How Paper Money Fails

Porter Stansberry, in the S&A Digest

About right now, I imagine 90% of our subscribers and most of the analysts in my building think I’m nuts. Truthfully… I feel a little bit like Chicken Little. I’ve been saying the risk of hyperinflation is a more serious threat to our wealth (and way of life) than a massive deflation. Meanwhile, just about every month it looks more and more like Europe’s banking crisis will cause another round of serious deflation in the world’s asset prices. I’m starting to look pretty foolish…

I thought economic growth would be stronger than expected, not weaker. I thought job growth would be stronger than expected, not weaker. I thought yields on long-term Treasury bonds would move higher, not collapse to less than 3%. And I thought silver and gold would soar, instead of stall out. What do I have to say for myself?

Well, I’d much rather be making money by being “wrong” than losing money while being “right.” And my short portfolio has been racking up stupendous gains. We were up 20% in one day on our short of Barnes & Noble this week, for example.

Now, you might say, “That’s fine, Porter, but I’m no speculator and I got crushed this week.” I know that’s what probably happened to the majority of individual investors, who for some reason will not allow themselves to short stocks. But that’s why in February of this year, on the front page of my newsletter, Stansberry’s Investment Advisory, I told subscribers:

U.S. stocks are woefully overpriced, and runaway inflation will drive stock valuations down. If you’re not willing to hedge your exposure to the stock market with short positions, then you need to go completely to a cash position hedged with gold.

What’s the country song about not wanting to be right? If being wrong is this profitable, then I don’t want to be right. But I will be.

Why do I still believe inflation is the problem that ought to keep you up at night?

It’s very simple: The collapse of the developed world’s sovereign borrowers, the demise of most of the triple-A-rated corporations in America, and the destruction of the U.S. consumer’s balance sheet are all signposts to the end of the world’s current monetary system.

Today, more than 60% of the world’s banking reserves are U.S. dollars. When governments have to bail out their banks (and they will), they’re going to need U.S. dollars to do it. And they’re going to need massive quantities. These dollars won’t come in the form of legitimate credits for the simple reason that the U.S. government is broke and so is the U.S. consumer.

Where will the new money come from? The printing press. Mark my words: Over the next few months, maybe six, maybe 12, the Federal Reserve will open huge new “swap” lines with its European counterpart, the ECB. And the Fed will begin buying massive quantities of questionable European assets. The Fed will bail out Europe. And just like when they bailed out Bear Stearns, the Fed will swear it is only lending against high-quality collateral… But it won’t let anyone else inspect its books.

This is how paper money systems fail. They don’t fail because people hoard dollars. They don’t fail because there’s too much confidence in the paper money. They fail because, inevitably, far too much credit is created under the paper system. There’s no fundamental limit to credit. Sooner or later, people realize the debts can’t be carried, much less repaid. At that point, the system collapses – and not because the money becomes more valuable (i.e. deflation).

It collapses because people suddenly decide any other asset is better to hold than the money the banks keep printing. I can’t tell you when, exactly, that moment will arrive. But I can tell you with 100% certainty it is coming. I know because of the size of the debts that must be monetized. What we’ve seen so far won’t hold a candle to the problems we will face when that moment arrives.

What should you do about it? It’s pretty simple.

Do your best to stay out of debt. You can’t know what’s going to happen to interest rates. You can’t assume you’ll be able to carry a debt load, even though inflation will depreciate the burden of carrying it.

Make sure to keep your savings in gold. Gold will become the new standard of international exchange (again) at some point in the next 10 years.

Buy high-quality stocks – companies with plenty of pricing power (like Hershey’s). They are the best hedges against hyperinflation. But… make sure you buy only when they’re trading at attractive prices. Less than 10 times cash earnings is a good rule of thumb.

And finally… most of all… be patient and prudent. Few people will get rich during this difficult period. Just holding on to what you have will be a triumph.

Porter Stansberry – Porter Stansberry: This is how paper money fails.


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