Financial Sense Newshour
The BIG Picture Transcription
March 11, 2006
- Walk the Line: The Fine Balance Between the Abyss & Prosperity
- Emails and Q-Calls
- Other Voices: Peter Navarro, PeterNavarro.com
- Are We Heading For Another Bear Market or is the New Bull Out of the Gate?
- Looking For Value in All the Right Places
- Other Voices: Reva Bhalla, Stratfor.com
Walk the Line: The Fine Balance Between the Abyss & Prosperity
[music: Johnny Cash I Walk the Line]
JOHN: Johnny Cash called it walking the line, Jim, I think Tom Lehrer once referred to it as sliding down the razor blade of life. And in this case the Fed is now walking a very tight line: there is a tight balance between real estate and the financial markets that is inseparable, and if they go too much to the left or the right – this used to be like the straits of Messina between Italy and Sicily: too much to the left, too much to the right, either one, and you’re done for on the rocks – and that’s what they’re facing right now.
JIM: If we take a look at this last recovery that began in 2002 everybody was remarking how strong the US economy was. It was one of the most shallow recessions in recent memory, and a lot of people were saying that that was really exhibiting how robust the US economy is. But if we take a look at what happened in the recession of 2001 – number one, consumers spent more and they saved less. Why did they do that? Well, we saw the lowest interest rates in half a century which encouraged borrowing at the same time encouraged dissavings; we saw inflation rise more than consumption so the only way that consumers were able to keep up their standard of living was to go deeper into debt. By contrast, John, in the 1991 recession when the Fed began to raise interest rates, Greenspan brought down the discount rate and the Federal Funds rate I think it was 24 times.
What happened in the 91 recession is, first of all, real estate led the recession, it went into a downturn before the economy did. Secondly, as interest rates came down, consumers used the lower interest rates to refinance their homes, which improved their cash flow; they used that improved cash flow to pay down their debt, and increase their savings. The average American consumer, according to the Wall Street Journal, in the 91 recession increased their savings $1400. So that was what happened in 91.
That’s not what happened in 2001. The consumers responded to massive stimulus, interest rates went from around 6% on the Federal Funds rate down to 1%; in 2001, and 2002 we enacted 2 back to back years of tax cuts, so they got tax rebates in 2001 and 2002. We also saw for example dealers, whether it was automobile dealers, or furniture sellers come out with these incentives – 0% down, 0% financing – or whether you were buying a big screen TV or furniture – no payments for 2 or 3 years. And after the tax cuts and rebates stopped, then we had the real estate bubble where we had homes becoming ATM machines.
So, the question is now we’re not going to get anymore tax rebates or tax cuts, in fact the next trend is going to be tax hikes, it’s already started, and with real estate prices starting to drop, the ATM machine is being taken away. So, as you look forward what is going to keep the US economy going? And that is this fine line that the Fed is walking right now because if they push rates too far then not only do they really pop the real estate bubble, but if they do that the consequences are not only do you get a bursting bubble which is deflationary, then you get a banking crisis which is also a major problem – unlike stocks the real estate market is tied very closely to the banking system which has over 60% of their loan portfolio in mortgages. And then the third issue which comes along is a major recession. And if your financial system gets into trouble that makes the job for the Fed all the harder, and that’s why they’re really walking this fine line here. We’ll get into what I think they’re going to do in just a minute. [4:58]
JOHN: But basically the indicators themselves are really the economy. They don’t have any little meters like you would have on an aircraft or something, they just wait till something pops or blows, and they go, “whoops.” I mean that’s basically it.
JIM: Yes, it’s not like they’ve got these fine digital gauges, and they could say, “Aha, we’re there. This is where we stop.” There’s a lag effect. And some of the things you feel immediately – when the Fed raises the Federal Funds rate the following month anybody that has a home equity loan sees their monthly payments go up, because they adjust monthly. Those are the things that you see immediately. But in terms how does it carry over into the housing market, when do people say, “wait a minute with these kind of interest rates I can’t qualify, housing prices are too high,” and all of a sudden the housing market starts to soften. And then all the stuff that is associated with the housing industry starts to slow – take a look at all the accompanying industries associated with housing, furniture business, home entertainment systems, landscape, Home Depot, decorating, furniture all these things – but that doesn’t happen immediately, because there’s a lag effect.
And now there are no more tax cuts, there are no more rebates, and housing prices are now starting to fall. The tax cuts are due to expire, and we also have a government who’s spending is now out of control – there is absolutely no spending discipline in both houses of Congress or in the White House, and there is no will to extend the tax cuts. So what we’ve got coming in the next couple of years is going to be a rising trend. In other words, the tax rates are going to go back up to 40%. You’ve got States like California that raised the top tax rate to 10.3% last year, and they have another initiative on the ballot this June, to raise tax rates another 1.7 to raise it to 12%. So, we’ve got no more tax cuts, we’ve got interest rates climbing, inflation is on the rise, and taxes and inflation are really squeezing the poor and the middle class. [7:10]
JOHN: Other than that, everything OK.
JIM: Yeah, yeah, besides that, things are wonderful.
JOHN: By the way, we should say the tax cuts, you were right in pointing something out that tax increases are not just at the Federal level, they’re at the State level, and also at the county and city level as well. I mean these things are rising uniformly at all quadrants. So how is this line going to be walked then?
JIM: What you have right now is you really have a bifurcated economy: you have the Walmart versus the Tiffany’s, and the Nordstrom’s. Frank Barbera, who we talked to in the first hour, his office is on the second floor in the Grove in Los Angeles, one of the most exclusive shopping malls in all of California. I mean they even have a shop that sells luxury olive oil – I didn’t even know such a thing existed – you know $40 for a bottle of olive oil. This is the shopping center where you’re more likely to run into the Paris Hilton’s. They are the ones still doing well, so if you have the means, the income or the ability to invest, you can profit from inflation. But if you’re like my friend who got that 3 ½ % pay raise and after taxes only 2%, how they’re coping with this rise in taxes and inflation is his wife who has a regular job has taken a job on weekends. And so you’re going to have this bifurcated economy. You will have the people that shop at Nordstrom and Tiffany, and then you’re going to have a lot of people that shop at the Walmarts, the Targets, and even some off the Costco’s. [8:44]
JOHN: Yes, but even the people that work on weekends really aren’t getting ahead, they’re breaking even still, which is always what happens in an inflationary environment. When you finally get to that end of it is the little guy winds up running faster and faster and faster just to stay where he was, 5 or 10 years ago.
JIM: Yes, and that’s what most people don’t understand when you have government spending – the welfare state that gets out of control. There is no way as John Williams pointed out last week on the show if you just took everybody in this country and said, “look, anything you make over 100,000 we’re taking 100%. It belongs to us the government” – you would still have a deficit. There’s no way, since we’ve been raiding the Social Security Trust Fund, which is one of the most giant Ponzi schemes, in the history of the world, that we have the money to pay out 51 trillion dollars of unfunded liabilities.
We had a study done here in San Diego where they took 7 or 8 different jobs, in the various cities in the San Diego metropolitan area and they compared the salaries of government workers to the private sector, and government workers were making anywhere from 30 to 60% more than the private sector, on top of these generous pension plans and benefit programs. We had a double-dip program in San Diego where 5 years before you retired you would file for retirement, you’d still continue to work, and they would put your retirement pay into a deferred comp. So, you had somebody like our Assistant Deputy City Manager retire and get a 1 ¼ million dollar bonus.
When you have government spending out of control, and there’s no way that we can pay our debt our debt levels are so scary, what is coming is an age of inflation. A lot of people think, “well, I’d love to get these benefits, and if we can just tax and take more of Bill Gates or Warren Buffet’s income, or the rich people then we can have these goodies and it doesn’t cost us anything.” Inflation always costs money. There is no such thing as a free lunch, and unfortunately it hits the poor and middle class more so because like my friend – he can’t go into his boss and say, “hey, after taxes, I need at least a 10-12% pay hike just to keep my standard of living or purchasing power.” It doesn’t work that way. So, what does my friend’s wife do, she’s working in a retail shop on weekends now because that’s what’s bringing in the extra money, and that’s what allows them to pay and live the way they did and keep pace with inflation. [11:21]
JOHN: What about the lower classes? In other words, a lot of the social programs are always sold under the banner of “we as a society are doing so well, we should care for those less fortunate than we are.” How does this finally slam down on them?
JIM: Well, what eventually happens is inflation levels rise high enough that even with welfare programs, and government entitlement programs (which was the real purpose of changing the CPI in order to change the cost of living so that they could keep that under control), you’re not going to keep pace with inflation. And so what happens is it gets harder and harder to make ends meet, which is why I believe you see today so many Americans going into to debt, whether it’s mortgage debt or credit card debt. That’s what it takes to live the American dream, you have to do so with credit because your regular means of income will not support an American lifestyle. And once again it’s taxes and inflation. [12:22]
JOHN: And regulation I would say. Those 3 things.
Alright, Jim, you believe right now that [for] the people who every weekend roll over to Wal-Mart or ‘Tarjay’ – otherwise known as Target – some of the average stores around the country, you think this is about to break. And of course that is the main source of keeping the economy sort of bustling, so to speak.
JIM: Sure, because as I pointed out early the tax rebates and tax cuts are over, you’re not going to get anymore tax checks from the government not yet. I think later on with helicopter money you will, but right now no more tax rebates. States are raising income taxes; the Federal government will be raising income taxes because they will allow Bush’s tax cuts to expire, so we’ll go back to the high Clinton tax rates. You’re taking a look at, as I mentioned after-tax rebates, the home appreciation came in the market with the take out financing on residence, which was used as an ATM machine. You’ve had nearly 5 months of declining home sales; we’ve got rising residential inventories around the country; you’ve got home prices gradually declining. And as I pointed out with my friend you have real wages and salaries after inflation continue to fall. So, the real standard of living is declining.
You also have a negative savings rate. And also if you look at the payroll growth or the increase in jobs in which over 50% of the job increases in the last couple of years in the economy have come through the bubble economy – in other words, they were associated with real estate, real estate appraisers, real estate agents, mortgage brokers, escrow officers etc. So, the whole financial sector participated in that. If you take a look at the job numbers on Friday, 243,000 jobs created, less than expected, of the 243,000 – 116,000 of those jobs were hypothetical jobs as a result of the government’s birth death model. But if we look at all of 2005 that birth-death model added a hypothetical 817,000 jobs. So of the million plus jobs last year, a lot of it was hypothetical as John Williams pointed out last week, the real unemployment rate is probably closer to 8-10%.
The bottom line is that consumers who account for about 2/3 of the economy are coming to the end of the line. Now what they’re hoping for is as the consumer starts to level off on his spending that businesses will pick up spending and pick up the slack. So, the real danger here is if the Fed pushes things too far and they kill the consumer. In other words, if they crush the real estate market, and they burst the real estate bubble, now they’ve got a banking crisis that accompanies the bursting of the real estate bubble. Then you have a real large scale recession, and a financial crisis on their hands. Do you think that’s the kind of climate that businesses are going to say: “Aha, we’re heading into a recession, let’s start spending money.” It doesn’t happen that way. And that’s why I go back to that Johnny Cash song, the Fed is really walking a real fine line here. [15:43]
JOHN: Alright, so where is the break point on this whole thing, if we had to set up little warning indicators and sensors around the system, what would we be looking for?
JIM:A continued decline in the real estate market, a huge jump in foreclosures, financial crises, you know, maybe an intermediate lender gets into trouble. In other words, they keep pushing interest rates, and finally is it kind of like one interest rate too far – the one that breaks the camel’s back.
And if you look at where we are today, we’ve got two perceptions of what the Fed’s going to do. You’ve got people like James Grant of Grant’s Interest Rate Observer, in his last 2 newsletters he’s said, “that’s it, the Fed is done. 4 ½ we’re it.” Then last week you had Lehman Brothers say: “no, Fed’s going to raise interest rates another full percentage point. They’re going to raise interest rates a quarter of a point at the next 4 Fed meetings, in March , May, June, and August.” I don’t think we’re going to get that far. I think we’re sort of somewhere in between, and we’re getting real close but if you really start to see the downturn in real estate gain momentum – foreclosures increasing, bankruptcies increasing, trouble at financial institutions – then you could have a full scale banking crisis on your hands, leading to a major recession in this country. And with a major recession you will see government budget deficits skyrocket, even higher than what they are today, because remember in a recession the economy contracts, the government takes in less tax revenues. And if the dollar gets in trouble as a result of a weakening economy, then you have a spike in interest rates which means the government will have to go out and finance its debt at higher interest rates. That’s the precipice the Fed is walking. [17:38]
JOHN: OK, so now we’ve set the indicators around the place, exactly what are they going to try to do?
JIM: I think they’re going to raise interest rates maybe one or two more times. They want to take the edges off of the real estate bubble, but they really don’t want to burst it, because they know it’s tied to the banking system, and then they’ve got a real crisis on their hands like Japan had, and that scares the bejeebers out of the guys at the Fed, and especially a guy like Ben Bernanke.
So what they’re doing is while they’re raising interest rates, they’re flooding the financial markets with liquidity. It’s not just the US but it’s also happening globally. And one reason John they’re going to get rid of M3, since March 1st, M3 has jumped by $87 billion, in the first two weeks of the year; it’s now almost 10.4 trillion- so no wonder we’re getting rid of reporting it in the next 2 weeks.
However, in order to get to neutral where the Fed says, “Ah, we’ve nipped inflation in the bud, we’ve taken care of the inflationary threat, they really need to hammer the commodity index, they need to hammer gold, they need to hammer energy, and they need to bring down the commodity complex; and the way they’re doing that is through derivative short positions. And if you don’t think they’re managing this – this is off GATA’s website, but it was reported in the Financial Times – a former central banker, by the name of John Nugee, who’s director of the official institution group at State Street Global Advisors, and a former foreign exchange official for the Bank of England, told the Dow Jones Newswire: “Central Banks will solve their dollar overhang only if they act together. If they try to act individually to diversify while hoping no one else will notice there’s a possibility that we could get a disorderly outflow out of the dollar and gold market as we had in the 80s.” So, central banks have got to control the price of gold. They’ve got to control the dollar’s decline. And that’s what they’re doing. And as I have reiterated on the program from a macro point of view, they need to get to neutral but in order to get to neutral they have to knock down the commodity complex, because they can’t say, “hey, we’ve nipped inflation in the bud, we can now go to neutral,” if you’ve got gold at 600, oil at 70, and the CRB index rising and reaching new records.
So, once they get commodity prices down, they can go to neutral, and when they do that you’re going to see some carry over effects into core inflation, and headline CPI numbers. And that is where I think they’re trying to manage right now. And as a result of that they’re going to reinflate the equity bubble. You’ve got global money supply whether you’re looking at the US, Europe, Asia, all central banks globally are reinflating – it’s a coordinated effort right now. You’re seeing them inflate at rates that are 7%, or 8%, and some are double digit rates. And what this is doing is creating that very strong liquidity that you’re seeing in the financial markets. In other words, John, central bankers around the world are printing oceans of money. And what they’re going to do even while they nudge interest rates up a little bit – this is like a throwback to the Arthur Burns’ Fed – yes, they’re raising interest rates but they’re flooding the world’s financial system with oceans of money. So, in other words, nobody wants to see their currency appreciate tremendously against the dollar, everybody’s trying to depreciate their currencies.
So, what is happening now for the first time is you’re seeing currencies depreciate around the globe against the real standard of money which is gold. But in the short term, they’re going to take it down and this is what I call that sort of whiff of deflation in the air I talked about in the first program of the year – first the gain then the pain; because what they’re going to do is they’re going to take the commodity complex down; they’re going to get energy prices down – they started hammering energy in the month of December, and January, and now they’re taking the gold complex down. Then they can say, “OK, inflation not a problem.” And once you get the commodity complex down that will carry over into the headline and core CPI numbers, and so that will give a little bit of a deflationary scare. You’ll see stories about real estate continuing to fall, but that’s what they need to get to neutral. They can’t get to neutral, and start lowering rates if you’ve got gold at 600, and commodity prices breaking out, and energy prices, they need to get that under control. [22:31]
JOHN: Well, Jim, let’s just construct a hypothetical here. Say the Fed reaches neutral some time in May, is it really conceivable that they could actually give us that long promised soft landing that we always hear about?
JIM: If they can keep the markets flooded with ample means of liquidity, and we’re seeing that bank credit lending is still going on, we could have a monetary cycle that ends without causing a major financial or economic mishap. And the trend in central banking, right now, is constant reflation as economies become more leveraged. I just don’t buy the fact that Japan’s central bank is going to be raising interest rates over the next 2 or 3 years, I mean they are barely coming out of their deflationary cycle. And the Prime Minister is jawboning their central bank, “would they raise rates maybe a couple of token times?” Yes - but their economy isn’t strong enough, nor is Europe’s strong enough – they’re barely growing at a little over 1% a year. Is that strong enough where they could come in and raise interest rates globally for the next 2 or 3 years? They would have a full blown depression on their hands, but in many cases like in the US, we would get an inflationary depression. So where there is a possibility, they know the fine line that they’re walking and they’re going to try to micromanage this. Will they be able to do this? But in my opinion I think the next great reflation is about ready to take place. [24:08]
JOHN: But in reality they don’t have any choice either, do they?
JIM: No, whether you’re looking at the Federal government, you take a look at some of those from the Fed Flow of Funds statement, the debt conditions of the United States, the government, the cities, the States, the individuals, corporations and it’s not just here, remember it’s also in Japan too, and also in Europe. Europe doesn’t have as much of a debt problem as the United States does – we’re the most leveraged economy probably besides Japan in the world today. So they can’t do a Paul Volcker like they did in 1980, where the US was running trade surpluses; our budget deficits were small by comparison; our manufacturing base was much stronger. We didn’t have anywhere near the debt levels that we have today at all levels of society. So they can’t. So they have to constantly reflate, we’re just not in a position, you will not see another Paul Volcker come in and say: “I’m going to wring inflation, I’m going to cut off the supply of money, and I’m going to take interest rates to levels you’ve never seen, and I’m going to burst every single bubble that we have in our economy, I’m going to cleanse the system of debt.”
It’s just not going to happen. [25:25]
JOHN: OK, Let’s summarize it all up because we’ve covered a lot of territory here.
JIM: I would say if you want to look at where we’re heading, take a look at the 1970s, and you’ll get an idea of where we’re heading – it’s amazing. That’s when I got in this industry, in the latter part of the 70s, and here I am many, many years later coming around full cycle to when I began my investment career. Except for this time I think what you’re going to see first is stagflation, and eventually leading to hyperinflation, because the stagflation of the 70s was ended with Paul Volcker. There’s no way with $51 trillion of unfunded Medicare, Medicaid, and Social Security liabilities that we’re going to go on some austerity program in this country. It’s just not going to happen. And so you’re going to have what I see as a consecutive chain of asset bubbles that we’re going to be going through. And it’s my contention that the equity bubble is coming next.
JOHN: Emails from listeners this last week, Jim. First of all, Nancy in Hyannis, Massachusetts regarding our ‘stuck on stupid’ weekly prize. We don’t have a ‘stuck on stupid’ this week, I didn’t hear anything overtly stupid that we can do today that should come up. But anyway:
Regarding last week you gave Ted Kennedy the SOS prize – the stuck on stupid prize – it’s so perfect. On the Cape here they all have SOS bumper stickers, it stands for Save our Sound, and now it means stuck on stupid.
JIM: Thanks, Nancy, love that!
Hi this is Mike, from New York City, I’m a big fan of the show. I’m kind of disappointed with how you’ve deviated from your analytical framework, you know, and gone long this market and truly conform to the bullish consensus out there. You’ve never contemplated that possibly the Fed is eliminating M3 to drain liquidity from the system not to print more. And you really have skirted around the bond market issues. I’m still going to listen to the show. I love the show, but I don’t know, you guys seem to be running with the crowd lately.
Well, I appreciate your comment Mike, we really aren’t running with the crowd in the sense that we still have big positions in energy – alternative energy – we still held half of our gold and silver positions, but if you’ve been listening to this show, or reading what I’ve written over the last couple of years I came to an epiphany in 2004 when I wrote The Great Inflation, and that’s when I realized which way or which direction that we were going. They were going to inflate or die. That’s the position that we’re in, and if you understand the mechanics of how these things work, and what they’re trying to do then the best thing you can do is take advantage of it.
I know a lot of you didn’t like my tech recommendations during the first week of January, but you know what those things are up 20 and 30%, since January. And if you understand what they’re trying to inflate, or you understand where money in a financial economy runs, then that’s where you understand. As far as the bond market scenario – yes, we’ve seen a hiccup. I think that’s an unwinding of the yen carry trade, with the belief that the Japanese bank is going to raise interest rates in a precipitous manner which I do not see. If they do it they’ll do it gradually, and they won’t do it that much because Japan’s economy could not withstand a series of rate hikes like we’ve had here in the US.
So, if you look at global money flows as I follow around the globe there isn’t one central bank that isn’t reinflating at rates 2 or 3 times or 5 times their economic rates. So as far as do we sell out or run with the herd – no, you’re not hearing me say, “hey go out and buy Google.” Listen to the second and third section of this program and we just follow money flows, we follow central bank behavior and we look at that big macro picture, and I think we’re going to be right on this. [29:35]
JOHN: Your argument here is basically we try to understand what is happening in the market and then take appropriate action? It’s not take a perpetual philosophic position and then defend it against all comers. How’s that for comparison?
JIM: Yeah, One of the things I’ve learned early on in my investment career, we got into tech stocks in 91 and 92, and we sold our tech stocks in 95, because I was a value investor and I looked at that and said, “ I saw the money supply being inflated, I saw valuations on these tech stocks.” And it was one of the worst mistakes because I got myself into this biased scenario, and I wasn’t reading the economic tea leaves right. I didn’t realize we were ready to begin the greatest inflation that we’d ever seen. Thank goodness we got back into technology in 97, but you can’t marry yourself to these positions and say: “You know what? I’m holding on to this position, and I’m not going to do anything about it.” If you know where the macro picture’s going to be placed then you play it to make money, and take advantage of it and that’s all we’re doing here. We still own, as I mentioned, our energy positions, we still own half of our gold and silver. The only thing is we thought the large cap gold stocks were overinflated, they weren’t replacing their reserves, and we think the next place to be is in late stage development juniors, and so we’re going to play that differently too. [30:58]
JOHN: And during the week we’re going to invite people to call into the question line – we call it the Q line here – 1-800 794-6480, that’s toll-free from the US and Canada. It does work internationally, but it’s only toll free from the US and Canada. 1-800-794-6480, if you’re calling from outside the US and Canada you drop the ‘1’ by the way. I’m sure most people know that calling the States by now.
A similar email from Clinton, Newsport, Minnesota:
I used to love listening Saturday afternoon about gold, oil and the impending collapse of the economy. Now what I hear is the S&P and Dow are going to record highs. When did you people become Wall Street shills. Buy Coca-Cola? Are you ‘blanking’ me? Goodbye.
JIM: Well, if I’m correct, we’ve been correct in our tech calls, I think we’re going to be correct on our market calls, I think you’re going to see a new record in the S&P – when I say a new record a new let’s say 4 or 5 year record. And I do believe you could see possibly a new record in the Dow this year. So, just watch and see what happens.
Hey Jim, this is Chris from Denver, love the show. Thanks to you I’ve made a lot of money in energy and gold, so I just wanted to say a big ‘boo-yah’. My question actually is I want to add [to] my precious metals position, number one is now the time and would you favor gold over silver? I don’t have too many silver stocks. And lastly majors versus juniors. Also my wife says a big, ‘boo-yoo’.
JOHN: Well, I want to see you do that type of show. Alright?
JIM: Is now the time to buy gold? I still think we’ve got further to go on the correction. Listen to the first hour with Frank Barbera. This is a seasonal cycle that you usually get in the precious metals. Precious metals get weak and get weaker, usually leading into late April, sometime in May, and then we begin the next leg upwards. So, no I wouldn’t be buying at this point yet. Secondly, I would probably favor silver over gold. I think you’re going to see silver outperform gold this year, which many of the silver stocks have, especially with the takeover of Western Silver by Glamis. I think you’ll see more of that because silver is becoming scarce.
And as far as the majors versus juniors, I mean if you’re going to be in the majors they’re not really growth stories, their productions are in decline, they’ve become grossly overvalued. If I was in majors you’d trade them. You get in towards a bottom technically, and get out somewhere around the top. I think the real play in the gold market would be the late stage development junior companies, that’s where I think you’re going to see the superb performance. That’s where you get the three, five and ten baggers. You’re not going to get those out of the Newmont’s in the short term. So, thanks for the booyahs, and we do accept booyahs, but - OK.
JOHN: How do you spell that? Boo-yah?
JIM: Heck, I don’t know, watch Cramer.
JOHN: Listen here, here we go. Rebecca’s in Springfield, Illinois:
I was sad to hear you and your co-host…
– I think she’s talking about me.
…trying to discredit and snicker about the power of the free market. I agree the free market will not make oil out of wine, but it will be able to find the alternatives to oil.
And she goes on saying things like, “the free market has provided things in abundance, everything mankind has needed and enjoyed throughout history. It will provide alternatives to oil as well.” And it goes on for a long email.
I think the issue here, Jim – I thought about this during the week – the issue is a formula of time versus technology. For example, if you jump out of an airplane, and you have a parachute on, the technology will work providing it’s done in the time window allowed. If you pull the rip cord too late, technology is not going to help you.
JIM: I think she misinterpreted the free market. We’re all big believers of free markets. I’m from an Austrian school perspective. But what we’re heading into is not going to like anything we have faced as mankind, for thousands and thousands of years. When it came to energy in the past, when wood was getting scarce we found coal, then we had whale oil, then there was kerosene, and then we discovered basically oil rock. But this situation that we’re leading into now, I mean, listen to the Stephen Leeb interview. If the free markets were allowed to work I would agree with you 100%. We don’t really have free markets globally. The fact that we have central bankers means we have centrally planned economies; we have intervention in our economies by government. Just take a look at a rise in oil prices which was the market mechanism working to shortages after Katrina and Rita. What did you have? You had Congressional hearings parading oil companies, blaming the oil companies instead of the environmentalists, the nimby, and banana people. That’s not the way our markets work. In a perfect world where you have free markets, I agree with you 100%, but we don’t have free markets in this country or globally. [36:29]
Other Voices: Peter Navarro, PeterNavarro.com
JIM: Well, Peter Navarro, economists are saying we’re headed for an uptick in economic growth rates – you pick up the paper, or BusinessWeek, we had a slowdown in the 4th quarter, but they said that was an anomaly, now they’re talking about 3 or 4% growth rates, where in the heck are they getting these kind of numbers.
PETER NAVARRO: I’m not sure, Jim. To me, this looks a lot like the year 2000, economists were saying exactly the same thing and most of them got fooled by the recession but what was happening in 2000 was a lot what was happening today, we had basically an oil price shock, we had the Federal Reserve in a long sustained interest rate set of hikes. What’s different today and bearish in my view is the dismal state of the consumer. The consumer is essentially tapped out. The consumer has been spending like a madman for 4 years now, using the home refinancing gambit as an ATM, and just a couple of days ago the latest report shows consumers even deeper in debt. I don’t see where the economy is going to grow from here. If you take out the refinancing money that has gone into the economy in the last 3 years, our GDP would have only been growing at about 1% a year. [37:44]
JIM: This is amazing because if I look at some vital statistics on the consumer – if you take home sales, they’ve been declining almost 5 months in a row, home prices are starting to dip, real wages and salaries on a decline, the personal savings rate is negative, and payroll growth is starting to decline. I mean if I was a doctor examining a chart, on a persons health that doesn’t speak of robust health to me.
PETER: Jim, you’re absolutely right. Just after the 1st of the year in my newsletter I called a market top. I did that based on an inversion of the yield curve, based on what is a sustained and likely persistent oil price shock, based on the Federal Reserve’s ‘come hell or high water raise the interest rates, no matter what’ philosophy. And most of all on the kind of things you’re saying, that there’s not a lot of ammunition left for this economy to grow. What the Fed is saying and has been saying is that OK, in order to have our smooth transition, and our next leg up on the recovery what is going to happen is that business investment is beginning to supplant any loss in consumer spending. And that actually is how historically, by the way, business cycles usually go – you sometimes you have investment led recoveries, sometimes you have consumer led recoveries, but one kind of follows the other. The problem with that theory is that there is no evidence that businesses are spending a lot of money – at least here. What they’re doing is engaging in a lot of stock buy backs, a lot of merger activity, and a lot of foreign investment, but there’s no sense that there’s any robust domestic investment which would help fuel this economy. [39:26]
JIM: You know, then you have to ask yourself where do we go next? I mean we had tax rebates for a couple of years in a row, then we’ve had the real estate ATM machine. It seems to me with the real estate ATM machine being taken away, now we’ve got interest rate hikes and who knows, they may not even renew the tax cuts, what’s left to keep this economy going. Is the Fed really walking the line here by pushing rates even higher?
PETER: I think that what they should’ve done probably two hikes ago is to pause and see how the hikes were taking hold in the economy – that would have been the sensible thing to do, but the Fed really makes sense, I mean if you remember again the analogy to the year 2000, we had a late stage expansion, robust booming economy, everybody and their brother thought it would never end, and the Fed kept raising rates, kept raising rates, and really the stake in the heart of the economy was the April 2000, 50 basis point rate hike which basically sent the stock market down on a tumble which it has never recovered from. The NASDAQ was above 5000, now it’s just a little over 2000, and it’s had 4 years trying to get back to that 5000, and not even come close.
So, I mean from a stock market investor’s point of view if you surveyed the land you’ve got to be dispassionate about it. I mean clearly the risk reward now favors the short side, and the risk-reward favors not investing in US securities but rather investing somehow abroad. So, it’s going to be a tough time for America but it doesn’t have to be a tough time for investors.
JIM: You know it’s amazing if you look at the investment views on where the Fed is going, you’ve got people like James Grant of Grant’s Interest Rate Observer saying the Fed is done. The last two newsletters reiterated that point. Then you have Lehman Brothers that comes out this week and says, “no, they’re going to 5 ½.” I don’t know about you Peter, taking the Federal Funds Rate to 4 ½ to 5 ½, to me, is going to be the final nail in the coffin on this recovery.
PETER: Let’s try to understand, Jim, what exactly they’re doing. I had an article on this subject in Investor’s Business Daily last month, and the basic article talked about the target that the Fed is seeking which is to try to get to what the Fed calls neutrality. They want to raise the interest rates – the short run interest rate- so that it’s neutral. What does that mean? Well, a neutral Fed short term rate would be a rate which was equal to the core rate of inflation plus the appropriate real return for short term securities. And that’s about 100 basis points in terms of what the real return might be. So then the only question becomes what’s the underlying core rate of inflation, and that’s the problem: we don’t know anymore. We used to know what the core rate of inflation was – all we had to do was go to the consumer price index, and take out energy and food, and that was the core, that’s stuff so-called CPI ex energy and food.
The problem now is that we’re in a different world than we’ve been in because energy is no longer volatile in terms of inflation – that is, it doesn’t go up like it did in the 70s, and come back down like it did in the 80s, and then go up again as it did in the late 80s, and then back down in the 90s. It’s not doing that anymore. What it looks like is that oil prices are going to be persistently high now for extended periods of time. So that makes it hard for the Fed to figure out what the underlying real core rate of inflation is – is it the low rate that the CPI ex energy is saying it is, or you have to include energy. That’s why you get the big swings in estimates whether the Fed is done or whether it’s got another 100 to 200 basis points to go. I’m not sure the Fed knows. [43:37]
JIM: Don’t they run the risk though, because you and I know there’s a lag effect from the time it raises the rates to the time it filters through mortgage rates, corporate bond rates, and other aspects of borrowing in this economy that they’ve been doing this persistently now since June of 2004. I’m just not so sure with looking at the charts on the state of the consumer that there is much room left that the consumer can handle.
PETER: Here’s the problem. The problem is that everybody thinks that the Federal Reserve is basically the controller of the entire economy, but the problem here is we’re running one of the most fiscally irresponsible policies we’ve run since the 1980s. We’re basically running large structural budget deficits, we’re deficit spending, we’re spending about 21% of the GDP, and only raising about 18% in taxes, and we’re running hundreds and hundreds of billions of dollars in deficits. What’s that got to do with the Fed? Well, deficit spending stimulates the economy, and because it’s overstimulating the economy it’s created inflation both on the demand side as well as on the commodities side, and the Fed is sitting there scratching its head, “if the Feds’ fiscal policy won’t be responsible, gosh I guess we have to be,” which would mean raising rates. But they’ve gone too far. I mean the problem isn’t that the Fed is raising rates too fast and too far, which they are, the problem is that there’s no coordination between fiscal and monetary policy now. It’s a very dangerous situation. I see the economy slowing down in 06, and probably getting into a recession in 07. But you know what, even if we don’t go negative growth, Jim, if we just have 1% GDP growth rate for a couple of years, that’ll feel like a recession, and the stock market certainly won’t go anywhere. [45:39]
JIM: Do we get into a situation where maybe they push it too far, and then when things really start to rollover, as they did in 2000 and 2001, they end up panicking as Greenspan did, and then just slashing interest rates – a repeat of the last cycle?
PETER: Yes, probably, but the problem there is the old phrase you can’t push on a string. I mean raising interest rates has a lot better chance of slowing down an economy than lowering interest rates has a of stimulating on, so it’s a very risky business. If you look historically at how many times the Fed has screwed it up, we really haven’t had a truly responsible Chairman since William McChesney Martin back in the days of the Vietnam war, when he held Lyndon Johnson to account for his fiscal policy. I mean Arthur Burns in the Nixon era was a disaster; Paul Volcker arguably did what he had to do, but he wound up creating one of the strongest recessions since the Great Depression; and then Greenspan, he was great at addressing the 1987 black Monday event, and great at addressing the 1997-98 Asian financial crisis, but he really screwed up 2000 and pushed us into a recession, and since that point I don’t think he’s conducted monetary policy very well. So, this is an unsustainable equilibrium we have right now, and it’s going to be tough on the market if you’re long, not if you’re short, but if you’re long – and it’s going to be tough on the economy. [47:09]
JIM: Alright. Well, Peter given those circumstances as an investor what does one do?
PETER: Well, if you’re not comfortable with the short side, you need to learn and discipline yourself to put your cash on the sidelines for extended periods of time. You can’t take your money out of stocks now and put them into bonds because interest rates are rising which means bond prices are falling, and you’re likely to lose money in the bond markets. If you’re comfortable playing the shorts, I mean being short the broad indexes right now is not a bad idea, being short some of the select sector funds, retail comes to mind, financial sector comes to mind is a good idea. And then trying to diversify a little bit internationally is a good thing.
The other thing is hedge funds. There’s a lot of different kinds of hedge funds, and you could certainly lose all your money quick with some hedge funds, but the advantage of hedge funds if they’re good hedge funds is they know how to go short, and if they know how to manage money and go short they’ll probably do a lot better than any mutual fund for the next 5 years. So, dangerous times but hey, in dangerous times you can also make a lot of money. [48:20]
JIM: Alright, well, Peter, why don’t you tell people about your website and also speak a moment on your new book called The Well-Timed Strategy, which is also available on your website.
PETER: Jim, I’d love to. PeterNavarro.com is my website. We post our weekly newsletter which of course appears on your site, and we thank you for that. In addition, I write a daily blog on the front page of the site. There’s another gentleman, named Matt Davio, who runs just an absolutely beautiful daily blog. He’s a hedge fund manager himself. We have a third contributor who’s a biotech expert, and there’s just a lot of good information, we have a free podcast on there as well, and the newsletter’s free.
The new book I’m really excited about this year. It’s called The Well-Timed Strategy, it’s a book that analyzes how different companies were able to successfully manage through the last recession, and the reason why it’s a really good book for investors is it gives investors really a new way of evaluating companies, particularly in these economically turbulent times. What we’ve found in the research we’ve done is that stock price performance is highly correlated with a company’s acumen when it comes to managing economic turbulence in the business cycle. So, this is another good screen to put your stock through, particularly in a time when we’re likely to see the economy slowing down. So that’s available on the website as well – The Well-Timed Strategy. [49:53]
JIM: Well, I look forward to receiving a copy and reading it, and perhaps I have you back and we’ll talk about it? Peter, thanks for joining us on the program, I know you have to get to class – you teach class at UC/Irvine. Alright, Peter, once again, thanks so much and we’ll talk to you again in the future.
PETER: Thanks so much Jim.
Are We Heading For Another Bear Market or is the New Bull Out of the Gate?
JOHN: Financial Sense Newshour continues underway with a full head of steam here, at all 25 knots or whatever it is. Are we heading for another bear market, Jim, or really a bull market? Is the bull out of the gate - I guess that’s the issue we want to address in this segment of the program.
JIM: Well, it’s interesting because in the latest Bank Credit Analyst for the month of March one of their special features that they do in the publication is they have a special report, and the name of that report was: On the Cusp of an Equity Bear Market. And they took a look at a number of things – market indicators. First of all, they looked at market sentiment, and they took a look at individual investors, are they bullish, or bearish and if individual investors are overly bullish that is a contrary indicator and you’re usually approaching a market top. There really wasn’t a clear signal – in other words, we’re about one standard deviation above normal in terms of investor sentiment, but nothing on the extreme as we had for example in 1999, and 2000. On the other hand, if you look at traders’ sentiment which is almost the opposite of individual investors, it works just the opposite – when traders are bullish the market goes up, when traders are bearish the market goes down. Traders are extremely bullish right now versus individual investors who are just moderately bullish, so there’s sort of a mixed signal here with traders predominantly in the forefront in terms of market sentiment.
The second thing, you’ve probably heard about these 4 year cycles, you hear Tim Wood talk about it – the Presidential cycle. Historically, the second year of a presidency, about 47% of the time the market goes down, and down by an average of about 4.3%. However, as Bank Credit Analyst point out it is different for two term Presidencies. If you take a look at two term Presidencies, the bulk of the time we see average appreciation in the market about 14%, and rarely is the market down – the market is only down about 20%. And when it was down 20%, it only occurred with one President and that was Richard Nixon, and that was in 1974, but you have to take a look at the circumstances of that 1974 which was probably the largest bear market since the Depression. But if you take a look at 1974, first of all we had the Yom Kippur war, with OPEC following with an oil embargo against the United States- everybody remembers the gas lines. And on top of that President Nixon was facing Watergate, and ended up resigning. So we had a lot of geopolitical factors that came into play. You had a war in the Middle East, an oil embargo, a sharp almost 200% or 300% run up in the price of oil, a major economic recession, a major bear market, and a major political scandal resulting with an American President resigning from office. But outside of Nixon, most two-term Presidents the second year, if you look at Bill Clinton for example, the second year of his Presidency – what was it? 97 or 98 – great bull market, the market was up double digits. So the Presidential election cycle, if you look at two term Presidents, is much different than one term Presidents. If you look at monetary policy, we’ve had five inverted yield curves over the last 30 years, and the average gain has been healthy over the next 3 to 6 and 12 month period, following the time from when that yield curve inverted. The other thing that we have today unlike the early 80s is you have an Arthur Burns Fed, where you have the Federal Reserve raising interest rates but at the same time flooding the markets and the financial system with liquidity.
A fourth factor that they looked at which was PE ratios: if you look at the PE for operating earnings it’s down from 30, down to about 15, so it’s down in half from where it was in 2000. If you take a look at the difference between interest rates and earnings yield– earnings yields are still greater. If you look at the valuation measure Tobin’s Q, it’s below 100. So valuations they’re not screaming bargains but they’re at least reasonable. And if you take a look at past bear markets, they were accompanied by high valuations, look at where they were in the first quarter of 2000, when you had companies like Amazon or AOL selling for 600 times earnings. You had a tight monetary policy, plummeting growth and extreme, I mean extreme bullishness in 2000. So, in summary what we have today is an accommodative monetary policy, not just here in the United States, but globally in Europe, in Japan, in China – the real major growth engines of the globe are all inflating. You have what I call reasonable valuations, you have investor sentiment which is neutral, and given the absence of some kind of precipitating event – if we had a major terrorist attack, or all of a sudden you had a major war in the Middle East, and an oil embargo – outside of some kind of precipitating event like that I think you’re going to see a higher equity market. And so far that’s what’s happened. If we take a look at where we are with the market right now compared to where we were last year you’ve got the Dow up 3.3%, the S&P is up 2 ¾ , you’ve got the NASDAQ up about 2 ½ %, and remember one of the things that’s been holding the market back is these constant quarterly or monthly rate hikes by the Federal Reserve, and that is coming to a close. So, if we were unable to derail this recovery in the markets with 14 Fed rate hikes, what makes you think 15 or 16 is going to derail it, if the Fed then goes on hold. And at the same time as I mentioned earlier, just since March 1st of this month, the Fed has injected that the money supply has grown by about 87 billion dollars – so they’re flooding the markets with money. So in summary I think the markets are going higher. [57:00]
Looking For Value in All the Right Places
[music: Looking for Love in All the Wrong Places]
JOHN: Well, looking for love in all the wrong places but that won’t ruin your life. Well, it may for a certain period of time, theoretically you should bounce back. Looking for value in all the right places, however, is what we try to do here on the show, and obviously in the environment in which we find ourselves walking the line and looking for love, where are we going to look for value?
JIM: Hello, Dr. Jim here, just send in your forlorn love questions in here, we’ll try to get them on the air and answer them.
JOHN: Say that three times fast: “forlorn love questions.”
JIM: What we’re going to do in this segment is I took four different sectors. I took 3 tech stocks, Cisco, Microsoft and Intel for the tech sector because everybody knows those were the big three in the 90s. Then I took 3 drug stocks: Pfizer, Johnson & Johnson – which is a combinations of drugs and medical devices, and Wyeth which is the old American Home Products. Then I took some consumer stocks and industrial stocks: I took Bud, Coke, General Electric. Then I took 3 oil companies.
To give you an example of what I’m talking about here, and what I did, is I took a look at the high in the stock market in 1999 before each one of these companies, and then where their stock is trading today in 2006. I took their PE ratios back in 99, then I also took a look at where their sales were in 1999, where they are today, and what their net income was. And I want to just given an example, when we say that, no things aren’t really cheap, but they’re reasonable. And let me give you some examples here. In 1999 Cisco reached a high of $80.06 a share, today it’s roughly $20.64; Cisco was selling at a PE ratio of 94 in 1999, and today it’s selling at a PE ratio of 19; Cisco sales have gone from 22 billion to roughly 25 billion, and they’ve gone from a loss in 2001 of $1 billion to a profit in 2005 of 5.7 billion. If we take Microsoft, Microsoft hit a high of roughly $59 ½ in 99, today it’s at 27. Microsoft’s PE has dropped from 36 to 20; their sales have gone from 25 billion to 40 billion; their profits have gone from 7 billion to over 12 billion. Same thing with Intel, almost $75 high in 1999 today less than 20; 64 PE down to 18, sales from 26 billion to 39 billion; profits of 1 billion to almost 9 billion.
So, the point I’m making here [is] every one loved Cisco when it was selling at $80 and 94 times earnings, they loved Microsoft at $60 and 36 times earnings, and they loved Intel at $75 and 64 times earnings. They don’t like it today at 18 times earnings and $19 a share. So, in 6 years, sales have gone up, profits have gone up, stock prices in many cases Intel’s dropping from 75 bucks a share down to 20, and PE ratios down from 64 down to 18. So what I’m saying is prices and multiples are reasonable today – they’re not cheap, and you’re not going to find anything cheap in an inflationary environment. I hate to tell you that, but you’ll find things that are relatively reasonable.
And let me just take an example out of the drug sector, Pfizer was selling at 50 bucks a share in 99, today it’s half of that roughly at 26 bucks, it’s PE ratio has gone from 32 down to 12, their sales have gone from 29 billion to 51 billion, and their profits have gone from 7 billion to over 8 billion, and plus you get a dividend yield of over 3%. The last time you could get dividend yields of over 3% on drug stocks was during the Hilary healthcare scare of 1994. If we take a look at for example companies such as Budweiser, Coke, or General Electric – Budweiser was selling at roughly $41 a share in 1999, here you are 6 years later it’s selling at roughly almost $43 a share; their PE ratios dropped from 28 down to 18; their sales have gone from 12 billion to 15 billion; their income has roughly gone from a little over a billion to almost 2 billion. Coke sold at $70 a share, it’s down to 42; it’s PE ratio has dropped in half from almost 37 down to 18; their sales have gone from almost 17 ½ billion to 23, their profits have gone from 4 billion to 5. If you look at GE – GE was selling at 53, it’s selling at 33; PE ratio of 30 down to 17; sales of 125 billion up to 150 billion; net income of a little over 13 up to 16 billion. So, is GE cheaper today? Yes, six years later, its stock has gone down, PE ratios are cut in half, net income and sales have gone up.
And then finally, let me just take the oil sector – Conoco-Phillips, Occidental Petroleum, Marathon Oil – now here you have seen stock prices gone up tremendously – I mean Conoco has gone from 28 bucks a share to roughly 60 bucks a share. Occidental has gone from $24 a share to over $90; Marathon has gone from 33 to almost 70. But here’s the remarkable thing, Conoco’s PE has gone from 24 to 6; Occidental’s PE has gone from 16 to 8, and Marathon has gone from 16 to 7, but here’s what’s happened, this explains why PE’s have gone down, and it has to do with the price of oil. Sales for Conoco have gone from 20 – let’s round it up – 23 billion a year in 1999 to 179 billion in 2006. Occidental Petroleum has gone from 8 billion to 15 billion and Marathon has gone from 28 billion to 60 billion, and Conoco if you want to look at it from a profit – their profits have gone from 1.7 billion to 13 ½ billion; Occidental’s gone from 1 billion to 5.3 billion; and Conoco has gone from 160 million, to 3 billion. So their PE ratios are going down while their stock prices are going up, and the reason is profits and sales are going up faster than the price of their stock.
So, the point I’m making here is: no things aren’t cheap, outside the oil sector you’re not finding too many companies you can buy such as Conoco at 6 times earnings, and get a dividend yield of 2 or 3%. So if you look at that earnings yield it’s phenomenal, so what I’m saying here is we are looking at a cheaper type market.
JOHN: Alright, Jim, as I understand it, I’m assuming that you’re assumption here is that the next reflation’s beginning, and then that there will be a new asset bubble in equities, that’s going to be part of this. So, where will you look for the value in there?
JIM: And that’s the point I’m making. When they reflate they can’t afford to have an asset deflation in the equities market and the real estate market because we’d be looking at a depression that would be worse than anything we’ve ever seen in the history of this country. So, I was trying to make a point here is when we reflate – and this equity bubble reflates – you want to look for value. Now, in case I’m wrong, and because of my belief in peak oil, and because of global reflation you want to have what is called your hedge assets, and that’s the oil and gas, and especially oil and gas companies with long lived assets in safe areas of the world – I think that’s critical.
Second, you want to have alternative energy. My goodness, if you listen to this show that should be obvious, and the other thing is you’re going to want to have gold and silver – we never got completely out of gold and silver, we just sold our majors, and our intermediates which we thought were overvalued. I think that in this next play you’re going to want late stage development juniors, because that’s where you’re going to get the 3,5 and 10 baggers. [1:05:57]
JOHN: Yes, and this should be emphasized right here, Jim, I don’t think you’ve abandoned your primary position about hedges against inflation, oil and gas for example, and gold and silver. You still own those it was just simply a question of moving at a time when it was like you say over-valued in certain areas, but the basic philosophy is still intact there.
JIM: Sure. We are redoing our energy portfolio. We’re going more towards what I call long lived assets right now in companies that have the ability to increase their production. We are also increasing the percentage of the portfolio in alternative energy. Now, what we did do is we kept our junior development companies and when we think we’re close to a bottom we’re almost going to go full bore and 70 to 95% in juniors, because that’s where I think the next major play’s going to be. I haven’t abandoned that, we still own it, and I think that’s something that’s been lost here. [1:06:49]
JOHN: Yes, but what you’re saying here is that OK, all of that aside, for the rest of the portfolio, the areas that we’re talking about now are where you want to be. It’s not a conflicting philosophy that’s the point.
JIM: No. We talked about technology stocks in January and that’s working out very well for us. So, select technology, we own positions in drug and healthcare, consumer non-durable stocks, and also some of the industrial stocks, especially on the water infrastructure; machinery, especially that has to do with mining equipment, and manufacturing globally. And so that’s what we’re talking about here that select areas of the market, in other words, if we get into this equity bubble that I think is coming – this next reflation – where’s the money going to gravitate, where are those 9,000 hedge fund managers, and 8,000 mutual fund managers not to mention the insurance companies, the pension plans, where are they going to be putting the money? And I’m just saying this is where the value is in the market, and we think this is going to be a big cap led sector. However, the thing we’d like to emphasize is companies that have strong balance sheets, a strong franchise, and are globally diversified – they’re international companies so any kind of dollar decline translates those foreign dollar sales into higher priced profits, back here in the US. [1:08:16]
JOHN: Alright, so if we had to put this into a sort of nugget Jim, basically you believe we have a global reflation underway, it’s going to result in an equity bubble, and what you’re basically doing is well, taking stock of inflation and investing appropriately.
JIM: Yeah, the two things that are going to dominate us for the rest of our lifetime for most Americans are going to be taxes and inflation. And if you understand the inflation cycle, and what’s going on right now you need to profit from inflation, and it’ll come in waves, it’s going to come in cycles, we’ll have pull backs as we’re getting in metals right now – and energy – but you need to learn how to position and take advantage of that as the global central bankers reflate in unison. [1:09:00]
JOHN: So, basically, Jim, all you’re really trying to say is we’re just trying to stay alive.
[music: Bee Gees Staying Alive]
Other Voices: Reva Bhalla, Stratfor.com
JIM: Well, on Wednesday, the International Atomic Agency referred Iran to the UN Security Council, is this getting out of control? Will it get worse, or is this the prelude to something bigger. To talk about that, joining me on the program is Reva Bhalla from Stratfor.com. Reva, on Wednesday the International Atomic Energy Agency referred Iran to the Security Council. One of Iran’s spokesman is now promising harm and pain to the US. Where is this going?
REVA BHALLA: Well, actually this Iranian controversy does sound extremely exciting in the Media but in reality not much has changed on the ground. There’s a lot of talk of moving Iran closer to sanctions. There’s a lot of political rhetoric coming out of Iran but really this is just a cycle of tensions that have been played out for years between Washington and Teheran.
The whole idea of taking this to the Security Council, this isn’t actually a referral to the security council, basically by saying that the Security Council is going to debate this next week that whole idea was outlined after the January IAEA meeting where it was decided that this issue would go up to both the IAEA, and the Security Council. So, basically, it’s going to be debated in both venues. So, you’re going to hear a lot of political rhetoric surrounding these meetings, but not any sort of punitive action is expected to be taken against Iran in the near future. [1:10:57]
JIM: And even if the UN was to take some kind of action in the form of sanctions. Sanctions rarely work, so what is it really that the West can do?
REVA: Sure. I mean I guess it’s the question of what are meaningful sanctions on Iran – let’s see, if Iran exports a lot of carpets, sugar, nuts, fish to the US, and the US gives pretty much food, and medical supplies. You could have air sanction but again as you said they don’t really work. And there isn’t enough momentum really within the Security Council to push for sanctions as well. An interesting thing is if you look at go back to 1990, when sanctions were imposed on Iraq, and it took a whole lot more back then to impose sanctions, and the conditions were quite different. You had Iraq invading Kuwait, a major crude supplier, oil prices were relatively low so you could afford the price increase; Saudi had had enough spare capacity for both Kuwait and Iraq; Perestroika was at its height and Russia saw the whole Iraq issue as an opportunity to join hands with the US, and sacrifice for Iraq, and even back then the US didn’t even really consult with the Europeans on the sanctions. And so now, looking at this today in the context of Iran it’s going to be a whole lot harder to push anything meaningful through. [1:12:13]
JIM: So, do they just throw it in our face and go ahead and get their way? One of the reports that came out that said that there was definitely a military dimension to Iran’s nuclear programs. So it seems like we’re almost powerless to do anything about it.
REVA: You have to really look at what are Iran’s intentions in this whole thing. You don’t exactly publicize your nuclear program the way Iran does if you’re actually going towards a weapons program. You would actually develop it covertly. So really always the Iranian nuclear issue has to be viewed in the context of the Iraqi political negotiations where right now the Shia are facing struggles from all sides in trying to form the government, and even select a Prime Minister, and keep in mind there are lots of factional talks going on between Washington and Teheran that surround this nuclear controversy. So, while it gets a lot of play in the media, it’s a lot more complicated underneath. Iran is using these talks as a way to actually create more room to have general discussions just like North Korea has. It’s a beautiful precedent for Iran, just because North Korea pulled out of the NPT, citing US hostility as a reason, but that led to the six party talks in Geneva and even more negotiations with North Korea. And so Iran is using that in the same context. The only difference here that we really need to look at is Israel, and the chances for miscalculation remain pretty high. [1:13:40]
JIM: When the President of Iran comes out and says that he wants to wipe Israel off the face of the planet, those aren’t the kinds of things that would endear. Is this just hard line blustering on his part, and then they come back when the final negotiations come, they tone it down a bit, or what is this?
REVA: Pretty much. It’s a lot of posturing and Mahmoud Ahmadinejad, the President is kind of the perfect figurehead to spout off these kind of remarks, but then Iran can come back and play that down with other figureheads. So, it’s all part of this really complex game that they play. And quite honestly, they do an effective job of it, but [for] Iran a lot of it is also for domestic consumption. Iran has done a very good job of convincing the Iranian citizens of its right to peaceful nuclear technology. It’s a way to rally support around the regime. So that whole idea, and the idea of Iran trying to establish itself, are to assert itself as the vanguard of the Islamic world. All these things combined. Iran is using this nuclear issue as a catalyst in all of those goals. [1:14:49]
JIM: Do we ever get to the point though however when the President of Iran makes these kind of harsh statements that you have the state of Israel, which is right next door, say: “you know what, we’re uncomfortable with them getting their hands on nuclear technology, or nuclear weapons.” That puts them in a very tough situation: do they stop it, take it out, or just live with it?
REVA: Yes, certainly and Israel will not allow Iran get to the point where it will be able to develop weapons capabilities, it will definitely preempt that and the US knows that. It’s definitely put a strain on relations between the US and Israel, but the US has to talk to Iran about issues in Iraq, there’s still a lot of things standing in between and I think there’s still ample time for negotiations. But of course Israel has factored it in to its national securities interests that it will not allow Iran move to its weapons capabilities. And if it comes to that point, yes, you would see strikes against Iran’s nuclear sites. Although the US wouldn’t want Israel to be the one to do that, it would just seriously complicate their interests in the region.
JIM: What happens though if this thing is not resolved and Iran continues to develop their nuclear enrichment program, to the point where they’re getting close to developing weapons. I mean at that point does it turn into a military confrontation?
REVA: I mean it could, but honestly the Iranian calculus is very careful, and it pushes the envelope but it stays just below the radar to keep negotiating, and any deal you hear of – a Russian proposal, an IEA proposal, Iran will make it sound like it’s really interested in it, and it will sound very serious about it, but it will find some problems with it, the whole point is to keep talking and talking to keep the negotiations going, and for these other objectives to be met. So it’s unlikely that Iran is going to cross that red line, and invite military action, although there is a huge grey area and what would that trigger be. So, again, with Israel in the picture the chances for miscalculation are always a concern. [1:16:52]
JIM: That’s the thing that strikes me. When you walk a close line and you keep pushing on the envelope, you’ve got to be very careful because sometimes you might just tick somebody off, and when they get ticked off reaction follows.
REVA: Right, definitely. And that probably be in the form of air strikes again against their nuclear facilities to set them back a considerable number of years.
JIM: But One thing as you pointed out, in 1990 when in this case it was Iraq that was grabbing the world’s attention by invading Kuwait, we put sanctions against Iraq, Iraqi oil went off the market but Saudi Arabia had so much surplus capacity and the spare OPEC capacity was much greater. We’re in a tougher situation today where OPEC’s spare capacity isn’t what it used to be, almost you know maybe a quarter of what it was 15 years ago. Iran has a very potent political weapon with its oil.
REVA: It definitely does and actually today Iran issued a veiled threat earlier in the day while the meetings were still going on. They said we may use oil card or cut off oil exports you know if the situation arises, where they feel the need to. Really this is still more posturing because it would actually be a shot in the foot for Iran. Iran gets about a billion dollars a day in oil revenues, and it has about $9 billion in currency reserves, so really they couldn’t keep that up for very long, a few days at the most until it really started hurting them. It would definitely shake up the markets though. [1:18:25]
JIM: What do you think ultimately happens here, I mean obviously is this a game that is just played in the same way posturing and blustering over the next couple of years? Eventually it’s got to be resolved one way or another.
REVA: Eventually, but I’m I think it’s going to be more of an agreement without a resolution – if that makes sense. Iran is looking for the most open ended resolution it can to try to distance itself from the NPT safeguards, and pursue its nuclear program while at the same time meeting its objectives in other arenas. But I don’t think you’re going to see a final resolution to this nuclear program where Iran is just going to completely cave in Libya style, or anything like that. We still have a lot more time with this whole cycle of negotiations. And rhetoric is going to continue. [1:19:14]
JIM: So in the meantime I guess the world and the markets are kept on edge.
JIM: Well, Reva, why don’t you tell people about Stratfor.com, and how people could find out more information about what it is that you guys do.
REVA: Sure. Our web site is pretty informative, but we’re a private intelligence firm, we have daily analyses, and we specialize in forecasting everything from weekly, quarterly, even decade forecasts, as well as a number of specific client tailored projects as well. Most of that should be on the website.
JIM: Well, Reva thanks so much for joining us on Other Voices, I hope to talk to you again in the future.
REVA: Sure. Thank you.
JOHN: And our best instruction to our listeners for the coming week now that we’re finished listening with the show here today Jim is to stay alive. It is the name of the game. And what will we be doing in future weeks.
JIM: Well, coming up next week on the program my special guest is going to be Warren Brussee, he’s written a book called The Second Great Depression. Anyway, we’ve run out of time, we just want to thank you on behalf of John Loeffler, and myself , for joining us here on the financial Sense Newshour, until you and I talk again we hope you have a pleasant weekend.
JOHN: And stay alive.
JIM: And stay alive
[music: Bee Gee’s Staying Alive]