The smart money is betting on moral hazard. From Reuters:

He highlighted the attractive yields on credit issued by GMAC due in Sept 2011, the former General Motors automotive financing company that the U.S. government propped up at the end of 2008.

By Paulson’s thinking, the government involvement is equivalent to an explicit guarantee on GMAC’s finances.

‘So instead of buying (a) Treasury bond which yields 84 basis points, I can buy GMAC which is almost, I consider equivalent to a government bond and I can get 11 percent. That is why we have allocated so much money to this particular security,’ he said.

John Paulson knows the deal. The government has made a policy of bailing out bondholders, and not forcing them to take losses.

He knows this policy is a long-term disaster (hence the gold bet). But if you can’t change it, why not profit from it? A great example of why it’s dangerous to be short (for now). Back in April I warned bears about this problem in More Bailouts and Inflation Loom.

Paulson: Gold is the best currency

Everybody knows Paulson likes gold. In the same article he he offers some interesting insight as to exactly why he’s so bullish.

Even as credit and equity markets looked attractive, he did reiterate his concerns that over the long-term inflation will be a problem because the government’s mountain of stimulus cash will be difficult, politically, to withdraw from the economy.

‘Therefore we are concerned about high rates of inflation in the future. As an investor I became very concerned about having my assets denominated in U.S. dollars,’ he said.

‘So I looked for another currency in which to denominate my assets in. I feel that gold is the best currency.’

hat tip TraderMark