Financial Sense Newshour

The BIG Picture Transcription

December 24, 2005

Part 1

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Part 2

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• Energy, the Big Story of 2005
• Commodity Bull Gets Its 2nd Leg
• Inflation, The Economy and The Business of Reporting
• Final Comments

Energy, the Big Story of 2005

JIM: Well, Merry Christmas everyone and welcome to our year-end program on the Financial Sense Newshour. This is going to be a special edition as we take a look at the last year and try to put it all together: what were the key stories, what moved the market, and the real big stories for not only 2005, but will they flow over into 2006. We'll be addressing that in this special edition of the Financial Sense Newshour. Also joining me on the program this week will be Ike Iossif for Ahead of the Trends. Our guest will be Mark Leibovit, rated by Timer Digest as the number one timer in the US. You won't want to miss that. But John, what else?

JOHN: Will, Jim, we've spent a lot time here this week reviewing a tremendous amount of what used the be called "footage" of this year's programs, listening especially our guest experts and trying to extract a final picture of what actually happened this year. And looking back over the year there are a number of issues which really, truly stand out. We experienced another energy crisis, oil and natural gas prices rose far more than the experts had anticipated.

Commodity prices really took off on copper, aluminum, platinum, palladium, silver, gold, oil, natural gas, cattle, even lean hogs. There is something obviously going on hear. Another fact is despite 13 rate hikes and higher energy prices, the economy hasn't fallen off a cliff. And finally, if you listen to those people who were arguing against inflation all during the year, we don't hear a thing. They're silent. It's obvious to everyone that there really is inflation.

JIM: I hate to say it, but one of the phrases you don't like to say in the financial industry is "It's different this time." But it is different. we've had, as you mentioned, John, 13 rate hikes and the highest energy prices on record. When oil prices were at 40, they said, “Boy, if it goes to 50, It's going the kill the economy.” Then it was $60. Well, heck, they got to $70 and the economy is still going strong. Long-term interest rates are lower today than where they were when the Fed began raising interest rates in June of 2004, and we've had a rising dollar this year. Gold has risen along with the dollar. And stock prices -- at least as we're talking now -- are still in positive territory. This is a different rate raising cycle.

JOHN: And if we look at all of these issue, it seems that energy, or the lack of energy, and energy prices have really dominated the headlines all throughout the year. Whether it was the crisis following Katrina and Rita - the two hurricanes - $70 oil spikes or today's high natural gas prices, the energy story has been with us throughout the year. So, why don't we begin with a look at the energy situation, which I think we both agree is probably the year's big story?

JIM: Yes. And to better understand that issue, I think we have to look at energy fundamentals. Because John, fundamentals are what drive every bull market. The bull markets in the '80s and '90s were driven by fundamentals. And even though commodities and energy prices have risen, why did they rise and how did they get to be this high? Well, it gets down to basic economics, which are supply and demand issues — something Jim Rogers pointed out when we talked to him earlier this year. [4:33]

JIM ROGERS: Jim, first, if you go back in history, you will see that this has recurred periodically for the last couple of hundred years. I have a chart in the book showing � documenting this. First, It's simple economic history. You have long multi-year bull markets followed by long multi-year bear markets. We can explain why in a little bit. The basic reason though It's not some magic from heaven, it's supply and demand.

During the '80s and '90s you had a lot of people screaming about hot mutual funds, hot money managers, and hot stocks. Nobody called you up, Jim, and said let's invest in a sugar plantation or let's invest in a lead mine, because commodities were in a bear market. Now, when There's a bear market, people do not invest in productive capacity, and so supplies dwindle and diminish.

There's been only one lead mine opened in the world in over 25 years. The last lead smelter built in America was built in 1969. There's been no great oil discovery in the world in over 35 years. Alaskan oil production is in decline now; Mexican oil production is in decline; England, which has been one of the great oil exporters in the world for the last 25 years, is now in decline - England will be importing oil within the decade - you know, the North Sea is in decline. So, as supplies dwindle, at the same time, Jim, you know what has happened in Asia, demand has grown - in America, Europe and everywhere. So when you have demand growing and supply dwindling, That's a bull market. And It's always happened. And as I said, it has happened throughout history. It's not simple, but It's pretty basic economics and basic history.

John, these supply and demand imbalances also take time to correct and That's the thing I think people really don't understand. This is something that doesn't happen overnight. Even if they were to go out and make one of the biggest oil field discoveries in the world tomorrow, it may take 2 to 4 years before you bring that oil supply online. If we were to get our act together and get rid of all the partisan bickering and all the funny business That's going on in Congress right now, and get rid of laws that prevent us from building a refinery, and even if we were to start to build a refinery, John, it may take 5 years to bring a brand new refinery online. If we were to go into mining and discover a new copper mine, a new gold mine, or a new silver mine, it may be 5 to 7 years before that mine comes online. And That's something that I think, once again as Rogers points out, that these things don't happen overnight.

JIM ROGERS: you're exactly right. I mean, if suddenly somebody finds a huge oil discovery in Berlin, or in downtown New York or Tokyo, it would be a wonderful, wonderful thing for the price of oil. But so far, no one has done it. Maybe There's huge amounts of oil left in the world, but we don't know where it is. And even if we start finding it, it takes a long time to bring it to market. In the meantime, Jim, other oil fields continue to decline. As I said, the North Sea is in serious decline. So, unless we find it very quickly and find it very conveniently, the price of oil and energy has to stay high. The surprise is going to be how high it stays and how high it goes.

You know, Rogers is bringing up a key point there, which is we're not finding a lot of new oil, a point, John, that people like Matt Simmons and geologists like Ken Deffeyes have brought out on this show. Wall Street and Washington just assume, for example, that oil will be there as prices rise. The economists look at that and say, “Well gosh, at $50 oil, we ought to get more oil out of the ground. And if it gets to $60, We'll get even more oil. There's a problem with this kind of thinking and Matt Simmons looked at this problem, which led him to his thesis in Twilight in the Desert:”

MATTHEW SIMMONS: It was really an incredible exercise of trying to collect the data no one had ever actually thought of doing before, and That's what are the top oil fields in the world - field by field? And the background for me doing this is that I've participated 2 years in a row in an energy supply workshop, conducted by the energy analysts of the CIA in Washington, where they got about 10 of the best oil experts together. We'd spend a day doing a discussion of all the key countries and how much oil capacity they had in place over the course of the coming 3 years. I sat there listening aghast at all of these experts with their laptops that kept looking at their supply models and It's how China will be producing 3,217,000 barrels/day this year and 3,281,000 barrels/day. And I basically said, “How do you all even know that? What are the 3 or 4 top fields in China?” And no one had any answers.

So I decided it would be interesting and educational to see if you could actually put together a list of the top 20 oil fields by name. And I thought somebody must have done this before. And the more I dug, the more I realized that no one ever had. So I basically decided � arbitrarily � 100,000 barrels per day [bpd] production was my cutoff of what constituted a giant oil field. All Fall of 2000, I believe this was, I basically took data from various areas and kept trying to hone in on the total list. I decided once I got it done, that I would circulate it widely to the 4 or 5 or 600 people, who really ought to know the areas a lot better, and that would flush out the real data.

What I came up with was finding that there are about 120 oil fields in the world that still produced over 100,000 bpd and that they collectively were 49% of the world's oil supply. What I also found is that the top 14 fields that still produce over 500,000 bpd each were 20% of the world's oil supply and on average they were 53 years old. The next thing I found was that in the Middle East you had basically somewhere between 3-5 oil fields in each of the major Middle East oil producers that made up about 90% of their supply � and until I did that, I had just assumed the Middle East had hundreds of oil fields � and all these oil fields were old.

And then what I found was � because we made it clear that anyone who wanted a copy could get one, but the caveat was that if you have any better information, let me know � I probably shipped over a thousand of these copies out to people and I had about 5 responses of �here's a field you missed, here's a field you misspelled or here's a field you said it was producing X, and I believe It's probably producing Y.� Only about 5 responses out of over a thousand people who got this. What I got from hundreds of people was �This is amazing. I've never thought about this before.� And these aren't just sort of random people. These are people that are all passionate energy analysts. So that gave me the background when I finally had my only trip I've ever taken to Saudi Arabia.

I knew ahead of time that they had these 5 key fields that must still be producing 90% of their oil. It was that knowledge and data that allowed me to just peer into presentations we were having, so that I came away saying, “You know, I really wonder whether in fact we're sitting on an illusion that Saudi Arabia has all this vast amount of producible oil.” And I also then had an idea of what issues I should start trying to research. Within months I had discovered this phenomenal database of technical papers at the Society of Petroleum Engineers. I spent all Summer, two years ago in Maine, plowing through them and it was at the end of that exercise that I decided I was going to write a book.

JOHN: You know, Jim, it would seem like the debate over this whole issue -- the real problem -- lies in the thinking on the side of economists with the belief that There's an infinite supply of oil and they assume that if the prices rise, then the oil will be right there to fill the demand.

JIM: John, you're absolutely right. These economists deal with these supply and demand curves and if you increase the price, then the supply will automatically increase with it. The problem is you're dealing with a commodity That's really a finite commodity. That's why a lot of these people have been wrong. Number one, as Simmons has talked about, is that their assumptions are flawed: [13:15]

MATTHEW SIMMONS: What's interesting is that we've based all of this assumption on no data.

JOHN: It would appear then that the markets are trying to analyze where we are based on old paradigms, or as one person on the program noted, looking in the rear view mirror to figure out where we're going. And this is really much different from the energy crises of the 1970s, which in reality if we go back and analyze, it was a political crisis. This time it looks more like a geopolitical crisis. That changes how things are going to play out. You know, we've heard Cassandras before, but this time I really think the Cassandras, such as Simmons and Kunstler, really have something valid to say:

JAMES KUNSTLER: One of the common complaints is that mankind has faced this problem many, many times before. And every time we seem to run out of one form of energy, we always come up with something else. And the fact of the matter is this has only really happened a couple of times in Western life especially. And by that I mean around the 16^th Century we began to have trouble with wood in Northern Europe and that stimulated the use of coal. There was a lot of it in England especially. Coal eventually ramped up into the use of the steam pump, and the engine for pumping the water out of coal mines so they could get the coal out, and that eventually morphed into the steam engine for locomotion, which really launched the industrial revolution.

And about seventy years after the Industrial revolution really got under way in earnest, we started drilling for oil. We discovered there was quite a bit of it and that it was even more powerful an energy supply than coal was. It was a liquid and it was easy to transport. It was superior to coal in every way. At that point, we made the transition from coal to oil and you see this especially around the turn of the century � end of the 19^th Century, turn of the 20^th Century � where whole systems like the British Navy begin to convert from coal to oil, and railroad systems convert from coal burning steam locomotives to oil driven engines, and so on. And that really launches the great robust phase of the industrial revolution in the 20^th Century.

Now, the point I'm trying to make here � probably in too windy of a way � is that this transition really only happens twice: from wood to coal and from coal to oil. It's not like It's something the human race has done thirty times. There isn't this enormous precedent for overcoming every case of a resource problem. In fact, anybody who’s a reader of Jared Diamond�s book Collapse or Joseph Tainter�s book The Collapse of Complex Civilizations, understands that there have been many societies that ran into trouble with their primary resources and essentially folded up. So, when people say I'm being a Cassandra or crying wolf, and that we will come up with some miracle fuel to replace oil or some combination of alternative systems, I greet that with a lot of skepticism. I think It's unlikely.

JIM: One thing that we're seeing as a result of this lack of supply and growing demand as well is the energy markets becoming more volatile: gas prices can spike up, they can spike down. Prices seem to rise or fall on any bit of news. It could be an inventory issue. It could be a political issue. The problem, though, is that there is no excess capacity in the system to handle any disruptions, either on the political front such as we saw in Venezuela or Nigeria or in the Sudan, or quite honestly, what we saw this summer on the weather front with the hurricanes. Earlier this year we interviewed an oil geologist, Ken Deffeyes, who’s written a number of books on energy. He pointed out the vulnerability of price spikes, especially weather:

KENNETH DEFFEYES: In one sense, all of those are right. And the way they can all be right is that we're probably going to be looking at enormous volatility in price, lots of flaps up and down. So that after one of the big financial firms announces that oil was going to go to $105, I said it was probably going to get to $105 a barrel, but We'll see 2 big dips between now and then. And we've had a small dip in the last week or so.

But when the supply is closely matched to the demand, as it is now, then little things like a hurricane in the Gulf of Mexico, a warmer-than-average Winter in the Northeastern United States, labor troubles in Nigeria, and those little things can cause the price to flap around a lot. And, you know, if we get lucky and have a warmer-than-average Winter, no hurricane hits the Gulf of Mexico, Chavez behaves himself in Venezuela, and so forth, and so forth, and then, wow, for a moment There's going to be enough oil and the price will go down and of course a thousand economists will chant in unison: See! There was no Hubbert's Peak. There was no problem: the price just went down. [18:38]

JOHN: You know, Jim, isn't the real problem here that in reality we are close to approaching peak oil? I know this is what you believe. you've been tracking this area for more than a decade, and you wrote about it both in 2001 and 2002 before it was front page news.

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JIM: John, I not only believe that we're getting close to peak oil, but I also believe we aren't prepared for it. You and I have had discussions on the air and off the air about this. Despite all of the difficulties, the price spikes, the shortages, and the hurricanes that showed all the vulnerabilities, (we've had a lot of debate on this issue) we've done nothing to resolve it. we're not building refineries. we're not opening up the West Coast or around areas of Florida for exploration. we're not doing anything to bring on wind or solar power. And the real problem � as Matt Simmons talks about � is what do you do when one day all of a sudden we just simply have hit peak oil? We can't produce any more. The peak oil people are the ones who have made a more compelling argument for this case, because we've had both sides on the program. But let's listen to a number of them from Ken Deffeyes and Matt Simmons to Michael Klare and James Kunstler as they talk about this issue peak oil.

KENNETH DEFFEYES: Well, one thing They're not likely to tell you, but Exxon-Mobil has come around to counting how much oil had been found in new oil fields each year. And they and I both have 1986 as the year when we ceased finding as much new oil as we were burning up.

Well, Mathew Simmons was here this past weekend for a conference and he said It's this year. we're there now as far as the peak is concerned. But part of the reason I tell people I pay attention to Matt Simmons is that I'm an academic. he's a banker. I'm a native Okie. He grew up in Utah. I grew up Presbyterian. He grew up Mormon. He doesn't use Hubbert�s data, he doesn't use Hubbert�s mathematical methods, and somebody told me he had 5 private jets and I drive a Ford pickup, but we get the same answer.

MATTHEW SIMMONS: I decided that this book was going to be so controversial that I really tried my darnedest to avoid a bunch of very specific conclusions that people could shoot holes in them, like �how would you know that?� But I've had enough time now to reflect on everything I wrote about, and also feedback from lots of technical people that said, �you know what, what you triggered in the memory of what was going on in the 70s�, and etc, etc. I think It's highly likely that They’ve actually exceeded sustainable peak production already. And I think at the current rates they are producing these old fields, each of the fields risks entering into a rapid production collapse.[9:03]

JIM:If this is indeed the case then by assumption, we have to assume global peak is at hand then.

MATTHEW SIMMONS: Absolutely. Once It's clear that Saudi Arabia cannot sustain increases in its production on a sustained basis, then in my opinion with a certainty of 99.9%, the world has actually passed sustainable peak production. Because one of the reasons all of these supply models always have Saudi Arabia producing 25 million bpd by 2025 is that there isn't another country on earth that has the potential to raise their production more than 1 or 2 million bpd at best.

JAMES KUNSTLER: Well, It's not a religion. It's a pretty simple idea. And yes, I believe it. I do not believe that the earth has a creamy nougat center of petroleum. I believe that the models that have been devised to show how much oil was out there and how much we've been able to get are pretty accurate. And with the numbers, especially the production figures and the sales figures � we know how much oil is being consumed on a daily, weekly basis � It's very clear. It's a little bit less clear how much oil is out there in reserve, but we have a pretty clear picture from most of the producers. It's only a few producers like Saudi Arabia that we're not quite sure about and that picture is beginning to resolve too.

So, yes, I believe in peak oil and I believe we're probably closer to it than the group that thinks we're closer rather than further away. we're in the zone.

MICHAEL KLARE: I think that the issue of peak oil is going to increasingly dominate our foreign policy, and that of other countries, because we've always assumed in this country that there will always be more oil when we need it. That we can plan our economy, industrial program on the assumption that more and more oil would be there down the road. And the Europeans, and the Japanese have thought this way and now the Chinese are moving in that direction pell mell. They're building highways, They're building automobile factories. Everybody is assuming there is going to be a lot more oil but that may not indeed be the case. We may reach a point in this decade of the next when the world oil industry is not able to increase production to satisfy all this new demand. [24:07]

JOHN: Alright, Jim, there you have it, a passel of experts telling us that peak oil is here or at least we're getting very, very close. Now the question that I would ask is, isn't one of the problems that we have accepting this fact is that you hear stories that OPEC, or Saudi Arabia, have increased their oil reserves, and these reserves are bigger today than they were during the last decade, and yet the increase in reserves isn't based on new oil discoveries? They're sort of paper barrels changing the figures as Matt Simmons contends:

MATTHEW SIMMONS: They jumped from 110 to 160 from 1979-1980 and then at the end of '87, starting with the number they reported in '88, the 160 became 260. They were called 'paper barrels' at the time. [43:42]

They all got into arguing that they should have production quotas based on the number of proven reserves. And so Kuwait, and Iraq, and the UAE went from 30 billion each to 90 billion. And actually, to give Saudi Arabia credit, they were the last to fall in line of the Middle East producers and also triple their reserves. But why anyone ever believed it is what I find so amazing. Any time you see a static number for twenty years, people should obviously start saying, “That obviously isn't a real number.”

JIM: “Static number for 20 years.” That's the surprising thing about the comment. Something that Matt brings up in his book, John, is that, for example, Saudi Arabia has pumped out about 45 bpd barrels of oil, and yet their oil reserves have remained constant. Well, anybody who looks at the production decline curve of an oil well knows that you can't keep producing more oil each year and have your reserves always stay the same. I think Simmons brings up a point right there that nobody has questioned this. It should raise a lot of questions in the intelligence community and the investment community: “Wait a minute, where do these numbers come from? What stands behind these numbers?” It's kind of like digging into a balance sheet and looking at the footnotes. Nobody�s looking at the footnotes here.

In fact, if we take this discovery process and where we are � why we've had fewer oil discoveries each year � Simmons gave a great analogy when I talked to him last time about the oil discovery process, likening it to a chess board. Yet, I think this analogy to some extent explains why oil discovery peaked in the late '70s and why we have continued to discover fewer oil fields each year. And John, those oil fields are not only fewer in number, but they are also smaller in size. As Ken Deffeyes says, Exxon-Mobil is keeping track of this and I think it was 1986 the last year that we failed to replace the amount of oil we were consuming each year. But let's listen to Simmons’ chess-board analogy:

MATTHEW SIMMONS: The French Petroleum Institute did a major study a couple of decades ago about the distribution of oil fields by basin. And what they found was that what seems to happen with phenomenal regularity is that within about 5-7 years of moving into a new area of prospective hydrocarbon, you tend to find the queen first, which is the second largest field you're going to find. You then calibrate in on the knowledge of how you found that and within a handful of years you find the king. And then over the next decade, you find there too, the next 8-10 lords. And once you've found the royal family, the rest of everything you'll ever find are basically peons in size.

JOHN: Basically, what we're doing here, Jim, is looking at the objections we've heard from people over the year as far as peak oil is going. First of all, we hear old figures from OPEC and Saudi Arabia [which are] unaudited � nobody�s verified these � so we have no idea whether these are true or not. There are other issues that have to be looked at. One of these is technology. There's a widespread optimism out there in the field that no matter what the problem is in this case declining energy supplies technology somehow will lead us out of it, and We'll discover a new source of energy.

JIM: I asked Simmons that question about technology and increases in production, because you look at Simmons Intl, They’ve financed the majority of the oil service companies that are around today. This is what he had to say about increased production and technology:

MATTHEW SIMMONS: Well, we continue to pull more and more out of the North Sea and then we found deep water, which was a fabulous last shot from the basins. We already had shallow water production. And we took the Middle East oil back up to unsustainably high levels of production. So probably, we're sweeping the cupboard bare. People looked at the way we were able to do this and thought, “Wow! this is actually easy,” without realizing what we were actually doing was totally non-sustainable.

JIM:If I was to use the analogy to advances in technology, were we just using bigger straws, in effect, to get the oil out?

MATTHEW SIMMONS: Absolutely. But so many oil experts got giddy. By seeing the return to high flow rates, they started believing that we were actually now finally getting a vastly higher amount more oil out of these fields than we could produce before, and therefore, we were headed to an era of unbelievably plentiful oil at unbelievably low prices. And I’ll tell you, as we speak right now, ironically the same week that Twilight in the Desert began shipping, Cambridge Energy Research Associates, Daniel Yergin, who, I think a lot of people think is one of the more respected � or maybe most respected oil analysts on Earth, began producing a report saying effectively and there was a big editorial piece in the Washington Post this Sunday � that the world, between now and 2010 which is not very long away is going to add 16.4 million bpd more oil and create a massive oil glut, and collapse the price again. Now, I've read carefully through Daniel Yergin�s detailed field-by-field bottom-up report and basically, it is a really flawed piece of analysis in my opinion. But the fact that they obviously believe It's correct. They're doing talk shows shows you the depth of limitation of people that really understand how serious this is. Cambridge Energy Research Associates also, in 2001, were unbelievably pooh-poohing the idea that the United States had now entered a major natural gas crisis. But by 2004 they got the religion. I expect by 2009 They'll issue a magnificent tome saying, “Gosh! It looks like the world is now past sustainable peak oil supply.”

But What's dangerous is how many of the optimists really believe we won't ever have any oil problems. I hope I'm actually wrong in my dire predictions, but I hope people actually take them seriously and figure out a way to prepare for them, since if we do that we win either way. [31:10]

JOHN: Jim, one issue that we really need to address before we talk about the geopolitical aspects of oil as something that continues to circulate around, and that is the belief that the higher oil prices today are nothing more than a sort of cartel a big conspiracy by the large oil companies to artificially make supplies short and thereby to get higher prices out of it. we've seen some memoranda supposedly floating around the Internet.

Source: www.oilnergy.com

JIM: The easy answer to that is to ask the conspiracy kooks, John, why we experienced declining oil prices for 2 decades [1980s and 1990s]? I have in front of me on my computer screen a chart of oil prices, which peaked in 1980 at around $40 a barrel. They got down to as low as $10 a barrel, then they spiked briefly during the first Gulf war, got back up to $40, but then they declined back to $20, $18, $17. We got down to $10 and around 1998 back up to $20. So, when you ask them, �Ok if There's this big conspiracy and They're controlling prices, then explain 2 decades of price declines?� They shut up when you ask that question. Really, if prices were at $40 a barrel in 1980 and the oil companies were so big and powerful. why did they allow the price to decline for 2 decades? You simply wouldn't do that.

Or for that matter, why did they allow the returns on their capital to fall almost in half? If you take a look at profits in the refinery business, they were so bad � at less than 5% � that many companies flat out went out of business and many majors scuttled their refineries. So, we went from 350 refineries to almost 148 today. The conspiracy theories just don't add up or hold water. If the oil companies could really control the price of oil, we would never have had $20 oil or $10 oil in the '80s and '90s.

The real truth, John, is the United States is no longer in control of its energy future. I mean, let's face it, we import 60% of our energy needs. We have to import it from places like Saudi Arabia. we're importing it from Venezuela. And not only are we importing oil, we're also importing gasoline, because we don't have enough refinery capacity.

You saw this was very evident after Katrina and Rita struck all those refineries. 7 major refineries were taken offline and then they wonder why prices are so high. Energy imports are another reason why we're running record trade deficits. As a result of Katrina and Rita as I mentioned, John, even as we are speaking today, we're not only importing oil and natural gas into this country because of a decline in our production, but we're also importing everything from gasoline to jet fuel, because of the lack of our refinery capacity. [34:19]

JOHN: Yes, and this also then reflects upon an issues that very, very few people outside of tough government or military officials contemplate, which is energy security, especially if we take unaudited numbers from countries that may or may not be our friends. You simply can't understand oil economics without also understanding the geopolitical and military significance of energy.

JIM: John, oil is a political commodity. It's similar to gold and silver. If you look at the US today or China, Russia, or Europe, energy security has become the number one foreign policy issue today. Whether It's the United States trying to secure the Persian Gulf or It's China trying to buy oil from Sudan, They're scouring the globe today trying to secure energy supplies. Energy security is a very major issue and playing along with energy security is geopolitics as Professor Klare talked about in his two previous books.

MICHAEL KLARE: “Well, the reason is that oil is essential to the world's economy on one hand and secondly, because it has become viewed as a matter of national security by powerful countries like the United States and China. No other resource in the current era has that character where governments actually say. "This is a matter of national security. We'll use force, if necessary to fight over it." So you combine the importance of oil and the fact it will become increasingly scarce, and its national security dimension, and it makes oil very special. And That's why I focused on it.”

This is the period when Huntington was writing. This is after the breakup of the Soviet Union -- the beginning of the Post Cold War era. What I did was I looked a lot of the same conflicts as he did: the wars in Africa, in the Middle East and the Balkans. He concluded that what was behind that was conflicts between civilizational identities as he called them � religious or ethnic � but when I looked at those conflicts, That's not what I found. I found that more often than not there were competing warlords who were fighting over valuable sources of resources: diamonds in countries like the Congo, and Angola, Sierra Leone, and Liberia; rare timber in Cambodia; copper mines as in Papua New Guinea; and of course, oil. So, my view was that you couldn't describe these wars strictly from an ethnic or identity point of view. You have to look at the reserve dimension, and when you do, it often turns out to be dominant. [37:18]

JOHN: Well, looking back on this year also as far as energy is concerned, we've experienced another energy crisis that is actually still with us, though you wouldn't know it from watching a lot of the mainline media. Oil and natural gas production in the Gulf of Mexico hasn’t fully recovered. I think as of this show, we still have less than 30% of our oil and natural gas production, which is still shut in. we've experienced record energy prices this year from oil to natural gas, we're paying dearly at the pumps for gasoline and at the same time, if you've noticed, virtually all politicians are running the wrong way. Congress is fiddling in the face of another oncoming crisis. This week Democrats blocked drilling in ANWAR. Democrats with liberal Republicans teamed up to block offshore drilling, reducing the permits on refineries and eliminating a lot of the Heinz 57 varieties of gasoline mixes, which would really simplify the whole process of refining here in this country. Not only refining, Jim, but shipping it down the pipes because they have to be cleaned before the different blends can be shipped down so they don't contaminate each other. In essence, despite another major energy crisis and record energy prices, Congress has done nothing to ease the energy burden or to make the country more secure with an energy policy.

JIM: You know the thing that amazes me more than anything else that I've seen this year is despite record energy prices. I mean oil got up to $70 per barrel shortages this Fall following the hurricanes Katrina and Rita and record energy imports, a month doesn't go by that we're not reporting record trade deficits. And behind them are record imports of oil, natural gas, gasoline, and jet fuel. Despite all this, John, Congress has done nothing but dither on the energy issue. Nor has the Media done a good job of educating the American Public in my opinion of the dangers of this energy security. The Media, as that one general said, “is still stuck on stupid.” Or the've gone on to other things. This reminds me of what veteran CBS news reporter, Tom Fenton, said last Summer.

TOM FENTON: I think That's a prime job then to see What's coming down the road, to anticipate things, and to warn people of the dangers that are there. And That's where we really fell down on the job. And one of the main reasons why the mainstream media fell down on the job is that we've been demobilized. At the end of the Cold War, at the end of the 1980s, the major newspapers, the networks, the big news organizations felt they could cash in on the peace dividend and they began to close down foreign bureaus. They got rid of foreign correspondents. They got rid of the eyes and ears that are necessary to hear What's happening, to see what is coming down the road, the boots on the ground. It's the same thing that our government did at the time of the end of the Cold War. They demobilized the intelligence services. Well, the news organizations did the same thing. [40:28]

The energy issue isn't going to go away as politicians may be hopeful that it will. But I'm afraid, John, if we're going to be doing this show next year, we will be once again be addressing the issue of energy. Perhaps, it will be a geopolitical event in the Middle East, such as Iran, or maybe It's another bad hurricane season that knocks out energy production in the Gulf. The problem isn't going away. And unfortunately we're doing nothing about it. Here is what we should be doing according to the experts:

MATTHEW SIMMONS: We have to figure out a way to do that because if we go to war, it will actually be the worst war we've ever fought. And if we don't address the problem, we will be in an energy war. What I find interesting is I actually think we can solve this problem, but I also think if we ignore it, you can't create a scenario that is too awful. What we have to do is first of all, long term, create some new forms of energy that don't exist today. That might or might not be possible. I suspect that actually it will be possible because we haven’t worked on it for a hundred years. While we're doing that though, we have to figure out a way that allows the world to prosper and not shrivel up while we're using a lot less oil per capita. And figure this out quickly enough so we educate the China and India's of the world on how to create a sustainable society so they don't build a society like ours. Because It's going to be easier for them to do some of these things than it is for us.

And I'll give you just a quick shopping-list of some of the things that we are actually going to need to do. In the shipment of goods, we use worldwide about as much, or a little bit more, diesel fuel than we do motor gasoline, and most of the diesel fuel is used by the truck fleets moving goods. If you could wave a magic wand and in a 5 year period of time and get all of the goods off the highway system going long distances by trucks, and put them on either railbeds or water transportation: on the railbeds, railroads, as long as you have long distance transportation, and long trains versus short trains, and short distances, you can get an energy efficiency savings of somewhere between 3 and 10 times. That's not 3 and 10%, That's 3 and 10 times; if you can get them on boats versus trains, it has an additional energy efficiency savings of another 2 to 5 times. So by getting trucks off our highway system we have a major impact on removing traffic congestion. And traffic congestion is public enemy number 1 through 5 on passenger car fuel efficiency. So It's a real win, win, win.

At the same time we have to alter our distribution of food. You know, the average thing we eat today comes from, I believe, an average of 1500-2000 miles. But there are a lot of items, like the first time I ever heard of this concept of food miles was a speaker in London, last Spring, who pointed out that in the Summer in the UK ,almost all the apples come from New Zealand, and they have embedded in them 22,000 miles of travel of a vessel, half coming from New Zealand, and the others going back. When They're onboard the vessel They're refrigerated. So It's a very energy intensive process. We actually can grow stuff close to home in most parts of the world. We just got lazy and thought it was really fun to just go into a grocery store and see all this produce: it doesn't taste very good, but it looks nice.

And then finally we can basically go to distributed work. Because I found being in Maine in the Summer is a lot more pleasant than being in Houston, I taught myself 10 years ago how to be up here and be more efficient than when I'm in Houston. I think there are lots of corporations that have a thousand people working together; There's no need for a thousand people to be working together, other than the fact it was just a historical coincidence. We now have the technology that people can actually either work at home or work in their village, and by saving 2-4 hours of commuting they will be far more productive. And then we basically end globalization as we know it today, which is effectively a really flawed plan of breaking manufacturing components down into their smallest parts, and finding the cheapest place in the world to manufacture the parts, and then zinging them around the world to be assembled into bigger, and bigger units, until they finally arrive on the showroom as a piece. If you make stuff close to home, you can have a major savings in fuel efficiency. That sort of a plan put in place over 5-7 years would take a lot of coordination; not a single one of those things are impossible to do. We could literally end up cutting oil consumption by 20-40%, by doing all of those. [45:10]

KENNETH DEFFEYES: Well, there are a few things that we can do right now. One of course is to convince all the kids to turn out the lights when they leave the room. To the extent you can keep the house cool by opening the windows at night and closing them at 9 in the morning, as long as you can do things that conserve energy, rig up a carpool if you can't take public transportation, at least get some neighbors together and start a carpool, and those are things that help. If you didn't do it for Jimmy Carter, check on the insulation of the house, the insulation in the windows, find out whether you can cut back on how much energy you consume. And That's good for your own pocket book, and not just for the world. So, there are some little things we can do to help. On a bigger scale one of my friends here in New Jersey went shopping for a Prius hybrid gas and electric car, and he was told There's an 18 month waiting list, and you'll pay $8 thousand above the sticker price. So, It's not easy right now to change some of the major things, but at least we ought to start doing the minor things and getting in shape. [46:26]

MICHAEL KLARE: There really is no easy answer to that question, Jim, the answer takes 2 parts. There's a short term and a long term. The long term is that we have to invest a lot of money in research and development of new technologies, and potential new sources of energy. There's a lot of excitement for example about the potential of hydrogen as a new conveyor of energy, to use hydrogen to power fuel cells in automobiles for example. I understand that General Motors unveiled a new fuel cell vehicle at the Detroit Auto Show this week. So, there is a possibility, but it is going to be many, many years before this is something you can walk over into your neighborhood auto showroom and pick it out and buy it and drive it, because there are no gas stations in America that supply hydrogen. So, we have a lot of work to do to make that possible if That's going to be our future. 20 or 30 years of effort have to be made. In the meantime what we have to do is to conserve the existing supply of petroleum and use it much, much more prudently. And that means I think driving cars � they may be oil fueled but much more fuel efficient: hybrids, or very fuel efficient internal combustion engines. That's going to require the States and the Federal Government imposing increasingly strict fuel efficiency standards. There is no other way, we have to conserve the remaining oil and give us the time so that we can develop the alternatives that we're going to have to rely on in 20 or 30 years. [48:13]

JOHN: Well, Jim, there you have it the voices of Matt Simmons, Ken Deffeyes, and Michael Klare on the issues of what it is we are going to have to do. And really, the fact that no one has digested yet is that life is simply not going to be the way it was. It simply will not be. And what makes this situation so precarious is despite the fact there are higher prices, shortages and record trade deficits due to energy, we've done nothing.

This week Congressional Democrats voted down drilling in ANWAR as we said before, we haven’t passed a bill to get rid of 800 different permits to build a new refinery outside the hurricane belt, nor review a lot of the regulations that are out there that are crushing these various industries. The Arizona refinery has been waiting for longer than a decade to get going. We haven’t opened up offshore drilling, nor have we simplified the 50 gasoline mixes and blends. In summary, we've done nothing and we're no better prepared to handle the next energy crisis that will soon be upon us. It's not in the farthest of futures.

JIM: Well, as Matt Simmons is fond of saying, you can boil it all down to this: we have no Plan B.

MATTHEW SIMMONS: Nope. While we're doing Plan B by the way, we jumpstart the largest energy R&D program ever envisioned, and just pray that over 5-7 years it has the same impact as when people got serious about developing radar, and developing nuclear power, so that we could actually win World War II. But if we don't do these things, then this really ends up being a very dark world no pun intended.

JOHN: And leaving us with the sobering thought, Jim, that we don't really don't have any Plan B right now and we desperately need one.

Part 2

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• Commodity Bull Gets Its 2nd Leg
• Inflation, The Economy and The Business of Reporting
• Final Comments

Commodity Bull Gets Its 2nd Leg

JOHN: Welcome back to our 2005 year-end summary as we look back over the year -- both in our words and the words of the experts, who were guests here on the program this year. You know, one of the other issues that was really a focal point in the investment markets was what happened to commodity prices this year. I don't care where you look, most commodity prices were setting multi-decade highs from gold, to oil, to copper, and platinum. And since we've been talking about oil, oil prices alone are up 45% this year. Natural gas prices are up 110%; copper is up over 70%; cattle and hog prices are up 17% and 10% respectively; gold is up 12%, after being up 17% to $531; and even silver is having a good year up over 27%. As Jim Rogers pointed out in your interview this year, bull markets are supply and demand driven.

JIM ROGERS: Jim, first, if you go back in history, you will see that this has recurred periodically for the last couple of hundred years. I have a chart in the book showing � documenting this � First, It's simple economic history: you have long multi-year bull markets followed by long multi-year bear markets. We can explain why in a little bit. The basic reason though It's not some magic from heaven, it's supply and demand. During the '80s and '90s you had a lot of people screaming about hot mutual funds, hot money managers, and hot stocks. Nobody called you up, Jim, and said let's invest in a sugar plantation, or let's invest in a lead mine, because commodities were in a bear market.

Now, when There's a bear market, people do not invest in productive capacity and so supplies dwindle and diminish. There's been only one lead mine opened in the world in over 25 years. The last lead smelter built in America was built in 1969. There's been no great oil discovery in the world in over 35 years. Alaskan oil production is in decline now; Mexican oil production is in decline; England, which has been one of the great oil exporters in the world for the last 25 years, is now in decline � England will be importing oil within the decade � you know, the North Sea is in decline. So, as supplies dwindle, at the same time, Jim, you know what has happened in Asia, demand has grown � in America, Europe and everywhere � so when you have demand growing, and supply dwindling That's a bull market. And It's always happened, and as I said, it has happened throughout history. It's not simple, but It's pretty basic economics and basic history.

JIM: John, you mentioned a number of commodities that were up this year, talking about oil prices being up 45%, natural gas up 110%, copper up around 70%, but It's the whole commodity complex as a whole that is seeing a continuation of what I believe is a primary trend: a bull market in commodities that is still in its infancy. The CRB index, which is 19 commodities, is up 17% this year. It's up nearly 78% since it bottomed in the Fall of 2001.

The thing I think that most people don't recognize in the early stages is these cycles last for a long, long time. we've had them every 18 years. From 1982-2000, it was a paper bull market. Since really 2000, It's a new bull market that has started in commodities. Jim Rogers, who has made a lot of money in commodities, explains why they last such a long time:

JIM ROGERS: You're exactly right. I mean, if suddenly somebody finds a huge oil discovery in Berlin, or in downtown New York, or Tokyo, it would be a wonderful, wonderful thing for the price of oil, but so far nobody has done it. Maybe There's huge amounts of oil left in the world, but we don't know where it is. And even if we start finding it, it takes a long time to bring it to market. In the meantime, Jim, other oil fields continue to decline. As I said, the North Sea is in serious decline. So, unless we find it very quickly and find it very conveniently the price of oil and energy has to stay high. The surprise is going to be how high it stays, and how high it goes.

Jim, I wish I knew. That's one reason I wrote the book. And even then I assure you there are going to be lots of skeptics. People don't know about commodities. People have been told to stay away from commodities for decades and therefore, if they don't know about it, they say, �Oh, go away and leave me alone.� It's the unknown for most people and you've seen it before. If we sat down in 1982 and said "Buy shares," there would have been so many horror stories about all the people who had lost so much money in stocks in the '60s, and '70s, and' 80s. There would have been so many horror stories. On the Business Week front page cover story, which said stocks are dead, that people just wouldn't have done it. Likewise with bonds. But of course that was a great buying opportunity. [5:11]

You know, Rogers is pointing out here why these cycles last a long time, John. You have supply and demand imbalances that come about as a result of a bear market: commodity producers go out of business, the prices fall, the industry consolidates. And then in the meantime you get more people on the planet and the basic things that we need in our life are basic commodities. So, you have in addition to a supply and demand imbalance that comes about, you also have demand catalysts that come into play, which are population booms. And It's something that Barry Bannister pointed out when we talked to him this Summer:

JIM: If we look at the last two centuries, we find that commodities sort of inflate and deflate in unison with energy leading that. In terms of patterns, where we are now, where are we?

BARRY BANNISTER: Energy doesn't always lead. Sometimes, such as during wars, you might have U-boats. So agricultural prices may be very strong because It's pretty hard to get the trade done. Or you have to divert some metals to other uses in wars and so metal prices have to be price controlled and rationed. But energy is the core. It is the life blood of economies. It prevents devolution to disorder. It holds everything together. It courses through the veins of the industrial economy and without energy, you simply wouldn't have anything. You wouldn't have any activity, except maybe brain power, and that may only last as long as your food supply, which again is derived from energy: used to make food, fertilizers is driven by energy prices, nitrogen fertilizer requires natural gas and so forth also, you have to feed the animals and process the food. And so nothing happens without energy.

Now we're at the bottom of one of these cycles, I believe. They’ve averaged about 18 years in each direction, up and down, so That's 36 years point to point. we've had 6 or 7 upturns and downturns in the last 2 centuries and we seem to be in one of those upturns, the last one having been in the late '60s, and we're doing it again.

JIM: That may slow down demand in the short term, to some extent. What about the long term catalyst that makes this a long term trend?

BARRY BANNISTER: Well, I've said There's been many years of low returns on capital. Only a fool would have put new money into oil field technology in the late '90s, when obviously the best money should have been spent on Internet. But the good thing as an investor is your interests are not aligned with the general consensus of the public. I don't think like the public. I don't act like them. I think in terms of what could be or What's going to be -- not what should be.

So when I looked at investment in the late '90s in energy, mining and new mines, we purposefully reduced the capacity through underinvestment. All we needed was a demand catalyst, which was the Chinese and Indians, to help tighten up the market. And then we had the ingredients present for a supply and demand-driven bull market for the hard assets, which are very difficult to produce. It takes years and years to bring fields on stream, to make them productive. And so I'm fairly pleased the investment is just beginning, which means that the peak is probably not till 2010-2012 for the investment rate, and so the new supply will not be an issue for probably 5 more years, as far as I'm concerned. [8:43]

JOHN: You know, I was wondering. Why do you think that -- perhaps outside of energy for that matter -- no one has paid much attention to this bull market in commodities? I mean certainly commodities like investments or commodities themselves have really had stellar returns in comparison to the general stock market.

JIM: It's really a stealth bull market at this point. Yes, people notice energy prices are up, but only because They’ve gone to the gas station and They’ve seen that the price of gasoline has gone up. Or maybe They’ve got an increase in their utility bills? But if you take a look at the Dow Industrials, the NASDAQ, and the S&P 500, we're at lower prices today than where we were in the first month or second month of the year 2000.

And yet in the beginning or the middle of a recession in 2001, commodity prices took off and they've never looked back. I don't care if you're looking at energy, oil, natural gas, heating oil, copper, lead, zinc, silver, gold any type of commodity lean hogs, cattle prices, That's where all the money has been made. But yet what I think we're seeing right now is we're in the early stages of a bull market. In the early stage, you have what I call the "early adopters" -- That's the smart money that gets in. And usually it isn't until you get to the final stage of a bull market that the trend is adopted by the public. If you look at the equity markets, the majority of money that went into the stock market came in to the mutual fund industry after 1995 when we had already had basically 14 years of a bull market. So the public came in toward the very end.

You also have a Fed rate-raising cycle right now, so some investors are probably skeptical if this trend can continue because everybody is worried about economic weakness. If the Fed raises rates high enough, the economy will slow down and go into recession. And with a recession There's going to be less demand for goods, so therefore less demand for commodities. So there is some of that thinking right now. But commodities can do well in an economic downturn even in depressions. As I pointed out, this commodity bull market began in the mid of a recession and It's not unusual in a recession or a depression that you see the greatest bull markets in commodities as Jim Rogers points out:

JIM ROGERS: In the 1970s, England was one of the five largest economies in the world, one of the five largest. England went bankrupt. It had to be bailed out by the IMF and economies all over the world were doing badly. And yet we had one of the great bull markets in commodities in history. And That's because there was no supply. If supply goes down faster than demand you have a bull market. In my book, I use lead as an example � as a teaching example, I have a whole chapter � lead in the last few decades has lost its 2 major markets. It lost gasoline and it lost paint, and yet lead as we speak, is at an all-time high, because despite the huge drop on the demand side, the supply went down even more. And so here's lead at an all-time high.

You can contrast that with gold, for instance, for which there are vast numbers of believers and lots of supply. Gold is 50% of its all-time high because supply has continued to grow or certainly hasn't disappeared. And therefore you don't have a huge bull market. All of this stuff is supply and demand. You can have a bad, bad economy and still have a huge bull market. [12:22]

JOHN: You know there was something that Jim Rogers mentioned in your interview, which I think is helping to change the perception of commodities as an asset class. That is their negative correlation to the markets.

JIM: I think what you're referring to was his reference to that Wharton and Yale study that showed commodities are not only negatively correlated to the stock market as an asset class, but John, even more important was the fact that commodity returns have equaled and at times surpassed the returns in the stock market.

JIM ROGERS: What's equally fascinating is they started it off by saying�when we started looking at commodities, we thought We'd find lots of studies. We were astonished to find there are virtually no studies on commodities. And you asked earlier well That's part of the reason that nobody understands commodities, because nobody has ever really systematically sat down and looked at them. The professors � and Jim this is not some whacko like me, this is Yale University and the Wharton School at the University of Pennsylvania � said in the last 45 years you would have made more money in commodities with less risk and you would have had a better inflation hedge.

Now, if I'm right, this is going to change the face of investing and especially commodity investing, because they have now confirmed everything nuts like me have said and they have made it legitimate. You remember when the academics did a study on junk bonds in the late '70s, it opened a whole new asset class which had never existed before. Now there are hundreds and billions of dollar invested in junk bonds around the world. In the '60s there was this academic study about stocks, which made them legitimate again after the '30s, '40s, and '50s. This is going to make commodities legitimate. All the Trustees and directors and investors who�ve always said, �Oh get out of here, I don't even want to talk about them,� are not going to be able to do that in the future.

If I'm right -- and They're not making much money in stocks and bonds -- and commodities are doing well, They're going to be terribly criticized for not owning commodities, because they have now been made legitimate. And you're going to see huge amounts of money coming into this field. Not this year. Not next year, but over the next 10 years. Ultimately, There's going to be a huge, gigantic bubble as there is in every bull market at the end. But you know, That's a long way away.

Well, yes, I would go further than that. I would say stocks and bonds are not going to do well in the next 10 or 15 years and commodities will. So you should put your money in commodities. But most people are not going to do that. Warren Buffet has said many times, among other people, diversification is an excuse for people who are losers and not [the way] to make any money. The way to make money is to put your eggs in a basket and watch the basket very, very carefully. That is the way to make money. But let's say that people insist on diversification. Well you're exactly right, the studies have shown repeatedly, some of your money needs to be in commodities, if you're going to be legitimately diversified.� [15:19]

JOHN: Well, Jim, I'm going to ask my famous question, with an obvious established trend in commodities, where does a person invest?

JIM: Well I think something that we have to look at that stage of the cycle, and something we haven’t seen so far -- which I believe is going to change -- is that the CAPEX spending cycle is going to pick up. As prices of commodities continue to rise, eventually management of mines and oil companies are going to feel more comfortable in starting to spend money to improve and enlarge either an existing mine, find new deposits, or find more energy. When we were talking to Barry Bannister, who also is a good friend of Jim Rogers by the way and follows the commodity markets, he is probably one of the best commodity analysts out there today. He addressed this issue. This is something that you'll see in the next phase of the cycle:

JIM:Looking at the individual sectors, energy companies in particular, they've done very well. When do you think We'll see the surge in CAPEX spending? Even though companies are spending money, I don't think we've seen a great surge in CAPEX spending from the majors yet, have we?

BARRY BANNISTER: Not much. you're just starting to see backlogs rise and companies that service these sectors and build their capacity. And you're starting to see the oil service rig count up sharply. Since the 99 bottom, It's about doubled, but it was down for so many years. Your first wave of performance is the commodity and then the second wave would be the commodity producer. The third wave of performance is the people who serve the commodity producers: the service companies. And so you're starting to see some of that -- not as much as you saw already, but because They're fairly light on assets and they have the ability to magnify their return on capital -- those industries that serve these cash intensive, cash using, capital intensive, reserve purchasing commodity producers, these serving companies may be attractive right now. [17:27]

JOHN: Well summing up, Jim, you've gone on record and stated that this is really a long-trending cycle. It is your belief that commodities are becoming the next big thing, right?

JIM: John, before the second phase is over and I'm talking about the second phase of this bull market all bull markets have 3 phases to them, we're entering that second phase now � but before this second phase is over, I think you're going to see the old highs taken out in many commodities. Gold is going to be over $1000. I think you'll see silver over $50, oil is going to be at $100, natural gas will probably be closer to $30 or $40, maybe as high as $50 per btu, copper is going to be close to $5 per pound. We had Ross Beatty, President of Pan American Silver, talking about peak copper last week. I think also you're going to see the price of agricultural productions are also going to be going up as energy rises. So, you're going to be paying a lot more for meat, vegetables, grain, milk and cheese. And I think to put it succinctly, as Jim Rogers and other experts have said on this program, you need to be in commodity-type investments for the long run, because we're only one-third through this cycle. we've got about another 10-12 years to go. [18:45]

Inflation, The Economy and The Business of Reporting

JOHN: And Jim, launching forward, intrepidly into the future, despite Fed rate hikes, rising energy prices, and natural disasters, the economy has held up well this year. You must admit that.

JIM: You know, There's a reason for that, John, and I believe It's because money and credit are still abundant. When I was doing research for the final segment of The Day After Tomorrow, I was talking to the homebuilders and to the various lenders on these projects -- in fact the new project that has started to the east of us. I was really surprised by what the lenders and the builders were telling me. I expected with the Fed raising interest rates for them to say, “Boy, money's tight right now. The banks want to see more money down, a little bit more equity to cushion them.” I didn't get that. I got, “Oh There's all kinds of loans. we've got option ARMs. we've got 3 year ARMs.” There was a plethora of all kinds of loans that you could take out. So, they weren't basically saying, “Hey, things are tight.” So, interest rates may be rising, but the fact is credit isn't tight. There is plenty of money around and banks are still in the mood to lend. In fact, you can't look at the money supply figures any more, because there are more ways that credit enters the system. A lot people say, “well, we've had a slowdown in the money supply growth, so maybe things are tightening.” That is not the case. There's a lot more ways in which credit enters the system. And this is something that Doug Noland has made a close study of, which is our giant credit bubble which keeps expanding to this day. And I think that is what is keeping the economy afloat. let's listen to Doug:

DOUG NOLAND: I like to think of it today as money and credit are just electronic entries on this massive global financial ledger that we keep. And money supply contemporary money is just certain types of these entries that we make on, say, the bank balance sheets.

So, a lot of money supply would include demand deposits, and savings deposits, but we also include like in M2 retail money market fund deposits, and M3 will include jumbo deposits, and even institutional money funds. So, when we talk of money and credit we can look at narrow money, which would be let's say, Federal Reserve credit or we can try to look at broad money, which goes all the way out to M3 and would include a lot of these institutional holdings.

Source: Credit Bubble Bulletin, December 30, 2005

And when we're analyzing money and credit, the first thing we have to do is step back and look at is the system extending credit. And if you look at it today, it sure is. I mean we're at record credit creation. Last year we had double-digit household debt growth, which was I think the strongest since 1988. We had 9% government debt growth. Total nonfinancial credit grew at the strongest rate I think since 1988. So we know the system is creating credit. Even this year with a real deceleration in the money supply, you can look at bank credit and see that bank credit is growing year to date at a 14% rate, which is really incredible. We have real estate mortgage loans in the banking system growing at an almost 14% rate. We know that right now we have incredible mortgage credit growth. Last year I think the number of total mortgage credit growth was $1.2 trillion, which was a multiple of what we did during the 90s. And we're on track right now, I'm sure we're going to beat last years mortgage credit growth because we have more home transactions at higher prices. So, we have to stand back, and we know today that we have enormous credit growth.

Source: Credit Bubble Bulletin, December 9, 2005

So, then we have to look and try to determine which types of debits and credits what types of financial instruments is this system creating. And even if you look at money supply -- right now I do a measurement where I take out the change in the money market funds, because right now we have a major disintermediation out of the money market funds where I think a lot of individuals and a lot of institutions are just saying I would rather not pay a fee, I'll just go out and buy Treasury Bills directly you can buy them online or I'll buy commercial paper, or I'll buy all of these new instruments that Wall Street is creating. So, just the shifting of their money market fund deposits into owning securities directly can lead to a contraction of money supply, but even if I exclude money market funds, I think my year to date number is that money is growing above 6%.

Source: Credit Bubble Bulletin, December 9, 2005

But I think what is really going on right now is that we have a huge increase in mortgage related securities that we're creating and probably selling to institutional investors. So, instead of this money being circulated into bank deposits, money market funds, and instruments in the money supply, a lot of institutions are going for higher yield and buying securities that aren't included in the aggregates. So, it gets very confusing but importantly we know there is huge credit growth and we can also look at most spreads and indications of liquidity and we also know today that there is tremendous liquidity in the markets generally, not in some areas recently, but there is a lot of liquidity and credit creation. So That's why I argue we have cracks out that, but the credit bubble is unfortunately alive and well. [24:39]

I think what you need to understand here is something that Doug points out is that as long as there is money available, and number two you can borrow that money at a rate that is less than the inflation rate, people investors and businesses will keep borrowing. we've been dealing with this issue this year. Are we going to get a hard landing or a soft landing as a result of these Fed rate hikes? And it was one of the questions I posed to Barry Bannister in terms of where are we going. Are we headed for stagflation? What's going to be the result of all this money and credit?

JOHN: Jim, you mentioned that as long as business or investors can borrow at a rate that is below the inflation rate and invest that money at a higher return, people are going to continue to borrow. But in mentioning the inflation rate, it has become obvious to everyone that there is inflation at the consumer level. It costs more to live this year, so you argue that inflation -- not deflation -- has proven to be correct so far. You don't hear much from the deflationists anymore with oil being $57 per barrel, natural gas at $13 per cubic measure, and gold at $505 -- not to mention every other commodity that is going up. Just look at the cost of services, from health care premiums to education, to utilities. It's very obvious that the business of living is getting more and more expensive.

JIM: What I think we're seeing here is that we're at a critical juncture where we move from what I call low inflation levels to higher inflation levels that lead us into what could become a staginflationary era: anemic economic growth, but higher inflation levels. It was something Barry Bannister commented on when I talked with him last Summer.

JIM: Barry, I want to start our discussion with some macro issues that could impact the markets and commodities. We have a couple of scenarios. Scenario one, the US economy continues to grow strongly, the Fed raises interest rates, oil prices start to rise. That's one scenario. Another scenario is as a result of these, we get a weak economy and a hard landing. let's talk about that.

BARRY BANNISTER: you're hitting it on the head. I think There's the “darned if we do, darned if we don't” scenario -- that if we have a strong economy, oil will rise. The only reason oil would fall is if it reached a clearing price that slowed the economy. That's not a very good outcome either. But oil is already rising and That's because we have strong demand and fairly tight supply from years of under investment.

JIM: What about some of the implications? I remember when oil prices hit $40, they said that would slow down the economy. Then the figure was $50. Now we're looking at over $60 and we're still going strong?

BARRY: If you go back to the peak, around 1980, oil was around $95, inflation-adjusted. It would be a long way from the prior peak. Also, consider that the US and Western Europe are less oil-intensive than they used to be. But on the other hand, we have large trade deficits from countries that use a great deal of oil to make manufactured goods that we import. So we essentially import a lot of our oil in finished products, not just in raw form.

Another factor to consider, Jim, is that oil demand is now largely inelastic, which means that as the price goes up that doesn't mean that the demand goes down. You have no other choice to fly a jet, or to drive a car, than to buy oil, as opposed to 50, 40, 30 years ago, when you could cease using industrial boilers and quit burning oil to heat homes and so forth.

JOHN: I think the problem here, Jim, is that, as Barry Bannister has said, the business of living is getting more expensive, but it doesn't show up in the inflation numbers. And you've written about the subject a number of times. Your article, The Core Rate, exposed some of the monkey business That's going on as the government cooks the books to understate the inflation rate.

JIM: Well, looking at it from the government point of view, There's a strong political motivation to understate the CPI. By understating, it keeps COLA adjustments down on entitlements, which are at this point the largest part of the government�s budget. And by understating CPI, the government can minimize the inflationary impact on things such as rents, which are indexed to CPI, or wages, pensions and a whole list of ancillary costs to artificially keep inflation rates down.

But you're starting to see some labor unrest in the pub and private sectors: the New York Transit strike and the UAW negotiations with Ford are starting to reflect this. I think people instinctively know that the inflation rate is grossly understated. I mean they see it every day in their lives, when they go to fill their gas tank at the gas station; they go to the grocery store to buy food; they see a doctor; or they pay their utility bill. These distortions not only are being seen in our daily life, but by understating inflation they also understate the economic numbers. When we talked to John Williams he pointed this out in his monthly Government Shadow Statistics an excellent newsletter by the way let's listen to what John Williams had to say about the way they understate this.

JOHN WILLIAMS: Jim, most government economic statistics, the ones that are most widely followed and the ones that are most popularly quoted in the financial press, are very misleading. There are biases that have been built into the system over time so that there are overstatement of economic growth and an understatement of inflation. And this goes back in time. But in terms of how far out of whack reality has gotten with the reporting, right now the government is estimating annual CPI is about 2%. If you look at the way the CPI was calculated before the Clinton Administration, that would be up around 6% right now. Unemployment, They're estimating is a little below 5%. If you go back to the way unemployment was calculated before the Clinton Administration and some before that, the broadest measure of unemployment is up about 12%. The GDP right now is 3% growth or so They're estimating, but in reality That's about flat and we're headed into a recession. And if you look at the government's budget deficit, the bookkeeping there is so far out of whack that if you applied business accounting standards to the government's numbers, you'd see a deficit about 10-fold the size They're reporting. It's one that eventually will lead to an extraordinary circumstance which will be along the lines of a hyperinflationary depression. I hate to be the bearer of such happy tidings, but the good news is if you know this, there is a lot you can do to protect yourself. [32:20]

JOHN: Williams really highlights, as you have done, exactly how this distortion takes place:

JOHN WILLIAMS: Well, There's several things at work and what happens with the latest reporting as far as I can see there was an actual, outright political manipulation. If you don't mind my digressing a little bit, this is something that has been common to economic reporting over time. The current key series, such as the CPI in their modern form, came into existence after World War II. There were CPI estimates that went back as far as 1880, but after World War II it was designed as a system for adjusting cost of living for auto union contracts. And the CPI was not manipulated for a while.

The first manipulations came during the Kennedy Administration, an Administration or so after the numbers actually got into their current form. The Kennedy Administration played with the employment statistics changing the definitions that actually ended up underreporting unemployment. The Johnson Administration, Lyndon Johnson was known for taking the GDP, or what was known then as the GNP, and if he didn't like it he would throw it back at the Commerce Department and keep sending it back until they got it right. The Nixon Administration played with the employment statistics. The Carter Administration played with inflation. With the Reagan Administration it was more the trade deficit at the time of the stock crash, but there was also some manipulation or changing of methodology of the GDP, which led to some of today's overstatement of the GDP.

It was the last Bush Administration where the CPI really came under attack. And the two people who were at least openly responsible for it were Alan Greenspan and Michael Boskin. They started talking about how the CPI really overstated inflation, that inflation was a lot less. Really, inflation should measure not a constant basket of goods. let's say you find the price of steak goes up, what does the average person do? Well maybe they don't buy steak that night and they buy hamburger. So they wanted to design a CPI with what they call the "substitution bias" in it. That's completely contrary to the way CPI was originally intended.

The CPI was structured as a fixed basket of goods. If I buy some steak and some potatoes, a loaf of bread, and a gallon of gasoline, That's what it costs me for this year, then I do the same thing next year, and you look at the difference in the costs, you take the percentage change That's your rate of inflation. That's how much your cost of living has gone up. It's not: “Gee, I can't afford to buy steak so I'm going to buy hamburger,” and then plug the cost of hamburger in for steak. you're not going to get anything that accurately measures inflation. but this was a change that Greenspan and Boskin wanted to make.

The reason they wanted to make it, and Greenspan was very open about it, was that if they could reduce the level of CPI reporting the level of CPI inflation they could reduce the level of increases in Social Security payments the annual cost of living adjustments. There was enough political furor at the time that the whole thing just died down. But then after Clinton came into office. the Bureau of Labor Statistics, which is the agency that put these numbers together, came up with a way of approximating what they call "the bias factor." So that instead of having what had been the traditional cost of living -- which is really a cost of living of a fixed constant standard of living -- they changed the CPI over to what I call a cost of survival.

Instead of using actually substitution though, they used what is really a mathematical trick. What they did is they changed the way the components of the index were weighted. Instead of just a straight weighting, they put in what is called a geometric weighting. And the nice thing about a geometric weighting is that if something goes up in price, it automatically gets a lower weighting. If it goes down in price, it gets a higher weighting. Of course, the effect there is what ever happens with inflation, with the geometric weighting, you get a lower rate of inflation. The difference that makes right now, It's very close to 3% against what it would have been before the Clinton Administration. The net effect is Social Security checks today are about a third less that they would have been had those changes not been made. And the current rate of inflation you can add something like 3% on top of it to come up with a rough estimate as to where it should be.

And then you have other things that are done as well. And what happened this last month, my goodness, you look at the cost of gasoline. I always laugh when some of these financial commentators start talking about the Core Rate � inflation net of food and energy � as though people don't need food or energy. Those are 2 of the basics of life. The concept of a core rate was to adjust monthly swings in the CPI, you could take some volatile elements out and see how the other components were moving. It was never intended as a long-term measure of inflation. But you now have people citing the core rate of inflation as being so low when you take out energy and food, inflation is down to 2% year-to-year right now. But who over a period of a year doesn't consume food or energy? It's just absolute nonsense.

I'm sorry to step aside a little bit there, but energy is the key of what happened last month. Oil prices are going up, gasoline has been going up. It has some ups and downs, but according to the Bureau of Labor Statistics, it fell in June, something like 6.9% year-over-year. That's not what other numbers show. If you look at gasoline station sales, for example, which pretty much move in tandem with the price of gasoline, they were up 15-16% year-to-year. They were up for the months the government�s Energy Information Agency show gasoline prices up for the month also the same as retail sales year to year. And right now the government�s Energy Information Agency is showing gasoline prices up about 40% from last year. If they left everything intact and reported the CPI with today's gasoline prices for July, which will be coming up in the next report, you’d see instead of flat inflation that was reported this last month, you’d see a monthly jump of 1 � %. And that would be catch up. Whether or not they are going to show that I don't know, but they are playing games with the numbers. They have tools for it called "intervention analysis" where they go in and can fudge the seasonal factors to adjust for major changes in things, very specifically such as gasoline. They mention that in a report. Then you have other factors like the hedonic measurements and I've seen you write on this and you've put out some very good information. [39:32]

JOHN: Well, that really says it all. So, it is very plainly obvious for all of us that are watching this that we are really living and dealing with an actual inflation rate that is much higher that the reported figures. Now, do you think this is one reason why the Fed has been so persistent in raising interest rates? I know that you feel, Jim, that interest rates are going up much higher than what the markets are currently thinking. But doesn't that pose a risk for the markets? you're fond of saying that the Fed will keep raising interest rates until something breaks. So, when something breaks, what is the something that breaks.

JIM: Well, let's talk about what breaks. One thing that you have to look at historically is that in every rate raising cycle, we've had something always goes wrong. We get a financial crisis or the economy goes into a recession. The point is, John, we don't get through these rate-raising cycles without something going awry. If we take � I guess looking back at the last 3 decades � the 1970 rate-raising cycle we got Penn Central bankruptcy, 1974 another rate raising cycle Franklin National. 1989, which was when Volcker was really ratcheting up interest rates, taking them up to the double-digit rates when you saw 15% long-term Treasury Bonds, money market rates at 18%, that year we got First Penn. And then of course we got a Latin American debt crisis which eventually forced Volcker and the Fed to relent. But a couple of years later, in 1984, in another rate raising cycle we got Continental Illinois in 1987. In April of that year, we began to raise interest rates to defend the dollar. We got the stock market crash in October of 87.

In 1990, there was another rate raising cycle and we got the S&L crisis. In 1994 by the way was the last time the Fed ever raised interest rates aggressively, and That's where they doubled the Federal Funds Rate in a year. You would never see that happen [again]. But in 1994 when they did that we got the Mexican Peso crisis, Orange County bankruptcy, we had derivatives blow up with Proctor & Gamble, Gibson Greeting. In 1997 they did it again, we got Asia, Russian debt crisis, Long Term Capital Management. In the year 2000 we got the NASDAQ bubble burst and we had a 3-year bear market. These rate-raising cycles never end well and it always amazes me when I see the Wall Street crowd talk about, “Well, as long as they do it in measured paces There's nothing wrong.” The reason They're doing it in a measured pace is, as I just mentioned previously, if they were to do what they did in 1994 and double the Federal Funds Rate, we would have a crisis on our hands.

The other thing they have got to be cognizant of now is the derivative market, which makes the likelihood of a crisis much more probable. Derivatives were originally used as hedges. They used them back in the '70s, if you were in the import-export business, or you were selling production overseas, or importing it, you might hedge your commitments by going into the currency futures markets to hedge your currency risk. But today, derivatives are used more to speculate and they create tremendous leverage in a portfolio. Doug Noland has an analogy that he uses on flood insurance on the danger of derivatives that I think is very appropriate:

DOUG NOLAND: Well, no one knows, but certainly There's a lot. But if we could step back just a bit, I like to use � I've used it so many times over the years � the flood insurance analogy. And I look at derivatives somewhat as you would writing flood insurance. And once you start writing the flood insurance then all different types of things can happen in your little community along the river. For one, you're going to have a lot more building along the river, and the cheap insurance not only changes the behavior in the real economy, it'll also changes the behavior in “We'll call it the financial sphere” the financial part of the economy.

Source: OCC Derivatives Report, December 21, 2005

And What's important to realize is when you have this massive hedge fund community and I call it the leveraged speculation community it becomes very enticing to write insurance to write flood insurance especially if you've had a long drought. Why not take those premiums? You could go out and write this insurance, take the premium and it looks like the easiest profits ever. It became extremely easy over the last few years what I'll call the Bernanke Greenspan reflation and it became the big hot speculative trade to write credit insurance on Ford and GM and a lot of other companies. I mean, the size of the credit derivative market place doubled last year in one year. So that was the hot game. I like to think of it like the flood insurance analogy where you have all these people that come in all these players and everyone wants to write flood insurance because There's been this drought, thinking they don't actually want to ever pay out any policies if There's ever a flood. They're going to be pretty smart, and as soon as you have the big rain start then They're going to go out and buy reinsurance and off load the risk elsewhere.

Well, the problem is when the market becomes huge, as it did in Ford and GM � I think the amount of trading in the derivatives market is much larger that the actual underlying debt of Ford and GM the players think if There's ever any trouble, I'll just go out and short GM bonds. Well, the problem is when an announcement comes, everybody just thinks the same thing and immediately when they go out to short the GM bonds, There's no liquidity and the bonds just collapse. So then they say, “Oh no, There's no liquidity there, what do I do to protect myself? I'll go ahead and short the stock instead.” So, the problem leads to a dislocation in the bond market that then feeds over into the stock price and everybody gets short the stock thinking that They're hedged, and as you say, here comes the news that There's a buyer for the stock and the stock is up 20% in one day. So, these derivatives in writing this insurance leads to so many distortions in the real economy and the financial sphere, and they kind of feed on each other. And one problem leads to the next problem. All of a sudden all of the different markets become one big liquidity trade.

I think they are very dangerous. Although we have to keep in mind that the credit default area the credit derivative area � is so small compared to interest rate derivatives, compared to the currency derivatives. And that is where we could really have the danger because so many of the players that are in these markets are either speculators or thinly capitalized financial institutions, that when the rain starts falling, when There's a potential for a flood, their plan is to go out and hedge themselves. They're going to go out if interest rates start to rise, They're going to go out and short bonds. If the stock market goes down, They're going to short stocks. If the dollar goes down, They're going to short the dollar. And That's where you get this real risk of the old portfolio insurance nightmare from 1987, where the futures contracts and the hedging strategies just feed into a collapse. And unfortunately, I think There's a real risk of that in the derivatives market generally. And I think Ford and GM are an early sign of problems that potentially lay down the road. [47:08]

JOHN: Well, Jim, obviously then, a crisis is lurking somewhere out there. I mean, given a look back at historical precedent, it looks unlikely that we're going to avoid one this time around. And obviously, sooner or later, it'll be some kind of catalyzing event. So do you have any ideas of what it might look like or what might surface?

JIM: Well, one of the place where we might want to look, in fact Doug was making a reference to it is the fact that I think there is a real danger of a major corporate bankruptcy, such as Ford or GM. There is a probability next year that Ford could file for bankruptcy, especially if they can't get this pension and medical cost containment with the unions ironed out, because They're not sitting on a lot of cash. And as you've looked at the dealerships, and I'm sure that you've seen a lot of the ads for rebates, people with high gas prices are just not buying a lot of these big SUVs that Detroit is pumping out. And There's a lot of those types of cars sitting on inventory right now. I've seen them here in dealerships. Somebody sent me a picture in California of a dealership that had a whole lot of Humvees. Obviously when you drive a car that only gets 8 or 9 miles to the gallon and fuel is at $2.50 � or whatever it is in your neck of the woods � that isn't selling. So, I think you could see a corporate bankruptcy in the way of Ford or GM. It could be a financial bankruptcy in the financial sector especially with the kind of lenders that are issuing variable rate interest-only, or negative ARM lenders, or for that matter, it could be a hedge fund. [48:45]

JOHN: OK, assuming that It's going to happen and when it does happen what do you expect the Fed will do? Do they go on hold or apply the standard prescription which is to flood the markets with money? Helicopter Commander Bernanke will be in charge at that time, so do we get helicopter money?

JIM: I think you're going go see a Bernanke Fed follow in Greenspan�s footsteps. But I think that Bernanke will be more aggressive on the money printing side. If we get asset deflation such as a bursting of the real estate bubble, or we get a financial crisis, a hedge fund blows up, Ford goes bankrupt, or you get some kind of banking crisis, he�ll be aggressive I think in reinflating the markets and the economy. he's the type of Fed Chairman who could give us not only stagflation, but if it got really bad, he could even take us beyond that to hyperinflation if things got really bad. Doug Noland, who follows credit, believes Bernanke is a dangerous man.

DOUG NOLAND: Unfortunately not very high and That's what has me worried. And I think Dr. Bernanke is the most dangerous potential replacement for Greenspan. I can't even imagine that Bernanke could be the Chairman of the Federal Reserve. But that tells you we are in the cycle, because I think There's a lot of support for him. Again he talks in conventional measures, and helicopter money, and printing presses. And That's what the system wants to hear. But to me, as someone worried about our country's currency and protecting the wealth of savers and the purchasing power we've accumulated as savers, I mean, if Bernanke does become Chairman, he's already said he�ll follow in the footsteps of the Friedmanites and say We'll never let it happen again, it is deflation. So he basically will do his best not to allow any collapse of the bubble which I think is the worst case scenario that could happen. [50:47]

I would go one step beyond that and say the greater risk is that Bernanke, in order to avoid a deflationary healing process that is really necessary to cleanse the economy from all its excesses, leads us into the abyss, Argentina style.

DOUG NOLAND: Well, the whole Argentina analysis is something near and dear to my analytical heart. It was fascinating to watch because with their currency board they effectively were pegged to the dollar. [51:15]

The Business of Reporting

JOHN: You know what amazes the most, I guess having been in broadcasting for 40 years now, I listen to the information from a lot of the experts interviewed on this show what we talk about on The Big Picture every week or read a lot of the stories, which are published on our website then I compare how little of that is covered in the mainstream media. In fact, you could really reasonably say much of what we discuss on this show whether It's inflation, or peak oil, the commodity bull market is barely even mentioned. Or, if it has the audacity to pop up, at some roundtable discussion, it is pooh-poohed and downplayed. The news business is interested more in entertainment, more than it is investigative journalism, or in covering the real issues. Look at its pursuit of these insignificant stories pursued to ad nauseum out there. I believe this is what prompted Tom Fenton to write his book about the dangers all of this poses, especially to an ignorant public.

TOM FENTON: There's a place for Laci Peterson. There's a place for Michael Jackson, but It's primarily in entertainment shows. It certainly shouldn't displace the really important news, the hard news, the news that enables people to understand the world about them, to monitor their own government, to act as responsible citizens. And for that, you don't need Michael Jackson news. It's a particularly American problem. I live in London and I can watch CNN here and they do a pretty good, workmanlike job covering the world. I have a good feeling about what's going on in Central Asia for example, or the Middle East, or Africa. I come back home I turn on CNN and I say: “Where's the world? It's gone It's disappeared.”

The CNN domestic service is almost totally domestic. And It's true with the networks. It's true with the television broadcasters in their little half-hour in the evening, which is actually 18 minutes of news. They do perhaps one story from beyond our shores. One! for the entire world. And usually That's Iraq. And There's a whole panoply of things that are really crucial for the future of America that aren't even mentioned. I think It's enough to say that the United States has something like 700 military bases around the world. Why are they there? What's going on? What are we doing. What are the threats? The average person doesn't have a clue. [53:48]

JIM: You know, John, I saw a bit of this. I had a friend in the late '90s who was a missionary in Cambodia, and he had to evacuate his whole mission, because there was a coup. I mean, he actually woke up outside his house one day and there was a tank battle going on. You could imagine how traumatic that was for his children.

And he had to evacuate, get out of the country, flew in to the United States, and came by to see me. And all of the things he was trying to follow as to what was happening, in other words, what was going on in the country, what political faction was taking over, he didn't get any news. I mean, when it comes to international news, Americans are kept ignorant. We just simply don't cover it. That's one thing I think you'll find, if you talk to somebody from overseas that they are much more informed on not only what's going on in there own country, but also what's going on in our country and in other places in the world.

But there is another thing that I saw that came into television, and especially into news, which was very dangerous. I saw a lot of this when I did television news back in the beginning of the '90s. We began to use what I call "packaged programs" These were pieces that were put together by other outside organizations. We had no idea how accurate these stories were because we had no reporters on the ground. But they became important filler pieces that were part of our evening newscast. And it was something that Tom Fenton warned about when we talked to him about his Bad News book:

JIM: doesn't a news bureau in effect lose its eyes and ears on the ground when it closes its bureau? Because obviously, if you have a bureau station somewhere in the Middle East or even in Europe, the people that are stationed there get to know who the movers and shakers are of the community. They see it first-hand on a day-to-day basis. They know What's real, What's factual. I mean, That's something you get with experience and being on the ground. It's the same thing with the military. You can drop bombs, but if you want to win a war, it always takes the ground troops. It's the same thing with news coverage.

TOM FENTON: Let me tell you something that I find absolutely devastating. That ABC and CBS and amI not sure about NBC because they have that MSNBC, but it may be the same covering the Muslim world, which you have to believe is of some interest to Americans. They each have how many correspondents assigned to and covering the Muslim world? Zip, zero, and haven’t had for years. They’ve got nobody out there. So if you talk about why do they hate us, or why don't we understand the Muslim mentality, look, There's no reporting, There's no connection whatsoever. I think that is absolutely unforgivable.

JIM: You know, It's amazing if we take a look at all businesses that use consultants. When did the role of the consultant become so important to the networks, the focus groups? It's almost like, rather than covering news stories of What's important, It's what the consultants think or what the results were of some focus group.

TOM: That's right. That was the end of the '80s into the '90s. You had Frank McGeeand people like that. You know when I first went to work for CBS News book of news standards and there was a preface to the book written by Dick Solan, who was a marvelous President of the news and really protected the news from the pressures of the corporation and the pressures of government. That I think is one of the main problems we face today. And it is one of the reasons why the public has such a low opinion of the media, because I can't remember any time in my long career when the media were held in lower repute.

JIM: You know, one thing, Tom, when I'm flipping through the news sometimes or when I want to get a different slant, let's say I'm looking at CBS or I might go to CNN and take a look at how a story is covered, I have noticed quite frequently today the same news video footage on all stations. Is that a result of packaging?

TOM: That's it, because none of them are there. They're all using this agency footage, and quite frequently They're all using the same footage. I had a nightmare for years, I used to say There's so much consolidating going on that some day There's going to be a major story someplace There's going to be one team, one reporter out there, covering that story for the entire world, and this person will get it wrong. [58:32]

JOHN: What Tom Fenton is saying is true because especially if you read, say the newspapers, most of what the country reads is published by a limited number of groups such as Reuters, Associated Press which is particularly bad both in grammar spelling and accuracy of a story or like the Washington Post Writer’s Group or some other supply. And when these stories go out to all of the newspapers in the country, or the wire services, or the feeder services that feed these prepackaged cuts to various outlets, the local editors do not sit there and say: “Gee, is this true? Have we investigated this ourselves?” And you know this from your own days in television. They just plug these things into a hole where they want to put them. And so a very few people are really controlling what everybody else sees. In reality, It's sort of like a giant gossip mill and it just has a certain patina of credibility to it.

JIM: You just heard Tom Fenton talk about it and he was disturbed enough that he wrote about it. But you're hearing about it from a veteran news reporter. News has become entertainment. Real important stories aren't even covered. We raised income taxes here in California and it wasn't mentioned anywhere. Investigative journalism is more dominated by political views and biases today rather than facts. As Tom Fenton says, we're all worse off because of it. You would think, John, with inflation on the rise on Main Street for example somebody would be covering the story. Instead, you see anchors and reporters glibly uttering the core rate numbers as if these people don't eat or drive.[1:00:16]

JOHN: You know It's interesting when my wife was getting her masters degree in journalism which is how we met by the way as she was working for a major television network the goal used to be to get the story and to report it. What happened in the '70s and going on into the '80s, is that there was a market shift away from reporting the story and trying to effect a social or political change by use of the media. That was a pronounced change in the whole profession and to a large degree that is what is actually driving things today.

We know for example just from studies that have been done that the majority of the main line media have a very far left bias, even further left than the average person out there and this is reflected in the story. Remember the ANWAR drilling incident? One of the lead stories that came out of Washington was that the Senate had blocked the ANWAR. Now you notice we didn't say the Democrats and liberal Republicans had blocked it. We said the Senate. Had it been the other way around on a different issue it would have been Republicans blocked. Do you see the difference? And therein lies the bias. It's not even necessarily What's reported, but how the reporting is actually accomplished.

There are some impacts to this because if we know the government numbers are cooked, we know that the media information is designed to achieve predetermined outcomes, reactions and attitudes in the public, then this makes investing much more difficult today because you really can't trust the economic or financial numbers. And so, whenever you're watching these stories, you can't just take the information at face value. You and I both don't do that. I spend my time throwing popcorn at the screen.

My first question is what is going on here. That is my first question when I see any story coming down. We have to play puzzle and detective and put this together. You simply can't take the economic and financial numbers at face value anymore. It really is something that would have made George Orwell very, very happy. we're just a few years later than 1984.

Final Comments

JOHN: Well, have coming to the end of that rather lengthy summary of the year 2005, summarizing the big issues this year, the rise of energy was at the top of the list. we've covered that. I guess behind that you would have to say the return on commodity investments this year whether it was energy, metals, base metals. The bull market in commodities has been definitely confirmed and yet it has still gone unnoticed by the general public for the very reasons that we have stated just recently here talking about the media coverage of this whole thing. We have also seen inflation rise even if you buy the official numbers as being accurate. They're on the rise. So somewhere out there, There's a big rogue wave, a perfect financial storm as you like to say lurking out there that could clobber the markets and the economy. And there does look like There's a collision course between the Fed and the markets in the year 2006 which is coming up. So, any thoughts as we close?

JIM: I would expect to see trouble in the first half of the next year as the Fed takes interest rates higher. Just as a side note, my realtor told me that he's starting to see more bankruptcies and foreclosures here locally. They're not being reported in the press. Here we go back to the story you and I just talked about on media coverage not covering what is important. In fact, he was telling me yesterday he listed a house, this young couple had bought this home 3 years ago with the 3-year adjustable rate mortgage. They just got their readjustment upwards, which would drive their mortgage payments up $700 a month. They can't afford to make the payments. he told me since September housing prices have been dropping about 1% per month. But at one of the meetings that he went to on the real estate market here, they were expecting in 2007-10 here locally, to be big years of bankruptcies as these 3 and 5 year ARMs get readjusted. Close to 70% of all of San Diego home sales these last 3 years have been these adjustable rate mortgages. Many of these by the way are negative ARMs, about one third of them are.

So, John, I would say if I were looking forward into next year, I would expect trouble the first half of the year, and a little bit more trouble next Summer as the Fed begins to go soft and the dollar goes down. I expect, number one, higher energy prices. I think the $70 level we took out this year will be taken out at higher levels next year. I expect to see higher precious metal prices, higher commodity prices. Now, here's one that will throw you all off, I also expect to see the Dow at record levels next year, as the next bout of reflation takes hold. In other words at some point the Fed printing machine is going to go into high gear next year and when that happens, we're going to see a nominal rise in asset prices. I think you'll see it reflected in the stock market as well as hard assets such as energy, gold, and silver. [1:05:20]

JOHN: Well, Jim, any other predictions as we wrap it down here? Of course, we have Ike Iossif and Ahead of the Trends coming up in the next hour too.

JIM: If we're going to do the predictions, I'm going to save that for our first show of next year when we go out on a limb and make our predictions for the New Year. But all of that, well, we're going to have to wait till next year.

JOHN: You know, we should give credit to the people who work behind the scenes to make this happen as well. There's your wife, Mary, who really does a wonderful job on your website as a matter of fact.

JIM: Yes, Financial Sense and the Financial Sense Newshour would not be possible without the hard work of Mary, because Financial Sense and the FSN Newshour have really become a passion to her.

JOHN: Right. And I'd like to credit my wife, Carol, who’s been doing journalism work for almost 3 decades as a matter of fact, and puts together a lot of the montages we hear on the program and researches the cuts. We have our editor, Glen Meyer, who packages the programs for posting on the internet, and then our website for the radio side is Mark Gustafson and he handles all the technical issues. Finally, Neil Mackellar provides transcription services. So, those are some of the people who make it.

One of the funny emails we did get a couple of weeks back was someone complaining that I was eating on the air if you remember that, Jim, and could hear it. Sometimes this is a 12-hour proposition to put together a show and we're pretty hungry. So we're sitting here and between things eating as we go. That's just the way it is.

JIM: As we mentioned in last week's bloopers, the interview guests are usually done during the week because it is just hard to get someone to do an interview on a Friday. But the experts, you know, Dave Morgan, Paul Nolte, Tim Woods, Joe Duarte, and Frank Barbera, all those guys are gracious enough with their time and we really appreciate them because Paul has to rush home from the office and get home on time. And he's always ready to tape. But these people put in time and we do a lot of that recording on Friday and then of course we have the market reports, which we can't do until the market closes on Friday and we get the final numbers for the week. And then a lot of time the Big Picture segments we're doing the montages or sound bites we've gotten from either a Greenspan testimony or something going on CNBC or something. It takes a lot of time to put that together. I remember when I did television news. For every minute on the air, it took one hour of preparation. And certainly just to put together this 2-hour segment for the end of the year program took about 15 hours of my time, because you've got to listen to the interviews and say: “OK, what were the important issues that happened this year. OK, let's listen to the guest, what were the things that they said that were relevant and try to edit and put all that together.” And it takes time.

And we hope you enjoyed it. And on behalf of John Loeffler and myself, we want to wish you a Merry Christmas and a Happy New Year.

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