Dear subscribers... we hope you pay special attention to today's Digest. The world has officially entered what we believe will be the final chapter of the U.S. dollar's reign as the world's reserve currency. The dollars in your wallet now not only back bankrupt U.S. money center banks and subprime home "owners"... they are also officially backing all of the economies of Europe. The world's monetary system has evolved into a new kind of global socialism. We don't think that can be bullish for long.
Here are the facts we've been told so far... The European Central Bank (the ECB) will spend $1 trillion (750 billion euro) bailing out Europe's sovereign borrowers (like Greece, Spain, and Portugal). It will also purchase billions of troubled assets from Europe's largest banks – like UniCredit. The mechanisms for these purchases will likely be convoluted. The EU treaties contain a no-bailout clause, forbidding any member to "be liable for or assume the commitments of" another EU country. And the European Central Bank cannot lend to countries or buy their debt directly. To get around the technicalities, the EU created an off-balance-sheet entity that will "borrow" the money and lend it to countries in trouble. Whether this matters to the EU's creditors or not, we can't say... but we certainly wouldn't lend to an off-balance-sheet entity of a central bank that's not represented by any country. Buying euros used to be a game of "who owes me nothing." Now, it will be a game of "whose off-sheet entity owes me nothing." We doubt that will make Europe more creditworthy in the long term.
What does any of this have to do with the U.S. dollar? More than you'll ever hear anywhere else. On paper, the money is supposed to come from Europe's biggest governments and the IMF. But in reality, most of the money will be borrowed from the U.S. Federal Reserve, which just happened to re-open its trillion-dollar swap account with the ECB this weekend. Ironically, the Federal Reserve says these loans are risk-free because the counterparty is a central bank (or at least the off-balance-sheet entity of a central bank). But if the ECB is truly creditworthy, why couldn't Greece, Spain, Portugal, Italy, or Ireland raise the money for themselves?
At the beginning of the year, we declared rising interest rates in the U.S. as "the single most important trend in finance." We believe interest rates on long-term U.S. government bonds will rise to compensate investors for the increased risk of owning paper-backed sovereign debt. Our logic is simple: The more money the U.S. prints to bail out banks and other sovereign borrowers, the riskier the U.S. balance sheet becomes. By the first half of 2010, the Fed had already spent $2 trillion to bail out Wall Street's banks and the U.S. mortgage market. And as we reminded subscribers just last Friday, because the world's banking system uses the U.S. dollar as its reserve currency, the Fed would eventually be forced to bail out Europe's economy. Indeed, that's exactly what happened over the weekend. The U.S. Federal Reserve has officially become the world's lender of last resort. We would humbly suggest these policies will likely lead to a permanent loss of value for holders of U.S. dollars.
Why are we so concerned? Printing money to bail out borrowers around the world will not solve the problems of overleveraged governments or debt-ridden economies. It simply shifts the risks from private balance sheets to the U.S. government's. The U.S. dollar has assumed all of these risks. Our currency has become a ticking time bomb.
You can watch the dollar die, one day at a time, by keeping your eye on the growing spread between the value of long-term U.S. bonds and the price of gold. Over the last year – even as the U.S. economy apparently improved – the spread widened by about 35%.
And these bailouts come with another ancillary problem: They make it much harder for entrepreneurs around the world to invest across borders. You can't price assets into the future when every government in the world is printing money. When entrepreneurs can't estimate the future value of different currencies, they stop investing. To prove this point, consider the long-term rates businesses pay to borrow money. GE's current cost of capital is an unsustainable 5.77%. The company has more than $200 billion of debt coming due through 2012. And the government is guaranteeing GE's debt until 2012. When the government guarantee expires, how much do you think GE will have to pay to borrow money or roll over its debts? How much would you charge GE to lend it money for 10 years if you couldn't trade out of the debt? These are very important questions. Their answers just got a lot more painful.
On the other hand, volatility and paper money make banking a very lucrative game. Goldman Sachs, for example, made at least $25 million every day last quarter. It made more than $100 million on half of those days. It did not have a single day in the red. It was the first time in the history of the bank.
It is rare for the VIX to trade outside of its Bollinger Bands. When it does, it often leads to a sharp and sudden reversal in the other direction. That was certainly the case in May and August 2008. The VIX rallied 75% and 300%, respectively. Each of those rallies started with the VIX at depressed levels below 20. And each of those VIX rallies coincided with sharp declines in the broad stock market... The Volatility Index closed yesterday at 15.58 – the lowest reading in two years. Investors are complacent, and it's hard to find anyone who believes stocks are vulnerable to a correction. If the VIX has indeed reached a turning point, it should start to move higher almost immediately, and it should rally toward its upper Bollinger Band – which is 18.43. That's a 20% move from yesterday's close, and it gives us a target of about $24 for VXX. – Jeff Clark, S&A Short Report, April 13, 2010
Short Report readers made around 17% in three weeks with Jeff's long volatility trade. The Volatility Index (^VIX) exploded last week with the breakdown in the markets. We think long-term volatility is another strong trend in the coming years.
New highs: AuEx Ventures (XAU.TO), Eldorado Gold (EGO), Inter-Citic Minerals (ICI.TO).
Did anyone get his "stink bids" hit last week during the meltdown? Tell us the story... feedback@stansberryresearch.com.
"I have been trying to buy HOME and EGO at less than the buy-up-to price for a couple of weeks, so I had limit orders entered on them. Imagine my surprise when my buys were triggered. And then EGO hit a new high! I am happy about that." – Paid-up subscriber Merrily Hardy
"What else can you do with a market like the other day than watch as Porter said. I use to gamble on the market and I paid my dues, not any more. Regarding GE, stick to your guns Porter, I know you'll be right eventually. I got my short when I read Porter's report and took my 7% loss and now I'm waiting for the technicals to show me when it's time to get short again. Until I started getting your newsletter I didn't do very well in the market, now I make money, thank you." – Paid-up subscriber Alexander Newman
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
May 10, 2010
U.S. dollar close to implosion... Where Europe's $1 trillion bailout really came from... The most important chart you can watch this year... Jeff nails a massive volatility trade...