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Financial Sense Newshour

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September 15, 2007

Part 1

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Part 2

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Part 1

If These Guys Were Doctors, We'd All Be Dead

BERNANKE: As you know the control of inflation is central to good monetary policy. High inflation countries almost always have high money growth, and low inflation countries have relatively low money growth.
In the long term low inflation promotes growth efficiency and stability.
Inflation injects noise into the price system

JOHN: Well, there he is, B-52 Ben, telling us how horrible inflation is as he injects tons of liquidity or fresh money into the market. You know what is amazing, Jim, is the buzz and chatter -- not just on the street but on CNBC – this week. It is like: “Uare they going to what do you think. Are they going to do a half point or a whole point, what do you think?” “No, no three-quarters of a point, what do you think?” It’s insane.

JIM: It’s absolutely insane because it’s like Wall Street is acting as if these guys actually know what they’re doing. Thank goodness these guys handle monetary policy and not medical policy. If these guys were doctors we’d all be dead.

JOHN: Yeah, but think of the malpractice potential there for suits.

JIM: Yeah, maybe we can stimulate the economy with that. But it’s not only these guys that don’t know what they’re doing, also there’s people on Wall Street that still don’t get it either.

JOHN: Hear this clip from CNBC this week. This sort of illustrates the point that you're making:

You’re saying, “hey, stop talking about it. That’s not the thing that matters.”
Dan, I’m bored of the Wall Street Journal. Sometimes I’m bored watching CNBC because it’s all the Fed talk all the time – not all the time, but…It doesn’t have any actual effect on the stock market. Long term there is no correlation between Fed rates and stock market returns.

JIM: Well, there you go. It’s absolutely amazing. Why do you think the stock market is up now, buddy. It’s called reinflation.

You know, what was amazing that one comment that Bernanke was making in that speech:

Countries with high money supply growth experience inflation, countries with low money supply growth experience low inflation.

And what’s surprising about that is we got rid of M3 because they said it just costs too much to compile – and you're talking about an organization that prints money. But money supply growth –as it has been reconstituted by people like John Williams – is growing in this country at 14% now. So here he is on a public platform talking about high money supply growth commensurate with inflation. And that’s exactly what we have right now in the United States; and it’s exactly what we have around the globe today – whether you're looking at countries in Europe, you're looking at Australia, whether you're looking at China. China recently reported that it’s CPI is running at around 6 ½%, food and energy inflation. And yet, every time we get a headline inflation number, whether it’s CPI or PPI and the numbers are coming in at annual rates of 6, 7% what’s the first thing you hear? [04:04]

JOHN: Okay, well, they're all babbling about the core rate. That’s the first thing you hear, the core rate this, the core rate that.

JIM: Yeah, the core rate as if we all live and die by the core rate. We alluded to this last week, but there’s been a change in economic thinking in the United States; and it’s very, very reminiscent of what was going on in Germany during the great inflation where the head of the Reichsbank basically said there was no correlation to the amount of marks that they printed and the rate of inflation. The head of the Reichsbank would blame the inflationary problems on the currency market. And what do you see in the United States today with the dollar problem? You know, we're blaming the Chinese or we're blaming somebody else for the problems in this country rather than the unrestrained growth in the supply of money. And unless you recognize what the true cause and nature of inflation is, which is an expanding supply of money and credit in the financial system and the economy, then how can you solve the level of inflation. [5:15]

JOHN: Well, here’s where the water gets a little mucky because every time we go through one of these inflation things they try to offload the responsibility for it on to something that really isn’t responsible for it. It may be labor, or they’ll talk about greedy companies, they’ll talk about energy – “the Fed can’t control energy,” remember Ben Bernanke saying that and, “that’s of course what’s causing inflation.” But that distorts the picture, because inflation is not a rise in prices it’s an increase in the money supply which results in a rise in prices.

JIM: This is absolutely amazing and if you're listening to this program this week, I think it’s Sunday, 60 Minutes, is going to do an interview with Alan Greenspan who has now published his memoirs and a biography. And I think it’s Leslie Stahl here on this clip who is asking Greenspan about the subprime mortgage market. And you're going to hear that he didn’t get it. But how could a guy not get it when he slashes interest rates all the way down to one percent and injects massive amounts of money into the banking system and the credit system, and not expect a response.

Let’s go to that clip from this weeks upcoming interview of Greenspan.

STAHL: With all of the financial insecurity today, Alan Greenspan’s opinion is worth its weight in gold. In his first major interview he makes predictions about the economy, talks candidly about the presidents he’s worked with, and admits he didn’t see the current credit crisis coming.
If you knew these practices were going on – or even maybe just suspected that there was something illegal or shady – why didn’t you speak out. You had a huge megaphone. People really listened to Alan Greenspan.
GREENSPAN: Well,I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late. I didn’t really get it until very late in 2005 or 2006.

Now, John, here’s a guy that runs the most powerful central bank in the world, he takes interest rates from 6% down to 1%; he injects and allows the money supply to grow by over one trillion dollars in just one year. And here’s a guy, John, after the events of 9/11 where they expanded and injected nearly $200 billion into the banking system that week. I mean you had a sharp spike and the money supply growth from the next 12 months we went from 7.7 trillion to 8.6 trillion; so in a span of almost 12 months the money supply in this country grew by one trillion dollars – and continued to grow throughout.

And what is even amazing: until they stopped reporting until the first part of 2006, you saw just before Bernanke comes in – which I found amazing – but the Fed goes on a rate-raising campaign beginning in the summer of 2004; and two months before the Fed goes on the rate-raising campaign Alan Greenspan makes a speech and tells everybody what a great deal adjustable-rate mortgages are. In the back of his mind he knows they're getting ready to raise interest rates and he’s telling people to go to adjustable-rate mortgages.

So in terms of his offloading and excuse here that he didn’t know what was going on you can only draw two conclusions: number one, the man really doesn’t know what he’s doing; or number two, he knows what he’s doing but he hides behind that veil or shroud of effort of what is going on.

And it was amazing because, during that period of time, there were some vocal criticisms in terms of Greenspan keeping interest rates unusually low; and a lot of his fellow Fed governors were actually going back and saying, “hey, we've got a problem here if we're going to do this.”

Let’s go to that clip when I think Stahl asks him, “well, other guys on the Fed said there’s a problem out there and you sort of ignored them.”

STAHL: One of your former Fed governors, Ed Gramlich, said that he proposed that the Fed examine these lending practices and look into the them to see if something could be done; and that you rejected that idea.
GREENSPAN: Well, I…that’s nothing to look into particularly because we knew that there was a number of such practices going up. It’s very difficult for banking regulators to deal with that.
STAHL: He insists there’s nothing he could have done to prevent today’s plummeting home prices and the fact that a million families have lost their homes, and many more could.

Well, you know, John, when you really look at what was going on here with monetary policy – and this once again goes back to expanding the supply of money and credit in the system – the Fed itself does that and creates the problem, it doesn’t recognize the very thing it does creating the very bubbles, the malinvestment and the distortions that we see in the boom-and-bust cycles.

I mean we just came off the largest monetary expansion in the history of this country which occurred under Alan Greenspan’s watch; especially after November of 1994 when political control changed in Washington. And there was a book written by Bob Woodward called The Agenda where there was a conference going on in the White House – Clinton had just lost control over Congress – Bob Rubin was there, another undersecretary of the Treasury, and Alan Greenspan, and they were worried about the 96 political elections and they said: “How am I going to win this and they start talking about bringing down interest rates?”

“Well, how do we do that?”

“Well, you’ve got to expand the supply of money in the system.”

And if you look at a graph of M3 beginning in the fourth quarter of 1994, that’s when we began the great monetary expansion. If you look at this monetary expansion which really began in about December of 1994 – and you can see this if you get a graph of M3 and take a look – the money supply up until that time was growing at about a rate of 3 to 4% a year. It was growing about the rate at which the economy was growing. And we didn’t really have major inflationary problems. But beginning in December of 1994, the Fed really began to put the pedal to the metal and you can see this in an upward spike – the M3 growth rates were basically flat and then all of sudden they start going up at a 45 degree angle.

And from December of 1994 when the M3 was at roughly 4.4 trillion, we took it from 4.4 trillion to when we last reported it at 10.3 trillion, which was basically in February of 2006. That was the last time the Fed began to report. And it’s no wonder that they stopped reporting it just before Bernanke goes in, because from that point forward beginning in 2006 we began to expand the supply of money and credit in this system at even faster rates. And that’s one reason why the housing market held up the way it did in 2006; it’s one reason why the whole mortgage situation did not start to unravel until this year – it was still going on even though the Fed continued to raise interest rates under the Bernanke regime all the way up through the summer of 2006.

But if we take a look at what happened to money supply in 2006, we increased the supply of money and credit by almost 7 to 800 billion dollars. And when you listen to these guys – as you've mentioned – they’ll talk about symptoms, tight labor markets, about rising energy feeding its way through the system, but they never talk about the supply of money and credit. And I think Greenspan will go down in history as a serial bubble blower. And in fact, that was a question came in the interview where many say that you were the creator of these bubbles. Let’s go to that last comment from the clip of this weekends interview. [13:55]

STAHL: But some economists now say Greenspan actually created the housing bubble and the credit crunch by keeping interest rates too low for too long.
GREENSPAN: It was our job to unfreeze the American banking system if we wanted the economy to function. This required that we keep rates modestly low.
STAHL: Fed governors who worked with you at the time are now saying that they think interest rates were too low for too long.
GREENSPAN: I think they are mistaken.

Greenspan has always gone on record. He’s said it’s very difficult to identify a bubble when it is occurring. And it’s not the Fed’s job to prevent bubbles, but basically to run a mop up operation once the bubble bursts. And the amazing thing about this is if we go back to when we were under the gold standard and you’d have these booms and busts, the economy would go through a self-cleansing process. We would have depressions, the excesses in the economy would be cleansed, the malinvestments would be liquidated, and the economy would right itself so that when the next cycle began we were in good shape.

But as we talked about on the program last week, there was a growing sense in academia, in government circles, and also in Wall Street circles that we could not go through anymore hangovers. Politically, they were unpopular. When you go through a cleansing process what does that mean? It means people are going to lose money because malinvestments are going to be liquidated at below cost in order to cleanse the system; the economy goes into a downturn, profits go down, unemployment goes up until the excess that were created during the boom period are cleansed so the economy can right itself.

Well, economic policy began to change beginning in the latter part of the 80s, and I would say it probably changed with the Greenspan administration. In other words, if Paul Volcker was Chairman of the Fed, and let’s just say through a miracle he stayed on in his tenure he kept being reappointed, I don’t think we would have had the bubble-like response that we got through Greenspan when he began his tenure. That’s because his first response to any type of crisis whether it was the stock market crisis of 1987, the S&L crisis of 1991, the Peso crisis of 94, Asia’s crisis in 97, Long Term Capital Management and Russia in 98, Y2K in 99, the bursting of the tech bubble in 2000, and then the recession of 2001 – the standard response from Greenspan was to flood the markets with money and credit, bring down interest rates and do not allow the economy to go through a healing and a cleansing process.

And you could really see this in a graph, if you go back and look at charts of M3 going back of August of 1987 when Greenspan became chairman of the Federal Reserve. And so, in reflection, if you take a look at that, basically Greenspan’s motto is: you can’t identify bubbles, and the only thing we can do is really come in and mop the bubbles up.

And in that comment, he’s admitting that number one the Fed has no responsibility for creating these bubbles. So that for example, when the tech bubble unwound, we went into a recession in 2001 and the bear market in stocks continued and the events of 9/11. Had he not cut interest rates as far as he did and held them as low as he did for such a period of time (there was always the talk about the Greenspan put: go out, risk money, do things that are stupid and the Fed will bail you out)…and in that process, what he was doing was creating the moral hazard that encouraged speculative risk taking because the idea was – and especially if you were big like a Long Term Capital Management or today, like a Citigroup or some of the other banks – that you know what, the Fed would come to the rescue.

So, even though these guys are sitting there talking tough about inflation, on the other hand, they are injecting tens and tens of billions of dollars into the financial system because the concept is politically: we cannot afford to allow any pain to take hold and cleanse the system. It would be too painful to do so. So what they do, as they're talking about there, is mainly mopping up after the events occur, and come and flood the market with more money and credit and create a whole 'nother cycle and postpone the day of reckoning. And that’s what we've been doing for decades now. [19:11]

JOHN: Okay, that’s sort of a snapshot looking backwards. This is how the Fed sees its role, what? Mop up operation. Well, if that’s the case, if we assume that’s the track record, now going forward from where we are right now, what can we expect out of that?

JIM: I think the Fed is walking a tight rope – a high-wire act that they're going through right now. They know that we've got a problem in the banking system and credit is locking up; commercial paper market isn’t functioning.

And here is one of the problems that we have in the banking system right now. You’ve got these banks that have committed to a large portion of these Structured Investment Vehicles that if the commercial paper locks up they’re going to have to take these loans to these Structured Investment Vehicles on to their balance sheet. That’s number one.

Number two, they also have committed to a lot of these private equity takeovers to fund them; they've got commitments in place. And the idea was that the banks never thought they would have to take these loans on to their balance sheet because they were simply the packager and the facilitator. They would bring these things together and they would get fees for servicing them. But basically, what banks have been doing for such a long period of time in this decade is arranging the financing and then turning around and repackaging the debt on those loans and selling it to investors. Basically, securitizing them. So when they took a look at putting these Structured Investment Vehicles together in the large money center banks – the Citigroups, the JP Morgans are one of the biggest vendors behind all of this – they never really thought that they would see a lock-up in the commercial paper market where these vehicles could not get funded in the commercial paper market; and that they themselves would then have to make the loan commitments to fund them. That means if they did make the loan commitments now, that investment and that loan is now on their balance sheet and they're at risk for any losses that occur on those loans.

So we've got a situation right now – and this is why this credit is getting tighter – where banks are taking a look and saying, “holy cow, we've got hundreds of billions of dollars in loan commitments to private equity deals that we may have to fund ourselves. We have hundred of billions of dollars of funding to Structured Investment Vehicles that we may have to fund and bring on to our balance sheet. And therefore, we're a little bit reluctant to loan to let’s say the Countrywide’s or some of the other financial intermediaries because we're going to have to husband our resources because we may end up eating all this stuff and putting it on our own balance sheet. And we’re much at risk here if this stuff starts to fall apart and we incur large losses.”

It’s okay from a bank’s point of view if you've offloaded that risk and losses on to somebody else, because that doesn’t impact your balance sheet. [22:10]

JOHN: Basically if you look at it, the Fed is going to have to cut just to keep things going, but that means another surge of liquidity out there, and what’s that going to do to the dollar?

JIM: Well, there’s the risk that they run. They run the risk if they cut interest rates too much to save the economy, they sacrifice the dollar. And if the dollar falls off a cliff and really begins to tank then what you’ll have is another repricing of risk in the market place. Credit spreads will widen, long term interest rates will go up – that’s going to impact the housing market – so they really need to get the cooperation of other foreign central banks. I think they'll get the cooperation of the Japanese, I think they’ll get the cooperation of the Chinese but at a price, and then I think reluctantly the last people to cooperate will be the Europeans.

But in order to pull this off for the next reinflation, because let’s face it, if we go into a severe recession, it is going to impact China, it is going to impact Japan, and it is going to impact Europe. So they're going to have to get the support of other central banks to come in and buy our paper and support the dollar, either by buying our paper or massive intervention. And if they do that to support the dollar that means they will have to print a large amount of their own currency to neutralize that currency’s appreciation against the dollar; which means they will be expanding their money supply as well. But I do think you're going to see revaluation of the Chinese currency. It will be one way for some of the Asian central banks to control inflation in their country.

But unless the Fed can talk other central banks into cooperation and they all work together, if they can’t do that, then what will happen is you will see a collapse in the dollar. So that’s what I think they’re working on now, which is trying to put together some kind of coordinated intervention in the currency markets and the interest rate market, because the Fed is going to have to reflate. And it’s going to reflate massively. As it reflates, your going to see other central banks around the globe reflate massively – as they have been doing because we’ve been getting double digit money supply growth in all foreign top central banks of the world who are all doing that simultaneously. And because of that you are going to see inflation rates rise.

And the one thing that’s going to be more difficult for them this time is you've got inflation that is baked in the cake with food, energy and agricultural prices. And that’s going to be the thing that’s going to be more difficult this time. And I think they’re going to have a serious battle. They’re going to be able to reinflate the markets. I do expect stock prices to go higher. They will be buying everything on the Street if they have to, but it is going to take coordination because the US central bank is no longer in a power position where they can do this by themselves. And I also think you’re going to see, as we get closer to the end of the year as the economy weakens even further, I’m not sure we can even avoid a recession at this point. Maybe the best that they can do is contain it, and make it a mild one before the real problems come home to roost. And once again, John, we go back to our window period where this really begins to unravel beginning in 2009. [25:37]

JOHN: And you're listening to the Financial Sense Newshour at www.financialsense.com.

Q-Calls

JOHN: Something we like to do every week here on the program is go to the Q-Line. We call it the Q-Line because it’s really the question line. We have this line open 24 hours a day to record your question for use on the program. The toll free number in the United States and Canada is 800 794-6480. That number does work for the rest of the world but it’ll cost you whatever your international dialing rates are.

And we do take questions from you – please give us your name and where you’re from. Try to keep it short – it’s hard to run long treatises on the air, people sort of lose interest in it. And remember, radio show content here is for informational and educational purposes only, and you should not consider it an offer to purchase or sell any securities. We have to base our response here on the information that you give us, and they're based on the personal opinions of Jim Puplava. We can’t take into account your suitability, your objectives, or your risk tolerance. And as such we won’t be liable to any person for financial losses that result from investing in any of the companies or subjects profiled here on the Financial Sense Newshour.

Good evening from Tampa Bay. This is Jason here. I have a question about Treasuries: Are they fiat in any way?
This is a side note – a light bulb went off when you used an illustration and I believe it would be beneficial for the listening audience to hear the illustration again about buying a gallon of gas for 50 cents. I remember somebody using the illustration about 2 silver quarters minted in the early 1900s made out of pure silver, and how if you take those two quarters to a gas station today you’d be able to buy a gallon of gas. And that was the illustration that was used to make the light bulb go off in my mind. And I think the listeners would benefit from that illustration again and again.

Jason, in a fiat currency system, money is created either through cash or through the banking system or through the debt system. So in effect Treasuries are fiat. They become fiat through the way they are financed. If debt is financed with real savings then it is not fiat. If debt, however is financed with monetization - in other words, the Fed simply prints money to buy that debt then Treasury debt becomes fiat.

You gave the illustration of the purchase of a gallon of gas – I can remember mowing the lawn growing up and going to get gas for the lawnmower and it was like 25 cents for a gallon of gasoline. Today, it’s $3. And let me give you another illustration. I grew up in a family of 10 children – my mother didn’t work, my father was a cabinet maker so he was in the building trades and he raised 10 children, and was able to accumulate a portfolio of real estate.

And just to give you an example of inflation, one of the first homes that they purchased – I grew up in Phoenix, Arizona – cost my parents about $5,000. There was a 10 year mortgage on it at about 4%. So unlike today’s mortgages which run 30 – some run 40 – the mortgage only lasted for 10 years; the price of the house was 5,000 and the interest rate was 4%. And I mean, it wasn’t a luxury home, it was a tract home of 3 bedrooms in a suburb of Phoenix. Try finding that today. The first rental property that my parents ever bought I think they bought for $10,000, 4% mortgage, 10 year maturity, and they had one tenant that lived in who rental property for close to two decades. So basically, that tenant paid for that entire house. So there’s just an example of inflation. [29:49]

This is Dan in Missouri. I did a spreadsheet analysis of the September 7th closing. [inaudible] 524 exchange traded funds. The results were interesting as the market plunged nearly 250 points. To make a long story short, about 78.6 billion in trading for that Friday. That dollar value was significantly intense from the day gold crossed $700 per ounce with only $47 billion bought that day. Three of these Exchange Traded Funds accounted for nearly 50 billion and that was 64% of the total market. Spiders STDR about 44%, Russell 2000 Index about 11%, and Power Shares QQQ about 9%. Being that so much money was spent on Spiders, my guess is those investors seem to think the market will surge forward on rate cuts by the Fed. We will know if they invested their money wisely by the 18th. Comments, Jim?

You know, Dan, I do expect the stock market to go up through this reflation process. We may go through a corrective period here because there’s a lot of expectations. Many on Wall Street would like to see the Fed get more aggressive with its rate cuts because of what’s happening to the economy and the financial markets. So maybe if they cut a quarter of a point, it’s not going to be enough for Wall Street. I think that’s already factored into the market, and you might see the market rally initially on that response – and depending on what they say in the language; and then eventually begin to sell off when we go through another corrective phase.

What I’m concerned about is what’s coming next in the short term, which is going to be when banks start reporting their profits for the third quarter. All the problems you've seen so far in the credit markets, I cannot help but believe that the big banks are immune to all this, and I think that this problem that we've talked about on previous programs here is working its way up the food chain to the big banks. [31:50]

Hi, my name is Greg, I’m calling from Sydney, Australia. I’d like to take issue with John, I guess, bragging on Saturday’s show on the 8th of September that Jim predicted housing would “fall apart this year.” I distinctly remember Jim making mild predictions about the housing market, something more akin to a slowdown not a major falling apart or price drops or credit crunch. So I was just wondering if you guys would like to revise those comments at the beginning of the year, or the comments made on Saturday; and kind of give us a clearer picture of where you thought things were going and where they have gone. Thanks.

JOHN: Well, I don’t know, cookie, if I bragged too much here on the program. I didn’t have a chance to look at the transcripts from the shows back in January, I don’t know how hard we hit it. But Greg, if you would go back and look at some of the things that Jim wrote in his Storm Watch Update (this would be in December of 2006) he predicted that one of the next big rogue waves – meaning ‘big, hard thing’ – would be the subprime housing market; they would take a hit. And he also reiterated those in a number of pieces on the website that are still there from January and February. So I’m not sure how hard we punched it on the show back then – I didn’t have a chance before air time to go ahead and look at that – but anyway, I’ll keep my bragging down for a while; Okay?

JIM: You know, Greg, the only thing that I have probably said is do I think this is going to be the great depression coming from real estate. No. I’ve said that the real estate market is going to get worse. But there were people talking about this was going to be the end of the world in real estate and I just didn’t see that. Was there going to be more pain? Yes. Were prices going to go down? Yes. Were people going to lose homes? Yes. But was this going to be 1929 as some people were predicting? I said no. [33:36]

JOHN: We’ll have more of the Q-Line coming up later on the Big Picture. This is the Financial Sense Newshour at www.financialsense.com.

[34:19]

Other Voices: Jim Sinclair, JSMineSet.com

JIM: We’ve got the Fed meeting next week, we've got subprime problems in the economy and financial markets, people are starting to mention the R word. Gold looks like it’s ready to explode and what better person to talk to about gold, joining me on the program this week is Jim Sinclair.

Jim, I want to talk about an issue that everybody has been focused on the last month and that is the subprime market, this disassembling that we've seen. Why don’t we begin with that and let’s talk about the broader implications and what this means for the financial markets and also the economy. Let’s begin with that – your take, please.

JIM SINCLAIR: The problem in the subprime mortgage area is really a spin word or a spin subject to cover up what is really a derivative problem in the credit and default derivatives. If you were to examine some documents of the commercial paper market you’d find out that a significant amount – in some cases up to 90% – of the collateral for the borrowing in the commercial paper market is involved in over the counter derivatives which are known as credit and default derivatives.

The reason why they are unable to value these is because these are special performance contracts, not futures. Not anything that has a tradable market; it can only be closed by negotiation by two parties. So the code word is subprime mortgage; the truth is the first shaking of a $20 trillion mountain and that’s credit and default derivatives just by themselves. The implications that you have from this is that in truth the Fed has no tool to use; no long term means of being able to address the shutdown and the lack of liquidity in this market, because every tool that they have that they can use is very short term in nature. And in a true and practical approach once you’ve put in the liquidity you can’t pull it out that quick – meaning a week, a month, two months – as you would in a normal sense because you’ll only exacerbate the problem.

And to use the Bernanke helicopter drop of the electronic printing press made in Japan where the Japanese intervened in their currency, bank-wired the money to the New York Fed and the New York Fed purchased Treasuries across all maturities for the Japanese float account of which they were managers. Putting liquidity into the international system is another application which can’t be withdrawn because the practical nature to withdraw it you would have to be selling those Treasuries; and even this huge Treasury market couldn’t stand that kind of selling.

The point being that there is actually no tool that has ever been devised to be able to address a beginning of the shaking and a partial meltdown in these cyberspace agreements that have no money in of special performance which have been given value by mark-to-model – that means, valued to a cyberspace conclusion – for which there is no real market. That in fact is your problem, and there are significant implications to that. [37:12]

JIM: Well, let’s talk about some of those implications, including what may look like an approaching recession here in the United States.

JIM SINCLAIR: Well, the first thing that I think to keep in mind is: the grand show of what the Fed will do is probably the most meaningless subject that you could put your attention on because the problem is not a problem that can be solved by any significant drop in the interest rates. So that is an attempt to keep the social order; so much attention put on by media and the marketplace so intent and focused on what Mr. Bernanke do at the upcoming meeting. It will absolutely means nothing.

There may be market reaction for a short period of time but that has no ability whatsoever to correct the present problems that are developing. And that is spreading through the economy because the commercial paper market is where day-to-day financing takes place for major – even minor – corporations. And the lack of that market functioning – which it’s not – the lack of the ability to make those loans has a significant impact on day-to-day corporate business. So it’s quite predictable that the downturn that has taken place in housing, in automobile sales, and now possibly even in the mad, mad, mad, mad American consumer might in fact bring about – and will I believe bring about –aa recessionary environment.

And that recessionary environment needs to be looked at not specifically and oh my goodness what does it mean to our investments in gold and won’t that, in the Prechter sense, cause a significant downer in gold. The answer is quite to the contrary, gold is the dollar, the dollar is gold, gold is a currency. The dollar is losing its great appeal as a reserve currency and from that moment forward gold began to appreciate. Every question you’ll have concerning what gold will do is really a question of what the dollar will do.

And what most people are failing to consider is what is the impact of a recession on the income of the United States in the sense of the Federal revenues from taxes? And that’s been extraordinarily good for the government allowing the United States to spend madly even though they’re overspending even that revenue. Now that’s going to fall off significant because profits come down in a geometric sense – a reverse curve – from the slightest drop in gross. So even a mild recession would bring down US revenues significantly; it would bring the Federal deficit up sharply; it would have an impact on the current account deficit and would have a definitive and extremely negative impact on the US dollar. In this environment, a recession, which will only exacerbate the derivative problem, individual of that, will have a significant negative effect on the US dollar. And that will have a significant and positive effect on the price of gold. [40:12]

JIM: That was my next question I wanted to get to because a lot of price are saying, “well, if we get in to a recession the stock market will go down and with it gold stocks will go down.” So let’s talk next about gold stocks in a recessionary environment. And then also perhaps the lack of action that we've seen in gold stocks for most of the year. So let’s address those questions.

JIM SINCLAIR: The answer to your question about where the relationship between the stock market and gold shares is really a question of how many people are both in equities as well as in gold securities. And it is also a question, in this unique environment, which way is gold going to go. So it’s a two-part question.

And there’s no denying a significant down in the US equity market would put a temporary psychological pressure on the gold shares. But if you take apart what’s happening right now I think the model you want to compare because we need to study cases – we need to find model cases to whatever is going on in order to draw a conclusion. And there is a definitive model out there, not in amplitudes, but in cause and effect. I’d like to repeat that: not in amplitudes, but in cause and effect – and that’s the Weimar Republic. The cause this time, for here and for us is the rolling over of the huge mountain of derivatives with code words: subprime loans and the commercial paper market.

In the Weimar Republic there was a defined appreciation of the currency in order to be able to get out of war reparation requirements by debasing the currency. That got out of control causing the currency to implode. What is required to keep any semblance will eventually be –and not in the too distant future –a global increase in liquidity concerted between all major central banks in order to hold together whatever can be held together when this 20 trillion – only one category! – of derivatives finds itself significantly challenged. It’s only moderately challenged now and look at the reaction.

And the numbers that are coming out of the Bank for International Settlements and the IMF would actually lead one to the conclusion that even if you backed out derivatives that are traded on organized exchanges first, and second, derivatives where you have a clearing house guarantee (and therefore some degree of stability) there are over 400 trillion dollars worth of these things outstanding and one shouldn’t get into slices and notional value. When they're called on to perform the value of the derivative is 100 percent, not of the notional value becomes real value. And there isn’t one dime in any one of these contracts floating in cyberspace. So the comparison to the Weimar Republic needs to be kept in mind. The stock market and the Weimar Republic didn’t – it went up violently. The price of real estate went up violently; the price of manufacturing went up violently; the currency went practically to nothing and then everything imploded on itself.

But look around you and see what’s happening: commodity market in a strong bull, stock market not exactly falling totally out of bed but the volatility is getting wild. Another thing to bear in mind is the grease of the wheels in an equity market is pure liquidity not fundamentals; and worldwide and globally orchestrated violent increase in global liquidity – a predictable event - as a result of the period of greed reaching almost spiritual levels creating such outrageous combinations i.e. considered structured products is really what’s behind what’s going on right now and we're talking 20 trillion in one category alone. That’s three times – a little under three time the entire US national debt. It’s enormous and the impact could very well be that the stock market doesn’t come apart or rallies from its significant downer. I don’t think in truth that should challenge the gold shares because how many out there are really long a lot of equities and a lot of gold simultaneously?

I don’t think the listeners would all be raising their hands. I don’t think you find funds that are in that condition. I think that’s a condition that would be better described as a mental condition more than a real condition.

Now, let’s take a look at the stocks themselves. Let’s go back to Newmont and their $2,000 million loss on closing certain derivatives. Let’s take the first. In truth, that isn’t buying gold in the market; that’s buying back paper that was issued to you; it’s buying back special performance contracts that you believe will become prohibitively expensive to perform on. So when Newmont took their $2000 million – that’s a lot of bottom line – in buying back special performance paper which was called gold hedging there is in that two things to consider: one, the billion dollars they borrowed was in my opinion directly from the other side that they just closed the billion dollars they borrowed. Yes, was from the other side of the transaction – in other words, they simply borrowed it from the people who just took the money from Newmont in order to keep Newmont’s cash position somewhat viable.

The other one is where is that 2000 million going to be charged? I mean on one side you've dropped your cash and near cash assets by 2000 million. Where does the other entry go? Under rule FAS 133 and FAS 138 it has to be booked to the project for which the derivative was taken out. And I believe some smart hedge funds understand the implications of that to certain gold shares. And in a sense, the pressure on the gold shares has been a combination of illegal short-selling and an understanding of what derivatives mean to small producers and the exploration and development business. I don’t believe these shares are going to remain in a bear market.

I don’t believe that the management of these companies might even understand what I’m talking about. I don’t think their was any intention to get in the pickle they're in. So I look for gold shares to strengthen selectively in the junior to moderate producer; and as far as the majors are concerned the potential is that there will be a significant period of acquisition between majors. My position is that the lenders to Barrick – even though that’s a company people love to dislike – are in fact the strongest in the business because you haven’t heard a peep out of them even though they may be the mother of all derivative hedgers. As is possible Barrick will acquire the field.

Now, what happens after that is an entire 'nother story. But right now, Newmont, if you examined what their cash position must be, would kind of scare the life out of you. So an Anglo, who today said they’re not interested in large acquisitions, is one of the largest hedgers there are.

So there is something that needs to be taken into consideration and that is the selectivity of the bull market that is about to take place in the gold shares – and undeniably will happen. And it’s going to happen across the board because again I assure your listeners the management of these companies haven’t a clue as to what I’ve just spoken about. But I assure, I am, sadly, a hundred percent correct.

So the answer to that, A, a downer in the equity markets only has a very temporary impact on the gold shares; B, there is another reason why the potential is that a selective bull market will take place and of course the general comment how many people own equities also own gold equities as well as general equities.

Don’t make a comparison to the 1930s except in the most general way because there wasn’t one single derivative – nobody knew what the word meant back in those days; and there was an entirely different structure to the mining industry. This is a different set of time, a different reason why. The best tool the Fed has is that nobody wakes up to what it is and therefore to speak as if it really was under control and isn’t a problem of a serious nature, is about the only tool that you have. It has to go away because it’s hidden and very little goes away that’s hidden. [48:42]

JIM: I want to ask you something about naked short selling because I see it – and you've written about it – where it’s at the end of the day and all of a sudden, you know, a stock has been up and you’ll see a tremendous selling pressure selling down. And I wonder if you might describe how this works and why in your opinion they’re able to get away with this?

JIM SINCLAIR: Well, they’re able to get away it because you've just seen a change in the regulations concerning short-selling and the regulatory bodies are not wholly attuned to violation on the short side, and because in the new environment we find ourselves in of authoritarian free enterprise the profit of the broker and the corporation exceeds the needs of their clients. It’s simple to swiftly execute the share transactions say through Canada and their regulations and especially because of the computer nature of stock transfer it may not actually even show up. Whenever you see a large amount at a very late time either bought or sold, as a trader – and I’ve been in this business now 49 years – you can be absolutely sure that that transaction was not made in order to sell or to buy but only made to influence price. So the late selling of the late buying is a product of trying to manipulate a price which will be quite successful until that entity, if it selects itself out of the others in the general bull environment, begins to move sharply against the hedge funds all of whom are doing this – most all of whom are doing this. [50:22]

JIM: You know, I saw a situation in Canada where a particular brokerage firm was caught doing this, they were allowing their hedge fund client to come in and sell short the stock on a naked position. But Jim, they were caught red-handed in the act and they were only fined $85,000. So, you know, they probably made more than that.

JIM SINCLAIR: It’s like dumping hazardous waste. The fine is $25,000 and you made 500,000 – not a bad business. And the firm that was found just wasn’t sly enough to be able to hide, and somebody probably dropped a nickel on the local authorities – that would be my opinion. [51:02]

JIM: Absolutely amazing. Well, I want to end on something that you published on your site. It’s got the three angels and you’re talking about at that time gold was at 650 and you had some hypothetical price targets for gold. Let’s end with that.

JIM SINCLAIR: They’re basically magnets. They deal with a concept in probabilities which is moving support and resistance of significance. It’s a bit of regression-type analysis. 682 had been a strong pull to the upside while 612 was the absolute bottom. 887.50 is where we're headed for here with various smaller influences around 751 to 761 and then a little above 800. But the primary angels are just areas of strong probability of a regression model which would indicate the potential for significant supply or significant demand and present it, as I do in most cases…I mean that argument and the presentation on the derivative problem in the gold industry is kind of mind-boggling. So what I do is I just illustrations.

In other words, I think it’s better to draw a picture for people many times than it is to try and go through and explain exactly what’s happening. So it started off as the four angels and as I’m convinced one of them is wholly passed then I lighten it to being almost invisible. So there were many angels on the way up, you know, 524.90 was the starter, 305 was a key point; and if you’ve noticed, Jim, I've had those key areas published as we've appreciated and you've noticed that those areas have been areas of major battle: 682 recently and over the last two months has been a point where it was like a Maginot Line – it was an area where people fought for basically not a whole lot of reasons but that’s where the bulls and the bears drew the line. Right now, what I believe is pulling on us is 751 to 761; and I do believe that will be accomplished. I really think that having come over 682 now, we are on our way to 887.50 for a variety of fundamental and technical reasons. [53:18]

JIM: Well, it’s absolutely fascinating to watch this unfold. A final question, Jim, the Fed will be meeting next Tuesday and I always felt that before a Fed meeting they would try to knock gold as much as they could before it, thinking like a criminal. And, you know, what do you think about that. Here we are, they're thinking about increasing the margin requirements for gold. So it tells me they're really trying to influence and knock down gold as much they can.

JIM SINCLAIR: Well, I’m going to steal a comment made by one of my friends and associates – trader Dan Nortini [phon.]– and say you show me the bear market in which you've ever seen an increase in margin requirements. In a sense, it’s a confirmation of a bull market. And that doesn’t affect people who have already put on positions; and it affects the bear as much as it affects the bull. So, although there is a psychology to that, in fact it’s a confirmation of a bull market and highly irrelevant in the long term. As you remember we went to total cash back in the early 80s – meaning if you traded gold and silver on the futures exchange you put up every nickel that it was worth, so to me that doesn’t make a great deal of difference. The fact that you tend to see gold come into the market prior to a Fed meeting basically says that…and truthfully, whenever the chairman is speaking or the president is speaking you’ll notice gold is standing –either standing still or going down because you must never make the head man look stupid. And gold going up against the speech of everything in control would obviously put a big question mark on it.

So, yeah, that’s kind of common. It hasn’t had up to now any significant effect on the trend and won’t have any significant effect on the trend in the future. And if the dollar happened to be falling they’d make every effort to stop that but look at the size of it now. Look at all of the people who wish to diversify. So the ability to be able to manipulate the dollar is almost now gone. And if you can’t manipulate the dollar then all you can do is create a day or two blip in gold because in truth the dollar is the currency and is without any doubt in inverse relationship to gold which is simply not going to change. It may be a bit difficult to identify but if you watch, let’s say, a 9 minute chart you could be absolutely certain that even if the closes don’t show you this inverse on a certain day you can absolutely see it during the day – maybe not in amplitude but in direction: the dollar goes one way inverse to the gold and vice versa. And it simply is in place even if the close doesn’t show it. [55:56]

JIM: And it’s amazing too and a piece out this week the US Mint has temporarily suspended the sales of gold eagles. What next?

JIM SINCLAIR: What next? Don’t look up when you're taking a walk or you might get your picture taken.

JIM: Well, Jim, it’s a pleasure to have you on the program. I hope you’ll come back and talk to our listeners again. And I want to point out for our listeners, Jim, is a proprietor of a website; it’s called Jim Sinclair’s Mineset, the moniker for that is www.jsmineset.com. And if you’re in the gold market it’s definitely a place you have to go to keep up on what’s going on in the market. You’re a gentleman, Jim, and thanks for coming back and informing our listeners.

JIM SINCLAIR: you’re a gentleman because listeners should know that you gave that page its kick start and I’m deeply grateful for that.

JIM: All right, well, listen, all the best to you and please do come back and talk to use again.

JIM SINCLAIR: Whatever you ask, Jim.

JIM: Thank you.

Part 2

$100 Oil

JOHN: You know, Jim, when I can’t sleep at night I go to bed and I count the future prices of oil. It’s so comforting if you listen to the pundits how it’s going to go to 60, baa, 50 baa, 50 baa, 30 baa-baa, on the program and it’s now up above 80 this week. And we ain’t seen nothing yet so to speak.

With all apologies to Greg in Sydney, Australia, here we go again. Back in January of 2003, you interviewed Jim Rogers on the show and he said that at that time that we never ever again would see $25 a barrel oil. And we got a tsunami of nastygrams from listeners because we’d been doing the show since 2001 so we had this little record of how things ebb and flow. We are going to see $100 a barrel; aren’t we, really, shortly here?

JIM: I really think we’re just one crisis away from $100 oil because the one thing that really struck me – you know, there are a number of documents that are released each year on the world oil markets. The bible that everybody sort of refers to is the BP Statistical Review – and if you’d like to get a copy we have it posted on our energy web page. And then of course, the International Energy Agency also posted its own forecast in terms of seeing a major energy crunch developing between 2009 and 2011. And it’s amazing that, John, it boils down to simplicity itself, it gets down to greater demand than there is supply. Demand growth is outstripping supply growth.

And there’s something that’s developed over the last couple of years that really sunk home when I read the IEA report, and also this year’s BP Statistical Review and that’s this: if you take a look at OPEC itself and you take a look at the Russians they produce about 60% of the oil in the world today; if they produce oil and they’re consuming more of what it is that they’re producing then there’s going to be less for the rest of us who have to import it from them. And the fastest growth in the consumption of energy itself is not China, it is actually OPEC countries, primarily in the Middle East and in Venezuela. That’s because in OPEC countries they subsidize the price of energy.

You and I pay something like – well, I pay over $3 for a gallon gasoline, but if you go to other areas of the world, for example, Caracas in Venezuela, consumers buy gas at 23 cents a gallon, which is the equivalent of about $10 per barrel of oil; if you go to Saudi Arabia or Iran you're paying 40 to 45 cents for a gallon of gasoline. So despite the oil demand in the developing countries, by comparison the demand growth is soaring by between 5 and 6% in Iran over the last half decade and Saudi Arabia and in the United Arab Emirates. And also, you have surging oil consumption in Russia, in Mexico and if you take a look at 2006 OPEC members, along with independent producers – you're talking about people that own some of the largest oil fields in the world – they consumed over 12 million barrels of oil today, or roughly 60% more oil than what China consumes.

So any time you hear about demand growth in energy you're hearing, “it’s China and the developing world.” Well, you know what, the number one area of demand growth in energy is within OPEC and the former Soviet Union and in some of the independent producers like Mexico.

And the problem is if you take a look at OPEC itself, outside Russia, OPEC has been struggling to increase its oil production. Saudi Arabia is doing everything it can possibly just to keep its oil production at 9 million barrels a day. We know that, for example, in Kuwait oil production has peaked; we know in other Arab countries that are within in OPEC oil production has actually declined. And now from large producers such as Mexico we know that Cantarell – the second largest oil field in the world – is in a very, very steep decline; and its depletion rate is increasing rapidly. They’re talking about the scenario in Cantarell is following a worse case scenario that they may not be exporting oil. The same thing holds true for Iran where they're one of the world’s largest oil producers but they don’t have the capacity to refine it. So the irony of it they export large amounts of oil, but then have to turn around and import large amounts of gasoline because they don’t have the facilities to refine it in a population that has a growing thirst for it.

And in Iran, cheap gasoline prices have become almost an entitlement. So here we have a situation where the world is always looking – I don’t care if you look at the IEA report, if you look at the EIA which is the Energy Information Agency in the US – all these reports say, “the demand will be there, OPEC will simply produce it.” Well, there are a number of studies that have been out there that are talking about this growing demand that is coming from within OPEC itself and the Former Soviet Union that over the next couple of years you could see exports drop by 2 ½ to 3 million barrels a day because of increased consumption within OPEC and Russia, and the inability to increase that production to not only offset it – not even talking about what it’s going to take to even increase their production to let’s say meet world energy demand that continue to grow at 1 ½ to 2% a year because of world economies growing and industrializing. [07:07]

JOHN: If you look at it, we're already at $80 a barrel as we sit here on this Friday, and we have not gotten into the fourth quarter of the year when, especially in the Northeast, the heating is in very high demand at that time; and also the government is talking about supply drops. So we’re already at 80 and we haven’t hit peak demand for the year.

JIM: Absolutely. And one reason is our inventory levels are dropping as more of the refineries are back on line. So if you want to look at it, you know, higher oil prices create a higher cost for the refiners. And there is something called the crack spread and the crack spread is the difference between what they can sell gasoline for and the cost of buying the raw input oil. And that crack spread has dropped and so one of the things I think is occurring in the oil markets right now are the refiners, in order to maintain their profit margins are using up their inventory of cheap oil, maybe bought when oil was in the 60s, as they prepare to create heating oil and other products for the winter season.

And so they're drawing down supplies rapidly, and so, you know, eventually we're going to get into situation where those oil stocks are going to have to be replaced and if you’re a refiner you're looking at, “oh my goodness, I’ve got oil inventory that I got in the $60 a barrel range and now world oil prices are in 80.” So, you know, what am I going to do? Do I really want to lock in and buy $80 oil here, what if the world economy slows down and, you know, the oil markets drive the price down to let’s say $70 a barrel, or 75. Aand so, you know, the refiners may be reluctant to go into the futures market at prices where they are today, instead they may just take the risk of going into the spot market and buying it. So there’s even a risk for the refiners.

So the point being, world demand is growing; it’s growing in China, it’s growing in Latin America – about the only place it isn’t growing is in Europe and some of the countries in the OECD. It’s growing at a very moderate level here in the United States because we're more of a service-oriented economy so oil consumption per dollar of GDP is less in western countries as we don’t manufacture or produce the way we once did. Whereas if you look at economies in India, or China that are heavy where the bulk of the world’s manufacturing is taking place, they're more oil consumption oriented, so oil means a lot more for their economies. So they're going to expand. Their demand for oil is going to grow, and by the same token, the largest supplier of oil to the world OPEC and Russia their demand is growing and they're unable to keep up with production supply to not only meet current demand not counting what they're going to have to meet with world demand.

About a month ago, before we went on summer break, we talked about the IEA paper that was released in the summer talking about this energy crunch that’s going to take place between the years 2009 and 2012. And that was one of the assumptions that they pointed to: that consumption is growing in the Middle East and they aren’t increasing production to keep up with that increase of their own domestic demand, much less meet the needs of a growing thirsty energy world.

And so all of this together just tells me that oil prices are heading much, much higher and if you listen to this program I’ve written about it going back to 2000, 2001 and throughout the early part of the early part of this decade we kept telling people oil prices are going higher. And when we get these corrections as we did in January of this year, we have told people to hold on, this is not going to last, the price of oil is going higher. And I believe it is not in the too distant future that we’re going to see something, either some of the variables such as weather, geopolitics, it could be something like refiners shutting down because they're aging and breaking down more frequently, or it’s a geopolitical problem, and the next thing you know we’ve got a spike in oil. [11:33]

JOHN: It’s amazing, every week here we’re sort of hyperfocused on the weekly inventory numbers but I think what really counts is what the rest of the world is doing, especially those who are producing the oil and what’s happening with internally or politically.

JIM: Absolutely. I mean, the most important question is what is world demand today, not just what the US demand is. You know, if the economy slows down as it is now, and economic growth slows down, the first thing your going to have is: “Well, oil prices have got nothing to do but go down.” There was actually an analyst on CNBC this week saying, “oil has no where to go but lower.” And his reason given is you've got a slowing economy in the United States. Well, the United States isn’t the world’s economic engine as it once was, with China and other parts of the world.

It was amazing that if we take a look at OPEC’s own oil consumption in 1995 they were consuming 5.2 million barrels a day. By 2006, it was 7 ½ million barrels a day, next year based on present consumption trends it’s expected to go over 8 million barrels a day. So if their production isn’t going anywhere, and their consumption is going up, that means there is going to be less oil exports.

The same holds true for Mexico which was exporting – the Mexican oil production peaked in the year 2006 at about 3.7 million barrels a day. It’s expected to drop to 2.4 million barrels a day by the year 2010. OPEC production is not expected to grow more than 3 or 400,000 barrels a day; meanwhile, OPEC consumption will grow by almost 2 million barrels a day. If we look at Russia, Russia’s oil production was 6 million barrels per day, it’s topped out at roughly 10 million barrels per day, so they are now the largest oil producer in the world; but its own consumption is going up. So you’re talking about OPEC production remaining flat and oil consumption within OPEC going up by almost 2 ½ to 3 million barrels per day, therefore beginning after the year 2007 you’ll begin to see a drop in exports coming from OPEC going into the next decade. And that’s where the IEA report was talking about this energy crunch that’s coming. [14:08]

JOHN: If you look at the political level too, people are focused on global warming or we’re going to have socialized healthcare or whatever you want to call it here in this country anyway, and this whole issue of the energy shortage is right around the corner; it’s confronting us almost immediately. But it is certainly not above Congress’s radar, or at least among the candidates running for president here right now in this country.

JIM: Yeah, absolutely. Energy is not on the agenda. There has been some bills submitted in Congress to start taxing and taking more profits from oil companies. And John, last year oil companies invested over $400 billion; they invested actually more than they received in cash flow for the first time since 1999. And it is a very capital-intensive business. I mean you've got drilling rigs in the Gulf of Mexico that rent out at almost half a million dollars a day. These guys have no concept. [15:07]

JOHN: I was talking to a conservative think-tank member a couple of weeks ago and I was talking about this whole oil issue and a lot of them on the conservative side are just as quick to pooh-pooh this on the liberal side of the slate. He said, “no, no, I believe in the free market and the free market can deal with this.” My response was, “it’s not a matter of the free market, it’s a matter of physics.”

JIM: Yeah. It’s becoming a geological issue right now, and I guess my response to him on free markets would be: “yeah, if oil goes over $100 a barrel, if gasoline goes up to 5 and $7 a gallon here you are going to see the market come into play; people will start changing their habits, they’ll drive less; perhaps a lot of cars this decade have been sold on leases, I think the market for used cars is going to be a big loss leader because people are going to start trading in for more fuel efficient cars.”

So in response to your conservative think-tank guy, that’s where the market comes in is it starts modifying people’s behaviors because they’ll respond to higher prices by responses to conservation measures such as driving less, relocating closer to work, or buying more fuel-efficient cars. That is the market at work. But the response of Congress to this will probably be some kind of windfall profits tax, a carbon emissions tax and a global warming tax. It will only be when you have gas lines, can’t get to it and people are so inconvenienced that is when you will see Congress respond. And that’s why, in some sense, I have become more pessimistic because I look around, I read the IEA report, I read the Statistical Review by BP, I get other research information I take a look at; how can policy makers not see this. Now, in defense, last time we had Matt Simmons on, he said there is a growing group within Congress led by Roscoe Bartlett that they’re studying this peak oil issue and looking more into it and taking it seriously. So, it’s starting to turn around in the sense that you're getting people starting to recognize it, but I think it will take a full blown crisis.

The one thing that we can say politically is it’s nowhere near on the radar screen of most politicians – global warming is the mantra of the day, the thought process of the day, and the slogan du jour. And that’s where everybody is focused on. And it’s not until you're in a crisis that Congress responds. And only when people start screaming and yelling to do something about it. I mean we just went through – here in southern California – a heat wave and the previous week before, a friend of mine was without power – we were going through rolling blackouts as air-conditioning demand increased tremendously with the warmer temperatures. And what happened is, everybody had their thermostats turned down to 96 and when the rolling blackouts came in the power was cut off, but when they flipped the switch back on to bring the power back online it created a power surge and blew out the transformers. So he was telling me, he had to open his Arcadia door at night and he slept on his back porch on a mattress because the stifling heat was so bad.

And I found at yesterday when I got home from work that we had had a four hour blackout, and yet my builder is telling me with trepidation – I’m going to be submitting a plan to put solar panels to power my house –he doesn’t know how this is going to go over with the HOA. And we got an email from a listener I think it was in South Carolina where I believe he wanted to put in solar panels and power his house, and the HOA is stopping it because they don’t like the look. And that’s basically my builders are telling me that this is kind of tough to get through.

But thank goodness we have a legal system and I said it’s law in California and if they don’t approve it they're going to hear from my attorneys.

But here it is. We don’t build plants, our utility is building plants in Mexico; they're building LNG terminals in Mexico. We're not building pipelines even though we have natural gas power plants – the only kind of plants we've built in California over the last couple of decades. It’s just absolutely amazing, John. Energy is not on the radar screen and it’s going to take crises to put on the radar screen. [19:43]

JOHN: And my argument about it being science versus the free market, I have faith in the free market but there is what is called turn around time. The best analysis I have of this is when pilots began to transition from propeller driven airliners to jet driven ones, they discovered when you shoved the throttle in if your sync rates are too fast when you're landing the turbines didn’t respond like the propellers did. And one pilot told me, he said “you can shove that throttle to the fire wall and nothing happens.” He said it’s a very sinking feeling when the ground is coming up fast. And that’s what it is.

Okay, so Congress gets excited, up cups the throttles, power up. It takes a while for that to respond, so there is an interim period there of a certain number of years, even if you started today to do something about it. There would be a response time before you overcome the physics of the situation.

JIM: Yeah. They could accelerate the permit process to bring on nuclear power plants. They could accelerate the permit process to bring more oil or drilling for oil and natural gas, but all of that takes time. I mean we discover the North Slope in Alaska in 1968 and I think it was nearly a decade later before we were turning it into crude oil and selling it in the open markets. It takes what? Seven to ten years to build a refinery, the same thing with a nuclear power plant. So you’re right, response time, even if we were to start today and do so immediately we might not see a nuclear power plant until the next decade. [21:17]

Profiting From Reflation

JOHN: Well, reminding you of Bennie and the Jets once again.

And as people are running around there furiously dodging giant sacks of falling money, what if there is any liability on the part of the Fed if they hit somebody with one of those giant stacks of falling money?

JIM: Oh, please, please, hit me, hit me, Ben.

JOHN: You can feel the surge of those thermobaric bags of money. Russia just tested a thermobaric bomb this week – a fuel-air bomb. The thermobaric bombs of money falling all around us. There must be some way to profit in this because as we’ve always said if you understand what’s happening you can make money no matter what’s going on.

JIM: You know, I really believe the central theme as we get into the fourth quarter of the year is going to be reinflation. We’re certainly seeing it in acceleration of money supply growth; the M3 figures are growing at 14%; they're probably going to be in the neighborhood of 16 to 18% by the time we get to the end of the year. We’re also seeing accelerating money growth in China, and elsewhere which they'll have to do to respond to keep the dollar from collapsing because one of the ways they neutralize and prevent their own currencies from rising significantly against the dollar is by printing more of their own currency which expands their own money supply. So I certainly expect to see reflation become the dominant theme.

There’s a lot of question can they pull this off again. I think they can because once again in a fiat world there is no limitation on the central bank of the Fed’s ability to monetize anything. And they've made reference to recent research papers, and especially during the disinflationary period we were going through from 2001 to 2003, and they said, “you know, we can buy stuff. We can buy Treasury paper, we can buy stocks.” And certainly a lot of people, and especially traders in the market know that almost every day in the market there is a strong bid in the S&P futures pit. So I guess what happens in this next reinflation, every time you go through another boom there is a group that is going to benefit more than other groups.

The big beneficiary of the late boom in the 90s was the tech stocks. And tech stocks, as everyone is aware, have grossly underperformed in this boom that we've seen in the markets and recovery since the bottom of the bear market in the summer of 2002. So the question one needs to ask oneself is gauging the main source of monetary stimulus, one result of that is going to be a weak dollar and also resilient foreign growth. Where is this stimulus going to take place, and what sectors are going to perform well under this scenario?

And in my mind the two best sectors to be in during monetary inflation are going to be in energy stocks and also gold bullion and gold stocks themselves. If you look at a chart of gold and especially the gold stocks we go through a big upsurge where the gold stocks really take off, make a new record highs and then you go through this consolidation period with maybe gold pulling back. But the thing that we've seen in all of these consolidation periods is that we are seeing gold consolidate and the gold stocks consolidate at much, much higher levels. If you look at the HUI it made a bottom in November in the year 2000 where it hit a low of roughly about 36, and today we're looking at the HUI at 365. So it’s gone up roughly about 10-fold since that period of time.

And as I look at the gold stocks which began to consolidate and they've remained in this consolidation pattern since December of 2005, it just looks like a coiled up spring that is just ready to go through another NASA space launch. And we saw a similar period in the middle of 2002 ,all the way to the middle of 2003 there was a similar consolidation pattern in the gold stocks and then they just ignited in the middle of 2003. They went all the way up till December of that year where the HUI went from a low of roughly about 112 to a high of almost 257. And then we went through a consolidation period from that all the way to December of 2005 and then it just launched all the way up until last year in May of 2006 where the HUI where the HUI went from a low of 250 all the way to a high of 394. That’s what I think we're about to see next as gold takes off and heads towards the $800 level. I think you're going to see the old highs set in May 2006 taken out first, and then we're going to take out the old records set back in 1980. And with the massive amount of reflation that is going to be required to keep us from going in to the abyss, it’s going to dawn on people that, yeah, there is inflation out there. They're going to recognize – they're going to see it on Main Street in the cost of goods. And the two mania areas that I would overweight a portfolio would definitely be in gold and energy. [27:23]

JOHN: But as you say that, that may sound like a wise thing to do, but let’s face it, there are going to be some white knuckle, roller-coaster ups and downs, Maalox moments. What do you do about that?

JIM: There is going to be that. And one of the reasons why we emphasize taking a long term view of investing is if you got in this gold market as we advocated people do in 2000 where the HUI was below 50, look where it is today. Yes, there have been hiccups along the way, in fact there have been quite a few of them. And as Frank Barbera has been fond saying, if you're in the gold market 20 to 30% corrections on an annual basis are normal – that’s just the way the market is, it is so small. But I think what we're going through next is going to be a very explosive period for both the energy markets and the gold markets; and it’s going to be breathtaking in terms of what you're going to see happening here. And right now the gold stocks have been trashed, the juniors have been trashed to levels that we just have not seen. I mean you've got companies out there selling gold in the ground at between 14 and $20, at a time when the price of gold is over 700. And I think eventually Wall Street will catch on to this. The hedge funds will go from short selling gold stocks to going long gold stocks, just as they did in 2003 before they switched to shorting the stocks in 2004.

And then I think it’s going to catch on in a much broader sense with the investment public because, John, I don’t think they’re going to be able to hide…they can talk about the core rate of inflation but the guy in the street is just going to be seeing higher utility bills, higher food bills. I mean, if you look at the baked in inflation rates that we have just from converting corn to ethanol, that means more farmers are growing corn, more corn is going to ethanol instead of feedstock for agriculture so you're seeing higher chicken prices, higher beef prices, higher dairy prices, higher cheese prices; you're seeing higher sugar prices. I mean just everything. If more and more farmers say, “hey, I’m going to stop growing soybeans and wheat and I’m going to convert to corn because I can make a bundle selling corn,” well that means there’s going to be fewer soybeans available, there’s going to be less wheat available. And those prices are going to start going up. So the two primary sectors I would say here are going to be gold and energy should be overweighted in every portfolio. [29:57]

JOHN: Aside from gold and energy, are there any other things that you think are going to do well during a time of reinflation.

JIM: Yes, and outside of those two areas, another area I see doing very well, John, are industrial type stocks, especially companies involved with infrastructure, because we've emphasized over the last couple of years, another dominant theme that we've been talking about over the last couple of years is infrastructure. You're seeing it in growing economies in Asia and India and Latin America, and even parts of Eastern Europe; and also a second catalyst is also decaying infrastructure here in the United States from collapsing bridges to refineries that are going through more downtime to an aging energy complex; we don’t have enough energy to power our economy. And so I think industrial stocks. And as the dollar gets weaker and we're already starting to see this in the trade statistics where exports are increasing of industrial type goods and capital type goods coming from the United States which will become more competitive as the dollar falls. So industrial stocks would be another area, especially tuned to infrastructure that I would overweight in a portfolio. [31:14]

JOHN: Gold and silver, I’m assuming. Energy and industrial; anything else?

JIM: I also think along the lines of infrastructure and also a sector that does very well with reinflation is going to be the technology sector. It’s been hammered, it’s been in a downturn now for almost 7 years. If you look at the NASDAQ it hit a high of over 5000; and on the day we’re talking it’s at 2600, so it’s half of where it was 7 years ago. I think technology would be an area I would look at.

And another area I would look at, and this is driven more by demographics is going to be healthcare. The country is definitely aging, we're getting older in this country as the boomers head into retirement, that’s going to mean more pharmaceuticals, medical instruments, operations, healthcare is going to be very big here. It’s going to be big in Europe as Europe’s population ages; it’s big in Japan as Japan’s population ages. So healthcare is another sector I would overweight and it is also somewhat immune from an economic downturn. I mean if the economy is slowing down and your doctor says, take this pill because it lowers your blood pressure or cholesterol, you're not going to say, “hmm, I’m going to wait to see what happens when the Fed lowers interest rates. And you know, maybe I’ll fill my prescription after that.” [32:37]

JOHN: What if you simply wanted to play it conservatively, anything in that area, in the area of stocks?

JIM: The one thing I think I would not be in is discretionary consumption stocks because I see – and you're starting to see – retailers break down. So I would be more inclined invest in consumer staples.

JOHN: But consumer staples really encompasses a pretty big area so you're going to have to define that.

JIM: I would say hypermarkets or discount markets as people struggle with trying to maintain their cost of living. Retail food establishments, soft drinks, packaged food, household products, drug stores, brewers, personal product companies – even tobacco companies. That whole list of companies. In other words, you're not going to stop using deodorant or buying toothpaste, toilet paper, paper towels, you're not going to stop eating. If you drink coke or beverages you’ll continue to do that. Cleaning supplies, detergents, drug stores because of an aging population – there’s all kinds of companies in this area, so that’s another area I think I would be overweighted. [33:45]

JOHN: So if we were to march this musical on to the stage, energy and gold are probably going to hold the starring positions there. But industrials because of the infrastructure relationship – we're going to have to do this, that’s going to have to happen. Healthcare is going to be in a much bigger demand, and then consumer issues because everybody needs them no matter how bad things are going.

JIM: Yeah, I think in terms of spending by consumers, it’s going to be staples rather than discretionary spending like going out to eat, or the luxuries that you can afford when things are going well. Right now, it’s back to basics and necessities because budgets are being squeezed with the high cost of inflation. [34:37]

Q-Calls

Financial Sense Newshour at www.financialsense.com. It’s time to go back to the Q-Line and the first caller is from California.

Hi, my name is Kathy and I’m from California. I want to tell you guys I am really enjoying your program. And I’ve got a question about long bonds. With all the talk of inflation and reflation it seems to me that the long term interest rates have gotten pretty cheap. Should I start selling bonds now in anticipation of a rise in 20 and 30 year rates, or should I wait? Thanks.

Kathy, I think with reinflation efforts, we're close to a low on the Treasury bond. We got down 4.3% on September 10th, we’re now working our way back up. As it dawns as we move forward over the next 6-12 months I think you're going to see the yield curve steepen as the Fed cuts short term rates and long term rates start to increase – that, in fact, increases the spread for the banking system. But in this period of reinflation that’s coming I definitely would start thinking about unloading my bonds. I don’t pretend to be a market technician so I can’t tell you we've hit the bottom here, but some of the knowledgeable technicians I talk to say that we're very close to that. So somewhere between now and the end of the year, and probably even sooner you may want to consider getting out of long term bonds because I do think long term interest rates are headed up. [36:36]

Hi Jim and John, this is Bob in Missouri. I was just wondering do you think in this period that’s coming up of hyperinflation do you expect gold and silver just to keep up with inflation or do you think the purchasing power will actually increase? Thanks.

Bob, in this period I see ahead, it will actually increase. And you know, you can see that actually from what we've experienced from 2001 where gold was at 255 and today we're talking about 700. So gold has more than kept pace with inflation keeping investors ahead; gold stocks even more so. So I do expect it to outpace inflation and to create real purchasing power. [37:22]

Hi Jim and John, this is Mike from Greenville. I just had a question and a comment. First of all, I’d like to say I listen to your show every week, and appreciate the insights you bring. My comment is I’m reading Richard Bookstaber’s A Demon of Our Own Design, and it would be interesting if we could get his viewpoint on the current state of affairs on the market.
And the question I had: I know we're getting very close to reaching the national debt level that’s been set at just under 9 trillion. And I hadn’t heard much stated as far as what they're going to do, where they're going to raise the next level to, whether that’s 10 trillion of something along those lines. I didn’t know if you’d heard that either. Thanks.

Mike, they're going to have to extend it beyond 9 trillion. Of course, there’s always the political jockeying that goes on between the administration and the various parties within Congress, in terms of, “well, we’ll extend the limit but we want to spend this.” But they’ll extend it, and as the economy slows down, that slow down begets lower tax revenues and the government begins to spend more, so the budget deficit widens. And so they're going to have to increase that debt limit and maybe they go to 10 trillion next, which is probably the next benchmark. [38:40]

Jim, this is Howard in New Orleans. Everybody is talking about the low job number figure that came out right before your last show. And what I don’t understand is we’ve been hearing for years how the government can get any number they want and then this terrible number comes out. And it makes me think why did they want this terrible number to come out. So I’m thinking that they're trying to engineer one more incredibly huge, scary leg down so that the cry for reinflation is so great that no one will get in any political trouble. I’d like to hear your thoughts on that.

I think there is some truth to that, Howard, but one of the problems that they've had is 70% of the jobs we've created over the last couple of years are a result of the birth-death model. And the birth-death model might reflect to some degree a bit of accuracy in an expanding economy but it gives a false signal in a contracting economy, or one that’s slowing down. So even if you take a look at the birth-death models that they're coming up with they're having a hard time keeping the number in positive territory. I mean nobody is going to believe that, for example, with the birth-death model they created 300,000 jobs. Even when you manipulate statistics it’s still hard to manipulate them and make them seem plausible or even credible to the public. [40:03]

Hi, this is Don from Texas, just calling to ask your opinion on the reflation. Now I know you guys are reflationists, my question is who’s to say that the housing reflation effort over the last five to six years is not the reflation effort that you guys are expecting to occur over the next few months. In other words, the inflation over the last five years is the reflation of the stock market bust of the 2000 tech boom. Thanks.

Don, the reflation from the tech bust is…remember the government is always reflating. We reflated in the 80s, we reflated in the 90s, so it’s just a matter of what asset class gets inflated next. And if you go to our website, we have a section called Fed Watch, and we have a bunch of scholarly papers on what to do if we go through another period of deflation or disinflation. They actually talk about how they could monetize anything. I mean if you take a look at a lot of the repos that the Fed is doing with the banking system right now, the Fed is taking on to its balance sheet a lot of this toxic mortgage debt that can’t be sold. So they could buy mortgages, they could buy stocks as many believe they do in the futures market, they can buy just about anything. So never underestimate a central bank’s power to print as much money as they can. If you print as much money as you can you get what you got in Argentina, Russia and Turkey. And we’re a debtor nation, and a nation that’s no longer self-sufficient in manufacturing, capital or energy. So plenty of areas to reinflate. [41:40]

Hi Jim, this is David in Los Angeles. A couple of weeks ago in your interview with Matt Simmons he made a comment that he didn’t elaborate on, in which he said basically if hoarding starts, if there’s some kind of shortage of gasoline the nation will go through its inventories in 48 hours; and once that happens we will never recover. That’s a pretty dramatic statement. I’ve been thinking about it and it makes a lot of sense because once the inventories are gone people will perceive a perpetual sense of shortage and will continue to hoard any chance they get, keeping the inventories empty. Anyway, I was hoping you could discuss this, either with one of your guests or in the Big Picture. I was much too young the last time we had a shortage in the 70s to remember how the rationing and hoarding took place and how it sort of unfolded. I wonder if you could draw on the past and how this might play out in the future.

JIM: You know, David, I remember what occurred in the 70s, and remember the rationing that took place in the 70s and the hoarding was more of a political problem than a geological one as we have now. And I can even remember people equipping their cars with extra sized gas tanks. And you did see this hoarding, which is one of the reasons why it was very difficult and there were long gas lines.

And if you listen to the segment that we did at the beginning of this hour on oil inventories and what’s happening with OPEC consuming more of what it produces, this time around it’s going to be a perpetual problem and they will have to go to some form of rationing. Which is what I think will happen. And it’s amazing the Council for Foreign Relations – I’m trying to think if we still have this published on our geopolitical page – published a paper last November that called for this very same thing. They talked about the risk to this country’s dependency on imports; and one of the solutions besides conservation is they foresee a time when we would actually go to rationing – just as we did in World War Two where you actually had ration cards. It may be that a family of four gets 20 gallons a week or whatever that figure is, and you’ll have to make do with what you have. [44:03]

Hello, this is Frankie from Brazil. As always, love your show and have been a listener since I was 25 – granted that was 2 years ago. Anyway, I’m a believer in Financial Sense economics and have reached a point where I have a nest egg to start putting to use and considering as it’s denominated in dollars, I cringe every time I hear your show speak of the global inflation rampage, and the way the Fed will sacrifice the dollar. After looking at your site and reading your contributors and doing as much research as possible I agree with your insights about investing in actual production units, raw materials and moving away from dollar-denominated assets. I’m currently maxing out my 401K, I have a solid real estate investment going, and now I want to put my dollar nest egg in a protected-investment vehicle that will take advantage of the macroeconomic changes that we are currently experiencing.
I would like to put approximately $50,000 to good use, and have been going back and forth between what are basically four options: One is an instant portfolio of ETFs managed by myself – gold, oil services and materials ETFs; another option are managed futures and possibly one of the programs offered by your contributor Ty Andros who writes some very interesting commentary; third would be an independent portfolio of well-researched equities a la Warren Buffett; fourth, I was even considering putting it under your management considering how accurate you guys are in looking forward.
Anyway, considering I’m in my late 20s, employed, and reasonably financially sound and can do a good amount of independent research, what would your thoughts around how I should move forward. Love your show, you guys are hilarious and any time you want to drive around in legitimate, viable economic vehicle you should make your way down to Brazil.

You know, Frankie, I like the way you're thinking. I like every one of the options you're thinking about. In fact, in your own country of Brazil you have quite a few very profitable natural resource companies. Look at your largest raw material’s producer. So you have raw materials, you have food. So your country is blessed and rich in natural resources so take a look at, eg, BOVESPA – your own companies that make up that index because I think Brazil will do well; you're part of the BRIC countries that have numerous natural resources from energy to raw materials. I like all the options that you're considering. I think you've thought this out well, and hopefully these years that you've been listening to our program I think you've learned a lot. I like what you're doing. [46:43]

JOHN: It’s sort of like when someone says, “I listen to Financial Sense Newshour.” And I say, “I do too. I never miss a program except when I’m on vacation.”

Hi, this is Darryl calling from the Ozarks. Just curious about next week, Tuesday, what your opinions are on gold and the Dow – if they cut interest rates by a quarter point what do you think will happen to those two and also say if they cut it by say a half a point; or if they do not cut it at all? Thanks.

You know, Darryl, the consensus seems to be a quarter point. I lean more towards that on the Federal Funds rate. I think half a point would signal a panicky Fed. I think you may see initially the stock market rally as they maybe put a bid underneath the market. But I think eventually you will see disappointment because everybody knows a quarter point isn’t going to do it. So you could see a pullback in the money. I said on last week’s program they would probably hammer gold one more time before they cut interest rates, and it’s amazing this week they increased the margin on gold, and gold has been a little soft. But I think it’s going to get increasingly difficult for them. So you might see a little pullback of gold ahead of that meeting or after the meeting. I suspect if they were tinkering around with the market they would want to prop the market up and hammer gold. [48:06]

Hello, gentlemen. This is George in Montana. Jim, you were predicting another round of reinflation. In a debt-based fiat currency it seems that someone must sign for the currency with interest attached before that liquidity can move into the economy. Real estate was the past conduit of choice. Well, that party is over and I don’t think Uncle Ben will really drop cash from a helicopter. So what conduits are available for the Fed to pump money into the economy for this next round of reinflation? Thanks.

You know, George, I think they're going to do it in a combination. I think they're going to reinflate the stock market. You’ll find in periods of hyperinflation that occur in countries – whether it’s Germany, Turkey, Russia, Argentina – the stock market does well in nominal terms when they reinflate so I think the market is going to be one area. I also think they will be using fiscal stimulus so the Fed will be monetizing debt. So the Fed will be buying Treasury as they are doing now. And I think they're going to end up buying a lot of this sick paper or toxic paper that they'll end up monetizing that. So I think the object of the next reinflation, or the biggest beneficiary of that is going to be hard goods. And the two biggest beneficiaries in my mind are going to be precious metals and energy. [49:33]

Hi guys, this is Lani in Washington State. And the first thing I wanted to do is thank you for spending part of your vacation with us. I really appreciated you having your show when the market was so unstable it was reassuring to hear you. Also, I’m curious about something – I've been reading that money market funds may be contaminated with the bad credit that we've been hearing about recently, and I was wondering how we might find out – if we're invested in a money market fund – if we're exposed to the bad credit? Also, I’m thinking that if we have our money in cash, or say in Canadian dollars, we should be safe. Is that a correct assumption? Hope this question made sense. Thanks.

Lani, there are problems in the money market funds because a lot of them have been invested in commercial paper which have been tied to these asset markets. So I would avoid most regular nominal money funds. And what I would be invested in, if I had to be in cash, would be pure Treasury money market funds where all they do is own Treasury debt. And in terms of the declining dollar and you wanted to be in other forms of cash you might want to consider the strong currency in commodity countries – Canada being one of them – because I do think the Canadian dollar is soon to go par with the US dollar; and then actually exceed it where the US dollar will be trading at a discount to the Canadian dollar as it once did a couple of decades ago. [51:16]

Hello, Jim and John, this is Ricardo from San Diego. I was wondering if you could explain how would the Fed affect the dollar and gold and silver if the Fed decides to cut rates this Tuesday; and what would happen if the Fed decides to leave them unchanged as well? I’m a long time listener, very bullish on gold and silver. And I appreciate very much all your hard work.

Well, you know, Ricardo, one things central banks can’t do is they can’t have their cake and eat it too; so if they lower interest rates and reinflate meaning they’re going to expand the number of dollars out there, one of the consequences is if you get a lot more of something it depreciates in value. So one consequence of what the Fed’s next reflation efforts are going to be is going to be a lower dollar. And with a lower dollar gold operates inversely to that. So you're going to see – maybe not immediately if they try to intervene in some way, but – the inverse relationship of precious metals to the value of the dollar. The dollar goes down, precious metals go up. [52:26]

Hi, Jim and John, this is Chase in Honolulu. I’m just calling – I saw a Bloomberg interview of golden boy Angelo Mozilo walking out of a meeting with Paulson and Bernanke. I just want to put a little warning out there for all of you folks who are short CFC: I would close those shorts right now. This guy looks like he just won the lottery. I’m calling Jim, to get silver bugs a little bit of encouragement in light of the relative weakness we've seen relative to gold. I just thought I would ask on behalf of us silver bugs for a little bit of encouragement because silver has been pretty weak lately. That’s all. Thank you.

You know, I’ve got one word advice, Chase, and it’s funny because Eric Sprott wrote a two page investment advisory piece on his website and it only has two words, on page one in large capital letters it says BUY; and on page two, in large capital letters it says, GOLD. And I would add to Eric’s wisdom and say buy silver. And remember, this is something we used to tell people in the 80s to dollar cost average in to mutual funds. The thing I would tell you, Chase, is if you believe reinflation and central banks are going to print money because there is nothing in the world to constrain central banks from chopping down every tree in the forest. If you think gold prices longer term are going to be higher than where they are today; and if you think along with that silver prices are going to be higher than where they are today, you can’t have a bull market in gold without having a bull market in silver.

Just look at what happened in the 70s where silver outperformed gold, then all you care about if you’re buying silver whether it’s bullion, silver rounds, silver eagles – whatever it is you're buying including silver stocks – all you care about is when this bull market hits its peak, how many ounces do you own and how many shares of silver producers do you own. That’s going to be the more relevant question. And the thing that I’d tell you right now from encouragement the silver market has been put on sale. And just as you would respond, or maybe your spouse would respond to seeing high quality merchandise being put on sale, you would love to see goods discounted. Well, that’s what you have right now is you have a discount in silver, and I’d jump all over it. [55:03]

Hi Jim and John, this is Brian from Georgia. I really appreciate the show. I just want to let you know I’m happy about two things. First, during the recent dip in the junior gold stocks, I didn’t feel panicky at all and I bought more of my favorite juniors at a lower price; and I appreciate the advice on that as it’s worked out real well so far. Second, to any of your listeners out there who are considering donating to the Ron Paul presidential campaign writing that check really things good; and if Ron Paul raises a significant amount of money by September 30th the media will consider him a more serious contender for the Republican primaries which start in January. So if anybody is planning on donating do it now so we can get counted in the third quarter donation total. And his website is www.ronpaul2008.com. Thanks.

JOHN: And the preceding was not a paid political advertisement. I have to say that for legal reasons, anyway.

JIM: You really do. Thanks, Brian. And you bring up something that you mention has worked well for you. In the latest downturn, with the silver stocks and gold stocks and you bought your favorite juniors and when gold turned around they turned around with it. And that’s the most important thing about long term investing. When the market offers the things that you want at a lower price you’ve got to be brave enough to step up to the plate and buy them and add to your positions. That’s what I did during this downturn. And I’ve done that throughout this entire downturn and every time we've had one, going back to 2001, I just keep accumulating. And that’s all that I care about because right now this is very reminiscent of the equity bull market that began in August of 1982, and ran all the way up to March of 2000.

The first part of that major run up between 1982 and 1987 the public was out of the market; it was mainly professionals from 1987 to 19[9]5 the public was out of that market because when Greenspan cut interest rates in 1991 those people that were invested in CDs at 10% interest rates moved over into the bond market, the bond market got clobbered when the Fed doubled the Federal Funds rate in 1994 in the Peso crisis, and then began to reinflate. The majority of the money that came into the stock market was in the third phase of the bull market from 1995 to 2000. And so we’re in that period right now, of the second phase of this bull market when you're going to see more institutional money coming in; it’s going to give more credibility among fund managers and institutions and we're going to see a big run-up here. But the ultimate run-up is in the final phase of a bull market when John Q. Public, your neighbor, starts bragging about he just got in on a new gold IPO – that’s when you see the most expansive part of the market, very similar to what we saw in the gold and silver market running from 1978 to 1980. So right now I’m glad to see you're doing what prudent investors should do which is buy when they put the things you want on sale. And we’ve just gone through a sale, and hopefully many of you have been loading up. We may have one more downturn here as they try to knock it down as they get ready to reinflate. But load up if that indeed turns out to be the case. [58:44]

Hi Jim and John, this is George calling from the Minneapolis area. Say, I’m trying to understand the process through which the Fed actually creates money for the banking system in general, how the process works. I understand that they are the bankers’ bank and that they lend money to their member banks so that they can make loans to other businesses and so on. Where does that money come from? Do they literally create it out of thin air. That’s my understanding but I want to confirm that. Do they literally say abracadabra, here’s 10 billion new dollars and now I will lend it to you member bank at 5% interest rate. Was there more to the mechanics of that, I think that would be useful to understand that process to see how they actually go about creating that money. Thanks.

JOHN: Well, Jim, when I heard this question come in I remembered an interview that I did with G. Edward Griffin who wrote The Creature From Jekyll Island on October 21st 1994 when I was doing daily talk radio in Colorado. And he very deftly addressed this entire situation and so I thought what we’d do here on the program is play that.

JIM: John. Let’s hear that because I interviewed him, gosh, late 90s and I think we interviewed him here on the program 2004 or 2005 but he certainly has done a wonderful job in his book The Creature From Jekyll Island explaining how this process works.

GRIFFIN: I mentioned earlier that there are two partners in the Fed. The government on one side and the banking cartel members on the other side. So the question is: where is the payoff?
We’ll start with on the government side. Let’s say a Congress needs another billion dollars over and above what it takes in in taxes, which is not an unusual condition. So where are they going to get the money?
They go down the street and they stop at the printing office and they print up some certificates called bonds or notes, and they try and offer these to the public who will lend them some money. And the public does quite a bit of that but never enough; Congress needs more than that. So he goes down the street a little bit further to the Federal Reserve building and now the Fed has been waiting for him – that’s one of the reasons the Federal Reserve was created. Congress walks in there with his hat in his hand and the Federal Reserve officer opens up his desk, pulls out his big check book and he writes a check to the Treasury of the United States government for, let’s say, one billion dollars. And he signs it. And it’s that instant that money springs into being for the first time. It doesn’t exist anywhere in an account, there’s no money prior to that; it is just created out of thin air.
JOHN: And the Fed accepts the bonds as collateral on that; is that correct?
GRIFFIN: That’s right, one piece of paper is exchanged for another piece of paper and a billion American dollars spring into existence.
JOHN: Just like that. And so far, the government goes down the street, walks into the Fed hands them a bunch of paper called what? Bonds, right?
GRIFFIN: Bonds; right.
JOHN: And the Fed sits down and opens up its check book and says: here’s some money.
GRIFFIN: Yes. Here’s a check. So the Fed gets a bond and the Treasury gets a check. They're just two pieces of paper with some ink on them. But though and behold, what that second piece of paper can do – that check. That billion dollars is sprung into existence and you notice that Congress didn’t have to ask for higher taxes to get it. You realize that Congress hasn’t concerned itself with what anything costs in a long time. It doesn’t even matter; it’s not an issue. They never even discuss it because no matter what the overrun is they can go down to the Fed and by law they have to write them that magic check.
But what do they get out of it? Now this is the rest of that story. If you thought the creation of a billion dollars was bizarre, now let’s follow it to the banking side. Okay, the Treasury has its freshly made check for a billion dollars. It deposits that into the government’s checking account. And all of a sudden, all the numbers show up in the computer and on the ledgers and the government has a billion dollars to spend. Which it does very quickly; it starts writing checks against that.
Let’s just follow a hundred dollars of that billion that they give to the postal worker who delivers our mail. So this fellow gets a check for a hundred dollars and he doesn’t dream in his wildest imagination that just two days ago that money didn’t exist anywhere in the universe. He doesn’t imagine that. But nevertheless, he doesn’t really care because he can spend it. He takes it to his bank and deposits into his local checking account. Now, this is where the action begins. Now that the local bank has a hundred dollar deposit, it goes over to the loan window and opens it up, and in essence the banker says, “attention, everybody, we have money to loan.”
And the question is, well, fine, he’s got a hundred dollar deposit he can loan $100; right? And the answer is wrong. The banker can loan up to $900 based on the $100 deposit.
JOHN: Because of what we call fractional reserve banking.
GRIFFIN: Because of fractional reserve banking. And the Federal Reserve system authorizes the banks to loan up to 9 times what it holds in reserves; or said the other way around, they are required to keep a minimum of 10% in reserve.
JOHN: 90% is created?
GRIFFIN: Yes. So they figure that $100 is reserve, that’s $100 – 10% of $1000 is $900. In reality, none of the banks ever loan that full amount but that’s the process that’s involved there.

JOHN: Well, that was October 21st 1994, an interview with G. Edward Griffin. And nothing has changed, Jim. that was one of the most eloquent explanations of it I have ever heard, where you clearly understand how the flow goes. [64:18]

JIM: Well, his book, and I’d highly recommend it – I think you can get it on Amazon – is called The Creature From Jekyll Island. It talks about the creation of the Federal Reserve, how the money system works, how inflation works and what the ultimate outcome would be. And it is a must read if you want to understand what’s going on with inflation today in the monetary system.

I think, John, he went to school and got educated for years researching and writing that book. Very well done. [64:48]

JOHN: It not only covers the Fed but also the International Monetary Fund and the World Bank, and other related organizations that are all tied into this. So by the time you're done with this, you really have a good handle on everything that’s going on. But it tickled me, you know, after I went dumpster diving into the tape archive that here we are – how many years later? I think my math is going fuzzy. Now 2007 ‘-‘ 1994 is 13 years ago. Nothing’s changed. It’s the same deal today as it was then.

All right. We are out of time for today. And obviously we are planning on being back next week. No. We're going to take another two weeks off and we just decided to do that.

JIM: Yeah, we’ll do that and let us know if anything happens with the Fed.

JOHN: And let us know quickly. That’s really important.

JIM: Well, listen, we have run out of time but let me give you a preview. Coming up on the program in the weeks ahead, my guest next week will be Richard Heinberg, he’s written a new book called Peak Everything. And it was interesting somebody told me they were listening to an interview with Jim Rogers and they were talking to him about peak oil and Jim said the very same thing – Peak Everything. And so Richard will be my guest next week.

And on September 29th I will be at the Denver Gold Show but will be conducting a roundtable with John Rubino, Axel Merk, Peter Schiff – a roundtable on the dollar. Coming up on October 6th, Emanuel Balarie, he’s written a book called Commodities For Every Portfolio.

So lots of great stuff coming up in the weeks ahead. I hope you’ll be there to join us. And remember, coming up in November we’re going to do a special edition of the Financial Sense Newshour. I’m going to be interviewing some of the CEOs of some of the top gold mining companies in the world, from large producers, intermediate producers to late stage exploration companies and development companies; gold, silver and some companies in between. So that’s a special program that we're going to be putting together in the month of November. And so lots of great stuff coming up in the weeks ahead; also working on some other great interviews.

So hope you’ll be there to join us. In the meantime, we’d like to thank you on behalf of John Loeffler and myself for joining us here on the Financial Sense Newshour, until you and I talk again we hope you have a pleasant weekend.

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