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Financial Sense Newshour

The BIG Picture Transcription

March 31, 2007

Part 1

Wally World: the Fed's Reality Check

JOHN: Let's see here. We're going to put the old glasses on and look at the Big Picture. Well, our friend Dr. Ben was on Capitol Hill this week talking; and your heart felt all sort of bubbly for a second there because he talked about strong economic growth in the second part of the year in his Bernanke type of way, and inflation which was way down there at 2%. Of course, Ron Paul challenged him on that, but in looking at it I keep thinking is Washington and the Fed really that out of touch. That does not reflect…remember the caller, Nickled and Dimed in Portland, who called into the show.

JIM: Sure.

JOHN: And she said this is what prices were doing way in excess of this 2% inflation that they are taking about. So inflation is radically out of control. I think Congressman Ron Paul quoted it as being around 11% right now in talking to Bernanke. And I don't know which world they are living in and now we're looking at the fact that the Democrats are off and running with the latest round of tax and spend and it's going to be dramatic this time. We are looking at whole areas of the tax code. And I keep thinking, are they living in the same world I'm living in? And I think the answer is no.

JIM: You know, it was amazing. I was watching Bernanke's testimony and it was very consistent with when he was on Capitol Hill in January and when he was on Capitol Hill in the month of February for his semi-annual testimony. And the assumptions the Fed is making is that growth is going to pick up in the second half of the year. And the reason they are making that assumption is they are making one whopping big assumption that all of the troubles that we've got in real estate right now are going to be contained, number one.

Number two that they are going to bottom, that the problems with housing, you know, are stabilizing and this problem goes away. By the time we get into this second half of the year and without the housing market causing problems, then all of a sudden, all of these dynamics are going to come into play and we're going to see this strong economic growth in the second half of the year. I don't see that, and I don't know where in the heck they are making that assumption, because one of the things that we've seen is soft business investment. We've seen a weakening housing market that I believe is beginning its second leg downward. So housing is not going to be strong. I think it's going to get weaker – that's going to spill over with consumer spending in the retail sector. And as the economy weakens, business spending which has been anemic to begin with will get even weaker. So all of these assumptions about second-half economic growth, you know, are some big assumptions to be made. Now, in fairness to the Fed Chairman, he did point out there are some risks that are starting to surface, and one of them is the subprime sector of the housing market that perhaps it isn't kept contained and it jumps over into other sectors of the economy; and I believe it's already beginning to do that – and we'll talk about that here in just a moment.

But the other thing is weakening investment spending. That has been anemic throughout this business recovery, remains anemic now, and there's nothing that I see on the horizon that's going to prompt some business to go out and spend money, to build new plant and equipment. Heck, we're shutting them down and we're shipping them overseas. [3:29]

JOHN: Yeah. But if you remember in the latter part of the Clinton administration, this was a Democratic president and Republican Congress, everybody was talking about how the budget had been balanced. You kept hearing this on the talk shows, Democrats would keep reasserting Clinton’s balanced the budget. Well, he didn't really do that. It was a balanced budget if within the next five years XYZ would happen. We're even hearing that now: President Bush talking about we're going to balance the budget and we'll get it balanced in the next five years or something like that. But the conditions for the balancing, not to mention all of the off budget items which get thrown on and off – which would land a CEO of a regular corporation in jail for fraud but we'll put that aside – those prerequisites never happen. Everybody forgets that, and we just move on to the next “we'll be all balanced in the next five years if…” – and it's the same thing here with what Bernanke is saying. It's almost like, "ignore that man behind the curtain" from the Wizard of Oz.

JIM: You know, it's amazing, going all of the way back to Jimmy Carter to President Reagan to the first Bush to Bill Clinton, everybody promised a balanced budget. We've never had one, nor will we ever have one.

JOHN: And Gramm-Rudman mandated it as law.

JIM: Yeah. And we never got it. And that's because politicians cannot resist the temptation that some way there is a free lunch out there for the average American, that somehow they can increase spending, increase taxes, increase money printing, and there's no consequences to any of this. And so it was interesting that at the conclusion of Bernanke's testimony he said inflation risk remained the main factor that are driving the Fed's interest rates decisions. And he cited all kinds of things about inflation: he talked about tightening labor markets, rising wage inflation, he talked about the energy markets.

And what is not understood here apparently, other than one person on that committee, Ron Paul, but was not understood in Washington or on Wall Street is what causes inflation. Wall Street and Washington focus on the symptoms, John. They might focus on, “oh, we’ve got rising oil prices, that's causing inflation; or now we have rising wages – that's causing inflation.” And the amazing thing: inflation has and always will be a monetary event. And what is taking place right now, and this is a key to understanding where we are going in the investment markets in the next three-to-five years, we are starting to see globally, not just here in the United States, but globally, the largest money printing credit expansion that I've seen in my 30 years in the investment business.

And just to give you an example of what is happening to the money supply around the world, these are year-over-year figures. Russia's money supply figures have grown by almost 41% in the last 12 months; India's money supply is growing by 22%; China's money supply is growing by 18%; Brazil's money supply is growing by 14%; Britain's money supply is growing by 13%; Australia's money supply by 13%; Mexico's money supply by 12%; Europe's money supply by 10%; Korea, 10%; Canada, 8%; and the United States 11%. This is money printing on a biblical scale. This is one of the reasons why real estate's expensive. It's the reason oil is expensive. It is the reason commodities are going up. The trouble is they are printing so much money, it's now spilling over into the real economy in terms of goods and services. And this is the thing that they are having a hard time keeping track of.

Let's go to the Ron Paul clip, John, and play that here because he's about the only guy on the whole Committee that really understands what's going on here. [7:32]

Thank you Madam Chairman and welcome Chairman Bernanke. It seems to me too often we run into our financial problems, and then there's the wringing of the hands. And yet, many have predicted we're going to get into these problems. For instance, in the 90s it wasn't a total surprise to a lot of people that things were out of whack when it came to the NASDAQ; and yet the NASDAQ bubble collapses and people panic and people get hurt and then there's an outcry: “well, what we have to do is we need more regulations again and there's been fraud.” Of course, all of the penalties necessary to take care of Enron were taken care of without new regulations; and the market sort of handled the distortions that were there. But no one asked the questions why was there such distortion. Same way in the housing bubble – the same predictions have been going on for years and years and yet everybody gets reassured, and everybody knows that we have to spread home ownership to those who don't really qualify. And yet the same bubble is being built and nobody says, “well, where does all of this credit come from.” And I think we fail to ask the question what the cause is, and then when the problem hits, then we treat the symptoms and we say what we need are more regulations: ”if we would only regulate the lenders we could have prevented these problems from occurring.” I don't buy into that. I don't think it's that simple.

And I think we fail too often to even look to the fundamental monetary policy because easy credit does allow people to do things that they wouldn't ordinarily do. When you have interest rates down to 1% and then you subsidize Fannie Mae and Freddie Mac with a line of credit and then you encourage these loans, I don't see why anybody should be surprised this should happen. But my concern is we don't look to the cause, which is easy credit. I mean, we have no savings rates so this credit has to come from somewhere. It usually comes out of thin air and we end up with these problems. But one measurement we used to have to sort of indicate what's going on monetarily was the M3 numbers which I think is an important number; and there is a private source now that reports M3 numbers. And I think most likely they are pretty accurate compared to the old M3. And they report that M3 is growing at an over 11% rate which I think would get people's attention if it was an official report from the Federal Reserve. So it seems like there was almost a distraction from the real cause. And then again, we look at our CPI and we say the CPI is not going up so badly, we have no inflation. Yet you look at the cost of housing, prices of houses were soaring but they are excluded from the CPI. And it just seems like we don't have everything on the table, and that we should be more concerned about monetary policy, per se, rather than saying, “well, we have problems, all we need to do here in Congress if we just wrote more regulations we're going to solve all our problems.” [10:30]

JOHN: Well, there was Congressman Ron Paul. He seems to be the only one in Congress who generally seems to understand what the core of the problem is. And if you notice what his message was there, it is that we create these things, and then when they happen, everybody acts shocked and surprised. If you remember just a few years ago, Alan Greenspan was telling everybody to go out and get these ARMs. So they began making loans to people who weren't qualified and everybody knew these interest rates were going to jump up in a couple of years – you signed on the bottom line knowing that. And then when is it happens, “oh, my gosh, what are we going to do, this is horrible,” et cetera. He says we created this problem. It's loose credit. That's it.

JIM: Bernanke made one comment, and I'm going to quote him here. He said, "At this juncture, the impact on the broader economy, and the financial markets, of the problems in subprime markets seem likely to be contained.” And, John, as you just mentioned, three years ago, the government officials – especially the Fed – in Washington were telling people, go out and spend money, borrow, go out and take adjustable-rate mortgages, do anything. They were trying to pump the economy. People did that. Now these problems are coming home to roost.

And I don't buy the Bernanke statement that these problems are contained. I think they are going to get worse. And there's mounting evidence that just the opposite of what he is saying is taking place. There's about 700 billion [in] mortgages that are going to reset this year, John. And a lot of the mortgage and housing credit is going to get worse this year than it was last year. I mean, we're just moving into the second phase of this downturn. You think it's bad the last year, it's going to get worse as we head into mid-year. Also, we had a number of adjustable-rate mortgages in the Alt-A market (that's sort of the market in-between subprime and prime). And in 2004, these adjustable-rate mortgages were very popular at that time; they were three-year fixed. They would fix the loan rate for three years and then after that, they would become adjustable. Those adjustable Alt-A mortgages are coming due for reset this year. Then in 2005, another popular model, they went to two year, it was called a 228. It would be a two-year fixed loan, fixed for two years only, and then it would go to an adjustable-rate mortgage. This is in that Alt-A category. Those loans are due to reset this year. So this problem is going to get much, much worse and it is already spilling over.

I disagree with the Fed Chairman. It's already spilling over into the secondary market where we have seen credit spreads already starting to widen. And there's now a reversal in the appetite for risk. Lenders are starting to lose money. They are starting to see delinquencies rise. They are starting to see defaults go up. 13.3% of the subprime loans issued last year are in default already. So the real risk to the investment markets is a lot of these subprime loans, which have been sliced and diced into different tranches of what we call collateralized mortgage obligations – these CDOs. When they were repackaged and sold to investors by Wall Street, how do you take a subprime mortgage, which basically would be equivalent to a junk bond, repackage them and all of a sudden they show up as AA and AAA rated? Many of these loans are going to go bad this year. Let's play that subprime clip where they basically think this is not going to be a problem. [14:06]

As a result of this deterioration in loan performance, investors have increased their scrutiny of the credit quality of securitized mortgages, and lenders in turn are evidently tightening the terms and standards applied in the subprime mortgage market. Although the turmoil in the subprime mortgage market has created severe financial problems for many individuals and families, the implication of these developments for the housing market as a whole are less clear.

The ongoing tightening of lending standards, although an appropriate market response, will reduce somewhat the effective demand for housing; and foreclosed houses will add to the inventories of unsold homes. At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all class of borrowers continue to perform well, with low rates of delinquency. We will continue to monitor this situation closely. [14:58]

JIM: Here he's saying basically it's contained. But you know, low rates of delinquency? Reality check, John! 13.3% of these loans are delinquent in the fourth quarter alone. In fact, Lehman Brothers and Bear Stearns have a base-case scenario that in the next couple of years we could see anywhere between 200 and $300 billion of these subprime loans default. That's their base case. And what that translates into is anywhere from one to two million homes that will default, which means one to two million homes are going to come back into the market. [15:36]

JOHN: So basically, are we saying, then, that the whole issue with the subprime market is contained or not contained, are they going to be able to bail this one out?

JIM: Well, eventually, they are going to have to bail it out, but as far as it being contained, I disagree with that. It's now spilling over into the lending market with widening credit spreads. It's spilling over: bankers are starting to pull back on the reins on granting credit. In other words, the no-doc loans, the no-money-down loans, the money given to people who couldn't qualify – they are reining in that. And when they do that, John, that means credit is being contracted. So in my opinion, what we're going to see unfold here between the second and third quarter is the second wave of the housing market downturn which is now beginning, and it's going to get much, much worse. Credit growth is going to contract and that translates into lower economic growth and good distinct possibility of what I call a nominal recession. In other words, if we had real inflation rates today, and we're using real inflation rates and subtracted that from nominal GDP, we're already in a recession. But we don't have real inflation rates, we use artificial inflation rates so that over states GDP. That's what I mean by a nominal recession. [16:54]

JOHN: Of course, one other thing that Bernanke was thumping very strongly was a strong economy at least in the second half of the year. And I don't know what indicators he's looking at, but I think this is more speech designed to achieve an outcome rather than speech describing an outcome.

JIM: Sure. In fact, the day he was speaking, we got the durable good orders and they were down, excluding transportation, one-tenth of a percent versus a forecast of an increase of 1.8%. This was for February. That follows a 4% slump in the month of January. So what we're starting to see now is a decline in business spending and that decline is beginning to deepen. So it’s almost the opposite of what the Fed Chairman was saying or has been saying since the beginning of the year. So the economic reports coming out aren't lining up with what the Fed is basically telling the market. And what the Fed is trying to do is maintain confidence, but it's a losing game because you can't hide these economic numbers. This week's durable good report, already, has caused many of the top firms on Wall Street to revise their GDP growth rate figures in the first quarter from over 2% down to (depending on which economist you're looking at) about 1.4 and 1.7%. So the Fed's forecasting a return to stronger economic growth by year end just doesn't hold up.

And it's not just the durable good orders, if you look at the leading economic indicators year-over-year declines become a big deal when you look at what happened in the economy. And especially if you look at the past, whenever we have seen this year-over-year decline, it has always heralded an approaching recession – every time for the last half of the Century. Also, when these leading economic indicators contract and they pull back, what happens is successive quarters they contract as well. So it's not like this is giving a head fake, or you're getting some kind of whip-saw type of statistic. It is a confirming trend that is in place.

So if you're looking at the leading economic indicators, you look at durable good orders, you look at housing sales, you look at business spending – all of this added together collectively is painting a picture. And a lot of times you'll see – and you see this on Bubblevision all of the time – a lot of these Wall Street economists will be very derisive of this leading economic indicator. They'll try to spin it, but you have to put that in perspective because when you consider how poor the consensus Wall Street forecasts have been, and how many times they failed to anticipate cyclical turning points, I think that is the more relevant question here. [19:29]

JOHN: Yeah. It's always interesting on how, when you get out of office, what you think you can say changes. I remember talking to Congressman Helen Chenoweth after she left office, and we had some pretty candid conversations at that point about things. And the same thing you notice that Alan Greenspan, now that he's out of office, is giving a pretty high chance now of a recession by the end of the year. Do you think if he had still been Fed chairman, he would still have been chanting that song right now?

JIM: He would have been chanting the mantra: “strong economic growth, things are contained.” Speaking of Greenspan, John, you can go back to the testimony in the year 2000 when Greenspan was on Capitol Hill, the Fed was basically saying the same thing: “the growth was going to pick up, yeah, there was a few problems in the stock market but it was contained,” and they anticipated that things would resume after a while. So it's the same message that Wall Street and Washington was telling the public in 2000. It's the same thing that's going on here. I want to talk about the economy, and let's go back to this problem that they are having with loans and whether they'll be contained. Let's go to Congressman Brownback.

BROWNBACK: If I can go right immediately to your predecessor suggested there are factors that are existing now – that have got a lot of media report on it – leading towards a recession. I don't know if he would put that quite careful a term, knowing he picked his term carefully. It got quite a stir. But you in your testimony don't point towards that, I take it. Are there factors that you're looking at that, or that he doesn't know about that would cause a situation towards a recession; or I would just like to hear your comment on that very public discussion that took place and give you a chance to comment about it because I think it's on a lot of people's thoughts and minds. Certainly when I get questions in the media.

BERNANKE: Senator, as I’ve indicated, we continue to expect the economy to grow at a moderate pace. So we expect continued growth. There are risks to the outlook in both directions as I indicated, so we'll have to watch to see how big…if those risks materialize, and if so, how serious they are. But again, our expectation is for moderate growth. I would make a point which I think is important: there seems to be a sense that expansions die of old age, that after they reach a certain point, then they naturally begin to end. I don't think the evidence really supports that. We look at history, we see that the periods of expansions have varied considerably, some of them have been quite long. The evidence that expansions must ultimately come to an end, essentially of old age, does not seem to be there. So our basic forecast remains for moderate growth and that's our expectation. [22:15]

JOHN: A lot of the problem in this is reading through some of the language. Last week, the Fed sort of came out with verbiage that said basically, “well inflation is not much a problem. It's way down there.” But you know, if you listen between the lines here to what Bernanke is saying, it's really still a factor in the game.

JIM: Sure. And I don't know how many times we have to say it. The Fed and the government caused inflation with money printing, credit expansion and over spending. In other words, John, they almost make inflation sound like some external, what was the one that Jimmy Carter said, “strange and mysterious things that cause inflation.” That's balderdash. Inflation has and always will remain a monetary event. And as we alluded to at the beginning of this segment, money supply, money printing, credit expansion globally – I don't care if you're looking in North America, Europe and Asia and Latin America – it is taking place now on a biblical scale. I have never seen, quite honestly, in my 30 years in the business, anything like what's taking place today where we have all fiat currencies, where there is no spending discipline within any government. All politicians can do is promise voters more and more programs, more and more entitlements. And where are they going to get the money to pay for all of these things? There isn't enough in the tax system to pay for all of this. The way they pay for it is it’s this promise for nothing that comes from politicians; they are going to end up printing their way out of this.

If an individual would look at their own cost of living and put that together and say wait a minute, he's talking about core inflation at 2% or 2.5, whatever number he's using this week; and take a look at your checkbook. Take a look, year over year, what you're spending money on. What did it cost you for groceries per week a year ago? What were your utility bills a year ago; what were your medical premiums a year ago; what were your utility bills a year ago? What were your trips to the dentist, the doctor, or any kind of service that you have. Maybe the guy that cleans your pool, a lawn service or whatever it is, what were they changing you a year ago, what are you paying today? And John, why don't we go to that clip that we had from a caller called Nickled and Dimed in Portland because this is the reality of what's going on right now.

Hi, Jim and John. This is Nickled and Dimed in Portland, Oregon. I stay at home with my kids and have to watch my budget, so I thought you might be interested to know how the prices have increased in my area at my warehouse clubs – all of these prices are since November first. Ground beef has gone up 25%. Whole chickens have gone up 11%; cheese has gone up 15%; pork loin has gone up 10%; milk has gone up 6%; gas has gone up 22% - that was since the end of January. Any way, I was enjoying the program last week when and had to chuckle when John Williams was remarking how Ben Bernanke was going to have to start substituting cat food. I sure feel like that. Any way, thanks for the show. [25:40]

JIM: So there you have it, John. There are the realities that most people are facing. And you know, when it comes to inflation and the implications going forward, my son wrote a wrap up on Wednesday – and if you go to www.financialsense.com, go to Wednesday wrap up or look up my son's name – and he did an excellent portrayal of what's really going on in the inflation rates in this country. And I'd really recommend that you read that because you're going to get a better understanding, just like this caller, of the realities that are facing Americans today. Let's finally go to that last clip, John, the core rate of inflation, which is a meaningless and worthless statistic, but let's hear it anyway. [26:19]

BERNANKE: Let me now turn to the inflation situation. Overall consumer price inflation has come down since last year primarily as a result of the deceleration of consumers energy cost. The consumer price index, or CPI, increased 2.4% over the 12 months ending in February down from 3.6% a year earlier. Core inflation slowed modestly in the second half of last year, but recent readings have been somewhat elevated and the level of core inflation remains uncomfortably high. For example, core CPI inflation over the 12 months ending in February was 2.7%, up from 2.1% a year earlier. Another mention of core inflation that we monitor closely based on the price index of personal consumption expenditures excluding food and energy shows a similar pattern. Core inflation which is a better measure of the underlying inflation trend than overall inflation seems likely to moderate gradually overtime. Despite recent increases in the price of crude oil, energy prices are below last year's peak – although I might add that in the last few days that’s become less true. If energy prices remain near current levels greater stability in the costs of producing non-energy goods and services will reduce pressure on core inflation overtime.

Of course the prices of oil and other commodities are very difficult to predict and remain a source of considerable uncertainty in the inflation outlook. Increases in rents, both market rents known and owners-equivalent rents account for a substantial part of the increase in core inflation over the past year. The acceleration in rents may have resulted in part from a shift of demand toward rental housing as families found home ownership less financially attractive. Rents should begin to decelerate as the demand own for owner-occupied housing stabilizes and as the supply of rental units increases. However, the extent and timing of that expected slowing is not yet clear.

Another significant factor influencing medium terms trends in inflation is the public's expectation of inflation. These expectations have an important bearing on whether transitory influences on prices such as changes in energy costs become imbedded in wage and price decisions and so leave a lasting imprint on the rate of inflation. It is encouraging that inflation expectations appear to be contained.

Although core inflation seems likely to moderate gradually overtime, the risk to this forecast [inaudible] to the upside. In particular, upward pressure on inflation could materialize if final demand were to exceed the underlying productive capacity of the economy for a sustained period. The rate of resource utilization is high, as can be seen most clearly in the tightness of the labor market. Indeed, anecdotal reports suggest that businesses are having difficulty recruiting well-qualified workers in a range of occupations. Measures of labor compensation, though still going at a moderate pace, have shown some signs of an of acceleration over the past year – likely in part the result of the tight labor market conditions. To be sure faster growth and nominal labor compensation does not necessarily portend higher inflation. Increases in compensation may be offset by higher labor productivity or absorbed, at least for a time, by a narrowing of firms profit margins rather than passed on to consumers in the form of higher prices. In these circumstances, gains in nominal compensation would translate into gains in real compensation as well. Underlying productivity trends appear generally favorable despite the recent slowing in some measures and the markup of prices over unit labor costs is high by historical standards, so such an outcome is certainly possible. More over, if the economy grows at a moderate pace for a time, as seems most likely, pressures on resource utilization should ease. However, a less benign possibility is tight credit markets might allow firms to pass some or all of their higher labor costs through to prices. In this case, increases in nominal compensation would not translate into increased purchasing power for workers but would add to inflation pressures. Thus the high level of resource utilization remains an important up side risk to continued progress in reducing inflation. [29:59]

JIM: You know, John, what you just heard was gobbledygook. First of all, I think we have to begin with the assumption, nobody lives by the core rate. He talked about tight labor markets, energy prices, business passing on prices to the consumer. So what he was talking about here were the symptoms of inflation rather than the cause. And this is where the confusion comes in. 30 years ago, Wall Street, the bond market and the public understood what caused inflation. Today, we've been dumbed down so much. You have cost-push inflation, which come in from rising labor wages, which is what you just heard the Fed Chairman talk about. Wages are going up, “gosh, this is inflationary, but it may not be as long as businesses don't pass on the price and we get higher productivity.” Then you have profit-push inflation, which is businesses raising prices. The Fed Chairman referred to that. And then of course, we always get crisis-driven inflation, which is acts of God. So here what you had was the Chairman talking about the symptoms rather than the cause – and this is what confuses everybody. So if you get a raise, that's inflationary. If businesses that gave you the raise have to raise prices to compensate for higher labor rates, they are passing on costs, so they are causing the inflation. Where the real cause is the money credit-spending, money-printing cycle that we have going on between Washington and the Fed, and the securities system which is also a factor for creating credit today, which is causing all of this inflation. [31:47]

JOHN: You know, it's interesting, Jim, because we had the Fed raise interest rates 17 times, but now we really see the economy starting to crater and at the same time the Fed is putting all of the happy talk out there to try to detract from that. What does this all mean in the long run?

JIM: It means, John, that the jig is up. The end game on inflation is before us. In the 80s and 90s, they could spend money, run deficits and they could just go to the bond market and borrow the money. They weren't creating new money. They were taking from existing savings. And with increased manufacturing costs, as manufacturing went global, that helped to contain the cost. We still had inflation, and we haven't had deflation in this country – for the last real deflation you’d have to go back to during the Great Depression when we were on a gold standard. But what happened is we had inflation every year, but the big inflation was taking place in assets markets which is okay. As long as assets were going up such as stocks or real estate, that was kind of like what Jens O Parson calls the good inflation, that's before the bad things happen. Now, we’re getting to the period when the bad things start to happen, and the bad things are catching up with the Fed: they are increasing the money supply, credit is expanding but now we're starting to see the side effects. [33:13]

JOHN: You know, it's interesting that if we look at the direction that this is all going in as a matter of fact, you realize that we're 584 days away from the next election from a new Congress and from a new president. When this really begin to unravel, they are going to be in office when the music stops.

JIM: Yeah. I've said that I would not want to be the next president of the United States because all kinds of crises are going to be experienced. There's a group of us that are getting together tomorrow – in fact, I won't be doing the opening part of the show – because we sense this crisis is coming. So we're going to spend two days together, kind of everybody is coming with their own ideas and articles and things that we think are going to be relevant. But, John, we are heading in for what could be some of the worse times in this nation's very history that may shake the very foundations of what was once a Republic. So the end game’s here. They can't hide it any more and that's going to be interesting to see how they wiggle around this in terms of what the economic reports, we're seeing wide spread intervention in the gold markets, and the commodity markets, trying to keep them contained from rising. We’re seeing intervention in the stock markets, to keep them from faltering. We're seeing the money supply and credit expand at levels we've never seen.

And we're going from one little crisis whether it's a Refco or a hedge fund blowing up that gets buried; and what we've talk about on this program what could be one of the biggest systemic risks in this nation's history, or the financial markets, is this large naked short positions. I mean, it's one way they are keeping the gold market contained. It's very difficult for them to keep bullion contained because they drive their price down like they did a couple of weeks ago – they drove it down 40 bucks – it goes right back up. That's because OPEC nations are buying gold, the Chinese are buying gold, the Indians are buying gold. So what they are trying to do to distort the market is they are allowing these large short positions to come in the mining sector by allowing these hedge funds where you have hedge funds working in collusion with some brokerage firms that are basically shorting in this market. I have never seen this kind of manipulation and intervention in my life. In fact, one of the writers on our site, and one of the Other Voices we have is Gary Dorsch, and in one of his newsletters, he wrote: “I slapped two words on the side of my face. On one side, I slapped liquidity; and on the other side, I slapped intervention,” because Gary is a well known chartist and expert and in his recent newsletter, he talked about he's never seen an intervention like this. They are working both sides of the fence. And what they are trying to do, John, is keep the sheep corralled on one side and they are trying to hide all of the problems of all of this money printing, but it's getting more difficult. It's just like Nickled and Dimed in Portland. You're starting to see it face-to-face, day-to-day in your lives, and it's getting more difficult to hide. [36:12]

JOHN: And it's often very difficult, you mention the gobbledygook that Ben Bernanke was uttering, shall we say, in the whole course of that and which when you get done listening, your first thought was gee, what did he say. And then you realize it has nothing to do with anything, but the average person who doesn't follow a lot of these issues goes “you're getting some big strange and mysterious thing, acting in strange and mysterious ways because he's the Fed chairman and he should know.” So that's as far as they get, which allows for this process of offloading we keep talking about where the finger is pointed away from the real blame and onto something else – it keeps it confused. Okay. Now that we know all of this anyway, what then should we do? Sounds like a famous book.

JIM: When money is depreciating and losing its value the first thing you should own is real money and that is gold and silver. I've been pounding and pounding and pounding the table. If they manipulate the gold market, if the brokerage firms and hedge funds short the gold stocks, take them off their hands, buy them, back up the truck, put them away, buy gold, buy silver, buy tangible assets, oil because that's what's going to maintain your purchasing power in your value – paper money is depreciating, vaporizing before your eyes. Just as Nickled and Dimed in Portland talked about these prices: another way to look at that is not that prices are rising but the value of the money you have is depreciating in value. That's why you want to own gold, silver bullion, gold silver equities; if they want to short and manipulate the market, buy the shares, take them off their hands; listen to the segment that we get in the second hour with Patrick Byrne, and the segment that will be coming up with Dave Morgan here in just a moment, but take the longer term view. [38:22]

JOHN: What about all of the volatility out there in the market? You're going to hear about corrections in oil, and that tends to confuse and intimidate people.

JIM: You know what, you've got to clear the mechanism. Rule out the noise. And just take a look at what's happening in your lives. Forget the propaganda that comes on the cable stations, forget all of the noise in the press and look what's happening in your real lives. What's happening to your food bill, as this mother from Portland was talking about. Take a look at your expenses. Take a look at your paycheck and how much of it is going to various taxes, fees and things like that. And then ask yourself, where are they going to get the money to pay for all of these things? Is the rest of the world going to loan this country $900 billion a year so we can borrow and spend money. Ask yourself these questions and don't pay attention to these other people. [39:18]

JOHN: And I would assume that's what you're doing with your money.

JIM: I have all of my money in two areas: oil, because I believe that peak oil is right around the corner – in fact, people like Matt Simmons thinks it's already here; and the rest is in gold and silver. That’s because I have spent six, seven years researching this; and we've written about it going all of the way back to the year 2000 and 2001 when, as you know, John, when we started doing radio, a lot of the things I was saying, gold, silver, commodities, oil, I mean people thought I was loony; just as people thought I was loony when I said get out of your tech stocks there's a correction. I used to do local radio here in 1999 and we would get angry hate calls on the radio station: “you don't know what the heck you're talking about.” Everybody was blaming the new era and I was telling them, no. companies are cooking their books; 600 times earnings; or no earnings or no sales. This is bubbleville. And this will not last. I wrote a piece called Plains, Trains And Dot Coms, which I published January 4th of the year 2000, that talked about this. So no, this is something that I believe in. It's something that we're doing for our clients and it's something that I do myself. And what I'm telling you, buy it while you can because you know the old saying, “it wasn't raining when Noah built the ark.” And I don't know what day it's going to be, what month it's going to be, but one day, the rains are going to arrive and it's going to be too late if you haven't taken steps to prepare for it. [40:50]

JOHN: Let me take the devil's advocate position here because I think this is probably going through the mind of some of our listeners. If they have to refloat another currency, say you're looking at the death of the dollar and we're going to refloat the Amigo or float it for the first time. What about jumping in and doing something a la FDR, with gold and silver, to do that. How would that affect what you're telling people right now? First of all, what could possibly happen, and second of all, how could it affect people investing in bullion?

JIM: Well, let's say they do confiscate gold. I think the easiest way to do that would be the ETFs because that's where the largest amount of ounces would be. But I think there would be a rebellion, John, because of the internet people are a lot more informed today – and to do something like that would create a rebellion. Where people were more docile, they thought it was for the good of the country back in the 30s. When that happened – when they confiscated gold – we had a crisis in this country. I mean you take a look at the crisis in Argentina. The people that fared well were the people that had gold and silver and had tangible assets. The people that lost everything were the people that had their money in government bonds and in banks. And there's a lot of this information out there that people are aware of this. That's why last week we covered the CPM group, their 2007 gold report, and we're going to have Jeff Christian on the program as an expert here coming up in April. But that's why we have seen in the last five years the largest amount of gold buying in the history of the world because, John, people are aware of this. They know this is coming. And that's why the smart money is taking steps like this, so that's why ignore the short term fluctuations, ignore the false propaganda, the false information that's being fed to you. And, once again, I go back to that caller from Portland who is a real mother that is experiencing this on a day to day life. Look at what is happening to your own life, your costs, your expenses, then turn on the television, the press and they tell you the opposite. You make the connection: you're being lied to. [43:07]

JOHN: It really comes down to that, doesn't it? You really have to sort of call it what it is.

JIM: It's manipulation, because governments aren't going to go out and say “hey, we're printing a bunch of money, inflation is going to increase, take steps to protect yourself, we're doing it.” That doesn't fly. And what you're talking about here is the credibility of the currency, so they will fight tooth and nail because every Congressman that gets elected feels that their job is to hand out goodies to the voters that contributed to their campaign to help them get elected. That is what has become the new job in Washington. I had hopes, when the Republicans got in control of Congress in 1994, that they would practice responsibility, fiscal responsibility. They didn't, John. They ended up becoming big spenders, just like their predecessors. Now that the Democrats are in, they are doing the very same thing. As we get into this third segment, they are planning the largest single tax increase in the history of this country; and the largest series of new pork and spending programs in the history of this country. They are no different than the Republicans; Republicans are no different. It doesn't matter who you elect. They are all the same. They are doing the same thing. They are promising voters that they can give them goodies. The most despicable lie I have ever seen is this Ponzi scheme with Social Security where they take people's hard-earned money, and they spend it and issue IOUs. John, if you and I did that with pension funds – I know if I did that with my employee’s pension fund – we'd be broadcasting from Sing Sing. But that's the way the system works. So you can't change the system, the system is going to implode. All you can do is protect yourself. [44:55]

JOHN: You're listening to the Financial Sense Newshour at with www.financialsense.com where the new file for the program where posted every morning by 7:00 AM Greenwich time.

Part 2

Real Estate: the Second Down Leg

JOHN: Well, it's like an economic Coney Island. Nothing goes straight up; nothing comes straight down. They go in what I call dipsy-doodles; and the dipsy-doodles on the way down are usually a lot more thrilling than the dipsy-doodles on the way up. We're looking at the second dipsy-doodle down leg in the real estate market. Where is it headed? When are we going to discover where the bottom is?

JIM: Well, there's a number of things that are now starting to hit the real estate market. All of the bad lending practices are now coming home to roost – the no-document loans, the no-money-down loans, the interest-only loans, option ARMs – all of these are going to be reset this year. Remember when these three year option ARMs were popular and were taken out in an incredible amounts in the year 2004 – they get reset this year. What they call the 228 program where a two year fixed and then it goes adjustable – that was a big thing in 2005. That gets reset this year. So as mortgages get reset, you're going to see these delinquencies and defaults will begin to rise. They were rising so that by the fourth quarter of last year 13.3% of all subprime loans were already in default. Now, as we're seeing more and more defaults, more delinquencies, banks and lending institutions are tightening credit. There are less loans that are going to be made. There's less refinancing. So the pace is going to slow even further. And as more loans go into default, more homes are going to come into the market increasing supply which is going to put further pressure on home prices. And we recently saw that, for example, in the housing numbers that were just released here in the last week. What happened is inventories went up to eight-months worth of supply – so what is happening here, in addition to the existing supply of unsold homes and new homes that have been built that haven't been sold, now you have the homes that were sold a couple of years ago. They are now going into foreclosure, so they are being brought to the market. So just as the builders are trying to work down their supply, you now have a new source of supply, which is foreclosures. [2:33]

JOHN: Well, as the pace begins to slow, we see that homes no longer sell. They are on the market for a lot longer – the turn overtime is a lot longer. And that's what we're seeing here in my area of the country – I'm in the Pacific Northwest – and you'll see homes that have for-sale signs out in front of them for, now I would say, a year, 18 months without being sold. The inventory gets greater, and as a result, the market gets weaker. That's sort of the symptom on this. And then buyers start acting in strange ways because they are trying to – remember before everybody was sort of the hanging on saying it’s going to go up and up and up and it’ll never stop; and then, when we go over the top and start sliding down, then what do they do to try to preserve their values?

JIM: Eventually, and especially when the job market starts getting hit, then what will happen is – maybe you'll have five homes for sale in the neighborhood – somebody loses their job, and they get desperate, they can no longer hold on to yesterday's prices. So what happens is either with the foreclosure, or they get desperate, and they go to the realtor and say, “what is it going to fake to move this property;” and they begin slashing the price of the home and that becomes the new reality. And all of a sudden, the market is sort of reset in terms of price. Let me see, we’ve got seven homes for sale in our neighborhood. The very first home that went for sale has been on the market now over a year. But the price that they are asking – and I've seen the little flyers – they are asking for what these homes were going for two years ago. So, you know, I don't know how long they are going to be able to hold out. We do have two homes now that are in escrow, so it's going to be interesting to see if they just finally said, “look, to move this, we're going to cut our price,” which is what I think happens. If that is indeed what has happened, then that's going to reset the price for the whole neighborhood. So you're going to start to see that happen.

And it’s going to spill over into the economy, John. It's going to spill over into retail sales. It's spilling over into the market right now with widening credit spreads. And there was a Bloomberg story that came out this week. And it was talking about what can happen to a community, and this community is Irvine, California. Anybody that's been to Irvine, it’s a very, very affluent community in Southern California. However, it's home to a lot of these subprime lenders including New Century. And Bloomberg did this story about what has happened to this town. And they start out talking about, for example, the Toleo Mexican Grill in Irvine where diners wash down Salmon Vera Cruz with $7 hand shaken margaritas. Reservations were often for 10 or more. Not any more, says the owner of the restaurant. It's located two blocks away from the New Century headquarters. We don't get any now. In Irvine just nine months ago, office vacancies approached a three-year low. Home prices were at an all time high and unemployment was less than the national average at 3.6%. Now, in the last six months, the unraveling of the subprime mortgage market is ruining the recent prosperity. Home lenders, including New Century and Ameriquest mortgage, have fired more than 3000 people. House and condominium prices are down 17% since June, and office vacancy rates are poised to double this year. And then they go on and talk about a New Century, Irvine's second largest employer may be forced to seek bankruptcy protection after the lender to people with bad or limited credit said, “New York based Morgan Stanley, and UBS of Zurich, are among the companies that are cutting off access to 17.4 billion of credit lines.” Then they go on and talk about how, for example, it's affecting everybody from the printer-paper suppliers to the office maintenance companies, to the retailers in the area. Before its collapse, New Century had 7400 employees compared with 8600 employees at the University of California at Irvine. “We're going to see massive layoffs,” said one real estate agent. So the cracks in the subprime market are just starting to show up. And for example, foreclosure rates for subprime loans are exceeding 22% in California metropolitan areas: Irvine, Merced, Bakersfield, Vallejo, Fairfield, Fresno, Stockton, Santa Ana, Anaheim and Riverside. Half of the 20 biggest US subprime lenders are in California including three in Irvine. So even though the collective number, you know the average is 13%, in many areas in cities, it's much bigger. In Irvine, already two dozen mortgage lenders have closed or sought buyers since the beginning of the year. And they were talking about, for example, condominium prices are down from $775,000. They've dropped to $641,000 – down 17%. Office vacancies are up. The luxury car dealers from Porsche dealers to Mercedes dealerships are saying cars are being returned. People can't afford to make the lease payments. And this is just one incident in terms of how this is spilling over and affecting the real economy. I mean, a lot of these people were making over 200 grand a year as mortgage brokers closing all of these loans. And this just isn't in Irvine – New Century was making loans all over the country. And a friend of mine who is at a major bank here in California, he does home equity loans, and he said they are down from 300 mortgage home equity lines a day that they would process, they are down to about 120. I haven't talked to him in a couple of weeks, but I suspect that number is getting worse. So we're far from this thing stabilizing. It's the second leg downward where you really begin to see the pain. That's what we're going to start seeing as we go forward. [8:36]

JOHN: Well, obviously, we're looking forward the middle of the year. Where do you think things are going, because you almost have to keep in mind the fact that Chairman Bernanke is going to have to go back on Capitol Hill, and is he going to be able to sing the same song then that he's singing now?

JIM: No. I don't think so, John. I think by the time you get to May and June, you're going to see new home sales continue to drop, existing home sales continue to drop, mortgage applications will continue to drop; you're going to see housing starts down; you're going to see real estate prices down; you're going to see basically this spill over into retail sales. And you're already seeing the spill-over effects right now with tightening credit spreads. And then also the next area it's spilling over into is this Alt-A market where all of these option ARMs and adjustable-rate mortgages are; and then also it's going to be spilling over into the securities market where pension funds, bond funds have been buying a lot of this paper that has been securitized – so a lot of these securitized mortgage pools have been packaged, sold to institutions, individuals, and prices are going to drop precipitously

Banks are also going to see their profits fall because one way banks have overstated their profits in the last couple of years is their loan-loss reserves have been lower than what they should be, so what is going to happen is as these defaults and delinquencies and losses start to come into play, bank profits are going to start to decline as a result of these losses. And remember, even though they sold a lot of these mortgages, they have about 60% of their portfolio in real estate, so they are going to be cutting back.

So no, John, real estate hasn't stabilized. The real estate market is going to get worse. And as it worsens, it will translate into slower economic growth, Wall Street and Washington right now are basically wishful thinking. The market stabilizes and then everybody thinks this is just going to kick in, and we're going to see this second half of the year where we're going to see strong economic growth. It's not going to happen. Two-thirds of the economy is based on consumer spending and business in the investment world, you know, they are not going to pick up the slack to offset a downturn. And what's going to happen at the consumer level as these mortgages basically are reset? [10:56]

JOHN: Well, if we look around us and say, look at the malls, I went wandering through one of our malls here and began talking to people who were selling things, asking how things are going and one of them said, “just practically totally dead.” Look at the for-sale signs that are hanging up there that aren't turning over property. People in the Fed and Congress seem to be in Wally World rather than here.

JIM: Sure. And I think what we're heading for is stagflation, higher rates of inflation. I mean look at it – the Fed has raised interest rates 17 times; the Fed stopped raising interest rates almost a year ago. You would normally begin to see, like in previous cycles, the inflation rates come down. That hasn't happened. What we've got going right now is stagflation with slower economic growth and rising levels of inflation – so that's the reality that we're facing here. And I think everybody, if they look at their own lives, what they are experiencing, or what you've said – I've had a little bit of different experience here in California, and we're probably going to be the last to feel it but I can sense it's coming here because we have two kinds of malls. We have what we call the middle-class mall I go to. They are starting to hurt. They are cutting back hours. One of my friend’s wife works in a clothing store. It's kind of like a bargain Ann Taylor store. And her work hours have been cut back during the week sometimes. In the evening, they are thinking of cutting evening store hours because they are just sitting around talking in the store. Nobody is in the store. On the other hand, I can go to a luxury store mall in San Diego, and we still see a bit of traffic yet. It's a little bit slower. I can tell that by the parking lot, but we're not quite there yet. But I think this is where we're heading, John, is for stagflation. [12:42]

JIM: Well, obviously, if we are constructing a portfolio in such an atmosphere, or at least anticipating one, the bottom line question we always ask is what would you be buying?

JIM: Two areas. You want to be in energy, you want to be in metals. I mean just take a look at the energy markets. You've got Brent crude at $67, oil prices at $66, gasoline prices are heading higher – and that's assuming the world is at peace, and there are no hurricanes or other disruptive events, John, and I just don't see that happening. I think alternative energy, water and food. These are basics, these are staples, things that people have to have, and that's what you want to be in. You want to be in essentials right now, not in discretionary-type consumer items because they are going to go out the window. As their budgets get stretched with higher taxes and inflation, people are going to buy only the things that they need, so another area that we like is consumer staples. We've owned them for the last year. I think they are going to start to outperform the rest of the market because as inflation rises, discretionary income is going to be squeezed, so money is only going to be left for the necessities.

The other thing I think you have to think of is think internationally because eventually the Fed is going to cut interest rates, which is going to weaken the dollar. So think of multinational corporations – good US multinationals that have a portion of their sales overseas. Also, think of foreign companies. And think long term. This cycle is going to last a long time – this inflationary cycle that I'm thinking about. Ignore the short term noise. Understand what it is you own and have the patience to stick with it. In other words, ignore if the stocks fluctuate one day, forget that. Take a look at the Big Picture. [14:31]

FSN Humor: Hedono Tax

Brrr-race yourself, income tax season is upon us again.

You know, it’s bad enough having to pay this outrageous tax, but do we have to go through so much pain just to fill out the forms – there are hundreds of them. And even if you do use one of those tax computing programs, that still doesn’t improve your bottom line: you still have to pay the tax. But now there’s hedono tax – a computer program that recalculates your income tax using the government’s own bogus hedonic indexing.

First, input all your W2s, 1099s and reporting forms. Oh my gosh, look at the tax you owe! But wait! Don’t panic. Now just click the hedono tax button and watch tax magic happen right before your eyes. Using our patented Ponzi algorithm hedono tax indexes your tax information based on current government nonsense; it divides the amount you reported by the current GDP, adding back in the cost of fuel and food and reindexing for a COLA adjustment reduced exponentially by a differential of the inflation rate versus the real rate multiplied by the increase in the M3 money supply, as offset by the standard deviations in the M1 and M2 money supplies, with a deduction for the cost of lunch at the Fed’s Open Market Committee meetings.

Couldn’t follow that, huh?

Good!

The IRS can’t either. And the hedono tax calculation is buried in thousands of pages of IRS forms, leaving a cloudy paper trail not even an IRS auditor can follow. It’s audit proof. It even randomly changes your tax payer ID number. Now look! You don’t owe any tax. Hedono tax is only sold in Bogotá, Colombia, and can be ordered online. Hedono tax is an income tax supporting program and tax evasion scheme. It’s not fun, it’s not even legal, but it gets the job done. [16:20]

Hold on to your wallet - higher taxes ahead

JOHN: Well, you have to reckon that no one's life liberty or property are safe when Congress is in session. I guess that sentiment will frame this next part of the Big Picture. Just when you thought it was safe to take out your pocket book, guess what, under the table right now in both houses in Congress, Congress is at work writing new budget resolutions – essentially, they are talking about all of the new benefits they intend to extend to everyone. This includes an expansion of federal outlays for child health care in the states, community health centers, the reauthorization of the farm bill, yada, yada, yada. Theoretically, they are planning some middle class breaks, including something to limit the alternative minimum tax which as inflation rises, Jim, more and more people from the middle to lower classes are getting pushed up into the AMT. That's one there. But for every new entitlement dollar Congress spends or tax breaks that it offers, it's got to come up with sufficient entitlement cuts or tax increases to compensate. And one of the things that President Bush was right about a few years back was when he said: “You don't understand. When you send more money to Congress, they don't pay off this deficit.” You know, we have talk now about getting the budget under control within five years; we've been saying every five years we're going to get the budget under control in five years.

JIM: We’ve been saying that for over 30 years though.

JOHN: Yeah. We don't judiciously squirrel that money away or get the budgets balanced. No, we spend it. You increase it, they'll spend it.

JIM: Well, what they are talking about, John, is probably going to be the largest tax increase in the history. The House version would raise taxes by 400 billion dollars over five years. That’s 100 billion more than what the senate just passed. Here, they've got five things that they are looking at. The first and the most obvious would raise the marginal tax rates back to Bill Clinton's rate of 39.6% - currently the top tax bracket is 35. And remember on top of that, there's a Medicare tax at 2.9. So right now, the top bracket is 35%. It starts at 335,000. However, they also would like to fiddle with the middle rungs of the tax cut because remember, there's only so many rich people. The bulk of the people – the larger portion – is in the middle class. So they are talking about recalibrating tax rates for middle class tax payers and especially for people in the 25, 28% and the lower 20%; and what they would do is raise those tax brackets back up to 33% in a 36% tax rate. So the second thing they are talking about is raising the middle class tax brackets because that's where you capture the largest percentage of tax payers.

The third and equally important is they would do away with the capital gains and the favorable taxation of dividends. And so they want to go after that, so they would unwind that. They would raise the capital-gains rate. They would get rid of the 15% favorable tax rate for dividends because dividends are already taxed twice, so they would go back to complete double taxation of dividends; and then also they would go back to raising death taxes because basically, John, you know, quite honestly, dead people don't vote.

So these are five areas that they are looking at. And let me just kind of summarize these. And there's a consensus. And the consensus is based on a poll that was done where if you asked somebody – let's say, John, I said, “would you like free medical care?” what would you tell me? [20:12]

JOHN: Well, everybody likes a free lunch, so I guess, yes, but I mean, you have to say well, who's going to pay for it?

JIM: Yeah. But that's what they are doing. There was a poll done asking people, you know, would you like all of these goodies. So we get back to the free lunch argument that you can have all of these goodies and it won't cost you anything. It won't cost you taxes and it won't cost you in the way of inflation. I mean we're promising universal health care in California here. And California is having to dip into its reserves and despite this recovery in the economy over the last five years, California has been running a deficit every single year. I don't know where we're going to get the money. I mean we've been borrowing money like there was no tomorrow. So what they are hoping is this message of all of these goodies – and what they are going to do is play the class warfare [game]: “gosh, the reason that you're having a hard time in life is because there's some rich guy taking your money away.” It's not the government inflating.

So the four things they are going to talk about:

raise the top tax rate for the wealthiest Americans
raise the broader spectrum of tax rates for what I call middle class Americans
raise the capital gains and dividend tax
raise estate taxes

and so here they've got four or five proposals. Now, the thing that's amazing about this is what they want to do – the only reason you weren't hearing about this already is that lawmakers don't want you to. They are hiding behind what they call this multi-step process of budgeting; and if law makers promised too much in the coming weeks in their budget resolution then later in the year tax committees will have to write legislation that comes up with extra money. A veto by President Bush for starters. In other words, they are going to try to go after some subtleties here and try to do it with some regulatory ways; and then what they are going to do is try to get the ground work and then hopefully by 2008 pass this. But they don't want to tell people. I mean, you know, who wants to hear that, “hey, if you like me, I'm going to raise your taxes.” You're going to see this come about as we get towards the end of the year. But they've already got two big tax bills: one is already cleared through the Senate; now they are working on the one in the house which would be $400 billion dollars – probably the largest tax increase in the country's history.

And John, economically, when the economy is slowing down – you do not raise taxes. That's what gives you a depression. And that's what we did in the Great Depression is we raised tax rates to 60% under Hoover, and then Roosevelt raised tax rates to 90%. And believe it or not, there are people that are talking – the real, real Far Left is talking about going beyond the 40% tax rate. They want tax rates back up to 45, 50%; and they also want to raise death taxes – get them back up into the 70% range where basically, a person dies and the government confiscates the estate. [23:31]

JOHN: Well, it's good to know the current Congress doesn't want to be in office very long.

JIM: You know, I don't think this is going to fly. You ask me a question: would I like a free benefit? Sure. Who wouldn't? I'd love all kinds of benefits, but I also know that when you give me a benefit, that has to be paid somewhere. It's going to be paid for either through taxes or it's going to be paid with inflation. As we pointed out – if you just said to everybody in this country, look, anything over 100,000, we're just going to tax at 100%, you're not going to be allowed to earn more than 100,000, you'd run the government for 30 days. So higher taxes aren't going to pay for these goodies. And just as you pointed out earlier, John, everybody's talking about a balanced budget in five years. Have you ever noticed that they talk about these new spending programs and taxes and then they talk about in five years we'll have this balanced. They haven't balanced the budget since 1971. [24:27]

JOHN: Nor do they intend to. Maybe that's the important part. Anyway, I guess the thing that I always ponder here – when pondering seems the appropriate thing to do is – is it that these Congress people do not understand sort of the fundamental laws of economics? Or do they just understand the laws of, “I've got to get reelected, and here's what I've got to do to do it?”

JIM: I think that's how you get elected. You promise people things. You promise voters you're going to give them goodies, so that's one thing you have got to do to get elected. The second thing is you've got to reward those who contribute to your campaign, so that's where all of the pork-barrel spending come in because some group – a union, trial lawyers, Hollywood industry, corporations – all of these PACs that contribute, they want to get rewarded. And so you've got to reward them. So you've seen the first thing that happened at the beginning of the year – all of these new pork programs are going that the Democrats put into place. Now, before we get the nasty grams, the Republicans did the same thing. There is no difference between Republicans and Democrats. Both parties do the same thing, so let's get that out of the way. But that was the first thing that came into play. Reid and Pelosi had to reward those who helped to get them elected.

The second thing to stay elected is you promise the voters some kind of goodie that you're going to pay for that they won't have to pay for – you’re going to steal it from somebody else. And they all act, and none of them have ever run businesses or most of them aren't business people, so they don't understand economics. What happens with businesses when you raise taxes on them? They cut back. I mean if you raise a person's taxes, they don't just say, “okay, that's fine with me.” No. They take evasive action. You get the fight, flight or fraud syndrome. And unfortunately, they are proposing doing something like this at a time that the economy is weakening. It’s very, very bad medicine, John. The thing that government should be doing – and you'll just never see it happen – and that is cutting government spending. But in Washington, a budget cut goes something like this: “Well, we're going to increase spending by 10%, but through the budgeting process and negotiations, we only increase spending by 8%.” That's called a budget cut. [26:53]

JOHN: What do increased taxes do to jobs – especially, I know you were talking about middle income. Small businesses, which are a big staple in this country, what do they run between? Half million, and a million gross income. Even some smaller ones where it's just a mom and pop shop making enough to support themselves, but when it comes time to hire people, how do taxes affect that?

JIM: You start looking at when the cost of labor goes up, when the cost of taxes go up, businesses look for ways to cut costs. One way is to cut your labor costs, and that's one of your highest cost in doing business. So what happen is you get job layoffs: the economy slow down, more companies start slashing. Look what happens when we go into a recessions. What do you read in the news? So and so company closing down plant, laying off 10,000 workers, this company laying off.

Look, we're heading into a recession in the real estate industry, as I just talked about in Irvine where New Century just laid off 3000 employees and it's not just the 3000 employees they laid off. The local restaurant was affected, the car dealers are affected, all of a sudden they start to lay off and this whole thing runs through the economy and that's the thing that people really don't look at – and they don't care any way. It's all about perception, getting elected, rewarding those who contribute to your campaign that help you get elected. [28:14]

JOHN: Well, it would seem like you're basically on this course then, if that's really the determining factor. You're on this course because it's going to play that direction until such time as the pain hits the street. Once the pain really hits the street, then there's some demand for a change. I mean typically, if we look at the Republican revolution in 94, that was essentially a tax revolution.

JIM: Yeah. It was in response to the Clinton tax increase. He took tax rates from 31% to 39.6 and then made permanent the Medicare tax of 2.9%. The tax increase was so large they had to phase it in over two years; and unfortunately, these taxes were hitting home just at the time the 94 elections hit. And so that's what happened. The same thing happened in the late 70s with taxes and inflation. People had gone through so much pain of taxes and inflation that basically, there was a revolution and they elected Ronald Reagan. And unfortunately, we're going to have to go through that period again until people experience a lot of pain in the economy, a lot of pain in their personal life – not until it affects them personally do they revolt. That’s because in the meantime, what does the media tell you, what do politicians tell you? They tell you there's a free lunch. We all know there has never been a free lunch. [29:38]

JIM: But on the Republican side too if you remember, Mr. Read My Lips Again, No New Taxes and George Bush reneged on that and out he went.

JIM: We are paying tax rates, the average middle class person pays taxes in this country today at rates that are higher than medieval serfs. The medieval serfs paid a lower rate to their landlords than what the average American family pays today in taxes. It's amazing. I've been in this industry for 30 years but when I started in the late 70s, the two prominent words that’s all anybody talked about were taxes and inflation. And mark my words, we're going right around full circle to that very same thing. We're starting with the same kind of thing that we saw – almost deja vu, John: troubles in the Middle East, higher oil prices, inflation, stagnating economy, political discord and mistrust, and taxes, high taxes and inflation. It's amazing how, as Mark Twain says, history doesn't repeat, but sometimes it rhymes – and it's starting to rhyme to me. [30:47]

Other Voices: David Morgan, The Morgan Report, "Naked Short Selling"

[montage of voices]

How come we allow $6 billion a day not to be reported. It ought to be stopped.

In intentionally failing to deliver that stock within the standard three-day settlement period can be market manipulation that is clearly violative of the Federal Securities laws.

“…which is just stealing is all it is. This is all an example of stealing.”

It sounds ominous, it sounds nefarious and by and large it's a non-issue in the marketplace.

Is someone manipulating the shares? What is going on here? It certainly smells bad.

JIM: In the past few weeks several high profile Wall Street firms have been fined by the SEC. One firm was fined for failure to maintain a wall between its research department and its sell-side brokers. Another firm was fined for allowing one of its clients to make illegal naked short sales. Corruption and scandals are resurfacing again. Is this the tip of the iceberg or just a series of isolated instances? The opening comments you heard were from a Bloomberg special report called Phantom Shares, and that's going to be the topic of other voices this week as we emphasize what could be one of the biggest growing scandals on Wall Street and, in fact, in the financial markets. And joining me on program is Dave Morgan.

You know, Dave, naked short sales – what this gets into, it's amazing, because you and I know as individual investors, if I wanted to go short a stock, I can't short a stock under $5 a share. But brokerage firms and hedge funds can do this. And so what they are talking about is a special privilege that is accorded a select few group of people that is not available to individual investors; and the consequence of which, they are basically robbing and stealing from investors.

DAVE MORGAN: Yeah. I think that's one of the absolute key points. I mean I've been on all sides of the market, and exactly what you state is true. And yet, I remember one of Doug Casey's books well over a decade ago, and he talked about shorting these penny stocks and I'm thinking how can they do that? I can't do that. And as you said, it's a privilege, and it kind of reminds me in the futures market where if you’re classified as a commercial, you get an advantage over the average investor because you don't have to put up as much margin as they do. So they are segregating out: all investors are equal, but some investors are a little more equal than others. [34:01]

JIM: Well, let's go to the basic clip from the Bloomberg Phantom Shares on stock manipulation inflation and naked short selling to sort of explain, as Bloomberg does, what this involves.

It's a problem that dates back to a time when Wall Street was just a wall. Built by the Dutch back in 1653. It stood 12 feet high and ran pretty much beneath where I'm standing right now. Over the centuries investors have learned many tricks to drop stocks both up and down. One of the newest ways to drive them down, and you can make lots of money doing that, is with an obscure Wall Street trading tactic called naked-short selling. In a normal short sale, an investor borrows shares and sells them. If the price falls, he profits by replacing those borrowed shares with cheaper ones. But in a naked short sale, an investor fails to deliver the shares because he didn't borrow them. In extreme cases, he even sells phantom shares: shares that don't even exist. While naked short selling is legal, manipulating markets is not. And regardless of intent, the effects of naked short selling can be the same: driving share prices lower. Our story now begins with a man who’s done more to call attention to this problem than anyone else.

You know, this week, we're devoting special attention to this on the Big Picture here, and I interviewed the gentleman that they talk about in the Bloomberg special report, which you'll hear in the second hour if you're listening or tuning into this program, you've already heard an hour and ten minute interview with Patrick Byrne.

And one of the questions, Dave, that I asked him, I said, I would think this is pretty hard to do with – if you were trying to do this with a General Electric or you're trying to do it with an IBM or an Intel. But he said, no, it's done with small cap stocks and he said the mining industry and the bio tech industry – where you have a lot of small cap stocks that are sometimes illiquid – is the playground at which most of these crimes take place. And Dave, you and I have been watching the gold markets over the last – oh, gosh, I know you've been watching them longer than I have – but one of the things that I began to notice last year as the price of gold was going up that there was some unusual things that were taking place with the gold stocks: that there seemed to be a lot more progressive selling. In fact last year right around this time when we began the big run up from March to May when gold went from in the 500 range all of the way up into the 750 range, and you would just see this aggressive selling of these shares.

And the one thing I commented on last year was that the net asset value premiums that used to exist in the gold market and especially with the gold stocks virtually disappeared, so you had large cap stocks selling for a discount; and then you had a lot of these junior stocks where you could not explain or account for the massive selling. In other words, I would go into my Bloomberg and I would take a look at events that were happening in a mining stock. I knew who the major players were, contacted some of the major players where they admitted they weren't selling. And I'm thinking: where are these shares coming from? So what has happened here, I believe, [because of their] inability to manipulate the bullion markets, they have now turned to the equity market to manipulate the gold equity stocks. And I think this is very widespread. [37:36]

DAVE: I think you're right. In the futures markets basically the shorts are allowed to sell any commodities – not just the gold and silver markets – that they don't have; and that's existed from the beginning of time pretty much. But on the equity side, I'm familiar with a lot of pretty heavy hitters in the sector, John Embry for example, Stefan Spicer of the Central Fund of Canada, Nick Barisheff from the Bullion Management Services; a couple in London – and on and on. And I’m not going to name specifically who it is but one of these type of funds that are pro gold and silver had a pretty good position in one of the mining companies that we follow fairly closely. And we noticed that they could account for practically all of the shares, and yet they kept selling more and more and more shares – ‘they’ meaning the shorts. And it was baffling to me. I thought well, if you can account for all of these shares, then how can this be done. And of course this is what this program is all about – what this Bloomberg special is all about: it's called naked-short selling that we’ve talked about a little bit before; and I know we'll get into it later on in this show, but it's FTD - and that's not your florist – it’s failure to deliver.

And there are rules set out that are supposed to prevent this, but they are not being adhered to whatsoever; and the shorts come in with no intention whatsoever to deliver the shares, deliberately are doing this, and are creating basically counterfeit shares and that's affecting the price of the stocks. [39:05]

JIM: Let's go to that clip on the Bloomberg Phantom Shares where they talk about essentially what they are doing is illegal counterfeiting.

Some people use the phrase counterfeit stock to describe the phenomenon that if you can sell stock and you never have to deliver, it's going to have the same impact as selling, selling, selling and selling. It's going to push the price down.

The next clip just talks about the number of short selling that's out there. It's incredible.

The New York stock exchange had nearly sixty companies on its list including: Delta air lines, Martha Stewart's Living, OmniMedia, Krispy Kreme Donuts and Winn Dixie stores and the problem is not going away.

Since Reg SHO took effect, more than 4500 companies have been affected by stock delivery failures severe enough to qualify them as threshold securities. That's roughly one in three companies traded on US exchanges. The majority of them with small, or very small, market caps.

“I don’t oppose hedge funds, I don't oppose short selling. I object to the accumulation of unsettled trades in our financial system.”

Reg SHO is supposed to restrict short selling in threshold securities. Once a company is on an exchanges threshold list, Reg SHO requires prime brokers to settle any new trade failures after 13 consecutive trading days.

But Byrne and other CEOs say the SEC’s own data prove that Reg SHO is failing to stop naked short selling. Companies including Overstock, Krispy Kreme and Martha Stewart, each have been on threshold lists for more than 400 trading days.

“I can see no reason why sellers should be able to fail to deliver shares for years in name brand companies. It just doesn't make sense. It raises the question what is going on here.”

JIM: You know, one of the things that you just heard in that clip, the amount of short selling, the amount of shares that are being sold that don't exist, so this scandal is much, much bigger. And Dave, let's relate this to what's going on in the junior mining sector and how this kind of worked. I'll give you an example. This is taken from something I’ve seen. Let's say a stock is selling at 70 cents. It's doing well, but let's say the gold market corrects, and all of a sudden trading dries up as you see in juniors. So let's take a day where a stock has only traded about 20,000 shares and let's say it's at 70 cents. Then out of the blue, you see somebody put in an offer for 60,000 shares at 72 cents. Dave, take our listeners through the uptick, downtick rules on short selling. And in this instance with somebody coming in – with the stock only trading 20,000 shares that day – with a 60,000 share offer, explain what's going on here for our listeners.

DAVE: Well, the first thing you've got to do in order to short, you've got to be on an uptick, so –

JIM: Dave, explain an uptick for our listeners.

DAVE: An uptick means the stock has to increase in price – any measurable amount. And once that's accomplished then someone else can come in and short the stock. So what takes place typically – not every case – is that some of these guys might have multiple brokerage buddies and they might move the stock up on a very few shares and now they are allowed to short. So let's say that the stock is a junior that has maybe an average volume of 30,000 shares a day – is the average trading volume when the gold market is weak. So you'll see 1000 shares, 1500 shares go by, it moves up a penny or something. And then all of a sudden, you see this huge offer come in for like 60,000 or 90,000 shares (which is, like, three or four times the normal trading volume) to be sold. Well, that's a huge supply to work through in the market, and it forces the stock down because there's maybe a few people that wanted to buy the stock, so it overpowers the amount of buying/purchasing power that's available.

And then you just see them continue to pound the stock. You also can see this happen normally at the end of the day. You might see a stock that's actually performing well throughout the whole trading day and then with maybe just a few minute to the close, you'll see a big offer appear out of almost nowhere for a large amount of stock and it moves it down. That reminds me again in the futures market. You'll see when these guys want to get the price down on a commodity that the trading might be very zesty to the upside almost the whole session; and then right near the close of the session, these guys will come out, they'll have their hands out and they'll just dump as much commodity on the market as can be had – and then all of a sudden the price drops significantly right before the close. [43:57]

JIM: And another thing they'll use too, and you'll see this happen is – everybody probably has seen the video James Cramer where he talked about a lot of times he'd use his contacts in the press to feed information out there. Well, in a lot of cases with juniors, you just can't call up CNBC. First of all, they are not covering the sector. So what they will do is all of a sudden, you'll see these characters show up on a chat room and they start putting out a lot of negative stories, pounding the management of the company, putting out false stories. And they appear out of the blue, out of nowhere, and essentially what they are trying to do is manipulate the price of the shares by putting out a lot of false information. And what they are hoping to do with either – like as you just talked about – they'll come in with their large offers and they'll do it at the end of the day, or when the stock is moving up, and especially if there's a low volume day in terms of trading. And what they are doing by going to the, let's say, the chat rooms – which is their favorite venue – is using the chat rooms in the same way the big guys use the financial press to get bad stories out there to discourage investors from selling their shares.

Let’s take a typical situation. Let's take this hypothetical stock: the stock goes down, it's trading around 70 cents a share; volume has dried up, it's only 20,000 to 30,000 shares. All of a sudden, out of the blue, you've got three or four characters showing up on a chat room; and they are bashing the stock; and at the same time, they are showing up with huge, huge offers that are just beyond the trading in the stock. Dave, if you're an investor, how do you counteract that? How do you deal with something like that in terms of somebody trying to manipulate a stock because essentially what they are trying to do – you see this kind of stuff take place, I see this stuff take place and we know what's going on – but the average investor out there in a stock like that who sees this, they start to get scared and they are saying, “oh, my goodness, there's something bad happening with a stock.” They may believe the intentional lying or the manipulation they are trying to do with a chat room, they get frightened and they start to sell their shares. So let's talk about addressing this issue in terms of how do you combat that, and how you can discover that this is going on. [46:27]

DAVE: Well, Jim, there's a couple of ways one is if fundamentally. If you're pretty solid about the company itself, you basically just have to buy it and hold it. And of course what we do in the junior sector is basically say these are speculations for the most part, you just want to buy and hold them. We have a stop-loss limit at ours, and that's not the approach that's right for everybody. In this month's Morgan Report, we went a little bit deeper and we talked about some of this stuff and we said, look, what you should really do is take the time when you buy these companies and get as much information as you possibly can during the day that you’re going to trade them – and that usually requires a phone call or two – and find out what's going on behind the scenes, so to speak. You can find out what the bid and the offers are, and you can find out what the size is. Like we're just talking about. So in a fair market, more or less, there should be some offset or could be, but if you see something that's normally trading 30,000 share a day and the offer is out there for, let's say, three or four times that amount, it might raise a flag. Certainly this stuff is not perfect. In other words, that could be legitimate, but in most cases I would question whether or not it is.

So now you've got a little more data to work with and you might just hold off on buying that stock for while. Again, on the other hand, if you have made your due diligence and you know the fundamentals of the company and you own the stock, I think the most important thing is to just know that you bought right, and sit tight. I'm not saying you should sit on a loss forever. What I'm saying is a lot of times that this thing is going to be overwhelmed. I think in these video clips we're watching in this interview we're going to see that this is so pervasive, and it's throughout the mining sector, that I think there's going to be enough pressure put on that hopefully something will be done about it. [48:19]

JIM: You know, Dave, I want to explain, as you just talked about getting your information, if you're getting into the junior mining sector as an investor, you really need to have Level I and Level II so that you can go in there and find out where the bids are, where the offers are, and you can see the stock manipulations. So let's go back to the example where the stock’s trading at 70 cents a share. Now you've got short-seller-manipulator firm coming in. They put a big offer at 60,000 shares, let's say at 72 cents.

The stock is trading at 70. What you might do is, let's say the offer is at 60,000. What we do is sometimes you'll go in and then you'll put an offer in and say, okay, the guy is wanting to sell 60,000 shares. Okay, let's see if this guy is real. So what you do is you put a bid in at, let's say, 68 cents – in other words, force the short seller to come down and sell you the shares at a lower price. Do not go up and chase that offer because what he's doing is forcing you as an investor to come up to his price so he can short the price at a higher price and then come in with the manipulation at the end of the day. And I've seen this, and there are several firms that are doing this right now, what they'll do is they’ll do a cross trade at the end of the day in-house, and they'll take the stock down. So you don't want to play that game. What you do want to do is come in and when they are doing that, and you see this big offer, your first tip-off, as you just mentioned, Dave, is the stock has only traded 20,000 shares for the day, and here is the short-seller-manipulator coming in and putting this large offer at 72 cents, and almost twice the amount of what's traded. So what you do is you drop your bid to a lower price and force that short seller to come to you, or you just stack your bids at a lower price, because what you don't want to do is chase them.

And Dave, let's talk about the manipulation that's going on here because let's say that I'm a mutual fund company and I own this junior that's trading at 70 cents. If I wanted to get out of my position, you know, let's say I own a half a million shares, I want to lighten up the position of my holdings in the fund, that's not the way I would sell the stock. Why don't you explain, Dave, if you were running a fund, and you wanted to unwind some of your holdings, how you would do it versus what stock manipulator is doing. [50:57]

DAVE: Okay. If I owned a large stock, especially in a junior mining company, what I'm going to do is I'm going to call the company up, I'm going to talk to the company, probably the CEO or Board of Directors and I’d say, “look, I've got this much stock, we like your company, but I'm going to move something in to something else,” or whatever – you have to give them a reason and what they'll do is they'll find a buyer for you. They'll say, “Okay, fine, David, we understand what you want and we're glad you're still holding some of it.” They might try to talk me out of it, but they are going to go out and they are going to find a buyer for my stock. And I'll give them some time and that's reasonable. And now what they are going to do is come back in some length of time and say, “so and so at blank asset management decided that they would like your position and we'll make a deal between us and we're not going to affect the little guy out there holding this company.” And we're both happy. That’s a free market – I sell something that I want to sell; someone else who feels they are getting a deal is going to buy it from me and we're done. [51:51]

JIM: Another way, let's say if there's liquidity coming into this stock as the stock is moving up you feed into that. In other words, Dave, if you were trying to unload your stock and let's say there's only 30,000 shares or 20,000 shares trading in the stock, you wouldn't put a big offer on the tape for 60 or 70,000, would you?

DAVE: No. The way they do it, Jim, is you have liquidity coming in, if you've got a big position, you basically taper in and taper out. That's the way professionals do it. In other words, when they take a position, they accumulate. They certainly don't put in an offer to buy two million shares of the XYZ mining company. They might eventually want to accumulate a position of two million shares, but the way you buy is you buy it slowly, carefully over time and put in smaller amounts overtime. Same thing when you want to get out of a stock, you simply put in a little bit at a time, and you feed it out over a very long time. In fact, I look at this in the general market, and it's called accumulation and distribution. And you can see them if you’re familiar with chart patterns when something is being accumulated in most cases, or distributed in most cases. And that's the way you would do it. [52:59]

JIM: But you wouldn't sit there if the stock was trading at 20,000 all of a sudden slap a big offer. When you see this consistently being done on days when shares aren't trading and then you start putting together pictures of negative things on chat rooms what does that tell you, Dave?

DAVE: It tells me right off the bat that they are trying to manipulate the stock price down.

JIM: Now, a lot of people are saying, we have a couple of specials here, we have the Bloomberg special that we're posting on the website, we also posted the interview with Cramer where he explained how he did it as a hedge fund; and also we have Patrick Byrne’s presentation on naked short telling. But one of the key things here and I think this is what has to happen, I remember, Dave, in the late 90s I began to write stories about earnings manipulations in terms of the way they were manipulating earnings; and it was funny because we had even hired an accounting professor from one of the local universities to come in and teach us forensic accounting. And one of the comment that's she made that was rather disturbing – and of course, remember this was in the later 90s when everything was going up – and she was talking about looking into the footnotes with these earnings manipulations to find out whether the company was really reporting good earnings. One of the students said, “why do we have to do this, and who cares as long as the stock prices is going up?” Well, a couple of years later when all of these scandals began to unfold, a lot of people all of a sudden started to care because their stocks were going down. Well, the earnings manipulation that was going on back then, and still goes on today to some extent, is nothing compared to the amount of naked-short selling that going on. This, to me, David is probably one of the biggest scandals in Wall Street history and it has the potential of systemic risk of bringing the whole system down. As listeners will find when they go through the naked-short selling presentation, how it brought Refco down. You know, Dave, most people don't realize how big of an issue this is. And I want to play a clip from the Bloomberg special on phantom shares of how they basically drove a stock down to nothing by doing this. And then we'll come back and make some comments.

“How much percentage of a play can there be altogether?”

“Max, you can only sell 100% of anything. And how much from Spring Time for Hitler have we sold?”

“25,000%.”

In the producers, down on his luck Broadway impresario Max Bialystock and his hapless accountant Leo Blum sell more shares in a play than is mathematically possible. CEOs like Frank Dobrucki have complained for years that the same producer-style accounting is at work when abusive naked short sellers target small companies.

“20,800% of our company was traded in a single month. The shares weren't available. They weren't there. There was no way they could be trading.”

In March 2005, the Senate Banking Committee confronted then SEC Chairman William Donaldson with a story about Frank Dobrucki’s company – the Nevada based real estate holding company Global Links. An investor named Robert Simpson had set out to prove that small companies were indeed frequent targets of abusive naked-short sellers. Simpson placed an order for $5000 worth of stock in Global Links. That got Simpson ownership of all 1.1 million Global Link shares in the market. Not some of them, all of them.

There were no shares available to be borrowed and yet in two days, there were over 50 million shares traded. That’s clearly something that needs work.

I was absolutely blown away when I bought 1,282,050 shares, which equated to 111% of the issued and outstanding. I just couldn't even fathom that. So it wasn't just crooked, it was Wild West times ten.

The day all of this started, trading in Global Links opened at ten cents a share. Within a second the price dropped to a penny. An hour and 16 minutes later, global link stocks was trading at 8 one-hundredths of a penny. Prices dropped 99% in less than two hours. Global Links CEO Frank Dobrucki wrote shareholders telling them the selling of Global Link shares was evidence of illegal trading. And when that occurs, he said, a company cannot meet its calls and shareholder equity is diluted so brokers can line their pockets with illegal cash.

This same conviction motivated Patrick Byrne to hire six foot six inch John O’Quinn, one of the attorneys in the country tall enough to look him in the eye, and by reputation, a giant killer. In Texas they called O’Quinn the billion dollar man because he won billion dollar judgments against makers of silicone breast implants and Fen-Phen, and against big tobacco.

“The deal is rigged so bad I can make this statement safely. You have more chance to be treated fairly in a casino in Vegas than you do in the stock market. The security industries has things rigged to where they can deal from the bottom of the deck regarding your stock and your money.”

O’Quinn’s co-counsel is another Houston based attorney: Wes Christian. Together they represent some 20 US companies that all claim damage from naked-short selling: including Overstock, Sedona corporation and Taser. They represent Overstock in a lawsuit seeking $3 ½ billion in damages from Wall Street’s biggest prime brokers accusing them of executing short sales with no intention of delivering stock causing Overstock share price to drop. All of the accused have declined comment on pending litigation.

“If you're a short seller and you abide by all of the rules governing short sale, then fine, it's legitimate, it's legal, it's proper. That's not what is going on on Wall Street. What's going on on Wall Street in our cases, and we're now seeing in many other companies is a rigged system.”

But where Byrne and his lawyers see naked short sellers driving down stocks and destroying companies…

JIM: Well, there you have it, Dave, here was a situation where one individual, they were testing the system trying to prove the corruption in it, and in one day, with a $5,000 order, he bought all of the outstanding stock of this company. And as that Congressman came in afterwards and said, in two days of trading, this guy owned all of the stock and 50 million shares traded. That's how pervasive and bad this is. But what they are talking about has nothing to do or even comes close to what's going on and what we see in the junior mining industry right now. [1:00:08]

DAVE: That’s so true. And I kind of want to revisit what we spoke about earlier in the show and that is someone that I know in the industry that's a rather heavy hitter and one way – I've been asked by individuals how do you combat this – and one way to do it is basically get your shares certificates. In other words, as you own the certificates, as this gentleman we watched did – it still can take place – that proves it's fraudulent, but it is a way to try to lessen the blow, so to speak. Well, this particular individual asked for their share position; it was a rather healthy share position to put it politely. And it took over two months to receive their shares. And they kept asking some other department to check into it – the legal staff – what's going on? And this is only one half of the shares that they had outstanding over two months. Now, that should be settled within a matter of a week to 10 days or so, and yet two months. The reason being, very simple, they didn't have the shares. The dealer that was supposed to deliver them had to go out and scramble to get them. It took them two months and again, only half the shares that this one fund owned.

You know, what’s interesting here is I think a lot of people are fed up – individual investors and some of these money manager types – and one I'm referring to that's going to be talking to the same lawyer that Byrne’s is speaking with and I think things can only get pushed so far. I think there's going to be some very interesting action. And I find it interesting that Wall Street all of a sudden is under the gun again in a very small timeframe: you have this Cramer story, you have this Bloomberg story and you have this other dissertation done by Mr. Byrne on your website that explains in detail how this naked short selling takes place. [1:01:50]

And it was amazing too, because just a couple of weeks ago there were fines against one major brokerage firm for allowing one of their clients to naked-short sale. But you know what, the fine was only $2 million. And basically, when you add that into the cost of doing a trade and if you're counterfeiting, making a lot of money, this is nothing. The problem, and this is where we get to the systemic risk problem, and I want you to go to the Bloomberg clip about the DTCC where they talk about almost one out of three transactions on the exchange cannot be accounted for. [1:02:26]

Byrne’s battle against naked short sellers led him to one of Wall Streets best secrets, the Depository Trust and Clearing Corporation, or DTCC. It's just a few blocks from here. On average, the DTCC says it processes more than $1.4 quadrillion worth of trades a year. That's more than 20 times the economic output of the entire planet. The DTCC also keeps track of the trades that can fail due to naked shorting.

Speaking at a conference just a few blocks from DTCC headquarters, Suzanne Trimbath who worked for a subsidiary of the DTCC explained the corporation's role in US capital markets by comparing Wall Street to Broadway.

Imagine if all of Wall Street is a stage, the DTCC is like backstage. These are the guys that run the lights and the cameras, the grips and the gaffers; the people that movie-goers really don't know what they do and you don't need to care about it, but we all do need to care about what's happening back stage at the capital markets.

Mean time, Patrick Byrne said he received data from the DTCC that stunned him. On January 12th, 2006, Byrne said the DTCC data indicated that there were 7 million more Overstock shares of circulation than there should have been. A discrepancy coinciding with the steep decline in the company's share price –

If it's only 7 million shares, it’s 35% of our company that has been counterfeited, I think I have a fiduciary duty to the shareholders or the people who think they are shareholders to clean this up.

DTCC data obtained from the SEC through the Freedom of Information Act also revealed the scope of the failed trade problem. On an average day last March, failed trades amounted to more than 750 million shares, and almost 2700 stocks, exchange traded funds and other securities. In all, the DTCC says about six billion dollar in trades can't be cleared every day. 1 ½% of the total dollar value. In this letter to the SEC Wall Street’s trade association, the Securities Industry and Financial Markets Association, or SIFMA, says trade settlement failures are only a problem for an extremely small universe of securities. Peter ChepuCavage is a former SEC attorney who helped write Reg. SHO.

To say it's trivial in the context of the entire universe is a meaningless statement. We all want to know more about how many fails there are with respect to short sales, and who exactly is failing.

Because trades can fail for innocent reasons like clerical errors, the DTCC says it doesn't know how many failed trades can be blamed on abusive naked short selling. A statement on its website reads: while we have data on the volume of fails, we have no information on the underlying causes of those fails. DTCC officials declined our request for interviews. DTCC members include the prime brokerage firms that control the $10 billion annual stock lending market, and are responsible for many of the failed trades. Officials at SIFMA declined to be interviewed too. Up next, is the SEC doing enough to crack down on abusive naked short sellers. [1:06:01]

JIM: You know one of the problems that we have here, Dave, is number one, people are not being taken to task for this. In other words, if you get your hand slapped and you're fined two million dollars for an illegal trade where you've made 10 and 20 or hundreds of millions of dollars, you know, that, to me, tells me crime pays. I think one of the problems here is the regulators aren’t being tough enough with these people. Let's go to the clip here where they talk about some of the problems the SEC has and why in my opinion they are not being tough.

In July 2006, SEC Chairman Christopher Cox admitted there were loopholes in Reg SHO that permitted naked shorting to continue.

There continues to be a number of threshold securities with substantial and consistent fail to deliver positions that aren't being closed out under existing delivery and settlement guidelines.

One problem, trades in a company that lands on a threshold list can remain unsettled for ever. The SEC wants to close that loop hole by setting deadlines for settling failed trades but some say this still isn't enough. Reg SHO they say will still fail to prevent naked short selling. That's because the rule only forces naked short sellers to settle trades after they’ve failed. And by then, it's too late. In 2003, the SEC filed suit against Rhino Advisors for naked short selling shares of software company Sedona Corporation two years earlier. Rhino settled the case in 2003 for a million dollars without admitting or denying wrong doing. According to SEC records Rhino instructed brokers at the now defunct brokerage Refco to clobber Sedona’s stock until its share price collapsed. The shares fell 50% in three weeks.

They were congratulating for clobbering Sedona’s stock: “go after and make sure you go all of the way. Run them out of business.” I have now 15 employees when at one time I had over 70.

Traders have committed federal crimes using naked short selling. This document contains emails written by a convicted naked short seller serving 11 years in prison for racketeering conspiracy, securities fraud, wire fraud and extortion. Anthony Elgindy directed members of his internet-based investing cartel to sell their stock in a certain company at the same time. Carpet bombing he called it. Ken Green was lead federal prosecutor in the case.

There was testimony at the trial with regard to volume pounding, volume trading. They were able to overwhelm the stock by just flooding the market with short sale orders. And these short sale orders would eat up all of the buy orders and it would just drive the price down.

Former Undersecretary of Commerce Robert Shapiro works as a consultant for lawyers representing alleged victims of naked short sellers. He says as many as 1000 public companies were damaged by naked shorting in the decade it took to get Reg. SHO into the rule books.

A lot of those companies are gone. A lot of them died. This was a fatal attack. Some of them were weak when they were attacked. Some of them would have failed any way. Others wouldn't have. Again, it's not up to the naked short seller to decide. It's up to the investors that played by the rules. [1:09:35]

Well, Dave, we've come to the conclusion of this segment and I hope those listening to the program will watch Patrick Byrne’s presentation, the Bloomberg video, as well as the Cramer presentation and get a sense of this. Dave, if you were to sum up how pervasive this is, what would you say?

DAVE: I'd say that this naked short selling is wide spread, it's deliberate, and in its essence, it’s simply fraud. It does appear throughout the mining sector, especially in the junior mining sector. Remember what we're talking about here: a sale is made, but no product is ever delivered. Basically, that's counterfeit stock. You might even show stock in your account, but the certificate for that stock doesn't exist. And that, Jim, is the bottom line. [1:10:20]

JIM: Well, the only thing that I can say is perhaps with legal ramifications coming, you talked about one fund manager who's working with Patrick Byrne’s lawyer and perhaps these people will be exposed. But hopefully, at least, we've alerted investors if they are investing in the sector a couple of things: you want to know what it is that you're buying and the best place to find research, go to the company's website, take a look at their financial information, take a look at analyst coverage of the stock; take a look at everything they have to offer you in terms of who they are, what they are doing, what's their business plan; then call up management – you know, it's not like you're calling up the chairman of General Electric. Most of these juniors, Dave, you know, a lot of the CEOs you see at gold shows, but you can talk to the company directly. Don't rely on the pump-and-dump people that will go to chat rooms sometimes. Get your own information.

Then if you're going to go into the sector, get Level II so you can take a look at the bids and the buys, or the offers out there so you can take a look at where the stock is coming from, how many people are bidding for the stock, you can take a look at the average volume, you can look at the offers and then that way it will alert you more when they are committing fraud. So that if a stock is trading at 70 cents, only 20,000 shares traded, and somebody all of a sudden someone comes in and offers stock at 72 cents, 60,000 shares, it alerts you so you don't go chase that stock and get yourself hurt. But more importantly, remember that these investments are on the riskier side because you're talking about development companies, late stage development. But if you understand the fundamentals in this market and you're a long term investor then what you do is take advantage of them, hold your shares and look at the long view rather than what the stock is doing this day or the next day.

Dave, I want to thank you for joining us in the special segment that we did this week. Your insights are always valuable and if people would like to find out more about, Dave, your newsletter, tell them how to do so.

DAVE: Just come to www.silver-investor.com and I did put at the website right at the top of the Bloomberg special on YouTube and it's called naked short sales – Bloomberg. And you can click that link and watch it if you have high speed internet.

JIM: All right, Dave, thanks so much for joining us this week and we'll be talking to you again in the future

Part 3

Q-Calls

JOHN: My favorite part of the program as we go to the Q-Line. The Q-Line is open 24 hours a day to receive your phone calls. We ask that you leave your name – first name is just fine – and where you are calling from, and a brief question or comment. You can make comments – we don’t just require questions here. Please avoid lengthy diatribes. We’re going to basically start eliminating those – we don’t have time for them.

The Q-Line call in number is toll-free from the United States and Canada (800)794-6480.

Please remember that the content here on the radio show is for informational and educational purposes only, and should not be considered as a solicitation or offer to purchase or sell any securities. And responses to the listener inquiries are answers based on the personal opinion of Jim Puplava here, and do not take into account listeners suitability, objectives or risk tolerance.

Now, if you’re planning on making some investments, one way or another, you should truly consult someone who is qualified at a personal level who understands your particular situation – and we can’t do that here on the program. Financial Sense Newshour shall not be liable to any person for financial losses that result from investing in any companies profiled or advertising with Financial Sense.

And currently, Jim, we don’t have any advertisers for a very specific reason. Which is?

JIM: We don’t take advertising because we don’t want any impositions of thought or of what we can say or do here on the program. That’s what keeps us, I think, objective.

JOHN: Alright, here we go with the questions.

Hi, my name is Lynn. I’m from New York. Can you please explain how to read a gold commitment of traders report. What do the different categories mean and the different ratios; and what conclusions should one be able to draw when one sees a report like that?

JIM: Well, they’ve got it categorized by who is doing the trading. Large speculator – when you see that, these are usually the large technical trading funds. Commercial hedgers – they can be companies in the business, more professional-type people and people associated with using the product. For example, a farmer with corn or something like that. That isn’t necessarily the case today because you have large investment banks that get involved in this. Long means they own it. The change is the change in the previous week from their long position; and short means they are shorting the commodity and there’s a change there. Usually, the area that people pay the most attention to are what we call the commercial hedger – they’re usually the largest players in the market, and you usually watch whether they are going long or short. There are a number of books out there on commodity trading that I would recommend. Just google that and you’ll come across some on Amazon. In fact, we did an interview, John, and I’m trying to think who we did last year, on the commitment of traders. If you go to our 2006 archive, or 2005 archive, we interviewed an author on the commitment of traders and I’d recommend that you listen to that interview. [3:24]

Hi Jim and John, great show as usual. This is Terry up in Seattle. I had a question last week, you answered a question: could variable annuities work for retirement planning? And you answered, of course, that they may hurt if we have some of the hyperinflation. But what about those new variable annuities that have the guaranteed income but give you the right to invest in natural resources within – could that maybe benefit with the hyperinflation? You would get the rise up while locking in the income in case they ever decided to come back down.

You know, the variable annuities that allow natural resources, gold and things like that would be one way to participate. But it’s a very expensive way to do it. The expenses and fees associated with variable annuities are about 3% a year. So I still don’t like it. If you take the guaranteed income option, what you’re talking about is annuitizing and locking in principal and interest at a set rate, which would never work in an inflationary environment. [4:32]

Hi, Jim and John, this is Walt from Wisconsin. I’m wondering if you would know if there is any rule or regulation, law, or reason as to why the Fed – or whoever is sitting on this huge short position in silver which has been there for years – is there any reason they would ever have to cover? Or can they continue to short on paper and manipulate the market. And is there any real control in that arena?

You know, a lot of people like Ted Butler have pointed this out, and has written to the Commodity Trading Commission but nothing is being done. And these large short positions, for example, that are in silver, the whole thing would come apart if the longs requested delivery. But what they can do when a market is overwhelmed like this is allow for cash settlement. The way the market is rigged in favor of the short sellers and which this whole program has been about this weekend. You know, you can short as much as you want, even though you don’t have the ability to deliver. But heaven forbid, if you want to go long and take delivery they would limit that. So no, there is no limitation in terms of shorting. [6:05]

Hi, this is Alan for Minneapolis. I’m a long time listener of the show. I had a question about gold – and I have an IRA that has an amount of money in it – a pretty good amount. And I was thinking about investing it in GLD. My question is: you know, you just buy the gold through the GLD ETF rather than diversifying into several different mining companies like you always suggest – juniors and different ones – why not just buy the gold itself.

You know, Alan, you could do that, and there’s always a question though with buying the ETF. I’d recommend you buy the gold coins and own them rather than the ETF because if there ever is a case for gold confiscation the first place they will go is where the largest amount of gold is which is the gold ETF. But it’s a simpler way. I recommend the bullion if you can’t stand the volatility because bullion fluctuates less, and certainly gold has fluctuated less. They’ve tried to hammer it, as they did a couple of weeks ago when they knocked it down by $42 I think on one Friday. You notice it came right back up. They are having a difficulty of keeping this market contained. So you could go into the gold ETF that would be an easier way to do it. When you start hearing politicians demonize gold investors, or terrorists who are using gold, that’s going to be your cue that you better look out because government may be thinking of some kind of confiscation scheme. [7:40]

Hi Jim and John, this is Yannick calling from Luxembourg. Here is my question. Regarding the decline of the second largest oil field, Cantarell, in Mexico, which has been [inaudible] the most important creditor to the debt of the Mexican government. I wonder where the money for financing this debt will come from in the future. Higher prices for basic food has already led to social unrest. So [the pressure] to get the needed money from somewhere else will increase and might embrace the precious metals companies. So do you think it’s still a good idea to invest in Mexican gold and silver companies regarding this possible development?

I believe it still is because Mexico has always had a tradition of a strong mining culture, and they are looking at developing mining because they don’t have the money to do it. Since they opened up the restrictions and allowed for land ownership beginning in 1992, the mining industry has taken off in Mexico, and has now become a new source of revenues for government. When ever governments become socialistic or communistic – just take a look at what’s happened in Venezuela when they go the opposite route. Venezuela’s oil production is down 40 to 46%, revenues have declined because that’s why they are trying to go to confiscation because the government has poorly run the project. And I think they understand that in Mexico, that this is a new source of revenue, that foreign investment coming in is positive, it creates jobs – especially in the local countryside. It creates well-paying jobs. And a lot of these mining companies that are going in the area are using the locals – Mexican geologists. I mean, I’m involved with a company down in Mexico – our geologist on the spot is from Mexico; we’re employing a whole village and we’ve created a lot of good jobs; spent money developing water wells for the town; helped with the school systems. So the government likes that. And I think Mexico is a pretty safe environment. [9:44]

Hi, Jim and John. This is John, I’m calling from Osaka, Japan. I’m an American citizen, resident of California. A quick question is this: I don’t want to have any of my cash in the US; I’m looking for an online broker outside of the United States that will accept American citizens; recently, many brokers tend to shy away from American citizens because of the regulation. So would you know of anybody? I’d like to trade in the Canadian stock market. Thank you very much.

You know, John, I’d look at some of the brokers in Japan where you’re at, you say you’re in Osaka. Also some of the large Canadian firms, you might want to look in to see if they will take you. You know, I’m not sure if Canadian firms will take you but I know there has got to be firms; I know, for example, in Japan. So the first place to look is exactly where you’re at. [10:48]

This is Dave from Texas. And I just watched on YouTube a video report that Bloomberg did on Phantom Shares – that’s the title of it. And it’s something I had never heard of before but basically they were saying that things are going on in the stock market, and it doesn’t matter what kind of stock it is, what industry it’s in, or whatever. Where for example, let’s say there was a gold mining company that had some shares. Let’s say they have a million shares that they have released to the public for purchase and for trading; that there can be naked-short sellers come in and basically counterfeit an infinite amount of shares for this particular say, gold mining company, where they could drop the share price to where the company goes bankrupt. This is something I had never heard of before and from what the video showed many companies are having issues with this. And it’s an industry problem that the SEC is being questioned on. And I was wondering as a question, how can people be sure that whenever they invest in the stock market, if for example you get recommendations as to buy this silver mining company because the price of silver is going to go up, or, you know, we’re trying to protect our capital from the coming collapse of the dollar that these manipulations cannot in turn destroy your ability to protect yourself when this manipulation is going on. I just wonder if you guys had any comments on that. Thanks.

Boy, Dave, the only thing I would say to you is listen to the second hour interview because I did interview Patrick Byrne this week. Also listen to the Big Picture with myself and Dave Morgan as we discuss this Bloomberg video. You’re exactly right, it’s a big thing going on in the junior mining sector right now, where brokers and hedge funds are doing this. You check with your broker, ask questions: are there a lot of FTDs; and ask them to verify with you in terms of are your shares real would be one thing you could do. Another one would be to take your share certificates. One of the reasons that we chose the broker-dealer that we did is we verify these things to make sure this kind of thing isn’t going on. But listen to the second hour with Patrick Byrne, and listen to my discussion with Dave Morgan. [13:13]

Hi, this is Michael. I’m calling from Malaysia. My question is: I wonder why your oil companies would be hiding the fact of peak oil. Why don’t they go ahead and declare the oil a fact. Why are they hiding this. Thank you very much.

I think they are in denial, Michael. If you’re head of a company like Exxon - “Hi, we’re the largest private oil company in the world and we believe in peak oil. Our reserves are going down and we’re not going to be able to replace them.” What kind of story is that going to be that you’re going to give to people. It’s just that they’re in denial.[13:53]

Hi, this is Matt from La Habra, California. I have a relative, who in her retirement account has a lot of Ginnie Mae, and I was wondering in terms of the housing market, how will that affect Ginnie Mae. Should [she] diversify into energy, mutual funds – things like that? Any thoughts on how Ginnie Mae will be affected would be greatly appreciated. Thanks.

Matt, Ginnie Mae is the one mortgage market, or the one mortgage security that is backed by the full faith and credit of the government. The others are implied faith and credit. So you’re okay with Ginnie Maes from that perspective, but if interest rates start to go up as a result of housing problems as a result of inflation, that’s where the value of the Ginnie Maes would go down. So you are going to want to be diversified in some of those areas that we talked about: metals, energy, food, water, consumer staples – rather than just one hundred percent in bonds. [14:48]

Hello, Jim and John, this is Tim calling from Oregon. Should I consider turning my portfolio over to a professional fund manager for better results. I currently own 40 stocks in the commodity industry: 13 are gold; 11 are silver; 5 are polymetallic; 4 are base metals; 4 are uranium; 1 zinc; 1 rare earth element company; and 1 position in an oil and gas trust. The properties owned by these companies I’m invested in are North, Central and South America primarily, with a few mining in Australia, Africa, China, Malaysia and Turkey. My portfolio performance has been 28.13% in 2005; 44.7% in 2006; and year-to-date, for 2007, I’m up 10.69%. Could I get a better performance from a professional money manager investor? I would appreciate your feedback.

The answer: probably not. It sounds like you’re doing one heck of a job yourself, Tim, and that’s what I would stick to doing. It sounds like with the 40 securities you have, you have in essence your own mutual fund portfolio. So keep up with what you’re doing. [16:06]

This is Steve in Texas and I wanted to ask your opinion on the fact if home prices nationwide go down substantially the next several years, shouldn’t the property taxes that local governments receive from the assessments also go down and put further pressure on local budgets particularly at a time when taxpayers are having a more difficult time financially?

Boy, Steve, you just hit on a problem. On the day we’re answering this – it’s Thursday – there was a story on Bloomberg that was called Housing Slump Erodes Budget Gains from Florida to California. And they are talking about that the states are having to draw down almost 17 billion or 29% of their total savings as legislatures debate tax cuts and plans to expand programs. You’re absolutely right. In fact, if prices continue to drop in much the same way as they did, for example, in the last real big housing slump in 91 and 94, that’s exactly what people did: they reapplied for lower property taxes because the assessments coming in were much greater than the value of the homes. And that’s exactly what’s happening right now; and it’s amazing because that was a big Bloomberg story on Thursday because it’s hitting states from Miami to California to New Jersey – all along the East and West coast a lot of governments are being hit for that. In our own state of California we’ve been running budget deficits throughout the whole economy. [17:36]

Hey guys, this is Dave from Phoenix. I was just wondering about your opinion of the Canadian energy trusts. And I know that they’ve recently been hit pretty bad over the last I’d probably say 8 months. Do you feel that they are a good buy right now, or do you think there is still some movement on the downside before I should start dollar cost averaging in? Thanks.

Dave, I think I would be dollar cost averaging. And remember, there’s a movement afoot in Canada to overturn…remember, this bill hasn’t been passed yet. And even if it was to pass, it wouldn’t take place until the year 2011. But there’s movement afoot to basically block having this being done. I think the message of why it was done to stop a lot of the companies from converting over to these royalty trusts – but when it comes to oil right now, natural gas, this would be a great play. Dollar cost average in and there are some pretty good entry points at this point. [18:36]

Hi, Jim and John. This is Deborah from Arizona. I wanted to let you know I just got my Bernanke Babble Dictionary – the best one hundred dollars I ever spent. Jim, I have a question for you regarding what you say will be the next bubble which will be in equities. If they lower interest rates, won’t the Chinese begin to dump bonds and at the same time, multinationals, their profits will suffer from that. So it seems to me this bubble already has a prick in it. How do you see this playing out? Thanks a lot. And john, keep up the good work with the skits. We can all use some humor these days.

I don’t think so because if you take a look at the interest rate spreads in the United States, our interest rates are still higher. Yes, the dollar will go down but it’s in nobody’s interest right now. When it looked like the dollar was going to have a precipitous decline, you even had European officials that were saying that they would go to some kind of capital controls to prevent money coming into Europe to drive up the value of the euro which would hurt their exports. So everybody is devaluing against each other. It’s all a race to devalue right now. And it’s in nobody’s best interest to have the dollar collapse because it would hurt Asia, it would hurt Europe. And as you heard in the first segment when I talked about money supply figures, Russian money supply is growing at 40%; India is at 22%; China at 18; Brazil at 14; Britain is at 13; Australia is at 13 – everybody is printing money. And so it really isn’t costing them anything. So central banks will diversify and the Chinese are going into harder assets now. They are going to diversify a third of their reserves but it will be more of, “we’re going to buy less than we used to,” than “let’s dump.” At least, I don’t see that right at this point. [20:26]

This is Doug from Castle Rock. Say, I was wondering if you might comment on something I was thinking about. I thought about writing an article and submitting it but I was just a little time constrained. And I thought I would just place a call and have you guys comment on it. We know that when things get a bit dicey in the inflationary environment and we start to move towards hyperinflation the velocity of money starts to increase significantly. I’m just looking at China and what they are doing and planning on doing with their reserves. They are planning on taking $350 billion of those reserves and moving them around in various investments. And I kind of take a look at that and say the velocity of money that they have accumulated now they are going to start spending that and investing it. And I think that is an indication that they are saying they need to get their dollars out of their hands and into something more tangible. And I’m just wondering if you guys could comment on that aspect, and all central banks that are considering lowering their dollar reserves – if that’s an indication of the velocity of money worldwide (particularly the US dollar) beginning to increase; and maybe a sign that the hyperinflationary environment that you guys are talking about is just getting closer?

All central banks are starting to do that now. I don’t care if it’s OPEC countries, China as you mentioned, diversifying a third of their reserves. As inflation increases, velocity increases when people no longer want to hold onto money, and they begin to turn it over much more rapidly. That’s when you really get the hyperstage of inflation. Right now, all you have is people that are beginning to diversify out of their reserves. And what you’re probably going to see unfold here is you’re going to have three or four large monetary blocks emerge. You’ll have eventually in North America what I call the Amigo which will be the emergence of the dollar, the Canadian dollar and the peso. They call it the Amero – I call it the Amigo. In Europe you already have the European currency. I think you’re going to see a similar type block of currencies merged together in Asia. And what you’re going to end up having is three or four regional type currencies where the dollar will no longer dominate or be the dominant currency. It’ll still be one of them – or the Amigo; however that emerges. But you’re going to see the emergence of three or four large currency blocks in trading. And that’s what I think you’re going to see unfold here in the next – I think by the year 2010 is when this is going to begin to unfold. [23:08]

JOHN: And Doug always calls from Caste Rock – that is Castle Rock, Colorado which is like halfway between Denver and Colorado Springs just off of I25 there.

By the way, for everybody, the new edition of the Bernanke Babble Dictionary is going to have a forward and commentary by Congressman Ron Paul and dissenting footnotes on every entry by Alan Greenspan.

JIM: And John, the same price?

JOHN: The same price, yes. We’ve just upgraded it to include his latest vocabulary and terminology along with his vagueness decoders, so that when he gets vague on terms you can sort of run it through this sieve.

JIM: What about a core interpreter?

JOHN: Well, we’re working on that, but the problem is they keep changing the definitions of the core. So we have to find some way of coming up with a graph which you can track that one on all the way through.

JIM: Okay, that’s just a heads up. We’ll have a new product line coming out here in the future. The Bernanke Babble Dictionary – and we’ll also have…what’s the other product?

JOHN: The Bernanke Online Realtime Interpreter.

JIM: This is a great product to have because think of yourself watching him on the testimony and having your Bernanke Babble Dictionary right there – or Online Interpreter. You could actually transcribe the words as they’re coming out, and then basically know what he is saying.

JOHN: And then you’re ahead of everybody else. Exactly.

JIM: Yeah. Just quite a conversation piece the next time you’re throwing a cocktail party. Just whip out your Bernanke Babble Dictionary.

JOHN: We should come up with a new process here called the Political Popover Processor so you can understand what your Congressman is doing.

JIM: Anyway, Jim, out of time this week.

JOHN: Out of time this week. This has been a special edition of the Financial Sense Newshour. As I mentioned over the last couple of weeks we’ve gotten a lot of emails, people sending me information about the naked short selling. I watched it; I knew it was taking place. The only reason I knew it was taking place is because we see it going on with junior mining stocks. This is very, very big in gold stocks right now. Huge in the gold sector in the last couple of years; and especially in the last 12 months; and right now, it’s going on as we speak. And when I saw this, I didn’t realize it was as big as the Patrick Byrne presentation is. And it’s amazing.

To me, this is probably one of the bigger, bigger scandals and is one of the things that could take this whole system down – and so that’s why we did a special presentation. You know what’s amazing, John, and I don’t know if this is fate or what but all of these things have all shown up: the Jim Cramer interview; the Bloomberg story; the Patrick Byrne piece. It’s just amazing how these things happen, all corroborating each other. I mean, this thing is big. And the only way it’s going to be stopped is if investors let their Congressmen know, investors let their brokers know; become more cognizant; learn how to detect it when it’s being done. And then, turn this in to the SEC, turn this in to the NASD, when this fraud is taking place. What it boils down to, unless you yourself take this responsibility, don’t look to your broker, don’t look to your Congressman you have to take it on yourself. And if enough people are made aware of it, more pressure will be brought to bear on regulators and maybe we’ll get an Elliot Spitzer or somebody like that to look into it, and bring these people to justice for what they’re doing. This is what happened with the corporate fraud in earnings with the Enron thing. This was going on for years before it was exposed. So that’s why we went a little long this week. I’m getting together with a group of individuals to contemplate for a couple of days. And I also want to thank Frank Barbera who was sitting in for me for the first hour, that allowed me to take a couple of days – there’s quite a few of us that are getting together that are concerned about the things that we’re seeing take place in government, around the world, peak oil, the markets, the economy, inflation – and we’re going to have kind of a pow-wow session here for a two-day period.

Well, let me give you a heads up in terms of things coming up on the program. And you know, when I do these kind of interviews things happen. Next week, my special guest is going to be Matt Simmons. Then, April 14^th, Duncan Clarke has written a book called The Battle For Barrels. He doesn’t subscribe to the peak oil theory as much. So I think having Matt first, and Duncan second… Doug Noland will be joining me on April 21^st as we take a look at the subprime market and the spill over that we think is going to unfold. Jeff Christian from the CPM group will be my guest April 28^th as we discuss the CPM Gold Yearbook 2007. Steven Hiatt will join me on May 5^th; and my apologies to Steven Hiatt he was on deck for this week. We’re going to be interviewing him on a book called A Game As Old As Empire. John Ghazvinian has written a new book called Untapped: The Scramble For Africa's Oil. It’s a great lineup leading into summer. And this year I’m going to take a few more weeks off so we’re going to try to load the deck leading up to the summer recess.

In the meantime, we hope you have enjoyed listening to the program. We’d like to thank you for joining us here on the Financial Sense Newshour, until you and I talk again we hope you have a pleasant weekend. [28:53]