Financial Sense Newshour

The BIG Picture Transcription

October 8, 2005

RealPlayer WinAmp Windows Media MP3

• The Perfect Energy Storm
• The Tipping Point On Inflation
• Climbing the Mountain: Why You Don't Want to Own Long-Term Bonds
• Emails

The Perfect Energy Storm

President Bush: “The storms that hit here in the Gulf also touched every American with higher prices at the gas pump. They highlighted a problem I've been talking about since I've come to Washington. We need more refining capacity. It ought to be clear to everybody that this country needs to build more refining capacity, to be able to deal with the issues of tight supply. We haven’t built a new refinery since the 1970s. And so I look forward to working with Congress to pass reasonable law that allow current refiners to expand and to encourage the construction of new refineries.”

JOHN: Well, Jim, It's obvious that as we go into the Winter, energy is going to become more and more and more of an issue. The Washington Times ran a report on Friday saying that home heating costs were probably going to double, and looking at energy markets this week, it looks like we may have been getting a bit of relief, however. Oil and natural gas prices have sold off, and I know, despite all of that, you have expressed some caution about the energy sector over the last few weeks.

JIM: Well, energy markets have sold off, and to some that is a sigh of relief. Certainly, we all want to see lower gas prices at the pump. However, I believe we are now in that calm period before the major storm emerges. What you've seen this week is merely hot money, John. These are the momentum traders, the Danny Day-traders exiting the market. I was a bit cautious after Katrina, when the hot money crowd moved in. This was the money that was looking for $75-100 oil, and when that didn’t happen the hot money crowd began to exit the markets, and we certainly saw that this week, at least Monday through Thursday, a big sell-off in the energy sector. And I think That's what a lot of these guys were doing, is saying, �look, we didn’t get higher energy prices we thought we were going to see.� Because remember, right after Katrina, we moved right up to $70 oil, and people were talking about $75-100 oil, if it got really bad, and then of course we got the second hurricane, Rita. That didn’t happen. Instead, a lot of oil traders took their profits, the price of oil came down, and so that is what is happening now. The momentum crowd, the day-traders have exited the market, this is healthy, providing at least to astute investors � in my opinion � another entry point to get in.

The storm isn’t over, John, as you pointed out. We still have Winter ahead of us. Already, I think it was in Montana, this week. they have snow storms � they came a bit earlier � and as we had Evelyn Garris on the program last week, and the Browning Newsletter of his, forecasting a colder than normal Winter. So, That's not going to be good news in the energy sector. This is just the quiet time before the storm�s next fury arrives. [3:00]

JOHN: Well, we know we didn’t get here overnight, Jim, the energy storm you're talking about which is going to correlate here with the Winter storms has been building, it has been gathering strength for several decades. let's face it, this is not an overnight event. You almost get the feeling that there is more to recent events in New Orleans, say with Katrina and Rita, than the media or the authorities are really letting on. They're trying to keep it all calm on the surface, but It's real obvious that what this has done is blown the cap off a long festering problem.

JIM: Well, let's look at a few facts. The Energy Secretary gave a press conference this week highlighting a few of the problems. Let me just list some of the damage from the storms: 108 oil and natural gas offshore platforms were destroyed; 53 major platforms were heavily damaged and will remain off line until next year; 342 offshore platforms are still evacuated because they are in disrepair, and They're going to have to do major repairs and maintenance on these platforms because of the damage; 12 refineries and 21 natural gas processing plants remain off line; underwater pipelines have been damaged; “but I guess the fortunate part about this, not as severely as for example from last year's Ivan which really disrupted a lot of the pipelines as of this week, 90% of crude oil production in the Gulf of Mexico was still shut in; 72% of offshore gas production is still off line.”

So, the first part of the perfect energy storm is that supply has been cut off. [4:40]

JOHN: OK. But meanwhile, demand’s going up, right, this hasn’t quit?

JIM: That's the second part of this storm, which is rising demand. Demand is up globally. While demand may be curtailed somewhat by higher prices here in the US, it is rising in other parts of the globe. This year energy demand will be up 1� - 2%. What recent events have helped to clarify are that a crisis is upon us. The US and the rest of the world were living a dream. Demand was, for example � you always heard about this too �supposed to moderate because we were in this new technology, this new era market, where we didn’t need as much energy, but instead, take a look at what technology has done. It's created greater demand, more people are using laptops today, we have PCs, we have big screens, all of this electrical equipment That's come on line consumes more power. And oil supplies were also supposed to grow, and the cost of energy was supposed to decline. Well, that happened in the 90s, the price of energy went down, but you know what, during that period of time we weren�t finding more energy to replace what it was we were consuming. And that has been going on for nearly 2 decades. This has been an illusion, if not a delusion. Instead of moderating demand, demand grew very fast, more than 15 million barrels a day in increased demand. Just in the last decade � to put this in perspective, in the last energy crisis, around 1975, right after the oil embargo of 73 and 74, and the Israeli war, the world was consuming roughly about 55 million barrels per day, a decade later in 1985 we were consuming 65 million barrels per day, so demand grew by 10 million. In 1995, in that decade, we only increased our demand by 5 million barrels, but something happened in the 90s, because in 1995 we were consuming 70, but as this technology came on board, as India and China industrialized, by 2005, a decade later, demand grew by 15 million barrels. And while demand grew, supply got smaller and smaller. [6:58]

JOHN: So, Jim, we've gotten to this point now, if we look everywhere, we're starting to face energy constraints, and I don't think the West has really reconciled with that.

JIM: we've got energy constraints everywhere: wellhead oil and gas is at maximum capacity; refineries are at maximum capacity, especially in the US where we've lost a lot of this capacity; pipelines and tankers are at stress points; drilling rigs. We have people shortages and this is a point I'd like to bring up: if you were looking for a career -maybe you have a son or daughter who is maybe thinking what they should do for a career � I’ll tell you, one area where you're not only going to make good money, will be in high demand with plenty of job security, is go out and become a geologist, because they don't have enough of them in the mining industry, they don't have enough of them in the energy industry, because a lot of the people that went into the energy industry in the late 60s and 70s, when the sector was booming, a lot of those people now are aging, They're getting close to retirement. And so you have a whole group of people within the industry that are going to be stepping down, and That's another issue people don't look at.

We have a people problem in the energy industry, and as many people are fond of saying, particularly Matt Simmons, Katrina was really the world's energy 9/11. Just look at the capacity that has been removed or is off line, right now; I mentioned 90% of oil production, 72% of natural gas production. The full impact of these Summer storms is still emerging. Oil companies are out there as I mentioned, there�re 342 platforms abandoned at this point because They're assessing the damage of what needs to be done to get these back on line; and the time frame to rebuild all these will take years. One of the things that we did last week in the global warming round table is we talked about these weather cycles that change and you had the benign cycle from roughly about 1965 to 1995, where you had cooler than normal temperatures. Now, beginning in 1995, we're beginning the 30-year cycle of warming temperatures. And John, a lot of these platforms were designed for, I think, 70-foot waves, and with Katrina, some of them, I think the Mars platform was hit with a 90-foot wave. So a lot of the building requirements, in terms of how these platforms are constructed, are built on old weather models and old weather cycles. And so now, as the engineers from the oil companies go out and assess the damage on these abandoned platforms, and those that are heavily damaged, They're going to have to rethink in terms of how They're going to build them. It's just like, for example, in the tanker industry when we passed a law that all tankers have to be double-hulled by the year 2015; so all the single-hulled tankers are being replaced, and obviously that came about with the result of oil spills, so we're trying to build environmentally safer tankers to bring the oil to us, but this time frame is going to take years. It takes years to build a platform; it takes years to bring new production on line; it takes years to bring a new refinery, and we haven’t faced this Winter which is directly in front of us. There's still a lot more pain that is coming this Winter, as a result of the damage done by these storms. [10:25]

JOHN: Well, obviously at this stage of the game, there is a lot of finger pointing, much of which reflects current political filters and emotions as to who was responsible. But we need some perspective, so let's stop where we are and tell us, how do we go back and get into this mess in the first place? Because that lets us know why we're here and then what really needs to happen.

JIM: Number one, cheap energy has been taken for granted. A lot of the big oil companies and the national oil companies drilled a lot of wells. The discovery process peaked roughly around the late 60s, and has been going down since then, but a lot of the older wells � remember when we had Matt Simmons on, he said � what technology has given us is really a bigger straw to suck that oil out of the ground and a lot faster, so that increased production. We were in a bear market so cheap prices were just taken for granted. It was just assumed that it would be plentiful. And the other thing that Matt Simmons has talked about is the poor and opaque data, poor analysis that we have in the energy industry, because when the major militant Middle Eastern countries nationalized their oil companies, basically we stopped getting data points from them. You remember Matt Simmons talked about, for example in 1979, when the Saudi government took over Aramco, they immediately increased their oil reserves to $160 billion barrels without announcing any discoveries to back that up, and then in 1988 you had everybody in OPEC doubling and tripling their oil reserves, without any facts to back it up. In other words, they didn’t come out and say, �look we just discovered another Ghawar,� or �we discovered another major oil field, and this is why we're raising it,� this was done politically.

The other thing that you have is Western economic models were always projecting higher supply � in other words the economists were running the energy models and were saying, �you get higher prices, more supply comes on stream,� which would be like manufacturing widgets �yeah, if you were looking at manufacturing � but oil is different, It's a finite commodity, It's a fossil fuel, that doesn't replenish itself quickly. I mean, it took millions of years to get us the oil that we have today. Those models overruled energy fundamentals. The point to understand is we need to get off this; we brought this up last week, where we are today on the energy debate, we're still stuck on stupid and what we need to be doing is implementing Plan B immediately. [12:59]

JOHN: Since we're in this perfect storm here, there is a third element to this, what is it that we're looking at? There's a leg to this triangle?

JIM: Well, the third element is the political fight � whether It's radical environmentalists, or the coming oil wars. There's a political element to this: you've got China, scoping the globe trying to find energy supplies; you've got environmental lawsuits now in New Orleans. [13:22]

JOHN: You know It's interesting you mention it, Jim, because There's some dispute � these always come as disputes, That's why I asked you to put this whole thing in perspective � and what happens is basically, there are certain policies that are put in place, when the policies backfire, then There's all this scrambling to try to disperse the blame or where it really comes from, and that just muddies up the water. Here we have another news story: �two environmental groups have filed to halt construction of the $22.5 million St. Peter�s levee in the Mississippi River flood plain, and there are groups, Great Rivers Habitat Alliance, and the Missouri Coalition for the Environment have charged the Army Corps of Engineers have failed to follow the requirements of the National Environmental Policy Act which is called NEPA, and the Clean Water Act, one of the agreed to allow construction of the 4 mile lakeside 370 levee. The groups claimed the levies would increase the possibility of flooding...� and it goes on and on and on. The bottom line being, as soon as you decide to make a move, bang!, There's that lawsuit you were talking about.

JIM: And this is the problem because we're still in hurricane season now, we know we're in this decadal cycle, where we're going to see warming temperatures. So, next years hurricanes could hit the same area, and we're still stuck on this stupid comment in terms of, �OK, we're dealing with old policies,� and the problem is John, we need to get this Plan B fixed now. We know that we have 50% of our refinery capacity, along the pathway where hurricanes travel, that doesn't make sense. And a lot of people say, �well, for peak oil, why should we build refineries?� Well, if you've got 50% of your refineries in the path of a hurricane, it might make some sense to build a few of them elsewhere. It's like having peak power plants that kick into gear when you have extra demand loads placed on energy.

The other thing is, as we develop alternative forms of energy, whether It's Canadian tar sands, or shale oil, we're still going to need a refinery to reprocess these things into finished products: whether It's plastics or pharmaceuticals; jet fuel; diesel fuel; or whatever it is. We also need to be working on our transportation system and rebuild the railroads. It's more effective to move goods by trains and boats than it is by trucks. And also, we might want to start thinking about our commuting system in this country, instead of building more freeways, we might want to start building more mass transit. So, I think anybody -especially who lives in Southern California, Los Angeles or San Diego � that spends hours on the road in freeway traffic jams, would gladly exchange for some kind of mass transit system -like they have in Washington DC, or New York City, where you can ride subways, or the L train in Chicago � and avoid traffic jams.

We also need to think about our food supply, in terms of it being heavily dependent on fossil fuel fertilizers, and just take a look at all the energy that goes into producing food. And another aspect, of this John is manufacturing today where we've globalized it: you buy your raw commodities from one part of the globe; you ship them to another part of the globe for manufacturing; and then you ship them to another part of the globe for distribution. That works when you have cheap energy. It doesn't work when the price of energy is heading towards � I predict in the next decade, don't be surprised if we see price spikes where you get oil prices up to $200/barrel.

And the other thing is, we need to take a look at natural gas. We have built power plants that use natural gas in fertilizer, we use it to heat our homes, but we're not building pipelines, we're not exploring for it, or trying to block exploring for it. We need to rethink what we're going to do about energy. It doesn't make sense to put in new natural gas appliances and build more homes with them, and put them in these new homes if you're not expanding your natural gas supply, if you don't want LNG terminals. This is this whole energy infrastructure is going to have to be thought through and we need to start doing something about it now, because the crises are only going to get bigger. [17:38]

JOHN: Yeah, the crises are basically upon us at this point, so We'll see where it goes. But remember, consciousness always lags behind. There is public consciousness and especially political consciousness about the whole issue, so It's going to be interesting to see how they deal with that. It's really the short term That's killing us, isn’t it?

JIM: Yeah, because, like the President has mentioned, you can't put up a refinery, They’ve been trying to build one in Arizona for 12 years. It's been stopped with more environmental lawsuits than I can think of and we've got the lawsuits now on rebuilding the levee. These things take time in themselves to build, and then you also have the politics that come in here, �well, the oil companies are making too much profit.� John, these oil companies are going to have to be spending billions and billions of dollars to do the repair damage, and yet the fact that we have higher prices, and the oil companies are making more money is demagogued � and I wonder if we might go to the O’Reilly piece last night:

“Tonight, as you know the ‘The Factor’ is urging Americans to conserve gas and energy, and not to buy gasoline on Sundays, as a symbolic protest against the oil companies, which we believe have taken advantage of the hurricanes and the war on terror to jack up prices. Now, today, the mouthpiece for the US oil companies, the American Petroleum Institute took out a huge newspaper ad, essentially saying, high gas prices are not their fault. Are you buying that? let's take a look at the last quarter: Exxon-Mobil made almost $8 billion in profit, 2 years ago its quarterly profit was about half that, so They’ve doubled in 2 years; Chevron, last quarter, made nearly $4 billion in profit, also doubled in 2 years; and Conoco-Phillips has nearly tripled its quarterly profits in 2 years. Dollars don't lie.”

Well, the interesting thing about this comment is the dollars are bigger, yes, They're bigger, Bill, because you need to learn how to read those financial reports. If the price of oil, for example, in 2003, was $25/barrel, and it goes to $60/barrel, your sales price is going to go up, It's like a cost increase, It's like paying $3.50 now for a gallon of milk. The important point is -I would agree with you, Bill if the oil companies� profits as a percentage of sales had doubled. In other words, the oil companies are only making a 9% return on sales. Exxon, last year, had net sales of almost $264 billion, this year They're going to have sales $300 billion, because you know what, the price of oil has gone up, and Exxon imports 132 million barrels a year from the Middle East. And if the Middle East is charging you a market price of $61, That's what you're going to pay the Middle East, because That's what the price of oil is. But Exxon’s profits have remained roughly about 9%. Now, you're absolutely right, if you look at Exxon’s profits, and we take those from where they were, let's say, 2 years ago, the profits have doubled because their sales have doubled. Their sales have gone from $178 billion to almost $264 or 300 billion this year.

Now, let's apply the same analogy to the company you work for, Bill, which is News Corp., your sales have doubled more than doubled. They’ve gone from $17 billion to almost $24 billion, News Corp.’s profits have gone from $822 million to $2.228 billion. You don't hear anybody griping about how much you're charging for commercials. It's the same concept. you're making 9% on your sales, just as Exxon is making 9% on its sales. And I hate to tell you, but Exxon’s going to have to spend billions of dollars to fix refineries, to fix platforms, as will British Petroleum, as will Shell Oil, all these companies are going to be spending a lot of money to repair the damage done in that storm. So, I would invite Bill on this show, anytime, or I would be glad to go on your show, Bill, but you need to stand corrected. Yeah, you're reading the financial reports, but you obviously don't understand them. [21:55]

JOHN: Jim, when you look at the whole numbers of the profits, you know, they talk about, “They're making X number of million dollars in profits, blah, blah,” you have to remember that that company is owned by shareholders, right, and that each of these wants a dividend at some point or another out of that. When you divide up the total number of profits by the total number of shareholders, that puts it a little more sanely, doesn't it?

JIM: Well, I look at it in terms of a percentage of sales, and Exxon has been fairly consistent, same with Chevron, They’ve made about a 9% return on sales, net after taxes, interest expense, etc. Now, if Exxon’s profits have gone from 9% of sales, to 18% of sales, well, maybe he might have a legitimate beef, but this is a capitalistic market, and how are you going to encourage an oil company to go out and make capital expenditures, build a refinery, and find new oil if you're going to go in there and you're talking about slapping on profit taxes. Why don't we slap a profits tax on Fox News, or News Corp., because their profits have more than doubled in the last 3 years. Their sales have gone up because we're seeing inflation in the economy, energy costs more to produce, labor rates are up, cost of steel, just about everything you can think of in the energy sector has gone up tremendously.

It's the same with the mining industry even though the price of gold has gone up, a lot of these companies are having trouble maintaining profit margins because costs are going up all across the board, we're in a period of inflation. So, demagoguing this, this is how you get shortages, by doing exactly what O’Reilly is doing, exactly what the Lefties are doing in Washington, talking about a new windfall profits tax, taking away the incentives. And nobody talks about how much money government makes on a gallon of gasoline, and especially with sales taxes at the state level. So, these are the kind of distortions that come into play. The only way you're going to get more energy on line is to increase supply. I don't care if It's alternative energy, tar sands, shale oil, clean coal, whatever it is, the only way you're going to get companies to make the commitments -think of the billions and billions and billions of dollars of investment it is a very capital intensive business, and as we have explained, nobody gripes that Microsoft makes 32% net on sales, Coca-Cola makes 22% net on sales, or Proctor & Gamble makes 20% on sales, nobody’s griping about that, It's this demagoguing That's why we're still stuck on stupid. And That's why, this is going to get worse. [24:39]

JOHN: Jim, before we abandon this, you really have to hear this closing exchange between Bill O’Reilly and Tyson Slokum who is the Research Director of the Public Citizens Energy Research Program, and Mr. Slokum was agreeing with O’Reilly that something had to be done, but listen to this interesting exchange:

Slokum: There's absolutely price gouging going on by the oil companies, by the energy traders, enough is enough, we need Congress and the White House to act.

O’Reilly: I don't know if we need that. I don't want the Federal Government regulating this industry.

Slokum: Well, who’s going to do it?

O’Reilly: The people! I want people to get so mad they cut back 20% and send a message that way. Gentlemen, thanks very much, we appreciate it.�

Now, let's face it, Jim, O’Reilly says he doesn't want the government in and the Gentleman said, “who’s going to do it if the Federal Government isn’t going to come in with Federal wage and price controls and caps.” And he says, “I want everyone to get so mad that they stop buying gasoline.” You live in Southern California, tell me, do you think this is going to happen. I'm sorry.

JIM: No. Not going to happen. But I’ll tell you, he's right on one thing, the people are reacting to the market place which is how things work, when the price goes up, people are trying to get rid of their SUVs right now, and They're finding SUV sales are going down and people want gas efficient cars. So, the marketplace is changing people’s behavior because, just as James Kunstler said last week, maybe people are going to think twice before buying the McMansion, or they may think twice before buying a brand new Hummer as the family station wagon. I found it hilarious, though, the number one complaint of Hummer owners is gas mileage. I mean, what do you expect when buy a Hummer? But, that is going to happen and That's how the problem is solved. Higher prices bring supply because it encourages those in the industry to spend money, to increase supply, and it also encourages conservation, That's the market place at work, and It's when the government goes in and intervenes and tries to subsidize energy, for example, like the Indonesian government did, and It's almost bankrupting the government because when you subsidize something you get more of what you subsidize. So, windfall profits tax, price caps, subsidizing, it just doesn't work. The market place is, like it or not, one of the most efficient means of allocating an economy and driving it to where it needs to go, and That's What's happening right now: consumers are backing off, They're trading in their SUVs and those that are going to buy new cars-I think I was reading, last month the sales fell for the major automobile manufacturers, but Honda�s sales, Toyota’s, were going through the roof. The same even with some of Daimler-Chrysler�s sales, because They’ve been selling diesels, for example. One of their Jeeps is a diesel model, which gets better gas mileage. So the market place works, John. We need to just let the market take care of it, and not screw things up by bringing the government and bureaucrats to dig us deeper into a hole. [27:38]

The Tipping Point On Inflation

JOHN: The Fed has certainly gotten the market's attention on inflation. In reality, you can't turn on the financial news or pick up a paper and read about a Fed governor saying that inflation is a problem, can you?

JIM: Well, we're at a critical stage in the inflation cycle. Up until recently most of the after-effects of Fed money creation has taken place in the financial markets. All that money and credit created under the Greenspan Fed went into the financial markets: stocks in the nineties, now real estate, mortgages, and bonds in this new century. This is the good inflation that everyone enjoys. Fortunately, for the US, all of that excess demand created by inflation was offset by our trade deficit. In other words, when excess money and credit creates more demand than you would have if you didn’t have all this money printing and credit creation -if all we could buy is domestic goods, the price of those domestic goods would be going up but because this excess demand was channeled into foreign imports the trade deficit is where all that excess demand has been channeled in effect. The US has been exporting its inflation to the rest of the world. Now, that inflation is starting to spill over into the real economy, you can't help but notice it surfacing everywhere. This week the ISM Service of Manufacturing Indexes, prices paid component increased by 15 � % on the manufacturing index, and 14.3% on the service index. Moreover, John, inflation psychology is starting to take hold: companies are starting to anticipate inflation, and factor that into their price increases, and once inflationary psychology takes hold inflation moves out of control of the Fed, and the Fed knows this.

John, this reminds me of a book that I have often quoted from. It's by a gentleman by the name of Jens O. Parsson, he wrote a book called Dying of Money: Lessons of the Great German and American Inflations. The quote that I want to read expresses where we are and it goes like this:

“Everyone loves an early inflation, the effects at the beginning of the inflation are all good, there is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets and spectacular general prosperity, all in the midst of temporary stable prices. Everyone benefits and no one pays. That is the early part of the cycle, in later inflation on the other hand the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait in the terminal inflation. There is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion. Now, however, accompanied by soaring prices and ineffectiveness of a traditional remedy. Everyone pays and no one benefits. That is the full cycle of every inflation.”

John, That's one of my favorite quotes on inflation. We talked about, in that everybody loves the early stages of inflation. You get the asset bubbles. Prices are stable because everything is being channeled into the asset market, and everybody is feeling wealthier, then you get the bad part, and That's the part we're in now.

Another important aspect is inflation psychology is starting to take hold, companies are starting to anticipate inflation, and factor that into price increases, and once inflationary psychology takes hold inflation moves out of the control of the Fed and the Fed knows this. [31:40]

JOHN: A certain kind of panic sets in which would probably explain why the Fed has become so vocal lately, right?

JIM: Yeah, precisely. If you look at the Fed, it is by its very nature an inflationary institution. It creates what we have come to know as the business cycle: the Fed creates a boom in the economy when it lowers interest rates, and floods the banking system with credit; inflation eventually surfaces and the Fed tightens credit which creates a bust. This is the business cycle we have lived with for the last half century. The only problem is that over the years, there is less political tolerance for those busts. Once the bust arises there are calls for government intervention, either in the form of fiscal policy, or monetary policy, and most times we get both. Just take a look at the Republican equivalent of the New Deal; we're going to spend $200 billion rebuilding New Orleans; we've just passed a $286 billion highway transportation bill that has more pork in it. This is fiscal spending because the powers that be in Washington know we're about ready to head into a recession again: we've got political elections ahead; you've got Republicans who want new entitlements this Medicaid bill that Grassley wants to fund we're spending like drunken sailors.[33:01]

JOHN: Well, I've never heard of that before, “Dear Alan Greenspan, Chief Drunken Sailor, Federal Reserve Bank...” Well, It's obvious that the Fed is concerned. Actually, They're getting to sound sort of militaristic in the speeches They're making, and frankly if we look back over the last century, I don't really recall them ever sounding this hawkish, Jim.

JIM: They're sounding hawkish, they know they have an inflation problem on their hands. What they are going to do is create another recession. There is no ifs and buts here, we are going to have another recession that if we're not careful could turn into what I call my perfect storm, or an inflationary depression. Right now, They're trying to slow down the inflation problem, but they aren't being very effective, they have lost control of that opportunity. After 9/11 they should have kept interest rates high, instead of flooding the markets with easy money. Now they have multiple bubbles on their hands in real estate, mortgages, the bond market, consumption and they need to deflate them, but they don't want to deflate them too much, but they want to let some of the hot air out of the economy, and the problem is John - this isn’t like Betty Crocker put in the right ingredients, and you know, you can bake a cake or stop the rise of the yeast in the cake � it doesn't work that smoothly. Either we get a crash landing, and if politicians are not careful like we were in the Great Depression, we should�ve never had a great depression. The economy, if they would have left it alone, but Hoover was a control freak, and just interfered in every aspect of the economy; he thought he could engineer and plan his way out of it. Roosevelt did the same with the New Deal. And so, had they let the marketplace work, cleanse the excesses, we would never have had the Great Depression, so we have to be real careful here. There's a tendency, more so today, for politicians to intervene in the marketplace and make things worse, That's why I think There's the distinct possibility for an inflationary depression. The probability of that happening, my perfect storm scenario, is increasingly becoming more likely, and especially as I turn on the news now, I've been watching this very closely, seeing the political fallout, how It's been handled, the talks about increasing taxes, sort of a windfall profits tax, increasing taxes here in California at the State level; there are calls for more government spending and increasing income taxes. we're going to do all the wrong things. It's like wisdom seems to skip a generation, and It's skipped this generation. [35:41]

JOHN: Why don't you explain windfall profit taxes before we sum it up. A lot of our listeners may not know what those are, and then We'll take a look at the whole thing?

JIM: They start taking a look at what you receive in the price of oil, it depends how they set it up. Back in the 70s they set it up on new oil discoveries; there were special taxes on it, basically as one leftwing Congressman is talking about, anything over $40 oil, there would be a special tax assessment on the oil companies, and that would go directly to the Federal Government. So, let's say you're Exxon or Chevron, and what makes this very tough, John is the US imports 60% of its energy needs, and if you're importing natural gas from Canada, or oil from the Middle East, and They're charging you $61 a barrel, then $61 a barrel is what you're going to pay for it. So, That's why these idiots don't understand the economics of that. If Exxon has to pay $61 for a barrel of oil that they import from Saudi Arabia or Kuwait or wherever it is that They're buying it from in the Middle East, and Congress taxes them on over $40, think what They're going to do to create energy shortages? I mean, these people, we never learn and we make the same mistakes. [36:59]

JOHN: That is the same thing that happened in California, isn’t it? The energy companies remember we deregulated the wholesale side of it but we kept a cap on the consumer side, and then squashed these companies into an impossible position. It's the same nightmare all over again.

JIM: Yeah, we had bankruptcies here in California, because we deregulated the market which means the utilities had to buy natural gas, in 2000, at spot prices, but at the same time we capped the prices they could charge to consumers, as they are doing right now. we've been informed They're going to be raising our natural gas bills this Winter, They're going up 26% maximum cap, so That's the situation you do, and then next thing you have is real shortages, and the price goes up, because when you have shortages, and you can't get it, I don't care how much you price cap something, if you've got to go out in the marketplace the utilities going to say, �you know what, I'm not going to buy more natural gas, you'll just have power outs. Why should I pay $20 per cubic foot, if you're only letting me charge $10 per cubic foot?� This is insane. [38:04]

JOHN: Yes, so inevitably, what you're trying to say is the market finally kicks back and establishes its own natural levels in things. It's going to do it no matter how you cut it back.

We know inflation’s on the rise, Jim. That means the Fed is probably going to keep raising interest rates until something breaks, as you are fond of saying, because they really don't know what They're doing. They are just really flopping around in the dark until something feels right, so to speak.

JIM: They are going to keep raising interest rates until the economy and the financial markets break, but they aren't going to be able to buy their way out of this one. The problems are too great. The Fed is confronting a financial crisis at about the same time we are arriving at peak oil. There is going to be no easy way out for them; They’ve boxed themselves, John, into a corner, and the rest of us are going to be left dealing with the fall out. It's time to put on your foul weather gear, It's going to get rough, we're going to see things unfold you haven’t seen for decades, and It's time to batten down the hatches. [39:12]

Climbing the Mountain - Why You Don't Want to Own Long-Term Bonds

JOHN: Climbing the mountain, why is it we don't want to own long-term bonds?

JIM: If we take a look at the last inflation cycle, which really began in the sixties, with a lot of the programs “The Great Society” programs, the war in Vietnam �the US government was spending more money than it was taking in, we couldn't support the dollar with gold anymore, we went off the Bretton Woods system, and eventually governments had a free license to spend, and to print as much money as they wanted.

We have a graph that is going to be accompanying this segment of the show almost a 50-year graph and it shows interest rates this is the government 10-year Treasury Note and you can see it almost looks like a mountain where we began in the early sixties, we began this inexorable climb until we peaked out at roughly 16% interest rates, back in 1980 and since that time -since 1980, for the last 25 years � we've seen this downward sloping cycle. we've been in sort of a disinflationary economy, where more of the inflation was transferred over to the financial system. That was the key turning point in central bank policy, instead of monetizing debt, we financed debt and we used existing savings, and therefore that had a non-inflationary impact. And most of this inflation was transferred to the financial markets. And you can see on the back side of that mountain curve of interest rates, since hitting a peak, roughly around 15.9%, and that was in the Fall of 1981, and that was when Volcker was raising interest rates, we were in a very, very tough recession -probably one of the worst recessions we've seen since the depression and then, all of a sudden, the Fed began to loosen up on interest rates. The Summer of 1981, we almost had Mexico default on its debt, Volcker reverses course on interest rates, but we've been on this downward climbing cycle -and you can just see that on the right side of the graph, now we're building a base, and we're going to begin climbing the upward climbing part of the cycle, and we're going to begin another climb over the next 5 to 10 years. you're going to see interest rates start to climb again, and the implications are horrendous for investment portfolios. [42:17]

JOHN: Well, Jim if you are a bond investor, the red flag you're going to see is if interest rates go up, because you know at that point there is inflation and bonds are going to be a very bad investment.

JIM: Yeah, because as interest rates go up - let's look at it from this perspective � let's say today you need income. you're getting ready to retire, so you go out and your advisor puts you in a bond fund, or you go out and buy a 10-year Treasury Note, and that 10 year Treasury Note is paying, let's say, 4.36%. What happens a year from now if Treasury Notes are at 5.36% and they go up? What's going to happen is that the price of your bond is going to drop almost by 20%, because a new bond investor could buy a new Treasury Note that would be issued by the government and get a 1% higher interest rate than your bond. So, what happens is your bond has to be discounted to equal the current yield on new Treasury bonds. So bond investors can take a very, very big hit.

This reminds me, John, when I first got in the business in 1979, I was apprenticing with one of the top financial planners in Phoenix at that time and I can remember this one gentleman, distinctively, he had been a big corporate executive with one of the big Fortune 500 companies, retired in the early 70s, put all his money in tax-free bonds, and Treasury Notes, and That's what he wanted � he wanted a conservative fixed income � and I can remember he had a bond portfolio that was $750,000 which was the face value of those bonds. And when he came to see us, it was roughly about $400,000. Remember back in 1979, 1980 and '81, interest rates had gone up to 16%. I can remember when you could get between 12 and 13% tax-free bonds. You could get 16% on Treasuries. And so he had seen his bond portfolio decline by almost 40-something percent. And unfortunately, That's What's going to happen to people here, because we're now beginning an upward leg in inflation. It's obvious to anybody if you look at, for example, just global money supplies: global money supplies have increased by almost 20%, just in the last year. This is from the latest issue of Grant�s Interest Rate Observer, just to give you an idea, global liquidity, which is the monetary base plus central bank holdings of foreign exchange, mainly dollars, grew by 20%, in both 2003 and 2004. That's the fastest 2 years of growth since 1975. So we are beginning another inflationary cycle, and with that, that means interest rates are going to go up, as interest rates go up, long term bonds will go down in value. [45:14]

JOHN: let's give a theoretical here. Supposing that I need income and I happen to be in bonds. Here I am. I come to you. What do I do?

JIM: If I was in bonds, I would go to a laddered bond portfolio. I would not go beyond 5 years at this point � That's number one. Number two, I would be going into foreign bonds because the dollar�s going to come under pressure and as the dollar declines, inflationary costs are going to go up and foreign bonds of, let's say commodity producing countries like Switzerland, are going to go up in value. It's almost like hearkening back to the 1970s.

The other thing I would have is if you want to be in Treasuries, you want to be short-term. You might want to look at TIPS, although I would only use TIPS in a pension plan if you must, if you are very conservative. I don't like it because the CPI index That's used to index these TIP bonds is artificially tinkered with, so the inflation rate is understated, so you're really being deprived of what the inflationary returns should be.

But the other thing you're going to have to have is inflationary type assets in your portfolio, things that would benefit from inflation, royalty income trusts from oil and natural gas, those kind of investments; commodity-type base metals and gold. we're almost going back to the '70s again. we're at a stag-inflationary point of view. But the important thing is keeping your maturities short. Keeping them so they roll over, so as interest rates go up, your bonds mature, you can cash in and get a new bond at a higher interest rate. Foreign bonds to protect yourself against the dollar; and then also using inflationary type investments in your portfolio. As we talked last week, dividends that can go up 10% a year, 15% a year; companies that have good business models; have pricing power; can increase dividends, so that you're going to see benefit as costs go up. You will see your income go up and That's really important. [47:18]

Emails

JOHN: Well, here we go, It's out of the bag. Jim, after last week's broadcast on global warming, we received a series of negative emails which we “believe it or not” anticipated before doing the show. We knew it wouldn't go down lightly in some quarters. That's fine. I think, Jim, what bothered me I don't know about you about most of the emails, and we went through a big pile of them, was that none of them did anything to provide any new scientific information, or point us to information that would have countered what the panelists said; how this factored in to the overall debate. It was either, It's a fact etc, etc,; some of them bordered on the hysterical, some begged the question and simply echoed the pro global warming viewpoint which you get off the main line media, and telling us we're in denial, which we're not. we're doing our due diligence here. we're asking hard questions, which is really only reasonable if you're going to ask the world to put its economy, its jobs, and food stores on the line, and That's what the Kyoto Protocol was all about. It was an economic treaty, not a scientific treaty. Only a few people offered a reasonable critique and unfortunately, the emails tended to reinforce the impression here, that much of the global warming scare is driven by hype and not fact. Now, one of the big comments, and what we're doing here, we got so many of these Jim we can't read a lot of them on the air but one of the big comments was, like gentleman said: “Jim, I've recommended your site to a lot of people due to your perceived non-biased analysis. Please don't make me look like a chump!”

JIM: The only thing I would say is you weren’t listening to what we said at the beginning of the program. It was the alternative to the popular main line view that global warming is man-made, a fact, and a threat to the globe. It's the side you don't hear. So, we let you hear it. Remember, our goal is always going to be to get to the bottom of issues. This program is a contrarian program, based on the premise that the herd is almost always wrong. It's how we make money for our clients and we've been very successful at it. [46:28]

JOHN: Jim, I want to add a comment on that if I could - just to make people know that you manage the Loeffler family trust, which involves things for larger than my own family here, and so far if we look at your overall performance, gold funds in your accounts are up 20% year to date, whereas the gold index out there is only up 13%; growth and income accounts 10.5% year to date increase: up; 16.5 over the last 12 months; and growth accounts 12% year to date, 13% over the last 12 months. So the contrarian type of attitude towards things does seem to be working.

JIM: Well, It's because we take that contrarian point of view we missed the downturn from the year 2000-2002, we got out of our technology stocks in December. It's because we don't accept everything we read in the news. If somebody says something is going to go on forever; we don't always except that. We may say wait a minute, let's look closer into that fact and That's one of the things we try to do here on the debates. For example, with peak oil, I began writing about this 5 years ago -and very seriously about the issue with major pieces 3 or 4 years ago � and because nobody was talking about it you got both sides: you got the people that didn’t believe in peak oil, that there was plenty of oil out there, or alternatives; you got the geologists; you got the investment bankers; you got the sociologists. You heard both sides of the debate. But when it came to global warming, everything is one-sided and so what we did is: we were the other side.

One of the requirements of being a contrarian is being willing to look like a chump in the beginning, because you're going to take a position that is unpopular or against the tide. I remember when I wrote a piece called Trains, Planes & Dot Coms, January 4, 2000, predicting the NASDAQ slide -It's on the web [Link], so It's documented � and how horrible the aftermath was going to be. People didn’t like hearing that and so we took a lot of flak � when I wrote The Perfect Financial Storm in the Summer of 2000, and saying bad things were coming to the markets and the economy, nobody wanted to hear it, we got negative emails - well, actually I call them nasty-grams � because people didn’t want to accept that. Wise contrarians, however, turn from chumps to champs once the dust settles and the reality emerges from an issue.

The first question we ask here is, “what is going on?”, not “what does everyone else on Wall Street or in the science profession, or government think?” CNN, for example, a few weekends back ran a pro-global warming documentary with the standard scare hype and only devoted 2 minutes to dissenting scientists. That's not balance. So much for the unbiased reporting of a larger issue. [52:22]

JOHN: Yeah, one of the larger comments that I always hear and it comes in a lot of our emails, That's the concept of being open-minded. And this one always disturbs me because I think being open-minded requires listening to all sides. And then at some point, however, you have to make a decision as to What's going on. That's where it changes. There's no such thing as unbiased analysis because every opinion or position on an issue naturally excludes contradicting opinions, which everybody filters through their own assumptions anyway.

So the question isn’t whether a viewpoint is biased, but whether it is demonstrably true. Does the viewpoint represent reality, or an effort to accomplish an economic or political agenda, or is simply wishful thinking, which you and I both know is really common in political circles. And It's really weird too, because through the years, I've noticed whenever we get emails from listeners from whatever show I've been on, the people who complain about being unbiased always let their own biases come pouring through in the very same email. So the trick about being open-minded is, you listen to all the facts, all of them, Jim, and then you find out What's fact, What's fiction, What's real, what isn’t real. But then you take a position on something like that. That's not being closed minded. you've already gone through the process.

let's look at some emails here and we can respond to some of them. Matt, from London, England, wrote:

“Always listen to your show. Greatly admire your insights, however the fourth hour about global warming should have been billed as being broadcast from ‘da Nile’. Global warming is not a hoax, It's real, environmental damage is real. Polar ice caps have shrunk 4 years in a row, the seasons are changing in Europe, and there are huge storms in the US, younger people such as myself should not have to listen to these people who won't live to see their words proved false. Very disappointed in this hour, I expect more insight from your programming. Regards, Matt.”

JIM: You know, Matt, you weren�t listening to the program. we're not in denial. we're trying to take a serious look at an entire issue, but we're very tired of 40 years of environmental hype and scare. Those who look at one side are the ones in denial. A lot of the changes are cyclical in nature, including the change of climate in Europe, even Evelyn Garris covered that; Dr. Grey, who by the way, has been quoted all this past week long on the main line cables for his hurricane predictions, confirmed that as well.

All the panelists agreed global warming is real, as long as you start measuring in recent times. Few are disputing that fact. However, we are cooler than we were in the Middle Ages when Vikings raised crops in Greenland. They can't do that today. It's solid ice. And by the way, Matt, for people in my generation, when we were in college, we were told to panic because we were going to be both starving to death from over population, and freezing to death due to global cooling. Later on, we were told we were all going to get skin cancer from the ozone hole, and that Freon had to go, and by the way, don't eat apples with Alar. Well, the Freon went at great expense; I'm not starving due to over population; and ozone holes are still there. All of the scares resulted in massive over-regulation and costs and they all fizzled and no one said, “oops, we were wrong!” They just moved on to the next scare, which is what we have today.

JOHN: Elizabeth wrote:

“I have the greatest respect for you and I am an avid listener to your weekly broadcast. I've been a bit dismayed by your anti-environmental comments, but this week�s roundtable on global warming was especially discouraging to me. A one-sided panel intent on attaching far-fetched and unlikely motives to people they disagree with. By the way, Jim, the other side is doing the same thing to the dissenters. The most obvious motive is that scientists and citizens are deeply concerned about the health of the planet that we depend upon for our survival and our quality of life. The elephant in the room no one mentions is that the global warming opponents have motives of their own, most notably corporate financial interests protecting future profits, while externalizing environmental costs on to others.”

JIM: Elizabeth, what can I say? we're deeply concerned as well. However, any solution must have two requirements: it must be based on sound science, not hype; and it must be economically sustainable. To date, environmentalists have ignored the second part simply by yelling �Save the Planet,� but They're about to reap the whirlwind on that, because if the global economy falters, environmentalism will falter with it. It's a luxury that wealthy economies can afford in good times, not one when you get into bad times. A sound economy is required to produce the amounts of money required to fund the environmental programs that you probably would like to see. They go hand in hand and it is impossible to have one without the other. The former Soviet Union, for example, is a classic case of what happens to the environment with top-down management and a collapsing economy. As far as the tired argument about funding sources, do you really mean to tell me the various governments who stand to gain more taxes and wealth transfer from global warming don't have a biased agenda when they fund research? Come on now! Global warming is now big business, in both the public and the private sector. And do you also mean to tell me that financial interests don't have a right to have input on something that is going to affect them and provide the evidence? [57:50]

JOHN: Edward said, “Jim, I respect your financial advice. You really should stay out of the science stuff. Your roundtables on this are always, and I say always, stacked with guests who have an animus against environmentalists. don't call this a roundtable, It's a one-sided table.”, [John] we did call it a debate, at one point, and that was a mistake, it wasn't really a debate, it was a roundtable, “Your previous guest the week before was not really very good either,”, he's talking about Dr. William Grey, “he said he was cut off from Federal funding because the Clinton Administration knew he was against the greenhouse gas theories. And they should cut off any scientist that doesn't do research with an open mind” There's that open mind thing again.

JIM: don't know if you ever took logic in school, Edward, but the last part of the statement is known as begging the question and It's a fallacy of reasoning. The guest you refer to is a well-respected climatologist, if you look at the number of times he's been quoted this week. He pioneered the art of hurricane forecasting. He was quoted all week long on just about every station that I was tuned on in terms of cable news programs, for his hurricane predictions. Let me see if I'm understanding what you're saying, Edward. Scientists who have different opinions should not receive funding? But That's what makes science run well. Dissenting scientists have made most of the major breakthroughs. An open mind requires an evaluation of all positions and that is precisely, by the way, what Dr. Grey has been complaining about, that There's been a concerted effort to silence dissenters by not funding them. he's not the only scientist - by the way - complaining. This was also true of when the IPCC suppressed, or edited, the report segments of dissenting scientists on the IPCC. If you only fund one viewpoint you're only going to get one result. Who then has the closed mind, Dr. Grey or the US government? [59:37]

JOHN: You know, I was watching testimony this week on C-Span about the situation of the European Union implementation of Kyoto. The bottom-line is they are not meeting the targets, newer statistics coming out are showing that if they were to try and do it in say, Spain, which was the example given, it would impact their GDP by about 4%. And Europe is just beginning to realize what this is going to cost, and what I really seriously think we're going to see as this progresses, is people will continue giving lip service to the global warming issue, but They're going to be quietly tip-toeing away from it, because they know they can't implement it. And besides, Kyoto was an economic treaty, even a lot of its adherent admitted it, and I've seen this in testimony before Congress, that Kyoto, an economic treaty, would not have reduced greenhouse gases, any amount to make enough impact on whatever�s supposed to be happening. So, even if all the other stuff is true you still come to Kyoto would it work, no! and so why do we keep pushing it.

And just by coincidence today, just as we hit the airwaves, there was an editorial in the Wall Street Journal written by Antonio Martino, who is Italy’s Defense Minister, and lo and behold, he is talking about Kyoto again. He makes several points, these will sound very familiar. First, It's not true that President George W. Bush is alone in opposing the Kyoto agreements that his predecessor Bill Clinton signed - in fact when Kyoto was submitted to the US Senate for ratification on July 27, 1999, the result was 95 nays, and zero yeas not a single Senator, not even the most liberal voted in favor of Kyoto. Second he says, there is no scientifically sound link between the rising global temperatures and an increase in the frequency and intensity of hurricanes, nor are the events of recent weeks unprecedented. As Max Mayfield, Director of the National Hurricane Center pointed out, a comparable series of hurricanes of similar intensity has already been observed in 1915. And third and most important, while a scientific consensus about the true nature of climate change is still lacking, we know for certain that the impact of Kyoto on the average global temperature will be negligible at best. The UN's intergovernmental panel on climate change forecasts that without the ratification of Kyoto, the average global temperature will rise about one degree Celsius by 2050. The same panel predicts that after implementation of Kyoto, the temperature will still rise 0.94 degrees. In other words, the benefits from Kyoto amount to be 0.060 degrees in half a century. In essence, it will have no effect. What's needed is less hype and more scientific data.

JIM: Well, It's international wealth transfer. It's a taxation program because half of the biggest polluters, China, India would be exempt from that treaty, if I'm correct. That doesn't make sense, if you look at this issue. If you think through the logic behind it, it was a taxation scheme and a wealth transfer scheme. And so That's one of the reasons why a lot of these countries are backing away, whether It's Europe, whether It's Tony Blair in England; you'll see other political leaders back away from it as well.

The important thing that really surprised me with all the emails, John, is nobody talked about this decadal cycle and yet when I was watching the news this week, when they had the weather forecasters because we had that one hurricane or tropical storm that hit the lower East Coast they were talking about, “folks, this is a cycle.” The weather people know about it. These are 60-year cycles, you get 30 years 3 decades of cooling, and That's what we got from 1965 to 1995, and then, beginning in 1995 you've got the backside of the cycle, which is the warming cycle. Nobody was aware of that. And there is another Atlantic cycle that is impacting Europe [John] called the Atlantic multi-decadal oscillation so nobody talked or brought up these issues, and so I never saw objectivity and the great disappointment we got nobody with any kind of scientific fact that was an “Aha!” here's something we can go with, have it on the show, here's a guest or something, or here's a significant insight. It was all ranting, raving. We got a few intelligent ones, but still... [1:03:57]

JOHN: And I guess It's not anti-environmentalism, It's saying if It's to survive in the future, it has to clean up its act. And it has to take into account other realities, other than its own ideology. And if it doesn't then, as you said, if the global economy continues to implode, that will be one of the first things tied up and thrown over board, even at the same time politicians are paying lip service to it, That's the way the game is played in politics: Lip service while at the same time letting it die a benign death, so to speak.

we're out of time for today, What's coming up next week, Jim?

JIM: Next week, Ike Iossif will be joining me for Ahead of the Trends, and we're excited about our guest. If you're into technical trading, technical analysis, our guest is going to be Gerald Appel, he was the inventor of the MACD, he has written a knew book called Technical Analysis: Power Tools for Active Investors, New Techniques for Active Trading in the Stock Markets, so he’ll be our guest next week on the program.