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How to Profit from U.S. Inflation

Written By Luke Burgess

Posted October 9, 2009

The FDIC’s Deposit Insurance Fund — the insurance fund that protects your money in the bank — is $300,000,000 in the negative.

A growing number of bank customers are beginning to fear the negative balance means the FDIC is no longer able to provide coverage for their deposits.

But the FDIC says the sum of its insurance fund does not affect its ability to protect depositors. That’s because the agency has access to sufficient capital needed to safeguard client accounts at member banks. But there’s a huge catch. . .

The American taxpayer could face losses that are already planned to total as much as $500 billion — over $1,500 per American citizen. Fortunately, we as investors can turn these losses into profit by hedging our investments in gold and shorting U.S. Treasuries.

Seeking Shelter and Pursuing Profits

The Federal Deposit Insurance Corporation (FDIC) is one of a handful of U.S. government-owned corporations. It was established by the Glass-Steagall Act of 1933 to preserve and promote public confidence in the American financial system by insuring customer deposits in banks.

Today, the FDIC insures deposits at 8,124 U.S. banks and savings associations with $13.1 trillion in assets, which include $9 trillion in customer deposits.

When a bank fails, the FDIC reimburses customer deposits from its Deposit Insurance Fund. This fund is financed by the insurance premiums paid by member banks.

And the end of 2007, the DIF held $52.4 billion. But after 123 bank failures in 21 months. . . the Insurance Fund that Protects your Checking Account is now $300 Million Negative.

. . . And according to the FDIC’s own forecasts, the DIF deficit could reach as much as $100 billion, thanks to a rapid increase in bank failures in the United States.

A total of 98 U.S. banks have failed so far this year — up from 25 in 2008, and only 7 total between 2004 and 2007.
As a result, the daily rate of U.S. bank failures has increased 3,400% since 2007. Click to enlarge the charts below. . .


bank_failure_chart_1_large.png bank_failure_chart_2_large.png

The FDIC believes bank losses could reach $100 billion. But Congress seems to have even less confidence in the banking sector.

In March, Congress approved a bill that allows the FDIC to borrow as much as $500 billion from the U.S. Treasury to cover customer deposits amidst the crumbling finance industry.

But the United States doesn’t have this kind of money just lying around; $500 billion is the GDP of Switzerland. It’s more than 3.4 times higher than what the U.S. spent on the Global War on Terror in 2008. Besides, the United States has run a deficit for most of the last 50 years — creating a jaw-dropping $12 trillion national debt portfolio.

For the 2009 fiscal year, the Congressional Budget Office (CBO) estimates the U.S. deficit will be $1.4 trillion. That’s about 11% of the U.S. GDP — the largest share since World War II. After that, the CBO forecasts the deficit exploding to over $9 trillion in the next 10 years.

But despite the facts that it’s more than twice what they spent on WWI and their budget deficit is projected to increase 545% over the next decade, the U.S. government isn’t worried about where they’ll get the money.

They know exactly where to get $500 billion. . . from you and (worse) me!

But I’ve got a few investments up my sleeve that I’m already using to. . .

Let the U.S. Government’s Plan to Raise $500 Billion Work for Us

To raise $500 billion in the annual budget, the federal government would have to boost taxes across the board by about 20%. But a 20% tax hike is going to be next-to-impossible to pass in an already cash-strapped nation. There’s been talk of a new Value-Added Tax (VAT), which is essentially a national sales tax. But whether or not the government raises taxes or creates a new VAT, it’s unlikely they’ll be able to fish another $500 billion out of the ole’ tax pond.

The U.S. Treasury holds about $134 billion in foreign currency reserves and 287 million ounces of gold, worth $287 billion at $1,000 an ounce. So even if the country sold off all of its foreign currency and gold reserves, it still wouldn’t be able to loan the FDIC $500 billion. Besides, selling off the national currency and/or gold reserves to cover banking losses would be a troubling signal to American investors, to say the least.

The fastest and easiest way for the government to raise the $500 billion to loan the FDIC would be to simply create new money or borrow by selling U.S. Treasury Bonds — or a combination of the two, which I think is much more likely.

And that’s exactly when we start to make money. . .

2 Easy Ways to Make Money as the Government Creates It

Investment Idea #1: Short U.S. Treasuries

The U.S. Treasury Department already sells about $4 trillion in U.S. debt bonds each year to help finance the country. So an increase of $500 billion would boost the supply of new U.S. debt by 12.5%. As a result of this supply increase, Treasury yields will need to increase, driving prices down. And the most direct way to profit from this scenario is, of course, to simply short U.S. Treasuries.

There are lots of ways to short U.S. Treasuries. And it’s a lot easier than you might think. You can short U.S. Treasuries directly, by selling the actual securities short. Or you can short Treasury futures contracts — or sell calls (or buy puts) on Treasury futures contracts.

But the easiest way for most investors to short U.S. Treasuries is with ETFs and mutual funds. At last count, there were about 80 U.S. Treasury ETFs on the market, including products from PowerShares, iShares, Proshares, SPDR Barclays, and Market Vectors.

Investment Idea #2: Buy Gold

The creation of new money means inflation. Whether or not gold is a hedge against inflation has been recently disputed among analysts.

Critics often point to the fact that inflation has outpaced gold’s performance since 1980. Gold prices experienced a 21-year bear market between 1980 and 2001. Average annual gold prices fell 56% from $613 an ounce to $271 an ounce.

Since that time, of course, average annual gold prices have risen. For 2009, gold has averaged $933 an ounce — a 55% increase since 1980. Meanwhile, inflation has increased 162% over the same period.

So, yes, inflation has beaten the performance of gold prices between 1980 and today. But there’s one thing those who are critical of gold as an inflation hedge don’t mention. . .

Gold prices have outperformed U.S. inflation every other year besides 1980 over the past two centuries.

If you compare gold’s price performance to inflation between 1970 and today, you get a completely different picture. Inflation since 1970 has increased 456%. Meanwhile, the price of gold has increased 2,564% — beating inflation by 5.6 times.

So gold prices do not outperform inflation 100% of the time. But in the past 200 years, gains in gold prices beat inflation 99.5% of the time. And that’s a track record that I’m sticking with.


To avoid DIF insolvency in the short-term, the FDIC will require some insured institutions to prepay their estimated quarterly insurance premiums for the fourth quarter of 2009 and for the next three years. The agency estimates that the total prepaid premiums collected will net approximately $45 billion. But that won’t last long. . .

Preliminary estimates suggest that the 50 banks that fail during the third quarter of 2009 will ultimately cost the DIF over $15 billion. If quarterly bank failures continue to cost the DIF at a constant rate, the insurance fund will be completely dried out again in less than nine months.

After the FDIC burns through the $45 billion collected from the prepaid program, they’ll have to go knocking on the doors of the U.S. Treasury. And that’s exactly when their actions will result either in your benefit or burden.

Before the FDIC schedules their next sit-down with the suits in Washington, I urge you to establish exposure to both gold and to short U.S. Treasury positions.

The number of U.S. banks to fail this year will most likely hit 100, as soon as next week. This will probably be a big story in the mainstream financial media. And I expect to see a nice little extra bump in gold prices as a result.

Good Investing,


Luke Burgess
Editor, Gold World
Investment Director, Hard Money Millionaire