Source: Karen Roche of The Gold Report (7/3/13)
America is staring down a fiscal catastrophe, says Porter Stansberry, the outspoken investment analyst who has coined the phrase "the end of America." Americans are living beyond their means, he says, and the global economy is tired of holding our debt. Nothing short of economic disaster will befall us. But amid such grim predictions, in this interview with The Gold Report, Stansberry takes a moment to praise the enduring value of timeless investments, such as farmland and. . .Krispy Kreme. Stansberry shares his thoughts on everything from the Federal Reserve to Hong Kong.
The Gold Report: When we spoke in December, you said that the tax base will expand and people shouldn't fear going over the cliff-they should fear not going over the cliff. Clearly, we went over the cliff. Were you surprised at the lack of public reaction to the sequestration and the enthusiasm the market has had since then?
Porter Stansberry: No, I thought the press about the so-called fiscal cliff was nonsense and that the amount of reductions in government spending wouldn't make any difference. I wasn't worried the fiscal cliff would have any material impact on the financial markets. I was worried that the fiscal deficit problems would get worse if we didn't expand the tax base. But at the end of the day, it's a wash because spending will continue to go up and there is no way we can finance it with taxes.
TGR: You've written about what you call "the end of America." This describes a shift of direct exchange treatments, caused by the debasement of the U.S. dollar through quantitative easing (QE), that will result in the dollar no longer being the world's reserve currency. Many other countries, notably Japan, have recently been doing aggressive QE. Has that impacted the effects of QE in the U.S.?
PS: I would rather answer the question this way: Everyone else's sovereign debt is priced off of the 10-year U.S. Treasury yield. Demand for U.S. government paper will, sooner or later, collapse when creditors around the world realize that the U.S. government is bankrupt. When that moment of realization comes, our bond market will collapse.
I wrote a piece for the S&A Digest on May 10 when the junk bond market average yield went below 5%. I said that this is as far as the Federal Reserve can press down interest rates. There is no way you can make money in junk bonds when your average yield is below 5%. I said get the heck out of bonds.
That happened to be the same moment when the market for Japanese Government Bonds (JGBs) also began to collapse. I don't think that's a coincidence. JGBs fell because the Japanese government said it was going to print unlimited amounts of new yen and manipulate its markets overtly.
That is the same thing that has been happening in America for the last four years.
We supposedly live in a free country-but try giving up your passport and leaving. We supposedly have free-market capitalism-but what happens to the entire world's markets when Fed Chairman Ben Bernanke speaks? What he says drives all of the world's stock markets, bond markets and currency markets.
I do not think we have free-market capitalism when one man's opinion determines the outcome of every market in the world.
I believe the most important impact of quantitative easing will be the loss of prestige and power for the world's central banks. I believe, sooner or later, the negative consequences of manipulating prices and debasing our currencies will overwhelm the near-term bubbles they have created.
In Japan, investors are abandoning the sovereign debt market in a wholesale way. I believe that is what triggered the run we have seen out of U.S. Treasuries, too. Investors suddenly realized that these markets can still crash. . .and if the currency falls far enough, the central bank cannot act. I believe both market moves were inevitable and were caused by the previous bubbles in those markets that were engineered by the central banks.
TGR: Bernanke signaled that there could be a potential scaling back on QE and that the market is going down based on that. Does that mean the Fed's decisions have been buoying the market?
PS: The recent activity in the markets is the natural reaction to a manipulated market. All of the previous central bank buying means that market participants do not know what the actual value of the bonds really is. We do not want to find out the hard way.
Also, who is going to buy when the Fed starts selling? It has $3 trillion ($3T) worth of assets. As people around the world begin to flee from sovereign debt, there is going to be a bear market in U.S Treasury bonds. We have not seen a crisis where people flee out of Treasury bonds in a very long time, but we are at that point because the Fed's printing of dollars to manipulate the Treasury rate destroys the credibility of the entire paper sovereign system.
TGR: Where will that money go?
PS: It can go into 30-day Treasury bills (T-bills), which is a great place to hide. It can go into real estate, timber, euros. It can go into Chinese yuan or Hong Kong dollars. The latter is an interesting trade because Hong Kong dollars are pegged to the U.S. dollar. You could have short-term Hong Kong dollars that would give you an upside as people flee into the dollar, and you have the option of turning it into Chinese yuan someday. If the dollar collapses, there is no doubt the Hong Kong monetary authority would stop following the dollar and start following the yuan.
TGR: How bad does it have to get before the Hong Kong dollar converts to the yuan?
PS: Hong Kong works on the basis of a currency board. For every Hong Kong dollar in circulation, there has to be a matching dollar in the Treasury. It's not mismanaged. It doesn't have to break the tie to the dollar-it can keep it as long as it wants.
"I do not think we have free-market capitalism when Ben Bernanke's opinion determines the outcome of every market in the world."
In the short term, the U.S. dollar is going to be very strong because people are going to move out of bonds and into T-bills. Investors are thinking: I do not want to hold Japanese government bonds anymore, and I do not want to hold Japanese government debt. I don't want to hold U.S. government bonds, and I don't want to hold euro bonds. What do I hold instead? The most liquid thing in the world: a U.S. Treasury bill.
But it could be a crisis if the Treasury crash turns into a real panic and you see the 10-year yield quickly go to 4.5%, 5%, 6% or 7%. If that happens, the Fed is going to open the floodgates. Screw the long-term consequences. It's going to manipulate the rate back down. At that point, the dollar would crater. Buying Hong Kong bills instead of Treasury bills is an interesting way to hedge against the risk of the Fed being more active rather than less active.
If the Fed sacrifices the U.S. dollar completely, we are going to have a 30% devaluation overnight, and the Hong Kong authorities will finally break the tie to the dollar. The Hong Kong dollar will have a new basket of currencies to base our currency on, or it will go to the yuan.
TGR: It has come out that Bernanke is leaving. How do you think the announcement of the new chair will affect Fed policies?
PS: It doesn't make any difference who is in the Fed chair because Fed policy is driven by the realities of the U.S. debt crisis. With the U.S. economy $60T in debt, the Fed cannot impose a significant real rate of interest on the U.S. obligations or insist on a hard dollar. We just can't afford it.
TGR: What advice do you have for the new Fed chair? Don't take the job?
PS: Nobody would want to follow my advice. The Fed is emblematic of a dramatic change in American society. We are so addicted to living beyond our means that when we hear someone say we shouldn't be borrowing so much money, it sounds like gibberish.
If you look at the promises the federal government has made with Social Security, Medicare, Medicaid-the current value of those promises is $124T. It is unreasonable to make these promises. It's insane. If you took the collective value of every privately owned asset in the country, it comes to $99T. The government has not only promised more money than it's ever going to have, it has promised more money than we all collectively have. Or consider this nonsense: Americans hold $1T in student loans! Are you kidding me? Does it make sense to anybody to spend $75,000 to become a dental hygienist? It has become the Fed's job to make this huge lie-the idea that we can borrow and spend our way to prosperity-the truth.
If I were Fed chairman, I would go in my first day and say we're going to have a real rate of interest that's equal to at least 3%. And we're going to do that because we want to reward people for saving. We want to have a hard currency, and everything else in the economy is going to revolve around that. That is how you reward productivity, saving and capital investment-the things that actually create wealth.
TGR: Which concerns you more-the fact that the U.S. is quickly losing its status as the world's reserve currency or this unfunded liability?
PS: Losing our status as the world's reserve currency is the greatest threat to our economy. It is one thing to decide for ourselves that we are not going to live a lie anymore and we are not going to live beyond our means. We could curtail our spending slowly and make sensible changes to the tax system, broadening the base, flattening the rates and getting rid of complexity. Most importantly, we could reform our entitlement programs and, in 20 or 30 years, we could end up with a healthy currency and a solvent government again.
On the other hand, if we continue down the path we are on now, the sheriff is going to show up at our house. He will say, sorry, but your creditors do not trust you anymore and they are foreclosing. At that point, they will just start taking collateral back-exchanging the trillions of dollars outstanding into hard assets in a rush. Just look at what is happening in Japan and then realize that almost 95% of their government obligations are held domestically. If creditors lose faith in the U.S. in the same way, the result will be much worse because foreign investors hold so much of our debt.
TGR: What does that mean for the average citizen?
PS: If the dollar loses its standing as the world's reserve currency, the value of the average citizen's savings and wages will disappear. Power bills and gas bills will go up. Doctor bills will go up, as will airline tickets, college, education, private school for kids. Yes, that has already happened quite a bit since the early 1970s, and it is going to get a lot worse. When you look around and wonder why things are not working the way they should, it is because the price system is so heavily manipulated.
TGR: Last November you were buying a lot of real estate. Are you still buying?
PS: I still am buying real estate. I'm closing on another big farm in about 10 days. I don't want to buy stocks. They're too expensive. I definitely don't want to buy bonds. They're an absolute wealth trap. I don't want to invest any more in my own business because I'm worried about the effects of this economic uncertainty. So what do I do? I hide the money in real estate. I buy an agricultural property. If agricultural prices go up, and I believe they must, eventually, as the dollar falls, the farm becomes more profitable. Wealthy people have sheltered their assets against inflation in farmland and timberland for all of recorded history.
TGR: But don't the underlying assets lose value if the dollars back out of the Treasury?
PS: No, they don't. I've been recommending that people buy farmland for four or five years. As the 10-year yield has gone down, the yield on farm properties has also gone down. The price of farm properties has skyrocketed. In many places, you will see these prices correct-a lot-because there will be yield contraction on farmland. But, on the other hand, where you have bought property at a good price, you will not get hurt because eventually inflation will generate additional revenue for you from the farm.
What you do not want in this environment is a fixed coupon. You don't want to buy something like a Treasury bond, which is denominated in dollars, and the coupon is paid in dollars. You are going to lose to inflation and you are going to lose as yields go higher and the value of your bond goes down. Income from a farm, on the other hand, is tied to the price of a commodity, so at least you are protected from inflation. For me it is still the least bad option.
TGR: And all the commodity prices will go up in this situation?
PS: If I am right about a run on the dollar, absolutely. The timing of the next commodity rally is, of course, uncertain. But it is also inevitable. In any case, I would much rather have a farm than a Treasury bond. I know a farm can feed me and my family.
TGR: Last December you were excited about the idea of exporting natural gas. Ernest Moniz, the new federal energy secretary, recently promised that liquefied natural gas (LNG) court decisions will be made this year. Do you think that he will come through, and if so, what will be the impact of those decisions?
PS: I don't know the guy, so I can't speculate on whether or not he will live up to his promise. But they have granted one more license-to a privately held company that is exporting LNG out of the Sabine Pass, near where Cheniere Energy Inc. (LNG:NYSE) is doing the same.
I'm certain that LNG exports from America are going to soar. We are the Saudi Arabia of natural gas. We have more natural gas production, more natural gas storage, more natural gas pipelines than anybody else in the world. We are going to turn that into a dynamic and fantastic competitive advantage for our country. All we have to do is get the scumbag politicians out of the way. And, fortunately, they can be bought.
TGR: Until that happens, is LNG a viable investment strategy?
PS: I am more bullish on natural gas today than I have ever been in my life. I think you're going to see a huge bull move in these stocks as their earnings ratchet higher and the market suddenly realizes that natural gas is at $3.50 per thousand cubic feet ($3.50/Mcf) rather than $2/Mcf. I am talking about producers in the natural gas space-Devon Energy Corp. (DVN:NYSE), Chesapeake Energy Corp. (CHK:NYSE) and others like them.
TGR: I'm going to read the first sentence from an article you published in the S&A Digest: "What if there was a secret way of looking at the stock market and individual companies that allowed you to see the real value of everything regardless of the price?" What you go on to describe sounds like value investing. Is it?
PS: The question of whether you call yourself a value investor or a growth investor is less important than whether or not you look at a business' likely earnings capacity and buy it based on a conservative estimation of that number. My experience with individual investors is that they know absolutely nothing about accounting or finance. They have no capacity to be buying individual stocks, and yet they still do. I'm challenging my readers to learn these simple tools so they can better understand our newsletters and be better investors.
"Gold is the only universally accepted financial asset that is no one else's corresponding liability."
On our radio site, Stansberry Radio, we have a videoup in which I just go through the numbers. I don't tell you what the companies are, but looking at the numbers I can tell you what kind of businesses they are in terms of quality, growth and valuation. It really becomes clear when I tell you what the companies are: the Hershey Company (HSY:NYSE), a super high-quality business, and U.S. Steel (X:NYSE), a super low-quality business.
TGR: Does it make a difference what state the market is in when you are looking at a business' core values? If you find a company that has real underlying value, do you buy it and hold it?
PS: Here's an example. I really want to buy Krispy Kreme Doughnuts (KKD:NYSE) for my own account. It's a legendary brand that has all the attributes of a capital-efficient business. People love their doughnuts.
They're a fantastic little treat. If anyone is ever feeling down or sick, bring them a box of Krispy Kreme doughnuts; it's way better than giving flowers. I can understand this business, and I know it will always be profitable. Last year, it had gross profits of $78 million ($78M). It distributed $20M of that to its shareholders. That's a pretty good rate of capital efficiency. It bought back $20 billion in stock on $78M and net sales. It is expanding all over the world, and I have no doubt it is going to continue to grow.
About a decade ago, Krispy Kreme almost went bankrupt because of accounting fraud-the management stuffed the sales channel and badly botched a massive expansion. But it is a great brand, so it survived. In the last year the stock has gone from $7 or $8/share to $16 or $17/share, and quite frankly, I missed the turnaround. I wanted to buy the stock, but I didn't want to get involved until the management was replaced. But I lost track of the story. I'm hoping that the turmoil in the bond markets will drive securities prices down and that this stock, which is now trading at 50 times earnings, will come down to a level where I'm comfortable buying it.
Turmoil and fear always provide opportunities to buy great assets. Will my grandkids eat Krispy Kreme doughnuts? I think so. Will a 100-acre farm be here in 100 years? I'm pretty sure it will be. So, you have got to remember to use this crisis to pick up great assets on the cheap.
TGR: It sounds as if you should do your homework now and buy selectively on dips and pullbacks. You don't want to be caught flat-footed.
PS: I try to, but it is hard to get organized enough to really take advantage. I have been waiting for five or six years to buy Krispy Kreme and I botched it, just because I was not watching the turnaround closely enough. Warren Buffett has this idea to have a 20-hole dance card for investing. In your lifetime, you would only be allowed to buy 20 stocks. Pick 20 great companies and follow those 20 stocks your whole life. Buy them when they are really cheap. I bet if you actually did that, you would be very successful. Look at Buffett and Geico, for example. He had been buying that single stock for decades before he finally took it private.
TGR: You've encouraged people to hold a large allocation of gold, some of it as a hedge against the dollar collapsing. Have people missed that window of hedging?
PS: No. We have consistently recommended that people buy physical gold. Gold is the only universally accepted financial asset that is no one else's corresponding liability. That is gold's only purpose. It doesn't have value as an industrial metal. You don't buy gold because of supply and demand. You buy it as a hedge against the failure of financial institutions, whether it's the dollar failing or JPMorgan or your credit union down the street failing.
TGR: What should be the allocation of gold in a good-sized portfolio?
PS: Assuming that price is irrelevant, I would like to see a cash and gold component of around 30%. I would have 30-day Treasury bills and gold bullion.
TGR: Where does real estate fit into that?
PS: In a balanced portfolio, something like 10%. I don't normally associate real estate with my investment portfolio. When I think of an investment portfolio, I think of things that are liquid that you trade, and I don't usually put real estate in that category.
TGR: What else are you looking forward to in investment ideas?
PS: Let me just say that today it seems as if everything is going great, the economy is getting better and everything is wonderful. But I think we're at the most dangerous point in the last 50 or 100 years in our country. We have tons of unsustainable policies, and we are racing toward a cliff. Not a stupid, phony, press-driven fiscal cliff but a real cliff. This cliff involves people around the world no longer being interested in holding our debt. People don't realize that there is no material difference between what has gone on in Greece and Spain and what's happening now in Japan and what is happening with us. We're just the largest kid on the block, but we're not in any better shape.
TGR: In fact, we have more to lose in one sense because we are the reserve currency. If that goes away, we miss a leveraged advantage.
PS: China is angling to become our competitor as the world's reserve currency. It is buying up as much gold as it possibly can to have a firm foundation for its currency. Over the next several years that will come to fruition. In fact, here's a stunner for you: Within the next 12 to 24 months, I think the yuan will open on the capital account, which means free trading around the world. I don't think anybody expects that.
TGR: Will that be the first domino in the U.S. dollar's retreat from reserve currency? Does this need to happen for the U.S. dollar to be removed as the reserve currency?
PS: Before the euro, the U.S. dollar made up about 80% of all bank reserves around the world. That fell to 62% with the advent of the euro. I think the yuan will take us to below 50%. In that case, we will no longer have claim to the world reserve currency. This is happening in lots of ways already: China has set up bilateral trade agreements with a dozen of the largest Organisation for Economic Co-operation and Development (OECD) countries. It has the banks in those countries set up to do capital account yuan trading, and the banks have bought lots of yuan so they can hold the inventory and make the trades. That's gone on with Australia, France, Britain, Russia, Japan and all the Latin American countries. They are positioned to go ahead and push the button and make that policy change at any time.
That would be an enormous change and would allow banks from all over the world to sell their dollars and buy yuan. That would be very bad for our country because it would push up interest rates on all of our bonds and weaken the value of our currency tremendously.
TGR: I assume that means the price of goods goes up for the average consumer.
PS: Yes, especially imported goods. But one positive would be that our current account and trade deficits would regain some balance because we wouldn't be able to afford to buy so much from overseas.
It would make a dramatic difference in our standard of living. In the most important way, it would greatly increase the cost to borrow. That's a big problem for our economy because as you know, just about everything in our life is based on debt.
TGR: Your insights, once again, are always intriguing and insightful. I really appreciate it.
Porter Stansberry founded Stansberry & Associates Investment Research, a private publishing company based in Baltimore, Maryland, in 1999. His monthly newsletter, Stansberry's Investment Advisory, deals with safe-value investments poised to give subscribers years of exceptional returns. Stansberry oversees a staff of investment analysts whose expertise ranges from value investing to insider trading to short selling. Together, Stansberry and his research team do exhaustive amounts of real-world independent research. They've visited more than 200 companies in order to find the best low-risk investments. Prior to launching Stansberry & Associates Research, Stansberry was the first American editor of the Fleet Street Letter, the oldest English-language financial newsletter.
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