Profiting from the $700 Billion Bailout

 |  Includes: ERO, FXB, FXC, FXE, FXS, FXY, SZE, UDN
by: Guy Bennett

It’s difficult to tell whether the levels of irony are odd or even. America, the bastion of market capitalism, is on the verge of nationalizing its banking industry. The $700 billion price tag comes out to about $7,000 per American household.

The Bush Administration attempted to muscle the bailout package through Congress with a panicky threat, reminiscent of the build-up to the Iraq War:

Do this now or something terrible will happen!

Once bitten, twice shy - Congress is taking a few days to mull over its options. Headlines from the business pages trace the outline of the general response:

"Congress Condemns Bail-out,”“FBI Investigates Companies at Heart of Meltdown,” and “US Lawmakers Express Anger,” etc.

Online financial forums (where I go to get a gauge of market sentiment) have been equally negative:

“We will become slaves to foreigners.” “The fat cats who scammed the homebuyers should be put into labor camps.” “Lynching is becoming quite attractive.” Etc.

A Los Angeles Times poll found that 55% of Americans reject the idea of bailing out the banks, even if the collapse of the banks will seriously damage the economy.

Venezuelan President Hugo Chavez couldn’t help putting the boots in. Chavez, who called Bush “the devil’ during his 2006 General Assembly commented dryly:

I nationalize strategic companies and get criticized, but when Bush does it, it’s okay. Bush is turning socialist. How are you now, comrade Bush?

And it’s not just politicians, malcontents and socialists digging in their heels on the bailout package. Hedge fund operator, Eric D. Hovde, who also owns the investment bank Hovde Capital, has come out with guns blazing in an Op-Ed piece in the Washington Post:

Looking for someone to blame for the shambles in U.S. financial markets? In my view, there’s no need to look beyond Wall Street and the halls of power in Washington. The former has created the nightmare by chasing obscene profits [$62 billion in 2006 bonuses] and the latter have allowed it to spread by not practicing the oversight that is the federal government’s responsibility.

For the first time since Pearl Harbor, it appears that almost everybody agrees. Bailing out the banks just feels wrong. The problem – and it is a big one – is that nobody is quite sure what will happen if the U.S. government doesn’t write this check. Or rather, I think they do know what will happen, and don’t want to deal with it.

Doing nothing will probably catalyze a global recession and sink the Dow to 8,000 or lower. Tens of millions of people around the world will lose their jobs and their homes, triggering a surge of inflation that will make the U.S. dollar worthless.

It would take a foolhardy giant to look the American people in the eye and say:

This is going to hurt a lot, but eventually (it could take a decade) you will recover and be better for it.

It's much easier to put them to sleep for a few a more years with a massive injection of cash and wait for the next bubble.

Oh, speaking of “cash”. Guess what? The U.S. government doesn’t have any. So how is it going to pay for the $700 billion bailout? The same way it always does, by printing money. The only thing I can see with absolute certainty is that the “bailout” is going to cause a significant further devaluation of the U.S. dollar. That creates an opportunity, and there are a few ways of playing it.

One is to buy PowerShares DB U.S. Dollar Index Bearish (AMEX:UDN).

click to enlarge

Click to enlarge

UDN is designed to rise as the U.S. dollar falls relative to its performance against the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc. As you can see from the above chart, UDN has outperformed the DJIA by 8% over the last 10 days as this banking crisis has heated up.

Of course, finding a way to short the dollar is not the only way to take advantage of this situation.

A good friend of mine has provided me with another example:

He spent C$1 million on a house in Canada in 2004. At that time, a Canadian dollar was worth $0.77. Last week, he sold the same house for C$1.55 million. A Canadian dollar is now worth $0.94. Therefore, in U.S. dollar terms, he turned $770,000 into $1.46 million in three years.

In the meantime, house prices have decreased 20% in the Los Angeles area. Where do you think he’s going shopping? Hint: the zip code of his real-estate agent is 90210.

These volatile markets are causing sleepless nights for many investors. But history teaches us that even in the midst of the worst storms, t

here are always opportunities. In this case, finding ways to safely diversify away from the U.S. dollar is a good strategy.

Disclosure: None