up... Europe's banks have to be recapitalized. And the U.S. Treasury has to be refinanced. The only way to accomplish this that has any chance of being approved by the democracies in question is via the printing press.
That's why I continue to warn about inflation. That's why I continue to advocate buying gold and silver. That's why I'm bearish on stocks (especially bank stocks). And that's why I think it's prudent for you to take steps to safeguard your property and your family – especially if you live in a big city. The population won't be ignorant of what's happening. The message will be clear: Governments and bankers have the right to steal from the whole world via inflation. That will probably inspire the crowds to do the same.
Step one: Make sure you have at least a year's worth of living expenses set aside in gold and/or silver. Haven't bought any yet? Sorry about that. Insurance gets mighty expensive once you can see the hurricane coming. Buy it anyway.
Step two: Make sure you and your family are relatively safe from the threat of violence. People used to make fun of me for saying this until they saw what happened in London. It will happen here, too.
Step three: Hedge your portfolio by shorting stocks or buying puts on some of the companies I've been identifying as vulnerable for months and months.
Step four: Get liquid. If there's a real bank crisis, you'll want to have plenty of cash on hand. Even though the U.S. dollar is likely to be devalued by 30%-50%, you might still need cash for a few days if the ATM network or the credit card network is turned off, which it might be.
Step five: Try buying into a farm co-op or other independent supply of fresh food. I know, this sounds a little crazy. Likewise, I suggest you stockpile critical medications. It's better to be safe. And prices for critical drugs would soar if there were any disruption to global supplies.
In closing, let me say that I hope none of these terrible things happens. Perhaps the crises of U.S. sovereign debt and Europe's rotten banks will have a better outcome. I simply can't figure out how we can get out of this mess without a huge inflation – but I'm certainly open to other ideas.
Yes, we could do the right thing, which would be to repudiate our debts as unaffordable and restructure our obligations. But I can't recall the last time any democracy took this path – it's far too honest. No politician is going to willingly take the blame.
Nor do I think these problems can be kicked down the road much longer. Confidence in the system is falling apart. Venezuela, for example, exited the modern financial system last week. It sold all of its Treasurys and recalled its gold from vaults in London. Yes, I know, it's only Venezuela. But other nations will follow. Central banks all around the world are buying gold, not dollars. That's a trend that's going to escalate. Quickly. I believe it's only a matter of time before a large Treasury auction completely fails, as our creditors simply become unwilling to lend. And when that happens, then a huge inflation will be our only way out.
New highs (as of 8/18/11): Lehman Bros. 20+ Year ETF (TLT), SPDR Gold Trust (GLD).
In the mailbag... two of the more confusing letters we've gotten in a long time. Enjoy. And send your feedback to us: feedback@stansberryresearch.com.
"I can't say I am very happy with you telling me to get out of gold and to buy stocks. Seems counterproductive and has cost me a lot." – Paid-up subscriber Ron Elliot
Porter comment: I don't recall ever telling anyone to sell gold and buy stocks, not since February 2010, certainly. I've been bearish on stocks, and my constant advice since February 2010 has been to hold 50% gold (via GLD) and 50% short-term Treasurys, unless you were willing and able to hedge your exposure to the stock market via short sells. I'm curious about your note... Where did you read my advice to sell gold and buy stocks?
"In talking about Platinum Group Metals and Implats, Mr. King did not mention that Implats is subject to power outages in South Africa which could substantially limit their Platinum production and hurt the share price." – Paid-up subscriber Larry McDonald
Porter comment: Who is Mr. King?
"I subscribe to both Porter's and Steve's publications and am not sure who to follow. Porter says the bottom is falling out, and Steve says this is looking like the best time to but stocks since the early eighties. Who's right and who do I follow? – Paid-up subscriber Joseph Magoun
Porter comment: The glib answer I normally offer is simple: I'm right. And though I say it jokingly... I mean it.
I've been right about this crisis from May 2006 when I first began warning about the inflation I saw building in our banking system. I was right when I shorted Fannie and Freddie in June 2008, about 90 days before they suddenly went bankrupt. I was right about this crisis when I recommended shorting GM in late 2006 and throughout 2007 and 2008.
Read the February 2007 issue of my newsletter. Read the December 2008 issue of my newsletter. I've been writing and writing and writing about all of these things that have come to pass. I warned about Italy's banks in early 2010 and even told you the name of the one bank that was sure to go under – UniCredit. It's trading for less than one euro today. What more could I do to prove my credibility on these topics?
Whether or not you trust or believe me, just look at the numbers. Look at Europe's banks and explain to me where the money to recapitalize them will come from. They owe far too much to simply be bailed out. They owe multiples of Europe's entire GDP! Likewise, explain to me how the U.S. Treasury is going to refinance $8 trillion-$10 trillion in the next 24 months without help from the U.S. Federal Reserve.
You think the "rich" in America are going to pay the tab? Only 237,000 people in the U.S. reported making more than $1 million in 2009. Only 8,274 reported making more than $10 million. That's down about 40% and 55%, respectively from 2007. Guess what? The rich are either leaving or are sheltering their incomes. They're not going to pay.
You think the middle class is going to agree to a tax hike? Fat chance. They'll riot first. Or maybe you think Congress can pull a rabbit out of its hat before the 2012 election by cutting the budget? No way. It hasn't cut a single penny of actual spending yet – and it won't. What's going to happen should be obvious to anyone with two eyes and a brain behind them.
Now... Sjug could very well turn out to be right. If you hit the turn perfectly... if you're able to get into stocks at exactly the right moment, you could do very well over the next decade. But how will you know when it's safe to buy? Maybe it will be obvious. But if so, I haven't seen those signals yet. I don't think you can go back into stocks in a big way until there's a real solution to the sovereign debt issues in American and Europe. And I think we're a long way from resolution.
Regards,
Porter Stansberry
Baltimore, Maryland
August 19, 2011
Not another Friday Digest... The crisis continues... Real panic in Europe's banks... Venezuela says 'no mas' to Western finance... What's really driving the price of gold... Porter explains gold to Altucher... Why you'd better get ready for riots... Who's right, Porter or Steve?...