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Financial Sense Newshour

The BIG Picture Transcription

January 12, 2008

Part 1

Flip-Flopping, Mood Swings & Bipolarity

JOHN: I think the American public by now, Jim, is discovering what the meaning of the word white-knuckle ride is all about.

JIM: Oh, yeah! One of those weeks!

JOHN: If you didn't like going to the amusement park, you won't like this. It's going to be a rough next four years, I think, with hopefully some soft spots in the middle. A rough first quarter is what we're looking at here. We were talking about our Oreo theory last week. Actually, it's your Oreo theory. I have to confess to you, I like Hydrox cookies better than Oreos, but I'll eat Oreos if pushed in my direction. I will not turn those down.

The market continues to make this correction. The market needs confidence and this week, the entire confidence building team from President Bush, Hank Paulson, Treasury Secretary, to Ben Bernanke were out there reassuring the market.

JIM: Not working.

JOHN: No. But I feel better, Jim. I just feel better. Don't you?

It seems like the Fed is finally realizing they have not just got a financial problem on their hands, but they have an economic one. And I would say they have a political one now because the problem has spilled over from Wall Street and the average person on the street is also watching it. You know, last month inflation was a problem and as Ben Bernanke reminded us on Thursday this week:

Continued increases in the price of energy and other commodities together with high levels of resource utilization kept the Committee on inflation alert.

JIM: You know, John. I got a copy of the text of Bernanke's speech. In fact, it was circulated before it was made I think, probably in an effort to keep the market going. But if you read through the text of the speech (probably the first three pages, it was a six page speech in total) what he was basically doing was off loading, once again leading people to believe that, for example, oil or economic growth was causing inflation. For example, that clip you just played where he was talking about increases in the price of energy and commodities and resource utilization (meaning that factories are running at full steam), what was never mentioned was all of this crazy stuff about the subprime, no money down loans, the SIVs, the CDOs. What created the environment that gave birth to all of this speculation and nonsense was the Fed’s money printing that brought interest rates down from 6% down to 1%, the lowest interest rates that we saw in half a century which created the incentive to go out and do this.

In fact, John, you remember, was it just before they hiked rates, when Greenspan was saying, “hey, you know what, if you're buying a home, I think the variable rate mortgages are a good idea.” So he sets the stage here basically laying the blame for real estate, the credit bubble, pushing it away from the Fed on the industry itself. And never once did he say well, between 2001, when we brought interest rates down from 6% to the summer of 2004 and kept them down at 1% for a long period of time, that's what created the incentive; and all of the money and the money printing that was going on, they never made any reference to any of that. In other words, once again they are talking about the symptoms rather than the root cause. [3:28]

BERNANKE: As you know, the losses in the subprime mortgage market have also triggered a substantial reaction in other financial markets. At some level, the magnitude of that reaction might be deemed surprising given the small size of the US subprime market relative to world financial markets. Part of the explanation for the outsized effect may be that following a period of more aggressive risk taking the subprime crisis led investors to reassess credit risks more broadly and perhaps to become less willing to take on risks of any type. Investors have also been concerned that by further weakening the housing sector, the problems in the subprime mortgage market may lead overall economic growth to slow. [4:13]

JOHN: Now, this speech got rather detailed in terms of where the problem supposedly originated. It pointed out that, say, for example, large banks were also in on the whole thing, which they were; and now because banks can't offload the loans and the loans are coming back on the banks, that leads to many more problems. In other words, the problem can't be concealed anymore, packaged up with securities.

BERNANKE: Although structured credit products and special purpose investment vehicles may be viewed as providing direct channels between the ultimate borrowers and the broader capital markets thereby circumventing the need for traditional bank financing, banks nevertheless played important roles in this mode of finance. Large money center banks and other major financial institutions underwrote many of the loans and created many of the structured credit products that were sold into the market. Banks also supported the various investment vehicles in a number of ways, for example, by serving as advisors and providing stand by liquidity facilities and various credit enhancements. As the problems with these facilities multiplied, banks came under increasing pressure to rescue the investment vehicles they sponsored, either by providing liquidity or other support as has become increasingly the norm by taking the assets of the off balance sheet vehicles back on to their own balance sheets. Banks’ balance sheets were swelled further by non-conforming mortgages, leveraged loans and other credits that the banks had extended but for which well functioning secondary markets could no longer be used. [5:37]

JIM: What he was doing there, John, was laying out the game plan for what's coming, and what's coming is the reflation strategy, which will follow two tracks. And in that speech he talks about one, the first track, which will keep the financial system liquid. That's basically what the Fed has been dealing with going back to August of last year. And the other one, which intends to limit the damage of a recession and restart the economy, which is going to be monetary policy, chiefly through the lowering of interest rates injecting money into the banking system. [6:13]

BERNANKE: Broadly, the Federal Reserve's response has followed two tracks: Efforts to support market liquidity and functioning and the pursuit of our macro economic objectives through monetary policy.

[Bernanke]

However, as a tool for easing strains in money markets, the discount window has two drawbacks. First, banks may be reluctant to use the window fearing that markets will draw adverse inferences about their financial condition and access to private sources of funding. The so-called stigma problem. And second, to maintain the federal funds rate near its target, the Federal Reserve's Systems Open Market Desk must take into account the fact that loans through the discount window add reserves to the banking system and thus all else equal could tend to push the federal funds rate below the target set by the FMOC. The Open Market Desk can offset this effect by draining reserves from the system, but the amount that banks chose to borrow at the discount window can be difficult to predict, complicating the management of the federal funds rate, especially when borrowings are large. To address the limitations of the discount window, the Federal Reserve recently introduced a term auction facility –or TAF – through which prespecified amounts of discount window credit can be auctioned to eligible borrowers. As I will discuss more in a moment our intention in developing the TAF was to provide a tool that could more effectively address the problems currently affecting the interbank lending market without complicating the administration of reserves and the federal funds rate.

[Bernanke]

Although the TAF and other liquidity related actions appear to have had some positive affects, such measures alone could not fully address fundamental concerns about credit quality and valuation. Nor do these actions relax the balance sheet constraints on financial institutions. Hence they cannot eliminate the financial restraints affecting the broader economy. Monetary policy, that is the management of the short term interest rate, remains the Fed's best tool for pursuing our macro economic objectives, namely to promote maximum sustainable employment and price stability. Although economic growth slowed in the fourth quarter of last year from the third quarter's rapid clip, it seems nonetheless as best as we can tell to have continued at a moderate pace. Recently, however, incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risk to growth have become more pronounced. Notably, the demand for housing seems to have weakened further in part reflecting the ongoing problems in the mortgage markets. In addition, a number of factors including higher oil prices, lower equity prices and softening home values seem likely to weigh at consumer spending as we move into 2008. [8:55]

JOHN: Now, obviously, that was a concatenated series of clips from Mr. Bernanke's speech.

Do you think they understand now that they have an economic problem as well because we're, after all, hearing a lot more about the R word on the street now?

JIM: Yeah. This was one of the issues that we had addressed in last week's show when we talked about three different kinds of financial crises. And I think their thinking, up until this point, John, is they were dealing with a stage one crisis. In other words, some kind of event happens, the market gets a little paranoid and you come in, you cut interest rates, inject a little liquidity into the market and then it goes on and the crisis is over. Very much like what we saw in 1987, what we saw again in 1994 with the Peso crisis; 97, Asia; 98, Long Term Capital Management. Basically, there was an event that appeared out of the blue much like say the subprime problem surfaced in August and the Fed would deal with this kind of event that occurred, inject money, lower interest rates and then the whole thing was over.

Now they are finding out not only do they have a financial problem on their hands, but if you take a look at last week's report, the ISM manufacturing report dropping much lower below 50 (indicating that the manufacturing sector is declining) and also even more importantly the big jump by 0.3% to 5% on the unemployment rate almost always mean you're either in a recession or close to recession. Just take a look in the last two weeks. You've had three of the top Wall Street firms Goldman Sachs, Merrill Lynch, JP Morgan all forecasting a recession. If we're heading there, nothing that the Fed can do right now can stop it. In other words, if we're in a recession, and they slash interest rates at end of this month, we're not going to avoid it. All they can do, at least at this point, is try to mitigate the damage and try to get us back on the road to recovery. And I think that's what they realize that they are facing now. Up until this time, I think they've been dealing with this more as a temporary liquidity problem: the commercial paper market wasn't functioning, banks weren't lending to each other. They were treating it as mechanical. I think they are now more than aware that what they have going here is an economic problem as well. [11:21]

JOHN: I always remember Greenspan in one of the interviews he did when his book came out Age Of Turbulence: “We just didn't see this coming.” And all I could think of the first time I heard him is: how could you not see this coming? We did on the program, and we don't have access to the data that the Fed does.

You've pointed out that the one problem the markets have is this constant flip-flopping. They flip-flopped in August, they flip-flopped in October and they did another flip-flop again in December, and at this stage in the game, it's no wonder that everybody is nervous.

JIM: Last week, we talked about a new study on FOMC forecast by the Romers. The Romers are two PhD economists at Stanford. They also sit on the National Bureau of Economic Research, the organization that pronounces whether we're in a recession or not. Anyway, they released a paper that was distributed last Friday, and what was very important about it is they said (whether it's looking at GDP, inflation or CPI) the FMOC forecasts are basically useless or worthless. In fact, the more accurate forecast at the Fed are what the Fed's internal staff is forecasting –known within the Fed as the Green Book – and that is probably more useful. What I think analysts are finding frustrating, John, right now, with this Fed, is the difference between the statements that they make that are released at the end of each Fed meeting, and then the minutes of that meeting which are released three weeks later.

For example, if you take a look at the December 11th meeting when they cut interest rates a quarter of a point and they basically did not say risk or balance between inflation or the economy as they did in October 31^st. But they implied that the obvious risk of an economic slow down and inflation (without actually saying it – but they were implying it) that they were balanced. And the market sold off sharply. You remember that big huge selloff in the market. And immediately the next day before the market opened, they announced their TAF program or Term Auction Facility, and they said, “oh, no, we didn't announce this because the markets were down.” Well, you know, dog darned well they did it because the markets were down. However, when we get the minutes, which we recently got from the December meeting, they were almost entirely different than the statement that was released when they cut interest rates. The notes from the meeting (basically, the internal meeting) was much more downbeat citing almost everything the Fed was looking at; from housing to mortgage finance to credit conditions to economic conditions to market conditions, it was much worse or even weaker than the Fed had anticipated. [14:03]

JOHN: Well, you must admit this was just before Christmas season and maybe they were more panicky than they really wanted to let on, but they didn't want to obviously make that public for reasons that if you do that in the Christmas season especially...you're trying to encourage your consumer spending during that time. That's the holiday shopping season and already it wasn't going well.

JIM: Yeah. I think that was a good reason in terms of why they didn't want to alarm the markets as well as the economy. The problem that people are having with the Fed –and this goes back to the Romers’ paper – you remember, you and I were talking on the phone the day that Bernanke was making a speech and remember they had the little countdown clock on CNBC in the right-hand corner, 41 minutes, 40 minutes...

JOHN: Yeah. Until Bernanke speaks. Like it's this great --

JIM: You know, I thought I was getting ready for an Elvis concert or something. Thirty more minutes, Elvis is going to sing or something. But, you know, the market spends so much time dissecting these verbs and adjectives that come with these statements, it reminds me of the oracles dissecting the entrails of sacrificed animals in an attempt to divine the future. And basically, this is nothing more than nonsense. I think what the markets would find probably more helpful at this time is if the Fed wants to communicate with the markets, say what you mean in plain English, instead of this gobbledygook Fed-speak, or Bernanke-babble we'll call it right now. The problem here is Bernanke doesn't have the confidence that Greenspan had. You remember when Greenspan would talk to the markets or make a speech or he would be on Capitol Hill, he would obfuscate his thoughts. What I think would be probably more useful right now, look, if you're going to make a statement, let's say the Fed is going to lower interest rates a quarter of a point, why don't you just come out and say, “Okay. We lowered interest rates a quarter of a point.” Period. Don't say any other stuff around that quarter point. Or, if you're going to leave them unchanged or if you're going to raise them, say what you did and then shut up and cut out all of this BS because quite frankly, right now, no one is buying it. [16:18]

JOHN: Yeah. What about all of the flip-flopping too? We should create a new term here. You know you've heard the term manic depressive. We should call it panic depressive, and, you know...

JIM: PD.

JOHN: There you are. A new term.

JIM: This could be a new drug symptom. Hey, they've got PD. Well, take something, Maalox or something.

How much of this is due to heightened uncertainty, or is it simply that they really don't know?

JIM: I think what is important here is when you're in the middle of a crisis is to speak confidently with one voice. When you have normal market conditions and you're trying to cajole the markets, there is little difference in the open mouth committee being understandable. In other words, if you're trying to talk down interest rates or talk the markets up or something and you're not in the middle of a crisis, then fine, you can play the good cop bad cop routine with the open mouth committee with various Fed governors. If you're concerned about inflation, then you have one Fed governor going out and talking about that “boy, we're going to get tough on inflation;” and if the market’s are a little weak, then you have another Fed governor saying, “hey, we're optimistic about the markets, we're optimistic about the economy.” Under normal circumstances, you get away with that. You know, you're basically trying to browbeat the market or the bond market or investors into doing something. But when you're in a stage two financial crisis, as we are today, you need to speak with one voice and more importantly be consistent. And this is the thing that Bernanke needs to have is what I call a “come to Jesus meeting” with the FOMC team and get everyone on the same page. That gets rid of the doubts and at least from a public appearance sake, it appears that you know what the heck you're doing. But when you come out and you do one thing and you give these statements that everybody is trying to scramble and scratch their heads, “what the heck are they meaning?” It's kind of like what does ‘is’ mean. And that's what they do. Then at the same time you've got various Fed governors going out saying one thing on Monday, another Fed governor saying something on Tuesday, on Wednesday, and then everybody is saying “what the heck are these guys doing?” You don't do that. When you're on the Titanic, and you just hit an iceberg, everybody needs to talk about, “look, we've got the life boats going. We've got the bilge pump running. We're taking care of business.” Not on whether “I'm not sure. Should we serve breakfast?” You just don't do that. [18:48]

JOHN: What are we going to have for breakfast anyway, now that you've brought it up?

Let's get back to the Bernanke speech because obviously he made some forecasts as to what they intended to do and that will tell us some things of where we're going.

JIM: Yeah. There are a couple of points that stand out in terms of where they are heading. They talked about a number of factors that concerned them regarding like consumer spending. The main ones that they highlighted –and this is very key – were falling asset prices. And remember central banks do not like deflation. They don't like a contracting supply of money. They don't like falling assets. So what that tells you is what they are going to be targeting, which is asset reflation; and what they are going to be doing is bringing down interest rates which causes assets to be revalued because obviously lower interest rates also dramatically lowers the risk free return on cash making it less attractive. So thus they are going to reflate assets. And one way to stave off a crisis or stop that crisis from, let's say, going from a stage two crisis to a stage three crisis is to reflate the collateral that is backing all of these loans and to make sure that there is an abundance of cash and liquidity in the system. So they are going to make sure they flood the markets with money, there is plenty of liquidity for those who need it, who need to make loans. And then the second thing they are going to do is use the monetary levers and bring down interest rates and start a process of reflating the assets. [20:25]

JOHN: Well, it would seem like, though, that this just creates more inflation exactly like Congressman Ron Paul said the last time they questioned Ben Bernanke by saying that the Fed proposes to cure the inflation problem with more inflation. And I've heard people say, you know, Ben Bernanke didn't really answer the question when he was challenged by Ron Paul.

JIM: No. He really didn't, but remember that's what the Fed does. When they have a deflating asset bubble that was created through too much money in the system, which is monetary inflation, then what happens is as that asset bubble deflates and they are worried about it spilling over into the real economy (which is what we're seeing now), what they are trying to do is fight deflation and keep it from occurring. And the main thing that they are worried about right now is the financial system because you have all of these loans and credits that have been given out there and what is backing all of these loans and credits is the collateral. So this brings us back to if this collateral deflates, then they have a much bigger problem and they can go from a stage two financial crisis to a stage three financial crisis. And that's why they are going to reinflate massively. [21:37]

JOHN: When we talk about stages of a financial crisis, is this just a Puplava-ism, or is there really such an official type of thing?

JIM: A number of economists have talked about it. Hyman Minsky is one where he talks about his financial crisis theory where you have hedge credits, speculative credits and then Ponzi credits where the system over leverages itself all based on the fact that we're going to have rising asset prices. Remember the clip that we played from the Two Johns where they said, well, everything was going fine, assets were inflating until finally somebody woke up and said wait a minute, what are these assets really worth? It's amazing because as these assets deflate, whether as the Fed referred to the problem they are worried about which is deflating real estate prices and deflating equity prices, and John, while you and I talking, as we speak, the Dow was down about 170 points. We are now down 300. So we've got a full scale major selloff. Now we're down 300 points. I mean it's just amazing watching this on the graph. I hope to God this doesn't look like somebody's EKG because we could be down 4 or 500 points here if we keep going in this direction. [22:53]

JOHN: More of that white knuckle we were talking about.

JIM: Yeah. More white knuckle. I suspect we're going to see a miracle here in real time soon, but it's getting into a full-fledged selling climax that we're seeing right now, which is what you want to see if you're going through a clearing mechanism and that's what's occurring right now. The market as we speak is down over almost down 2.5%. We've got the NASDAQ down 60 points. We've got the S&P down nearly 2%. Actually, the S&P is down less. Most of the selling seems to be in the NASDAQ and the Dow Jones Industrial Average. But that's occurring, John, as we speak here doing this program and here comes the miracle. We just picked up about 50, 60 points and it looks like the market has gone back straight up again. So there is a real battle here that's going on in the marketplace. [23:47]

JOHN: Well, getting back to your Oreo thesis, I mean you've pointed out that this all comes back to bite them at the end of the year. In other words, we have a rough first season and then it’s smooth for the second and third quarter. It seems to have some effect. But toward the end of the year, the inflation rate is going to escalate again along with the long term interest rates and it's going to be just as turbulent at the crossing of the New Year as it was this year.

JIM: Yeah. Because there is already enough inflation in the system. We often talk about money supply growth. Yeah. I'm just looking at the latest figures. It's almost up to 50% in Russia, and Australia it's 23%. In India, it's 23 percent. China is 19%. Brazil is 16%. So there is all of this money creation and credit that is in the system right now, and now they are going to inject even more money and credit into the system to try to reflate their way out of it. That's why I expect that this Oreo theory that will have this kind of nice creamy filling in the middle but by the end of the year with all of this money creation that's going to come back to bite them. And with that is going to come higher rates of inflation, but I think you're going to see that probably after the election next year. I predict, if things go the way we expect, they'll be raising interest rates. But right now they have a financial crisis and soon to be an economic crisis on their hands. So they need to sort of finesse this. That is why the emphasis is on inflationary expectations. Remember, inflationary expectations is nothing more than ‘how long can we keep them fooled’ index. So as the inflation rate rises, it will probably be rejiggered in the way they mess around with the CPI, with hedonics, with adjustments, with geometric weighting. That will probably be dismissed. They will probably start emphasizing: “Yeah, the headline number is up, but that's oil prices. The Fed can't do anything about oil and food. But if you look at core rate...”

And there's a number of reasons why the core rate could go down: In a contracting economy when manufacturers and retailers are trying to control inventory they liquidate that inventory and lower prices. Very much what you're seeing the home builders do, which is they are selling off – Lennar selling off large tracts of land, condominium projects for 40 cents on the dollar. So you have some things that are bringing down prices at the same time you have things that are increasing prices because of the amount of money and credit in the system.

But what is very important for the Fed is inflationary expectation. So everybody right now is saying, “oh, the economy is weakening, we could be going into a recession.” That's going to take demand off labor. That's going to take demand off prices. It's sort of what you're seeing a little bit in the commodity complex now with energy with the theory being that the slowing US economy demand for energy will be less; we'll see demand destruction and therefore the price of energy will go down. But nobody is looking at what the consumption of energy in China and India and Middle East is right now. In fact, one of the economic statistics that we got on Friday is the trade deficit went up and the chief reason for it is greater oil imports. In other words, we're consuming more oil, we're consuming more refined energy products; and in addition to consuming more, we're paying more for it, which is one of the reasons that trade deficit was up larger than anticipated. [27:22]

BERNANKE: Even as the outlook for real activity has weakened, there have been some important developments on the inflation front. Most notably, the same increase of oil prices that may have a negative influence on growth is also lifting overall consumer prices and probably putting some upward pressure on core inflation measures as well. Last year food prices also increased exceptionally rapidly by recent standards, further boosting overall consumer price inflation. Thus far, inflation expectations appear to have remained reasonably well anchored and pressures on resource utilization have diminished a bit. However, any tendency of inflation expectations to become on board or for the Fed's inflation fighting credibility to become eroded could greatly complicate the task of sustaining price stability and reduce the central bank's policy flexibility to counter shortfalls in growth in the future. Accordingly, in the months ahead, we will be closely monitoring the inflation situation, particularly as regards inflation expectations. [28:24]

JOHN: Well, it seems like they have sort of discovered religion here and the whole process of it, but there is still an effort on to try to pull the wool over the public's eyes. And so far it seems to be working to a certain extent. Everybody understands there is a lot of anxiety, a lot of anxiousness, but sooner or later, there is going to come this point where everybody sort of realizes what's going on.

JIM: Yeah. Because right now, basically, they are saying inflation expectations are well anchored. In other words, nobody is anticipating higher prices. And as long as people are thinking that way, then Katie bar the doors, we can go in and inflate at will. In fact, at end of the speech, Bernanke lays out in terms of what's coming, let's go to the financial cut in that speech where he basically says this is what's coming.

However, in light of recent changes in the outlook and the risks to growth, additional policy easing may well be necessary. The Committee will of course be carefully evaluating incoming information bearing on the economic outlook. Based on that evaluation and consistent with our dual mandate, we stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks. Financial and economic conditions can change quickly. Consequently, the committee must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and in particular to counter any adverse dynamics that might threaten economic or financial stability. [29:47]

JIM: You know, John, if you really want to understand where they are heading with this, you need to go back and read some of the Fed working papers from 1999 to 2001, where they basically talked about some of the facilities or the actions they could take in case we got into a real deflationary crisis, similar to what we went through in the 30s. In fact, this concept, this Term Auction Facility or TAF was first talked about in these papers. So even if things get worse than they anticipate, they still have lots of ideas up their sleeve in terms of fighting deflation. And I think it's from monetizing assets – they talked about monetizing everything from stocks to real estate to helicopter drops to this term facility, so they have a lot of tools. And I think it would be very instructive because depending on the severity, right now they are way behind the curve on the crisis. You can see this very clearly if you take a look at the Treasury market. I mean on the Friday we're talking about as we get this meltdown in the market –money shifting over into the treasury market – you've got the two year Treasury note roughly at almost 2.5%; you've got the 10 year Treasury note below 3.8% and you have a 4.25 federal funds rate. So the spread between the two year is close to 1.75%. The spread between the 10 year and the federal funds rate is close to half a percent.

So depending on how aggressive they get, and I suspect if you keep seeing the stock market developing, John, remember, I told you –we're in the middle of this program and it's around 12:30 when you and I are actually discussing this – we went from 170 points and we went over to 300 and I told you I believe in miracles. And as we speak, one of those miracles is taking place. The stock market is experiencing a rally that's going straight up here. So you could see them, for example, if the stock market continues to selloff, do a surprise cut in interest rates, let's say 50 basis points and then on January 31st, even go with another 25 basis points, actually taking the federal funds rate down to 3.5%. So depending on what happens in the market. But if you listen to the Bernanke speech, the one thing they are concerned about is deflating asset markets specifically real estate. They know that's going to continue, so they want to arrest that, and then also the stock market and as you and I talking here, I'm seeing a miracle. In fact, as we mentioned earlier, it's 12:30. The last half an hour, the last 15 minutes, be surprised what happens in the market. Anyway, just a heads up of where they are going. [32:41]

FSN Humor

JOHN: Well, since we're back in the silly season, otherwise known as the US election year, we were going to sponsor a debate between candidates. However, we listened to the last election debate we did some time back and guess what? Everything still applies. Nothing has changed, so we're saving time and money and we're just replaying the old debate. Here it is.

The following program is made possible by a grant from the State of California suing its way to energy independence and by the Sierra society, saving the world from global warming. Remember, your tax today or you're toast tomorrow.

Indecision 2006 where you the legal or illegal voter get to decide the future without ID and regardless of the length of your stay in our country. Now, here is the moderator for tonight's debate, Jim Puplava.

JIM: Good evening. Welcome to Indecision 2006 sponsored by the league of perplexed voters. Hello, everyone, I'm Jim Puplava. As we all know, the silly season of the US election is almost over and very soon both American citizens and illegal aliens will dingle their chads at the polls to decide the future of our fair country.

DANNY D. DEMOCRAT: You ain't going to steal the elections this time either.

RONNIE R. REPUBLICAN: We didn't steal it last time.

DANNY: You most certainly did.

RONNIE: Did not.

DANNY: Did too.

RONNIE: Did not.

RONNIE: You call me a fascist pig?

[fighting erupts]

JIM: Gentlemen. Gentlemen. Please. You both have a chance to speak. This election season has been especially confusing for voters as candidates in all races around the country have been campaigning with sound bite ads that are -- well, stupid. So in the interest of bipartisan debate, our two participants represent both parties but are not running for reelection, hopefully enabling us to get to the bottom of the issue. Our participants are congressman Danny D. Democrat representing Baja California's first congressional district; and congressman Ronnie R. Republican representing British Columbia's second congressional district.

RONNIE: Huh?

JIM: Security And Prosperity Partnership. Remember gentlemen?

RONNIE: What's that.

DANNY: Republican conspiracy if you ask me.

RONNIE: Socialist.

DANNY: Fascist.

JIM: Gentlemen, stop it. You're beginning to sound like politicians.

BOTH: We are politicians.

JIM: Try to pretend you're not. Anyway, we'd like each of you to give an opening statement of your party's position on the issues.

BOTH: Ha ha ha.

BOTH: We can't do that.

JIM: Why not.

DANNY: We can't tell people exactly what we're thinking. We'd never get elected.

RONNIE: Just the sound bites. Just the sound bites.

JIM: What about saving the environment versus saving the economy?

DANNY: As Democrats, we believe in taxing the oil companies, the greedy oil companies and prohibiting offshore drilling while providing abundant gasoline for SUV guzzling left wing soccer moms while restricting global warming and saving the future for Bambi.

RONNIE: Aw, just shoot Bambi and get it over with. Dig drill, it's wonderful. I love the smell of pollution in the morning.

DANNY: How can you say shoot Bambi?

RONNIE: If I had a gun, I'd shoot you.

DANNY: You gun-toting Fascist.

RONNIE: Anti capitalist socialist.

JIM: Gentlemen, gentlemen. Please.

JIM: Yes. What about saving Social Security?

RONNIE: We don't mention that.

DANNY: We don't either. Inflation. You've got to love it.

JIM:Gentlemen, seriously. We need to hear the Republican position.

RONNIE: As a compassionate Republican, we believe in a gun in every pot and a man's right to wreck his own property and pick his nose if he wants to without government intervention. We believe in constitutional rights for everyone except this list of terrorists which includes, by the way, most Democrats.

JIM: Do you really believe that?

RONNIE: No. It just makes good press.

DANNY: Listen, Fascist, you guys couldn't get good press out of a shirt in a Chinese laundry.

RONNIE: Pinko commie, this is conservative America. Love it or leave it.

DANNY: I think I'll leave it.

JIM: Stop it. What about the war in the Middle East.

BOTH: [sung to Beach Boys Barbara Ann]Bomb bomb bomb, bomb bomb Iran. Bomb bomb bomb bomb bomb Iran. Bomb bomb bomb, bomb bomb Iran. Bomb Iran. Bomb bomb bomb, bomb bomb Iran. You've got to --

RONNIE: Rockets area going.

DANNY: And oil is a flowing. You can't bomb Iran. Bambi is there? If I had my gun, I'd shoot Bambi.

DANNY: How could you shoot Bambi, you war Monger?

RONNIE: Terrorist lover.

DANNY: Assassin trainer.

JIM: Well, we'd like to thank both of our participants for helping us further the interests of that bipartisan spirit. On behalf of the League of Perplexed Voters, I'm Jim Puplava.

JOHN: Yes indeed. It’s been a white knuckle ride here today as we've been recording this program and watching the markets going into yoyos. You had a bet didn't you with somebody in-house here.

JIM: Yeah. We took a little break from the first segment as we were watching in and there was an internal bet with one of my staff, and we were watching this miracle take place. And the bet was, this is where we're in, as we're speaking one minute until the markets close. One of my staff said that, “you know what, we're going to be at 250 on the Dow and they are going to hold the 1400 mark on the S&P.” And so here we are, John, we're counting down to 1:00 o'clock on the West Coast.

JOHN: Do we need a drum role in here or something? Hey, Scott. Are you in real time?

SCOTT: Yes.

JIM: Where did we close.

SCOTT: 246

JIM: I'm showing 246.7.

SCOTT: Yes.

JIM: And 1401 on the S&P?

SCOTT: Correct there.

JIM: Pretty dog darned close.

SCOTT: Told you! 1400. They’re holding that line.

JIM: Okay thanks. I owe you lunch.

SCOTT: Okay.

JIM: Okay. Taco Bell?

SCOTT: Huh?

JIM: Taco Bell.

SCOTT: Wendy’s

JIM: Taco Bell or Wendy's. Feast.

SCOTT: Wendy’s is expensive, Jim.

JIM: Okay. We'll go to Taco bell then. All right. Bye.

JOHN: Jim, what were the numbers you guys were chattering about here? This is all happening here in real time as we're doing the show here.

JIM: We had a side bet going because remember, John, when we started doing the Big Picture, the Dow was down about 140, 150 and then in the middle of the Big Picture in the first segment, I have, like, 12 computer screen in front of me, and I'm watching this thing in real time and it looked like somebody just drove a car off a cliff. And we went down over 300 points. So I interrupted what we were doing and I called the trade desk and we have a side bet when these things happen. And one of my head of operations said, “you know what, 1400, they’ll hold the line at 1400 technically.” And we're going to be down 250 points and so I bet him lunch. [40:11]

JOHN: Last of the big time spenders. I mean McDonald’s. The least it can be is Olive Garden.

JIM: Wait a minute. No. No. No. No. I went as much as Wendy's.

JOHN: Oh, jeez. I get better deals in Vegas in smelly, smoky casinos than that.

JIM: Hey, listen. He's pretty good. He said 250 on the Dow and 1400 on the S&P and we held at 1400 and roughly almost 247 on the Dow. So anyway, it's Taco Bell next week.

JOHN: What we were discussing as we were watching the meters fall off the charts here was the fact that we have more shoes which are going to be dropping right here. We're going to be hearing terms about credit default swaps. And so why don't we begin with an explanation of that.

The Next Shoe To Drop

JIM: Well, if you want to think of credit default swap, the easiest way to think about it is as insurance. I'm going to give you a definition that gets a little bit more technical. A credit default swap is a derivative. It's a bilateral contract between two counter parties that agree to isolate and separately trade the credit risk of at least a third party reference entity. Okay. That means a bond or an issue. In other words, let's take a GM bond. I don't even have to own a GM bond, but I'm taking a bet that I think, you know what, GM's market value of that bond is going to go down. Somebody else could be taking the opposite side of that trade. The person that writes the contract and thinks “hey, the GM bond is not going to go down” and he writes a swap which I buy. Now, under a credit default swap agreement, a protection buyer, let's say a person who is worried about something going down, pays a periodic fee to the protection seller (hence, the insurance person in this case) in exchange for a contingent payment by the seller upon a credit event, such as a default or a failure to pay, let's say, an interest payment happening in the bond entity or that third party entity. And when a credit event is triggered, the protection seller either takes delivery of the bond or the defaulted bond for par value and pays the protection buyer the difference between the par value. In other words, let's say I bought a thousand dollar bond and I bought a credit default swap in order to protect. The bond defaults. It drops to 50 cents. I give the person that wrote the credit default swap the bond and he pays me the difference between the value of the bond 50 cents and what I paid for it: a dollar. So it's kind of like car insurance, John, in a way if you think about it. You have a car. You take out car insurance on your car. You get into an accident, what happens is you total the car. The insurance company comes in, they pick up the totaled car, get whatever money they get for it, scrap, and then they pay you the full value for that car. So a credit default swap, it's insurance on a bond entity. [43:23]

JOHN: So I guess you could say this is sort of like bond insurance. It’s somebody trying to buy insurance on bonds and they are doing this basically as a hedge.

JIM: On the surface, that's what it would appear and when you take a look at today's leveraged market and speculative markets they've also become a way of making extra money and a new way to speculate.

JOHN: Why don't you show us how this process works so people can visualize it.

JIM: Okay. Let's say that, as we mentioned earlier, credit default swaps were used basically as a means of managing credit risks. You're investing in corporate bonds. You're worried about them defaulting. So owners of corporate bonds are going to go out and protect themselves from default risks by purchasing a credit default swap on a particular bond. For example, let's say I'm a pension fund. I own $10 millions worth of a five year bond issued by ABC corporation. Now, in order to manage that risk from losing money, if ABC corporation defaults on that debt, the pension fund buys a credit default swap from, let's say, a derivative bank in the notional amount of $10 million which trades, let's say, at 2%. I'm going to pay 200 basis points. Now, in return for this credit protection, the pension fund pays 2% –this 200 basis points – of the $10 million and that amounts to $200,000 dollars in installments to the derivative bank. So I'm paying 2% annually of the value of that bond to protect myself if the bond defaults. Now, if ABC corporation does not default on its bond payments, the pension fund still makes the payments to the derivative bank for five years and you know when the bond matures at $10 million, the pension fund would get its money back. Meanwhile, the protection payments reduce the investment return because if I have to pay out, let's say, I buy a junk bond and I'm getting 9%, well, if I'm paying 2% a year for insurance on this credit default swap, I'm getting only 7% because the insurance is costing me some money to protect myself in case the bond defaults.

Now, if ABC corporation defaults on its debt, let's say three years from now, the credit default swap contract in this case, the pension fund would not have to pay its quarterly payments to the derivative bank and the derivative bank would have to buy the bond. Let's say the bond is worth 50 cents on the dollar and it drops to let's say $5 million. I would give the person who wrote the insurance, the derivative bank, the bond, and in exchange, they would give me $10 million. So it would be collecting on an insurance policy. [46:20]

JOHN: Okay. So at the current you're talking about the hedge like an insurance policy, but actually we've gone beyond that now in this market. We're out into speculation now.

JIM: Sure. Because what is happening right now, credit default swaps can give and are used as a way to speculate; a way to, let's say, make a large profit from changes in a company's credit quality. A protection seller (in this case the insurer in a credit default swap) effectively has an unfunded exposure to the value of that bond, with the value equal to the notional amount of the credit default swap. And what has happened as a way of earning income a lot of hedge funds have gone out and basically written credit default swaps because we were in an expanding economy, things were doing well and it was like printing money. So it was a way that – and I'll give you an example of how this could come back and haunt you at times.

But let's go back to the example where, let's say, you invested in a bond or there is a company out there that's having credit problems. Maybe it's Countrywide. Maybe it's Washington Mutual. Now, it may be possible to buy the company's bonds or the debt at a discounted price, because if a company is experiencing financial problems, the value of their bonds will drop. So let's take an example of a one million dollar bond. It could be possible to buy that one million dollar bond for 800,000 or 900,000 from, let's say, another owner of that bond if that owner of that bond is concerned that the company may not be able to repay its debt. So if the company does in fact repay its debt, let's say they don't default and you bought that bond for, let's say, 900,000 and it matures at $1 million, you’d make $100,000 profit.

Alternatively, you could enter into a credit default swap with another investor by selling credit protection and receiving a premium of $100,000. If the company doesn't default, then basically you get to keep the insurance premium without having investing anything. And this is the problem that we have today is a lot of people are underwriting or issuing these insurance protection policies on these bonds and they don't have any collateral backing it up. Now, it's okay if you're in good times. But in bad times, one of the problems that you have is if the economy slows done, what happens is companies experience let’s say margins contract, their sales contract, profits contract, and you start seeing a lot of companies that are unable make their bond payments. They get downgraded by a credit agency which can lower the value of their bonds. There has been a ton of these credit default swaps that have been issued in the last couple of years that goes way beyond the amount of bonds that have been issued out there. So it was a way of speculating, earning extra premiums with the idea that hey, we were in good times; just like people went out and made 100 percent loans of property assuming that the value of property does nothing but go up. The same thing is going on with these credit default swaps. A lot of people were assuming that the good times go on forever and they weren't concerned about the fact that hey, we may get into a recession. If we get into a recession you could see corporate defaults rise substantially. [50:03]

JOHN: Well, how big has this market gone?

JIM: Globally, today, credit default swaps have grown almost 12 fold just in the last three years. The Bank of International Settlements is estimating that the market of credit default swaps is now about 45 trillion. Now, if you just look at the US banking system, which has reported, since 2004, in the last three years, we've gone from one trillion dollars in notional value of outstanding at the end of 2003. At end of 2007 we're looking at almost $12 trillion just in the last three years. [50:38]

JIM: Wow. Who are the guys doing this anyway?

JIM: Well, the usual suspects. And this is one of the things that is concerning a lot of people right now. I mean of the 12 trillion in credit default swaps, JP Morgan has 6.5 trillion, Bank of America, 1.3 trillion, Citibank, which has its own problems, 2.5 trillion; Wachovia, almost half a trillion; HSBC, almost a trillion; not to mention the numerous hedge funds that are out there.

And the problem that we have now is the credit default swap market is larger than the outstanding bonds on which these credit default swaps were issued on. It's kind of like a bunch of people going out and buying car insurance without actually owning cars and there have been a number of people who have commented on this. Warren Buffett has talked about some day this is going to blow up and it's not going to look pretty. And recently, if you go to the PIMCO website, Bill Gross and his forecast for 2008, has written a piece where he talks about pyramids crumbling. And what he's basically saying here is you have this shadow banking system that wrote these contracts without the reserves. In other words, an insurance company when it writes insurance policies –whether it's property and casualty insurance or car insurance – is required to set aside a number of reserves to provide for these catastrophes when they occur, so you have the money to pay your policy holders. In the case of credit default swaps, the most egregious offense here is a lot of these non-regulated entities, whether they are hedge funds or banks have had no requirements to hold or set aside reserves against a significant, or what we call a black swan or a rogue event. What happens if a Countrywide, or somebody, goes into bankruptcy? The problem is they don't have the reserves for this.

And so if you look at this market today, which is somewhere between 43 and 45 trillion worldwide, it’s more than half of the size of the entire asset base of the global banking system. And not only on that, as of the last, I think it's the third quarter or fourth quarter –I don't know if we have the fourth quarter figures yet – total derivatives outstanding are 500 trillion. So everybody is focusing right now, John, on the mortgage problem, the subprime problem, but here is the next problem, I think, is going to be the headlines here the next two-or-three months. And especially if the economy continues to decelerate and is in fact in recession (as we now think) then you could have these default swaps.

Bill Gross estimates even if we get a normal recession or a slow down where the average in a slow down or recession as you get anywhere from between 1.5 to 2% of these bonds default, then you're talking about losses in the neighborhood of almost $250 billion. So that's another mess that we have out here that the Fed is looking at which is one reason why if they don't start reflating rapidly and try to turn this around, then on top of the mortgage defaults...And as we talked about last week as you have the economy going into recession, people lose jobs and you have people that may be in good financial condition (meeting their mortgage payments etc)...Right where we're at around this neighborhood, one of the problems that you have here is in these planned communities, you have homeowners association and right now people aren't making their homeowner association fees. So you have the HOA trying to negotiate, work out a payment plan with people and then you have to start raising fees on everybody else that's making their payments because a lot of people are under duress. You're seeing bankruptcies, foreclosures. And if you can't make your house payment, you're certainly not going to say to your self, “well, we'll make our HOA payment, but we'll skip the house payment.” So as this economy weakens, this is another problem that we can face. We talked about last week the two areas that aren't on the radar screen yet are credit default swaps and credit card defaults. And that, I think, may be one of the next headlines you're going to see here in the next two-to-three months. [55:05]

Part 2

Living with Uncertainty, Thinking Strategically

JOHN: Well, to quote Saturday Night Live, Jim, “the markets go up, the markets go down. Relax.” But relaxing doesn't seem to be what a lot of people are doing as things are going up and down and up and down and up and down, and it is indeed becoming a time of anxiety here. So now we're going to talk about, I think the marines used to say “thrive in chaos,” survive in a time of anxiety or uncertainty.

JIM: That's certainly one of the issues that investors are dealing with, politicians are dealing with, companies are dealing with. There is no question, John, that the credit bubble, the real estate bubble is deflating, much in the same way as the technology bubble deflated between 2000 and 2002.

And one of the problems that we've had with this deflating real estate market, and remember, this goes back to the Fed rate hikes that began in the summer of 2004 that went on virtually for two years, during the two year period, people were making loans, people were borrowing money, people were buying homes, nothing seemed to unravel until February of last year. We had a brief spurt, a downturn in the market and then they said, “Okay. Problem is over.” And of course it came back to bite us in August. Now, the full effect of that bubble is unwinding. And unlike the stock market real estate unwinds over a slower period of time. It takes, for example, several months of delinquency before foreclosure proceedings begin on a homeowner. So all of this takes time. And one of the problems the market has been dealing with, one of them is trust. Because all of these mortgages, CDOs, SIVs, all of this stuff was dispersed (that's the good thing because there is no one large player that's sitting on it all), the other thing that came into the equation is okay, who is sitting on the dirty laundry? And as more and more of this comes out (and you're going to see this in the first quarter) and the market can finally get a handle on it and say, “okay, this is what the loss is going to be. It's going to be 300 billion,” whatever it is, and they get a handle on it. And also, you go through a period of severe liquidation, for example, this week, Lennar Homes announced that they sold a whole block of real estate for 40 cents on the dollar. And that's what you have to do. You have to get through this liquidation process, let the capital markets work and just hope the government doesn't come in and muck things up. And one of the problems as we dealt with in the first hour is up until this point, you know, the market hasn't had a lot of confidence in terms of the way the Fed has handled it. I think they misdiagnosed it as just a stage one crisis. Now, they are dealing with a stage two crisis, in other words, an economic problem as well as a financial problem. All of this, though, creates uncertainty. [3:09]

JOHN: Well, nowadays, everybody is a technical trader. You know, you've got thousands of pairs of eyeballs out there watching what's going on on the boards, and that has a multiplier effect because when everybody is antsy as something starts to trend in one direction, everybody begins to jump on board to sell. So that would seem to have an accentuating, amplification factor here in whatever trend things are going in.

JIM: Sure. Because a lot of markets trade 24 hours a day. If you live in the US, you can find out what the markets are doing in Asia before the new day begins. And you're right. You have a gazillion eyeballs all following the same charts and if a chart start to wiggle down, everybody jumps on board and then it becomes a short term magnified trend, and that's why you see the sharp either downturns in stocks or oil commodities, whatever it is.

And let's face it, today we have a highly leveraged market globally, hedge funds are leveraged up the wazoo, financial firms are leveraged. And when you're leveraged and something starts to go against you, you have to move quick if you want to remain solvent. So I forget –last count I think there is something like nine to 10,000 hedge funds. You probably have an equal number of mutual funds and then you have endowment funds, you have corporate pension funds. It's a more institutional market. A lot of the investment banks account..or .program trading is almost two-thirds of the trading on a daily basis. So the plain fact is we live that time of uncertainty. There is just no way that you're going to get around that. So until this credit crisis is resolved, until they find out who the winners are, who the losers are going to be, who is going to be the survivor, the amount of losses, is the economy heading into a recession; if it is, how bad of a recession is it going to be? Is government going to try to do something to monetize its way out of it? Until that uncertainty clears up, you're going to have this volatility that you see almost on a daily basis almost in all of the markets. I mean, you and I did a program the last year, the last week of the year on gold and oil. We told you then that it was one of the best performing sectors in 2007. Did we have any insight and could tell you that the first day of trading gold was going to jump and sky rocket, same with oil? No. But we do know that we are in a long term bull market in commodities. [5:42]

JOHN: Well, all right. If you're not going to be one of the chart chasers and watch the things every day and buy gallons of Maalox, it would seem you're going to have to rely more on fundamentals and basics in the market and just let the daily wiggles take care of themselves.

JIM: You're absolutely right, and I think the key to making money in this market, surviving this market, sleeping at night, John, is knowing and thinking strategically. Every major corporation today is competing with other corporations in the same business unless they are the gorilla or the monopoly in the group. But all corporations go through what is called strategic planning. And unfortunately investors don't do that for themselves when they are thinking about their own portfolio. When you make certain decisions and assessments they can have major outcomes in terms of how successful a company becomes, whether they become a dominant player, whether they survive. And thinking strategically has major impacts in terms of long term portfolio performance. And we'll get into this when we get into a section we're going to do today called Planning For Income. But just to give an example, in the early 80s, IBM decided strategically they were going to get into the personal computer business. Steve Jobs had invented the Apple computer, the personal computer and the age of personal computing began. But IBM made a strategic decision: They decided, “you know what we're not going to mess with the software or the operating system. We're going to outsource that to this little bitty company of long haired guys called Microsoft and the brains of the computer, the processor, we're going to give that to a company called Intel.” Think of the strategic implications of the decision that they made. They made two of the most powerful corporations in the world: Microsoft and Intel.

So thinking strategically about what you do in your investment portfolio is very important and it gets you to focus on fundamentals and longer term trends. In other words, rather than worrying about, okay, the Dow was down today, where is it going to be tomorrow or where is it going to be on Monday, thinking about what are the long term trends in place. And if you can get yourself to think that way, then I think you're going to have a greater opportunity for success when you're investing. I mean, there are five phases to any kind of bull market: Three up phases and two corrective phases. And if you can just get on board a bull market in its beginning stage and just hold on during the periodic corrections, I think you're going to make much more money than you could trying to constantly trade in, trade out, trade in, trade out. I mean if you take a look at bull market in the 90s, would you have been better off trading in and out of Dell, Cisco, Intel or Microsoft, or would you have done much better as an investor just buying the stock and just holding on until the end of the bull market and when there are clear indications that the bull market is over? [8:57]

JOHN: Obviously, this is sort of thumping a theme we've had here on the program going all of the way back to 2001 when we really started doing this show. But if we're looking at this sort of age of uncertainty in the market right here for the next however many months we're going to go through this, what strategic actions would you take? Or at least, what perspective would you take strategically looking at the market to make these investments?

JIM: When I wrote my Perfect Storm series in 2001, I laid out an investment scenario and I said there were four basic areas (and they were sort of related) that you could make money in the next decade –and I would extend that over into the next decade: One was energy, two was precious metals, three was water, and four was food. And I still believe more so today than even when I wrote it back in 2000, 2001, that not only are these trends in place, but it's clearly visible. I mean let's take the area of energy, if you look at a chart –and this is something that will help you think strategically – just go back to the year 2000 and look at the price of oil. Yes, we've had corrections along the way, we saw oil go up to 30 and then go up to 40, pull back into the 30s, and then from the mid 30s, it went up to 50. It pulled back to 40. When it pulled back into the 40s, it went all of the way up to 70, a little over 70 with Katrina and Rita, and then it pulled back to 60 and then went down into the mid 50s. And here we are on this Friday and we're talking about oil prices at $92. Now, a little over a week ago they were close to 100 and everybody is just like in previous downturns, they are saying, “oh, the US economy is weakening, there is going to be demand destruction.” The same kind of things they said around Katrina and Rita; the same kind of things that they said when the Fed embarked on raising interest rates. It was going to slow down the rate of growth.

Here we are on this Friday, John, and the markets were surprised because the trade deficit in the US jumped from October roughly about 57.8 billion to 63 billion or 63.1 billion. One of the main reasons the trade deficit jumped is imports of crude oil amounted to almost 25.1 billion in November compared to, let's say, 23.8 billion in the previous month. Not only were we importing more oil, but we were paying a higher price. The price of crude oil increased by almost $7.16 a barrel. So, no matter what you hear in the short term (the fact that oil has pulled back, there is demand destruction), one thing that we know right now, for example, conventional crude oil production peaked in, I think it was May of 2005. In fact, Matt Simmons in his latest piece has made a very, very strong case on energy. And we're going to have Matt on the program later on this month. He wrote a piece called Another Nail In The Coffin Of The Case Against Peak Oil. And since May of 2005, we have produced a couple of million barrels less of crude oil. At the same time, we have got demand globally growing faster than supply. And that is becoming more recognized. We have more countries around the globe that have peaked in their oil production. Last year, I think there was only, like, three or four countries that actually increased their oil production; I think it was Brazil, Canada and Russia. Most of the Middle Eastern countries saw their production decline; production declined in the United States and it declined in Britain, it declined in Mexico. So we have a situation here today where the world's economy is growing –especially in the developing world which is more energy intensive. So there is more demand for energy.

We're not discovering...now, Brazil made a major oil discovery last year. Probably the biggest oil discovery since the early 90s with the Kashagan field in Kazakhstan. But outside that ten-year period and this one discovery made last year, which they estimate could be anywhere from five to eight million barrels of oil, that oil field may not come on stream for the next 5 to 10 years. And meanwhile, last year, the world consumed more than 30 billion barrels of oil. And John, we're not discovering 30 billion barrels of oil. We haven't discovered what it is that we consume since 1985, which was the last year that we discovered enough oil to replace what it is that we consume. So now this is playing catch up.

If you want to see another worrisome trend, one of the ways that we're making up this short fall between demand and supply is our inventory levels in the United States have fallen to the lowest level that we've seen in three years. We've gone from about 350 to 360 million barrels of inventory down to about 280. I mean these are the kind of trends that are in place that they don't talk about in the market place. It's always saying, “well, we'll find more if the price goes up, more oil fields are coming on.” We're going to have to find 25 million barrels of new oil production a day in the next couple of years. Not only just to meet future oil demand, but also just to replace what it is we're losing from depletion. [14:47]

JOHN: All right. So if you look at the whole trends that we have in oil, say for example, right now buy, hold, what?

JIM: You know, when you're in a bull market and you're into early stages in bull market, what you do is when you see the market correct or pull back, you add to your positions. Maybe there was a stock or an oil stock you wanted to buy, but it got away from me, the markets took off when you least expected it. Well, you know what, when you go through a corrective cycle, the oil stocks pull back, you add to it. And the great thing about it is oil prices are still incredibly cheap when you compare other sectors of the market. And, like it or not, the world runs on oil. And we're not about to replace oil any time soon over the next two decades. There is nothing out there right now that's going to replace oil to power industrial societies. So I would add to the position. In terms of if you don't have any, you can add when the price goes down., or if you want to increase your position in this sector, that's what you do: You use these downturns to add to your positions. [15:56]

JOHN: Yeah. But there is always that temptation, Jim. You know what if it corrects 5, 10 percent? You go “oh, boy, I need to do something” or just the converse and the stock doesn't do anything. It just sort of sits there.

JIM: You know what? You sit there. I can remember we were buying oil stock in 2000, and 2001 and people were saying, “what the heck are you guys doing.” We sat there for a couple of years. But you know what, we were getting dividend yields of over 4, 4.5 and some cases we were getting 5% dividend yields at a time the Fed was slashing interest rates and taking them down to 1%, and at a time the actual stock market was actually going down. So sometimes you just have to be patient. I mean, even people that bought real estate that have made money in real estate, you don't go out and buy real estate and expect the day you buy it or the next day it's going to go up. I mean we basically sat on our oil investments for two years. But you know what, we were getting 4 and the 5% dividends and we bought them at incredible prices. But if you take a look at by doing that, not only were we compensated with dividends, but since that period of time, oil stocks have gone up almost four fold; in many cases we have some that have gone up 8 and 10 fold. And that's the concept of investing versus speculating. You buy something that's undervalued. You buy it, you hold it, and you hold it until everybody in the world wants to buy it and pay you a ridiculous price. And that's usually, you know, when you get to the end of that crazy period, that's when you unload it. But that's what I mean about investing strategically for longer term trends. [17:35]

JOHN: So if we assume that energy is in a bull market right now, there are several other areas, which we would say pretty much the same thing – gold, precious metals are doing the same thing.

JIM: You know, we're titling this segment Living With Uncertainty and one sector that drives with uncertainty is the gold market. And just take a look at the price of gold since the beginning of the year with all of the uncertainty. So one question you have to ask yourself: Given the current environment with Mr. Bernanke talking about lowering interest rates, with the central banks of Canada and England more recently lowering interest rates in December (and I think they'll be lowering them again and eventually I think the ECB could be lowering interest rates), looking at global money supply figures around the globe, looking at rising inflation, looking at the credit problems, all of the geopolitical problems that you see today around the globe, ask yourself, given this uncertainty, does that make gold more attractive or less attractive as an investment? [18:40]

JOHN: Well, given all of the uncertainty, and I think we're going to see a lot more of it over the next 48 months, especially on a geopolitical basis, gold just seems to make sense. And there are people recognizing this. You know, these prices of gold are reflecting this.

JIM: Yes. There are people that are recognizing that gold is in a bull market, but you know, it certainly isn't Wall Street. Goldman Sachs saying their number one trade is to short gold stocks when they said that in November. Here we are, the HUI is up 16% for the year, the XAU is up almost 12%. Gold is acting as a hedge and it's also assuming its historical role as real money. And the amazing thing as we talked about in the first hour with Nick Barisheff, unlike the gold bull market in the late 70s where you had gold up for just a couple of brief days when it got up to 850, (same thing with silver), John, this rise in gold has been relentless every single year. We're looking at gold up in 2001, 2002, all of the way up to 2008, which to me, makes the case that this bull market is going to be much bigger, much stronger than any other bull market that we've experienced. And I just think we're just in the beginning stages and it still isn't on the radar screen of any major institutions or individual investors. They might be able to relate to oil stocks being up because of the price that they are paying at pump, but talk to people about gold and they kind of look at you like “oh! you're one of them!” [20:15]

JOHN: Well, you are one of them.

JIM: Yeah. I know. We've been buying gold for, what, seven years now.

JOHN: Yeah.

JIM: But the amazing thing about it is this market is so small, if you take a look at the market capitalization of the gold market itself, whether you're looking at the bullion or you're looking at the gold equities themselves, this thing is going to explode at a level that I think we're going to sit back and think the internet craze was mild compared to what's coming to the sector. It's just absolutely amazing.

JOHN: I know one of your pet areas is juniors and last year it wasn't really that terrific a year for juniors. Do you think that's going to change in this year?

JIM: Absolutely. Well, you know, what we've seen, John, probably since the beginning of 2005, is we've had this long period of consolidation with the gold stocks. Bullion has actually done much better. Bullion was up 31% last year. I think the HUI was only up about 20%. And quite honestly, a lot of juniors lost money, whether it was exploration or development. In other words, they were down last year. And it was only towards the end of the year, especially after that August period when the Fed began cutting interest rates that we broke out of this long, almost 18 month consolidation and we saw the gold stocks shoot up at the end of the year. Then they went through sort of a sharp selloff in the last couple of weeks of the year; and here they are with the HUI at an all time record. And you heard last week where James Turk believes that we can see the XAU actually double this year. And I see that. And the problem that we've seen, because we were in this consolidation period in gold stocks from 2005 to basically 2007, what you had was more trading in and out of the sector. And if you're a hedge fund, you're an institution and you're trading, well, you know what you did, you went into the large cap gold stocks, you went into the Barricks, you went into the Newmonts, the Yamanas, the Agnicos, the Goldcorps, and also the larger silver stocks like Pan American, Silver Standard, because you could trade out of them. They were very liquid. So if the gold market pulled back, it went through a correction. And if you just look at a chart, we saw numerous – what? One, two, three, probably about ten corrections in gold stocks over the last two years. Well, guess what, you could trade out of? If the gold market turned against you, you just flipped out. It was very easy to do that. You can't do that with juniors because by their very nature, they are not very liquid. In other words, the amount of stock available to buy is very small, and if you take a position and you build a position you want to dump, you can't dump a small junior mining stock in the same way you can dump say a Barrick or a Newmont, an Agnico or a Yamana. Whereas you take a look at, for example, Newmont on Friday, not quite a record on Newmont, certainly a record level. And if you take a look at the last 52 weeks of trading, Newmont had a high of nearly $62 a share back in February of 2006. But Newmont traded almost 10 ½ million shares on Friday. I've seen juniors some days that don't even trade more than 10, 20,000 shares a day. So that's why when you buy a junior, you buy them, you accumulate them overtime and you have to have the patience to hold onto them if you intend to make money. [23:53]

JOHN: Well, right now, people are trading in and out of the big stocks because there is liquidity there, they’re liquid. If the price of gold goes up, how will this affect the juniors in that area?

JIM: I predict –especially as we head over 1000, and if we can hit a 1000 and maybe (we don't know, even numbers are kind of funny technically) 1000 could be resistance and we see a pull back at 1000 or it will below right through it. It's hard to say. It depends if it picks up. But if you look at the gold market, it is so small today, the HUI has a market cap of 156 billion. That doesn't even come close compared to the market cap of GE, Exxon or Microsoft which are over a trillion. So as people start moving into the sector, whether it's money going into mutual funds, money going into gold stock ETFs, eventually there is going to be no other place to run. I mean you just can't have everybody buying the same large cap stocks like a Barrick, a Newmont or Yamana. Eventually they are going to have no place to run. And what's left, which is a screaming, there has never, ever been another time with gold close to $900 where you can buy gold in the ground with juniors at, let's say, 15 to $25 an ounce. And so there is nowhere left to run. So eventually, it's going to spillover into the junior market.

It's like right now, the small caps didn't do well. It didn't do well in the gold market last year. The small cap stocks didn't do well in the regular stock market. And so eventually it catches on. And when it spills over, the magnification, John, becomes explosive. You can see juniors go literally up ten fold. We're getting involved with one right now that's had a ten told increase because of a major discovery. So that's what happens overnight and that's why I think eventually, as it catches on, more and more gold mutual funds or gold ETFs, they just can't buy the top five or six market-cap weighted stocks. They are going to have to go further down the food chain. Also, I think the larger companies, just like the large oil companies are not replacing their reserves. Barrick is going to have a tough time replacing eight million ounces of production. Newmont, which used to produce almost seven and a half million ounces of production is not going to be able to replace it. So you're going to see, from the intermediate companies that are moving up the food chain to the major companies, they are going to start gobbling up. And this idea that well, a couple of years ago, a lot of the majors were saying, “we're not going to look at anybody unless they have a 5 million ounce deposit.” Well, you know what, they are reassessing that because there aren't a lot of five million ounce deposits out there. So they are going to get much more realistic. And I think companies and juniors that have two million to three million ounce deposits are going to be on the target range. And especially if the ounces are measured and indicated. So there is more certainty to that. And especially if they are located in a region where you know there has been production or other companies are going into mining, so you know that these ounces are going to be economical. [26:59]

JOHN: Well, since going into juniors is somewhat risky, what are the things you've got to look for?

JIM: Well, you know, when you're looking at an exploration company, one of the first things you look for is management, what is their track record, because basically you're taking a company or investing in a company that's going to go out and find gold. And so what you're hoping on is the person that is heading up the company, the geologist, the management team has had previous success and has been successful in finding it, so you look at management. A second thing that you look at is: Where are they looking for the gold? And if they are looking at an area that is very prolific in terms of gold, silver and a metal, in other words a gold producing region, a region of the world where you know there is a lot of companies that are finding gold in that area, so you look at the region because that's going to have a higher probability. Two of my favorite areas of the gold right now, actually three, one is the Sierra Madre gold and silver belt in Mexico, and also the Yellowknife area in Canada, which is very prolific. You have the Con mine operating in Canada, which used to be a very profitable mine. You had in the northern Yellowknife area, a company by the name of Miramar had over 10 million ounces; they just got taken out by Newmont. And we know, for example, the whole area has high concentrations of gold. They've mined it, they’ve made a profit.

You look at the Sierra Madre area. You've got a number of companies including majors from Goldcorp (and prior to that, Glamis) from Agnico-Eagle, all of the majors are down in Mexico right now (and intermediates) because they've been mining this stuff there profitably for 400 years and actually much further than that. If you take it back to the Aztecs and before the time of the Spanish arrival, so they’ve been mining it there for thousands of years. And so going into an area that is a prolific area where other companies have found precious metals in that area, that increases your chance of success.

And then the third thing is it's got to be in an area where you have political stability because you've got to be careful. Would you want to have a gold deposit in Venezuela? I don't think so with Hugo Chavez. Or areas where governments have been rapacious and have actually said “oh, you've got the stuff. Now it's ours!” So you've got to be careful there – so political risk.

When you're looking at juniors, you're looking at management, you take a look at where it is, the deposit is, that's going to tell you if there is a higher chance of success, and three you look at the political stability of the company. And, you know, management is a key, not only in terms of finding it but in terms of how well the company is managed. And so that's why I think those are the kind of things I would look at.

But anyway, to make a long story short, I just think anybody that is going to be in the junior sector when this bull market ends, the returns are going to be magnified much more in comparison to the gold stocks, and I think the gold stocks will produce higher returns than the bullion. But once again, you know, John, you have to have patience, you have to do your due diligence. And when you go in this area, you know, there is some risk. I mean, somebody can drill a dry hole. Just because they poke a hole in the ground, it doesn't mean they are going to find it. And if they’re finding it you better hope that they are in a politically friendly jurisdiction, so that if they do find it, they can turn it into a mine and produce it. [30:27]

JOHN: One of the other areas we've talk about recently has been the whole area of food.

JIM: Well, you know, the one thing about food, which if you take a look, and this is the most alarming thing, is we have had bumper crops of grain in the United States, one of the largest producers of agricultural products in the world. And despite the record output of production of crops in the United States, John, inventory levels of grain, a main feed stock, have been falling. I think we're down to, what is it, 30 day supply or something like that from a 100-day supply. And now, globally, you have one thing going on: population increase. And if the population of the globe goes up at 1-2% in a year and especially in the emerging market, that means there are more mouths to feed in the world, so you have greater demand coming in for food. That's number one.

Number two is the dumb thing that we're doing and especially in the US where you're going to devote close to 25% of your corn crop for ethanol. So now 52% of our corn goes in as feed stock –whether it's chickens, hogs, cows, it's feed stock to grow beef or protein. And as the world's economies expand, especially in the emerging markets, their diets are becoming more protein rich, which means they are eating more chicken, they are eating more beef, which means they are consuming and ultimately we're going to need more grain to grow this beef, to grow these chickens, to grow these hogs. And at the same time, the food market –the cattleman, the ranchers, the chicken farmers – are having to compete now with the ethanol producers. So we've got two elements of demand that are driving prices up: You've got growing population and you've got the growing diversion of much of our grain crop into growing ethanol to power the cars that we're in. And another factor that you're seeing in many parts of the world is much of the arable land has been torn up. John, what's that song of Joni Mitchell “put up a parking lot.”

JOHN: Put up a parking lot.

JIM: Yeah. It's happening in China. They have polluted water supplies. A lot of the arable land along the coast has been turned into cities. I mean China is building, I think what was the figure that I was reading the other day, over 100 or 200 –I forget what the figure was –of cities in China with populations over one million. Much of that is all along the coast where they have some of the richest land. So they are plowing this agricultural land and they are turning it into cities, paved parking lot just like the Joni Mitchell song. And also, and we'll get into the fourth area of investing, is corn crops require water. And I don't care if you're looking at polluted water systems in China and much of the Third World and declining water aquifers in the United States, it's an issue here that we're going to have to contend with because what do you need to grow crops? You need water, you need fertilizer, you need energy. It's involved in all forms of growing agriculture.

In fact, there was a great piece written by a guy by the name of Hugh Henry and he's a manager and cofounder of an asset management company and this was in Mark Faber's Gloom, Boom & Doom Report this month – probably one of the best of Marc’s letters – and he was talking about making investments in agriculture. And he said there are six ways that you can invest in this area of land. They are not making more of it and there is probably less arable land. For example, one of the big grain baskets in the world besides the United States was Russia and Hugh quotes a statistic here: Land under cultivation in Russia has fallen from 120 million hectares of land in 1990 down to 80 million hectares in 2004. A second area that you can invest in is agriculture: Agriculture requires infrastructure from the railroad cars to transport it, silos and elevators to store it; and the ports in which you can bring it in and ship it. Then machinery – Look at all of the modern methods of farming today: the harvesters, the tractors. A fourth area is fertilizer. A fifth area is chemicals – whether it's insecticides to control and protect the crops or weeds. And then also seeds themselves. There is just great opportunities here. And John, the more population goes, the more we divert our crop to ethanol, the higher prices that you're going to see in the agricultural sector. So food is another sector that you can think of strategically as a long term investment. [35:24]

JOHN: And related to food it's something that is becoming scarce and a lot of people don't give thought to it is water. It is a major issue as a matter of fact in the Middle East.

JIM: Oh, absolutely. They are having to build desalination plants. And we're probably going to have to start doing that here in California where I think we have, what, 12% of the population in the United States, most of that living along the coast line. And this is an issue not just in the United States. One of the problems that we have as we divert more of our crop to producing corn (and corn is a very water intensive crop), but the underground aquifers in the United States are dropping. And you take a look at Hoover dam that's in Nevada where water levels are dropping to such levels that another four to five years they are going to wonder about whether they’re going to produce hydroelectricity there. And it's not just the fact that our underground water aquifers are dropping, you take a look at areas like China where they are hiring water companies to come in because one of the problems is their water supply. Because of their industrialization and not watching what it is that they are doing, it is becoming very toxic and full of chemicals where you get a lot of Chinese that are developing cancer. All of these diseases and illnesses as a result of water pollution. And so we're going to have to develop more efficient methods of farming that use less water.

And cities are dealing with waste products, they are dealing with water systems. In California, you saw last year the water infrastructure break in a couple of areas of the city and flooded. This is a global problem. We don't have enough potable water, John, globally and there is just a great business. You've got a lot of major corporations that are moving in this area where cities are having to cope with this and they simply don't have the expertise, the management or the wherewithal to deal with these water and clean systems. So the thing that we said back in 2000, four things that you can invest in: We talked about energy, we talked about precious metals, we talked about food and water. What are some of the best performing sectors, John, last year? Materials, energy stocks, precious metals, water, food. And this is a trend that's going to continue.

So rather than worrying about what's the stock market going to do next week, where is it going to be tomorrow, I would rather worry and think strategically: Given the fundamentals of a growing population, given the fundamentals that water tables are dropping, given the fundamentals that water pollution problems are creating serious problems for governments and cities and municipalities; given the fact that we're diverting more of our agricultural crop to creating ethanol; given the fact that demand for energy is growing as the world industrializes; given the fact that we aren't finding enough energy to replace what it is that we have; given the fact that central banks are inflating their money supply and the value of money is depreciating; those are the kind of things that you have to think about strategically as an investor rather than worrying about what's this little wiggle telling me, or gosh, the price of oil is down a buck today. [38:42]

Part 2

Investing for Income

JOHN: Maybe the hallmark of the next few years is actually going to be the word “uncertainty” like we've been using here on the program today. A lot of people, baby boomers, a huge block of population moving into retirement, and if they are moving into retirement in a time of uncertainty, especially given the fact that the Social Security trust fund is bust, there is nothing in it, nor can it be sustained at these levels except by devaluating the currency (which means everybody will get their Social Security check, but it's not going to be worth very much), what does that mean for people who are trying to plan economically in these times?

JIM: Well, you know, we used to have these standard formulas. I started out as a certified financial planner –and you know, you retire, you put 50, 60% of your portfolio in fixed income because now you need income to live on because you no longer have a paycheck or money coming in from a business. But, John, that assumes that you're in a period where you have low inflation as we did throughout much of the 80s and 90s. But what do you do in a period where you have high inflation? You know, it's very tempting, right now, to say, “okay, I'm going to retire, I'm going to turn my portfolio into fixed income, I'll get 4 or 5% income.” The problem that investors have today is if you look at where the yields are, you've got less than 2.6% on a two year Treasury note, a 10 year treasury note is less than 4% (it's actually less than 3.8) and it's probably going lower here in the short term. I sure in heck would not want to be investing long term given the levels of inflation that we see today. And so, you know, that's why we've always stressed about, you know, about blue chip dividend-paying stocks.

And over the long run, the rate of return is going to be much, much higher to an investor or somebody that is retiring today than, let's say, somebody who is going to be in a fixed income. I mean if I go out and buy a 10 year Treasury note today, let's say I invest $10,000. I can get right now 3.8%. And every six months I'm going to get my check. I'll make $380 dollars a year every single year. The question is what is going to be the cost of living in the year 2018 or 10 years from now, you know, because 10 years from now, I will get my $10,000 back, and I will have gotten $380 dollars a year. But that $380 dollars a year that I'm getting from that Treasury note is not going to buy the same goods and services 10 years from now that it will buy today. And for that matter, the $10,000 that will mature 10 years from now is not going to have the same purchasing power. And if you just think about anything you're buying today, what does it cost to buy a house today compared to 10 years ago? My kids can only afford to buy a condo for the price that I bought a large house 10 years ago. And that's what's happened. I mean think of what a car costs today compared to 10 years ago. Think of what it costs to send your kid to a four year college to get a degree compared to 10 years ago. Compare that to what you're paying to visit your doctor, compare that to what you're paying to just go out and take a vacation. It's just absolutely remarkable in terms of what we've seen and the cost of living in basic goods. [42:55]

JOHN: Well, does that mean, then, that some people aren't going to retire? The day of Sun City Arizona and retirement places like that may be over, per se. People are going to have to work.

JIM: Yeah. I think that is probably more in the retirement formula today for a lot of boomers, which is going to be that you're going to retire, but during retirement, you'll be doing some sort of part-time work. And actually, you can look at it quite positively, John. They find people that keep themselves active in retirement, actually live longer, their minds are more alert. And, you know, maybe you don't do what you did for a living during your working career. Maybe you do something that you enjoy doing. I had a client that retired many years ago who was in the publishing industry and he ended up being a tour guide at the Hearst Castle. Just absolutely loved it. I have another client that retired six, seven years ago and because he was a history professor he serves as a tour guide for one of the travel companies. So let's say you're, I don't know, you're taking a trip to Europe, Italy or something like that, he's sort of a tour guide. So I mean he's having the time of his life. And actually, he gets to go free. So working during retirement is going to be part of the retirement picture for a lot of boomers, but I think more importantly investors or retirees are going to have to think differently about their portfolio in an age of low interest rates and higher rates of inflation. I mean if you take a look at the yield on a two year Treasury note or one year Treasury bill or 10 year Treasury note, the yield on a 10 year Treasury note is less than the headline inflation number, and even though we know that headline inflation number is actually basically a sort of a fictitious number. [44:44]

JOHN: Okay. Every year you put together, usually around this time of the year, a portfolio of 10 stocks. And say you had bought these stocks, what, 10 years ago?

JIM: Yeah.

JOHN: What would your income have been?

JIM: Well, what we do, and I use this as an exercise and I don't -- anybody listening to this, this is not an endorsement or recommendation. It is done for illustration purposes. But mainly we take a look at the Dow 30 stocks. And we pick sort of a wide variety of stocks, some financial stocks, consumer stocks, industrial stocks, medical stocks, energy stocks. And we've been using this formula for these stocks mainly over the last couple of years to illustrate this point. But what we assume is you had a portfolio. You had $100,000 and you put $10,000 into each one of these stocks and then you just held on to them for 10 years. And just once again, I'm going to mention the companies and this is not an endorsement. This is done strictly for illustration. But we had a financial stock, an insurance company AIG, a consumer retail McDonalds, Disney Entertainment, Johnson & Johnson (on the medical side), Honeywell, Exxon, American Express (financial company), 3M (manufacturing), GE (manufacturing) and Coca Cola (consumer products company). And so in 1998, had you invested in these stocks – remember, we were going through a stock market boom during that period of time, and stocks were expensive –but let's say you put $10,000 into each one of these stocks, you would have received in dividends at the end of 1998 holding them for a whole year roughly about $1700 in dividends. Five years later in 2003, the 1700 in dividends grew to 2400 in dividends. So basically, we saw a 700 dollar increase in the value of those dividends. And finally 10 years later in the year 2007, dividends would have grown to a little over $4100. But what's really remarkable about this, assuming that you spent all of the dividend income, your $100,000 would have grown – and remember, that would have meant buying stock in 1998, and remember the terrible bear market that we went through for three years in 2000, 2001 and 2002 – during that period of time, you would have gotten over $81,000 of capital appreciation; you would have gotten almost $33,000 in income. And so basically, without dividends, your return was 181,000. Final investment with dividends was 214,000. If you want to take a look at that, it was a simple return of 81% or 8.1% a year. If you want to look at total return, which was income –the dividends – plus capital appreciation, it was 114% return, or an annualized return of 11.4%, easily increasing what you would have gotten in fixed income.

What was even more remarkable, the top performing stocks, Exxon, McDonalds, 3M and J&J had the highest total dividend payments. So companies that had good business models, that had good cash flow and consistent earnings are able to increase their dividends at a much higher rate than companies that don't. So the top performing of the 10 stocks were the stocks that had the highest total dividends payment. The worse performing stocks, AIG and Disney had the lowest dividend payments. And here's something that's even more remarkable. The average total return for the top two dividend players was 219%, an annualized return of 21.9% a year, while the total return for the two lowest paying dividend stocks was only 33.5%, or a return of a little over 3%. The highest dividend paying stock out of the group was Exxon Mobil that had a total return of 282%; and even if Exxon stock price went nowhere, the dividend alone would have given you a return of 76%, an annualized return of 7.6% just on the dividends. And Jeremy Siegel in his book The Future For Investors did a comparison. I'm not going to repeat it here because we talked about it last year on the show where he took, from 1950 to the year, I think -- I think it was 2004, he took two stocks: and if one would have thought of the ideal growth stock in the year 1950, it would have been IBM (the computer industry was coming into itself and changing the way we work today with computers); and then Exxon, which is basically an oil stock. And the total returns from Exxon versus IBM were far superior. And here, John, is just the study that we do each year confirms this very same thing because the best performing out of those 10 stocks were the stocks that produced a consistent higher stream of dividends. [50:19]

JOHN: And that would seem, you know, in this environment we're in right now of really high inflation, which threatens to stay that way for some time to have things in your portfolio that are going up which offset that, so you're keeping pace with it.

JIM: Absolutely. I mean if you look at Exxon in the last five years, Exxon has increased its dividends at an annual rate of 8.3% a year. Imagine getting an 8.3% pay raise every single year. If you look at Johnson & Johnson, another one of the top four performing dividend stocks, Johnson & Johnson has increased its dividends 15.3% a year over the last five years. Here's one that will blow your mind: McDonald’s. I mean we're talking about basically hamburgers here. McDonald’s has increased its dividend roughly 45% a year. Think of that number. 45% a year over the last five years. How many of us would love to get a 45% pay increase every single year with the kind of inflation rates. And even 3M, a manufacturing company has increased its dividend roughly about 9.2% a year over the last five years. And this is why, John, I think that as you get into retirement, having blue chip companies, and that's why I like to look at the Dow stocks. They are the biggest, the most stable, sound financially. And you don't get to be a blue chip in the Dow without having a successful business model and being a very stable company. I mean Johnson & Johnson (medical), 3M (manufacturing), Exxon (oil), McDonald’s (food franchises and now they are getting into adding coffee bars to compete with Starbucks).

And whether you're looking at a book written by three authors Dimson and Marsh wrote a book called Triumph of the Optimists. They talked about dividend studies going back over the last 100 years. Not only just in the US but 16 other markets. Study after study after study, it's confirmed dividend investing is a far superior approach and a more stable approach. And especially for somebody entering into retirement that wants to be a little bit more conservative in thinking about what they are going to be doing when they retire: maybe they have 401(k) program or a pension that they are going to have to rely on. That's why I think in an age of inflation, you've got to think about the dividend approach for income with high stable companies because that's what's going to keep you even with inflation. A Treasury bond today, yes, it may allow you to sleep at night the first six months of the first year. But with the levels of inflation that we're seeing today, it's not going to keep you even with inflation five years from now and you're going to be struggling 10 years from now if you're on a fixed income because what are you going to have that's going to increase and compensate you and allow you to buy the same goods and services that you buy today. It's absolutely amazing, but year after year, the study continue to improve itself. [53:50]

Surviving the Night of the Living Populists

JOHN: Hey ho, away we go, the more they say, the less we know. Well, welcome to silly season everybody. It's actually been under way for a whole year. It's one of the earliest election that we've ever started a run up to, so to speak, and we still have another -- a little over 11 months to go. But it seems like the word du jour has changed. Everyone is walking around glassy eyed saying: “Change.”

“What kind of change?”

“Don't know but must have change, must have change.”

And I think we're in trouble because when you hear politicians talking about change, you really need to ask a whole series of questions, Jim, that are very important.

JIM: You and I were talking about this and one of the things I do each week is I exercise on my treadmill and you can get bored running on a treadmill, so I watch the political shows, the news shows. John, I don't think I could keep track of the number of times that every one of the candidates, I don't care, both sides “change, real change, change for the people, change for the middle class, change for the poor and downtrodden, change for the...” -- the word change, change, change. And then it was funny because one of the programs I was watching, they were interviewing a couple of the supporters of this particular candidate (and I'm not going to get into bashing candidates here), but they were asking one of the supporters outside waiting to hear this candidate how come you're here? Why do you like this candidate? Well, they are going to bring change, so the reporter asks, “what kind of change?”

“Well, uh, change? We're going to be better.”

So they were talking about the word change, but they really couldn't define what it was that was actually going to change. And you wrote a piece for our site and why don't you go through a couple of rules as it applies to change that I think could help a lot of voters this year? [55:55]

JOHN: Well, the fundamental rule of silly season is don't appoint the same people to get you out of a problem that got you into a problem in the first place. So I guess we can rule out change right there since they are all the same people. They are all members of the ruling bodies in our land which have gotten us into bankrupt Social Security and inflation and everything else like that. But there are probably four questions you really need to ask every time a politician says we need change.

Number one, you have to say what does that mean because a government program is more than a name and you'd better know exactly what's being changed or whether it's more of the same, and moreover, are you even going to benefit from it? You know, a lot of these new programs sound really great, but they just simply result in more taxes, a bigger bureaucracy, with very little benefit to the public; or even if it does come to the public, lots of string attached. So you can usually answer the first question by asking a second question:
Number two, how will it be implemented or enforced? The devil is always in the details in the bill. Most political programs sound great until you discover exactly what that program is going to demand of you, which brings us to question number three.
Is it voluntary or mandatory? That’s because politicians are always volunteering your time, resources and contributions –read mandatory taxes for their programs – asking that you make sacrifices to get us out of a problem they created, which is why you really always need to ask question number 4.
Who is going to pay for it? And most of the time it's you. If somebody says we should soak the rich, you really need to ask who rich is and how wet rich can get before they discover your money. And if you can't get hard answer to these four questions, you really don't want the change these people are proposing. [57:34]

JIM: You know, the other amazing thing about this, and this is going to apply to both parties in terms of everybody is talking about a fiscal stimulus program. We'll get into that in just a moment, but if you take a look at, John, the failure of communism at the end of the 90s. Look at where China is today as they move towards capitalism. It's the most vibrant economy in the world. The fastest growing economy in the world with the lowest tax rates. Remember the Soviet Union. Well, guess what, they went to a flat tax rate. Vibrant economy. If you look at all of the economies that are prospering in the world, they are probably the economies with the lowest tax rates. And there was an article in the Wall Street Journal this week, and it was all about taxes. And it was called A Supply Side World. And I'll read this paragraph and this is right from the Journal article, so let's dispense with the nasty-grams and it goes like this:

Democrats in Congress remain committed to raising taxes on the grounds that tax rates don't much matter to economic growth. And in any case, they only help the rich. They may be the last public officials on the planet to believe this. In recent weeks alone, some of the unlikeliest political leaders around the globe have endorsed tax cuts in the name of making their economies better. Let's start with Europe where socialist party Prime Minister Jose Luis Rodriguez Zapatero pledged in December that if reelected “one of the first decisions I will take is to eliminate the wealth tax,” which he says is one of the highest in Europe and punishes savings. And he's no conservative. Likewise in France, Germany, and Spain, they are cutting taxes because of tax competition from their European neighbors. There are now at least 11 nations, formally behind the Iron Curtain with flat tax rates of 25% or lower. The newly elected Polish parliament is also planning to cut taxes.

And it's not just Europe that’s doing it. If you look at Middle East, for example, Kuwait has decided to slash its corporate income tax rates on foreign companies from 55% to 15%. Kuwait's foreign minister said last year, we only got 300 million in foreign investment last year compared to Saudi Arabia that got 18 billion which has no tax or corporate tax. So anywhere you're looking at, it's getting lonelier at the top for America, which has the second highest corporate tax rates in the world at 35%. Very few developed nations have tax rates that are above 30%. 26% of developing nations have cut personal or corporate income taxes since 2005. And whether you're looking at Estonia, Ireland, Russia, Spain, Italy, Germany, France, all around the globe they are cutting taxes because they know it stimulates economic growth. Only in the US are we talking about that raising taxes. [60:48]

JOHN: I'm always wondering why this is such a hard sell to people. I guess the analogy I always thought of is one of raising taxes that makes us wealthier let's just take 100 percent of what you make. Okay? You should be rich. You know the other thing too is like Hillary Clinton unveiled 70 billion dollar tax stimulus program and it's basically going to give a tax rebate to voters. And you know, Bush tried this in 2001. Let's say that we want to stimulate the economy, John, so let's say we're going to give every single individual 300 bucks, or a married couple 600 bucks, very much like the Bush rebate in 2001. They tried that. It didn't work. And the reason being is, let's say the government gives you a check for $300. You go out and maybe you spend that money over a one month or a two month period of time, so you get this temporary surge in consumer spending for a month or two. What happens afterwards? So after the second month when you've already spent the $300, what's going to keep the economy and stimulate the economy to go even more? Even worse, what if, in order to give you the $300 they take that away from a business entrepreneur, they take away 600 dollars of his income or her income to give to somebody else. So now that business person, who is mainly responsible for creating most of the jobs in the world in this country, has less money to reinvest in new plant and equipment. It's the whole economic system in the United States with economic thinking. If you can go into debt or consume more, they think that's what brings wealth. And that's one of the problems. One of the reasons that we think if we go this way, we're going to end up in a great depression, especially given the amount of debt in the system right now and also the fact that the economy is weakening. [62:48]

JOHN: Well, maybe that falls in the line of the old adage of if you give a person a fish, you feed him for a day, which is good, I guess, in a crisis situation, but if you teach him how to fish, you then feed him for a life time.

JIM: And you know, the other thing too, you hear all of this economically and you're hearing it more and more, “we need more consumer spending.” Oh my goodness, it accounts for two-thirds of GDP. We've got to have more consumption. We've got to consume more. Well, one of the problem is we're consuming too much! Just the opposite. What we're not doing is saving and investment. And I want to draw an analogy and this is why I think a lot of this is misplaced. If you take a look at the way we measure GDP in this country, we measure GDP in terms of finished products. So let's say I'm Ford Motor and let's say last year and we built one million automobiles and we sold one million automobiles to dealers. Those one million automobiles will get counted in finished product in terms of measuring GDP. What GDP doesn't measure, John, is at the Ford factory, at the end of the year, not counting the million cars that Ford sold, you had cars that were in the process of being built on the assembly line. You might have had, let's say, 100,000 cars that were on the factory floor that were at the chassis stage. You might have had another 50,000 cars that were in the final assembly stage. Maybe they were putting in the windows and the seats. What we don't count in GDP is in process goods and if you take a look at that, I think the last figure we have is 2004, 2005. We had 11 trillion GDP, but if you counted all of the goods that were in process inventory, our GDP would have been closer to 18 trillion. So manufacturing accounts for a much larger portion of our GDP. We just don't measure it.

And the real emphasis is and should be on saving and investment because there is the old saying, “well, if we cut taxes for the rich, they will just save it and invest it.” Well, let's talk about that. Let's take a look at where jobs are created in this country. Let's take a guy like Steve Jobs. Late 70s he works at Xerox or I forget what company he worked for. He's messing around in his garage and he invents the Apple 2E personal computer. And all of a sudden, it takes off. He gets venture capital. He starts a company, he starts a manufacturing plant and let's say he goes out and creates as a result of his business 100 jobs. Think what happens when Steve Jobs created 100 jobs for Apple Computer. 100 people now have a paying job that gives them the ability to produce more. And it's not just the 100 people that Steve Jobs created at Apple computer. Think of all of the parts suppliers, whether it's plastics, whether it's steal, whether it's copper wiring. Think of all of the ancillary companies that were providing product to Steve Jobs. Now Apple has thousands and thousands of jobs. That's what creates wealth and that's what stimulates the economy. And that's what Bush did in 2003. He finally said, wait a minute, the tax rebate idea worked for about a month or two, we got a little blip and increase in GDP and then the economy began to slow down again. So what they eventually did was they created a stimulus program in the capital markets. They lowered the capital gains rate from 28% down to 15. They cut the dividend tax on dividends down to 15%. They lowered the tax rates to 35% from nearly 40% and they created a stimulus; and what they won't tell you, John, is tax revenues actually went up. And that's how you create real wealth.

And the unfortunate thing in this country is we do everything to discourage savings and investment. We penalize you for it. And instead, we encourage you to go into debt and consume. And unfortunately, because we consume more than we save and most of what we consume, we consume or made overseas, that is why the United States has gone from being a creditor –one of the most powerful manufacturing nations in the world – to a debtor nation that is dependant on handouts from the rest of the world for $3 ½ billion a day in terms of consumption. And so I don't care if you're looking at the Bush administration, which is talking about another tax rebate, or the Democrats talking about tax rebates, John, that's the equivalent of giving a man a fish instead of creating policies that teach more people to fish and create more jobs. [1:08:03]

JOHN: What would it do in terms of sticking more liquidity in the cash system, though?

JIM: You know, short term, what they are trying to do -- they are worried about consumer spending is going down as a result of falling real estate prices, foreclosures. Even if you're doing okay and you're seeing houses go up for sale, your neighbor is talking to a friend of mine, he lives in a development where two of his neighbors just lost their jobs and they are putting their houses for sale, you know what? If you're seeing that in your neighborhood even though you may have a good job and doing okay, you probably aren't going to think it yourself, “you know what, let's go out and spend a whole bunch of money right now.” You might start thinking about pulling back. So what they are thinking of doing is actually, “okay, let's get some money into the system to keep up consumption,” instead of coming up with the stimulus pack damage to let's say, why not rebuild the country's infrastructure, the rail system, the energy system, the water system, the airport system, the bridge system. Roads, transportation, all of the things that make this economy work and also create incentives to have more Steve Jobs, Bill Gates in the world.

Think of the jobs that are created when a guy in Seattle decides, you know what, people like coffee, I'm going to come up with this high blend of coffee. We're going to franchise it and start building franchises all over the United States and all over the world. That's what creates wealth in a country. That's what creates jobs. Most of the wealthy people in this country are self-made individuals, that are entrepreneurs. You're not going to create wealth and stimulate the economy by going to all small businesses and raise their taxes in order to get rebates to voters that may not last more than one or two or three months. It has failed. The Bush rebates failed. Any new rebate will fail equally as well. That's not how you create jobs. We’ve got the whole thing backwards. We've put the cart before the horse. Savings and investment are the horse that pulls the cart. And I don't see anything, John, other than Ron Paul on the campaign front who is coming up with an economic fiscal stimulus program that would actually benefit the country in the long run. All of these things are just short term solutions, fly by night solutions that would do nothing more than maybe buy a few votes for the election. [1:10:38]

JOHN: Well, as we are 297 days until the next elections, this whole silly season is going to get sillier and we think we're going to see the conversation here shift because this whole effort, this whole concept about “spend and go into debt to keep the economy afloat” versus save and invest versus higher or lower taxes, I think that's going to become more and more center stage as we go through these, well, we're almost at 300 days here, 297 days. I think you're going to see that. So we will revisit that here on the program.

JIM: Well, we'll probably do a series here on savings and investment and explain how this works and how going into debt and consuming does not build wealth. There is a site out there called www.mises.org that has a great article by a very astute economist Robert Blumen. I recommend that you Google, go to the site and read Robert's latest piece that he's written about saving and investment and consumption. Very well written and will give you a greater understanding of how this all works and how our politicians have really got this backward. If you look at some of the statistics, it's just absolutely amazing of where we've gone over the last, two, almost three decades from a nation that produces goods, makes goods that had a trade surplus to a nation that has gone from becoming a creditor to a debtor to a nation that is running huge trade deficits. And all of this is explained in economic babble as good, kind of economic planning, when we know if you were looking at the balance sheet of the United States of the American consumer and you were a financial analyst there is no way that you would come away and say “I want to invest in something like this.” That's not how you produce wealth. And we're doing to be covering this topic to a greater extent in the weeks and throughout the months ahead as we head into that final election season, because this election is going to be a pivotal turning point for the United States. Will we move towards free markets, saving and investment, creating real prosperity for the long run or are we going to go to punitive taxation, less freedom, more regulation, a greater welfare state and greater levels of inflation? The time and our history has never been as critical as it is today. [1:13:05]

JOHN: Yeah. I would tend to say in there that the answer is probably the latter until such time as people feel a lot of pain. At that point you'll see the conversation shift. A lot of this has been brewing for a long time but it didn't affect a lot of people, but now more and more people are being affected by it. And providing you can keep the debate on track, like I say, if we think, say for example, that Ron Paul gets a lot of traction now, look at the contributions to his campaign. Think of what it would be four years from now after we've been through a lot of this pain.

JOHN: Well, coming up the next hour, we'll take your calls on our Q-line as the Financial Sense Newshour continues right after this.

Part 3

Q-Calls

JOHN: Now comes the part of the Big Picture where we like to hear from you. We have the Q-line open 24 hours a day to record your call-in questions to us. By the way, every once in a while, someone does this on a speaker phone. It doesn't sound as good, and sometimes we can't even use it because the quality is not very good. So if you're going to call in a question to the Q-line, please use your telephone hand set and do it that way. We have a toll free number, which is toll free in the US and Canada, 800-794-6480. That number does work from the rest of the world, but it's only toll free from the US and Canada.

And please remember that the information we present here on the Financial Sense Newshour is for informational and educational purposes only. You should not consider it as a solicitation or offer to purchase or sell securities or any other related items. And our responses to your inquiries on the Q-line, for which you should provide your first name and location are answered just based on the opinions of Jim Puplava. We are unable take into account your suitability, your objectives, your risk tolerance. We don't know enough about you. And as such, Financial Sense is not liable to any person for financial losses resulting from investing in companies profiled here on the program. Please always seek out the counsel of a qualified investment counselor before you make any investments.

Here we go with the first one. First caller today is from Toronto, Canada:

Hi, Jim and John. This is Greg from Toronto calling. Happy New Year to you. Just had a quick question regarding stock buy backs and your views. Over the last two years we’ve heard nothing but the stock buy backs, whether it's Home Depot, General Electric, Intel, Citibank. I find it ironic how these companies are buying back their shares at much higher levels. Yet when the stocks are at depressed levels there is no news of them buying back their shares. Is this a function of the fact that they can't get credit or is their balance sheet in that poor shape that they have no extra cash to buy back their shares? So just wondering what your comments were. Hoping you all of the best in 2008. Thank you.

JIM: Greg, sure, buy backs have actually increased over the last couple of years, and I expect that to continue. One reason that they've been doing that, (and you look at some of these corporations and you do this with companies that have good cash flow, and also have a good return on investment) let's say a company earns 20% return on equity. There is a good incentive to buy back your stock. There are fewere shares outstanding. That means more of the profits that you earn and the cash flow can be used to retire this stock, and you create shareholder value. Last year was another record year for stock buy backs and I expect if PE ratios contract or cash flow continues for a lot of these companies with successful business models, I think they will continue to buy back their shares. It actually helps shareholders. And last year was a record year, so I'm not sure which companies you were saying weren't buying. I know that the very successful companies that were making a lot of money were plowing a lot of that back to not only increasing dividends (if they paid one) but also buying back their shares. [3:15]

Jim and John. This is Richard on holiday in the Argentina section of Changmai, Thailand. Although my Stockhouse.com buddies thought your November gold show was fabulous, many of us were disappointed that there wasn’t more discussion on the challenges faced by mid to late stage gold exploration and development companies as to their progress toward going into production. Would it be possible, Jim, for you to select from your list of favorite gold juniors a CEO to interview who can speak about these issues?

JIM: Richard, I think you know the company that you're talking about, and actually, I've been talking to that CEO and we'll probably have him on this program as soon as certain things happen here in the next, I would say, probably four-to-six weeks. And also we'll be having a couple of things that we're going to do this year. We're going to have some CEO round tables. We're putting together, for example, a gold round table in February that's going to have an all star, one of the best money managers in the world who happens to love gold and buying it; James Turk and Bill Murphy,. The other thing I'm thinking of doing this year is having two or three CEOs from junior companies, some in the exploration stage, some in the mid stage development, as well as one that's going into production. So we are already going along those lines and the one that didn't get done in November will be done in the first quarter. [4:44]

Good morning, Jim and John. It's your loyal listener, John, over in Austin, Texas with a comment. Jim, I've got a new indicator to go along with your parking lot indicator about the economy. Mine is an indicator about where we are in this gold and silver market. I was out a couple of days over the Christmas holidays and the good old boys paid me a visit. I wasn't here, so they went ahead and kicked the front door in and ransacked my residence and did take a couple of guns, they took my computer. But right next to my computer on the desk was two beautiful Johnson Matthey 10 ounce silver bars, which they just left there. And on the coffee table in the living room, I have a beautiful Engelhard 10 ounce silver bar and a small little gold coin just for decorative purposes. They left that there. So I'm calling this my burglar index, and when the burglars leave silver and gold in plain sight and take guns and computers, you know that we're very, very early in this precious metals bull market. So I'm chalking that one up along with your parking lot indicator to offbeat indicators as to where we are in these markets. Have a good day and a good year. Thank you.

JIM: That is absolutely amazing, John. They take the computers, the guns and they leave the gold and the silver. You're absolutely right, they probably looked at that and said, “what's that? Silver, what do you do with that?” [6:11]

JOHN: “I don't know, George. What do you think of it?” “I don't know. Grab the guns. Take the computer. Take the guns.”

JIM: That is absolutely amazing, John. Sitting there a ten ounce silver at 15 bucks an ounce, there is $150. If it was a gold coin, gosh, a gold coin is worth almost 900 bucks. Absolutely amazing that they left that, but it just goes to show you, gold, what's that.

Hey Jim and John , Jeff from Myrtle Beach, South Carolina. I called a while back asking your opinion on coal bed methane production in China and I didn't get an answer to that yet. I totally agree Americans are not at all interested in gold even now. They are totally clueless on it because I talk to people all of the time that I had mentioned about gold years ago or even six months ago or more and I don't mention it, but I wait for them to bring it up about how well gold has done and they never do. They are just not even aware of it. But I can't thank you enough for all of the great information you bring us every week and I listen every week. Thanks a lot.

JIM: Well, Jeff, if you think your friends aren't interested, listen to the previous caller, John, whose house was burglarized and they left the gold and the silver. So it just goes to show you it's not on anybody's radar screen. [7:30]

My name is Steve from Virginia Beach, Virginia. And my question to you all is regarding retirement accounts. I have my retirement account managed with a well known brokerage firm in the United States. The question is: do I need to worry about them becoming insolvent because of the current financial debacle, first off. And second, if so, should I look overseas perhaps to Hong Kong for an investment firm that can help me secure my funds’ future. Thank you very much. I really enjoy your show.

JIM: You know, Steve, I don't know how much you have in your retirement accounts. Most major brokerage firms are covered by SIPC. And all SIPC does is basically if they abscond with your shares or money or something, you're covered for that. You're not covered if the value of your shares go down. If a major brokerage firm was to fail, they would consolidate and merge it. I mean just take a look at the purchase of Bank of America of Countrywide on Friday. Basically Countrywide was insolvent and bankrupt, which is why that merger went through. So, no, I wouldn't worry about it. [8:37]

Hello, Jim and John. This is George from Texas and my question is in regards to asset allocation among sectors within a currency versus allocation among various currencies. For example, my assets are now all in US dollars distributed in decreasing amounts among various holdings in energy, municipal bond funds and precious metals. I'm in the process of dollar cost averaging on a monthly basis so as to change some assets from municipal bonds to precious metals largely based upon what I've heard from listening to your show. Now, here is my question. Do I also need to consider diversifying my assets among different currencies according to the approach recommended by Peter Schiff who you had on your show last year, because several times, Jim, you have made the point that all currencies are now being debased because governments have their printing presses going. So from an inflation hedging standpoint, there is nothing to be gained by global currency diversification; right? However, is it nonetheless a good idea to diversify into other currencies in case of a fairly sudden failure with the US banking system with all of the problems that you've been discussing on your is show? Thanks Jim. Great show.

JIM: George, when it come to currencies, all currencies are debasing, so I still stand by the fact that the ultimate currency is gold and all currencies are depreciating against gold. So I still stick with gold as the ultimate currency. Now, I do like international diversification in terms of owning companies. Almost 40 to 50% of the companies that we own in our investment portfolios are international companies either based here or overseas. Our mining companies are overseas, a lot of our base metal companies are overseas, a lot of our oil companies are overseas, some of our medical companies are overseas, because that's where you're seeing faster growth. So outside of owning gold as a real currency, I do like international exposure from companies because the strongest economic growth is there. So if you want to have exposure overseas, think about it in terms of either owning, let's say, an international oil company, international gold company or an international, or let's say, an ETF that invests in blue chip companies overseas that will give you that international exposure.

Hello, Jim and John. This is Larry in Evergreen, Colorado. Happy New Year to everyone at Financial Sense. I just had a suggestion for a guest. I think it's about time for another interview with Bob Prechter. His long standing forecast is that the market is on the verge of a crash and he’s believe that gold and metals will go down with them, which is in contrast to your more bullish view. Keep up the good work, guys and look forward to your program every Saturday afternoon. Thank you.

JIM: You know, Larry, it probably is the time to interview Bob Prechter and that might be something that comes up later in the year. We're already working right now adding somebody from Elliott Wave International –Bob's organization – to our technical experts in the first hour. So hopefully we will have somebody from his organization as one of our experts. And of course what Bob believes is reflected throughout the organization and that's something that we can ask that individual should he decide to come on and be one of our experts. [12:07]

Hi, Jim and John. This is Dilip from Santa Clara. I have a question about hyperinflation. What is the definition of hyperinflation according to you? Is it an inflation rate of 50% a year, 100 percent a year, any particular number like that? Would it be measured in terms of x percent per month. What precisely is your definition of hyperinflation. Now, since you’ve mentioned that 2010 onward we could probably see hyperinflationary depression, another question I have regarding inflation and deflation is that I read in a book that gold does well under deflation as well as hyperinflation or even straight inflation, a higher rate of inflation, whereas silver can only do well in a situation where we see inflation, but it will do well in deflation because it’s mainly a commodity and secondarily a money or currency. So does that explain why it's kind of lagging behind gold at this point. A lot of people are thinking in terms of deflation rather than hyperinflation. So once it becomes obvious to more people that we're heading towards higher rates of inflation, would silver be able to catch up with gold and get back to the older ratios that it had with gold like 20 to one –something like that – from its current ratio which is only like 50 to 1, gold to silver. Thank you very much. I really enjoyed your year end summary and also the look ahead that you published dated January 5th. Thanks.

JIM: Hyperinflation's official definition is inflation that's out of the control. A condition in which you get prices increase rapidly as a currency loses its value. Dilip, they have no precise definition of hyperinflation universally. Generally, it's inflation rates of 20 or 30% more, much like the mismanagement of the Venezuelan economy right now where they are experiencing 22% inflation. Venezuela has a hyperinflation economy.

In terms of gold and silver, we had some unique aspects of silver in this country in the 30s that made it a little bit different. But if you look at throughout history, gold and silver has always been recognized as real money whether you're looking at inflation during the Rome Empire period where the emperors went from gold and silver coins to copper and they started cutting the metal. But silver is recognized as money. Whether silver has been a laggard here in the next year, but remember up until the last year, silver was actually out performing gold. And I expect silver, this year, will out perform gold. [14:49]

Hi Jim. This is Charles from Huntington Beach, California. And I had a question regarding these sovereign funds. If sovereign funds, basically, are national and the monies are being created by central banks out of nothing, what is to stop political unrest from some countries’ sovereign funds buying up real asset in other countries? Thank you.

JIM: It really depends on what happens politically. I mean a good example of that is when the Chinese try to buy US based oil company Unocal and they stepped in and stopped it, or when they stopped Dubai from coming in and taking over some of the ports. You could see that. But I think there is going to be a trade off. In other words, the US is such a debtor nation, we cannot survive. I mean take a look at anything that you buy in a store today is not made here. And if you take a look at a country that has to import 70% of its energy, both in raw form like oil and natural gas or in refined form like gasoline and diesel or jet fuel, eventually, we're probably going to have to make a deal with some of these people in order to get financed and we'll allow them to come in and buy some of our assets. Much as, for example, they did in the late 80s and early 90s when the Japanese were coming in and buying Pebble Beach and Rockefeller Center. So I think you could see a political backlash, but in the end, we need money and when you need money and you're the debtor, you don't make the rules. [16:16]

Hello, this is Bill from New Jersey. I have a question regarding James Turk's GoldMoney service that has been featured on your show. I was curious: Is it necessary to list a GoldMoney account as a foreign account on US tax returns, and if so, what information is the account holder required to list. Thank you very much, and I look forward to your reply.

JIM: I'm not sure. I don't think you need to, but you know what, Bill, I'm going to plead a little bit of ignorance on that in terms of you might want to contact the people directly at Gold Money, and I think they can advise you on that. I don't have an answer. [16:50]

Hi, Jim and John , this is Mike from Michigan, just wondering if you happened to catch Secretary Paulson, I guess on that morning financial show, quote, unquote. He was saying something to the effect he expects that all world currencies to reflect global competitiveness. Anyway, I just thought it was an interesting window into his actual thinking and keep up the good work. You guys have a great show.

JIM: You know, Mike, he was basically acknowledging the fact that it's happening today. It's beggar thy neighbor policies where all of this money printing and pegs is being done for the very reason nobody wants their currency to appreciate against other currencies. Although, I expect the Chinese to let their currency float up especially as inflation rates rise. But, yeah, it's pretty interesting that he picked up on that, but he should know. He's the Secretary of the Treasury. [17:44]

Hi, Jim. This is Tyrone from the Gold Coast, Australia. You are predicting that the US will enter into depression in 2010. This would mean that GDP of the United States will drop drastically. Wouldn’t this imply that oil and precious metals prices will plunge as well and we may see them back to where they were in 2001. What is your take on oil and precious metals prices during a depression? Thanks.

JIM: Tyrone, one of the factors that I see in the perfect storm in 2010 is peak oil. I think prices are going to go even higher and I also think this is going to be a hyperinflationy depression. Much like what happened in Germany and Argentina when their economy collapsed with their currency going down. So hyperinflation rather than deflation. And under those circumstances, given what is happening to declining oil production, and the world's thirst for it, you just don't stop the economies overnight. And one of the things I think they always forget when they talk about demand destruction, you also have supply destruction. If the price was to drop, you would have a lot of drillers that would just pull up their drills and stop producing, stop drilling and production could actually go down faster than demand is dropping because on the demand side, if you have a utility that burns natural gas or, let's say, oil to create electricity, you don't stop that. If you take a look at what most people do in normal driving, it's getting to work, getting from work. It's getting to the store. People aren't going to trade their cars for bicycles, or going to start walking. Although, maybe longer term, that's the direction we're going to go in if we do nothing to fix this problem. But in a hyperinflationary depression, I expect gold and I also expect energy because energy is going to be one of the storms that we're going to hit. And you've heard us talk about that window period from 2009 to 2012 on the energy front. We'll be addressing that issue by the end of the month in an energy round table with Robert Hirsch who did a study for the government; Matt Simmons' and one of the all star oil analysts from CIBC, Jeff Rubin. [19:58]

Hello, Jim and John , this is Forrest from Alberta, Canada. I was wondering what you think about cobalt and in particular a company called Formation Capital Corporation. Cobalt seems to make more sense to me than silver. Thank you for your response. Love your show. Listen to it every week.

JIM: You know, Forrest, I can't comment on individual companies and especially a small junior type company. Cobalt is a very important mineral. It's used as an alloy for example in gas turbines, aircraft engines. It's used as adhesive for our alloy for corrosion. It's used in high speed steels. It's used in magnets and it has all kinds of industrial applications. And we're having a harder and harder time increasing and finding base metals and precious metals. So it has a good future in it, but in terms of commenting on individual companies, I'm not going to comment. [20:52]

Hello, Jim and John. This is Michael in Vista, California with a suggestion in case you two ever decide to open an online store featuring Financial Sense merchandise. You could offer a T-shirt featuring a sketch of former Fed chairman Paul Volcker clamping down on his characteristic cigar as he decides how to clamp down on our run away inflation. The artist could depict him as a cross between General George Patton and the grinch who stole Christmas, or at least the grinch who took away the punch bowl. Underneath the drawing it would read where is Paul Volker when we need him. Of course, given the way commodity prices are going, including cotton, in a few years, you might have to charge $100 per T-shirt. Take care, gentlemen.

JIM: You know, one of the T-shirts I probably would have in addition to Volcker more importantly would be a Ron Paul T-shirt.

JOHN: Yeah. I'd have a Greenspan, “we didn't see it coming” T-shirt too.

JIM: Or how about one of Greenspan, “what, me worry?” [22:01]

Hi Jim and John , this is David in Los Angeles. Jim, I manage a very small amount of money for my elderly father and a year ago, I got him two Everbank CDs. One in the loonie and one in the euro and they've done quite well for the year. They are about to roll over in early February. I was just wondering about your thoughts on the different currencies. I'd like to roll them over again unless you think this is just an awful idea. I need to keep him somewhat liquid and in somewhat traditional investments, otherwise my siblings will squawk that I'm doing something crazy with my dad's money. So I'd like to try to keep him in those CDs or something similar. Anyways, I was just wondering what you think about the Canadian dollar and that's probably pretty safe for the next year and the Euro I'm wondering about, is that safe for the next year? Or are there better currencies I should move the money into? By the way, I also have another $20,000 of his invested in gold and silver. So I'm following your advice as well as possible and have done quite well, so thank you for that. Any way, your thoughts would be greatly appreciated as usual.

JIM: You know, David, in addition to those currencies, I'd roll them over, one currency I'd look at right now is the Swiss franc, they have the lowest increase in the supply of money. The Swiss bank has been raising interest rates. So if you take a look at another currency to consider, I'd add the Swiss franc. [23:31]

Hi, Jim and John. Richard again from north San Francisco Bay. I want to thank you guys for filling in my economics education, but as you know, the more you know, the more questions you have. And you've done a marvelous job. So, here's a question for you. How much money has the Federal Reserve bank actually issued in paper coin or electronically? We have accounting because dealing with money is so difficult and whenever there is money, there are schemers. We know some 400 to $600 billions will miraculously appear as debt on various balance sheets then the miracle makers of the Fed and various accounting departments will perform more magic and perhaps make part of the debt disappear again. These miracles will change what we call the money supply yet not a single dollar has to have been issued in print or electronically. It can be done using interest rates and reserves and accounting. So how many real honest to God dollars has the Federal Reserve bank actually issued? Looking forward to your answer and thanks again for a great job.

JIM: You know, Richard, I've got my computer shut off at the time you and I talking. I forget what it is. I know that for example, M1, which is currency in circulation and checking accounts, that's somewhere around 1.4 trillion. And monetary base has unfortunately been declining and I just don't have that figure off the top of my head. But one thing I'd recommend too is stay tuned next week. One of my guests is going to be John Williams. He's got a new issue on the piece that he’s written on the money supply, and we'll be talking about that, and I'm sure John will have that. But right now, my computer system is turned off. This is the last part of the show. I don't have that, but I do know that M1 is actually around 1.64 trillion right now. [25:20]

Hi, Jim and John , this is Ben “burn the currency” Bernanke from Washington D.C. Excellent website, amazing interview. I have two questions the first one is the hyperinflation that you predict or foresee coming in 2009 and 2010 timeframe What's your definition of deflation? Is it unemployment rate greater than 10%, 15% or even higher? I'm just curious. The second question is about a Puplava deflation bunker. Where can I order one, Home Depot or Walmart? and is it structurally constructed that you can take one hits or two sack or three sack or money hits from B52 bomber. Thanks. Enjoy your show.

JIM: You know, probably the definition of a depression, and I'm not sure that it's widely accepted, I mean if you take a look at a recession the sort of the quasi-official definition is two consecutive quarters of negative economic growth; a depression would be definite economic growth and probably an unemployment rate that is well over 10 percent. I think of -- John, do you remember what the figures were during the Great Depression? Was it 25% or one third of the people of this country were unemployed? Ben, I don't know what that figure is and can you order a Puplava depression bunker. Probably the easiest way is you can get it through any coin dealer and that's gold. [26:51]

Hey, Jim and John, this is Josh calling from the oil fields where it's been a balmy 70 below the past, oh, three weeks or so with wind chill. My question is regarding bullion. I have a pretty sizable bullion stash and physical bullion. Most of it is silver. I do have some gold. My question is: viewing the economic outlook you see through 2010, would it be wise to sell some of my physical bullion and maybe keep it in account, like GoldMoney, or would you hold on to it. Thanks. You guys have a great year.

JIM: Josh, I'd hold on to your bullion most definitely. It's going to be your lifesaver. If you're thinking of increasing and diversifying your bullion holdings, then I would add to GoldMoney would be what I’d consider, but definitely hold on the what you have. [27:34]

Hi. My name is Larry. I'm from Arcadia, California. First of all, thanks for the great show. I want to let you know that I listened to it over and over many times during the week. My question has to do with gold bullion. I noticed that you recommend gold bullion as part of a portfolio in addition to gold stock. And certainly gold bullion has out performed stocks recently, for example in the year 2007. However, since the beginning of the bull market stocks have way out performed bullion. My question is why not have all of your precious metal allocation in stocks 100 percent, and no bullion, since stocks way outperform bullion for the overall duration of the bull market. Thanks very much.

JIM: You know, Larry, we always recommend owning physical bullion as part of any portfolio. That's part of your insurance policy and just like last year and actually where gold was up 31 or 32% where the stock HUI was only up 20 and a lot of these smaller stocks actually had negative returns. Actually even within the HUI, I think it's only a handful of stocks that created the performance. There were a lot of companies in the HUI. But, you know, there is a little bit more risk, and towards the end of a market, the gold precious metal stocks will get so bonkers at the very end bullion tends to outperform the stocks. But it's good insurance. And you've got to be careful with the gold stocks. I mean what if you owned a company that has its mine confiscated by a country, so at least you own the bullion. It's probably the safest form to begin with. [29:20]

Hello, Jim and John. This is Dave in Nevada. In last week's show, there was a talk about the possibility of a depression occurring sometime within the next few years. I know that you've read a lot of books about the history of the Great Depression in the US, and I have two questions. One, if you could recommend only one book to read about the Great Depression, which one would it be? And my second question is: As I recall, you think that the next depression will be different from the Great Depression in that it will be an inflationary depression? Are you planning to do a special feature on how to prepare for and survive in an inflationary depression? Many thanks for all of your help. I really enjoy your program.

JIM: You know, Dave, if there was one book that I would read right off the bat. It's probably one of the best books. It's by Murray Rothbard and it's called America's Great Depression. If you read this, you will understand why we see a depression. It describes the events leading up to the Depression. It talks about the mismanagement by the Hoover administration and the Roosevelt administration that turned what could have been a minor recession into the Great Depression. It will give you an understanding of the government schemes. You read it and you're going to say they are talking the same thing today. And so I think that's one of the better books. And Dave, two other books. If you really want to understand hyperinflation, you're going to have to search maybe a library, maybe you're in a big city that you can get to. It's called Dying of Money by Jens O. Parsson. You've heard me quote this over the last three or four years, so it's kind of hard to get. And another one is When Money Dies by Adam Ferguson and probably another one called The Great Inflation by Bresciani-Turroni. Three great books that I would add to Rothbard's books if you want to understand where it is that we're heading. [31:22]

Hi Jim. My name is Ram [phon.], born in India, educated in the USA. My Dad has been a banker all of his life but I never bothered to know the mechanics of money, but I’m a mechanical engineer. I would like to thank you for educating me. Now I think I know more than my dad. I have a question. Tech bubble was limited to but unlike tech bubble, I think gold is a global commodity. I feel your view of the gold price and US and Europe centric. What impact will gold have if people in India, China, the Middle East start thinking of gold as money? Is there any chance that will happen. I read that the Middle East is buying gold like crazy. Is it going to accelerate the price of $1000 as you mentioned considering the global need as a policy creation? And I would like to thank you very much. I look forward to your answer. It's a wonderful program.

JIM: You know, Ram, one of the biggest things that have been driving the price of gold is exactly what you just made reference to, especially the country of India which is the largest consumer of gold in the world. You've been buying gold, gold is a more important form of savings in your country. I don't need to tell you that, so I expect that to continue and accelerate and that will be just like China and India has been driving commodities up, like for example, the demand in energy as your economies industrialize. I expect likewise as your economies become wealthier, as people in your country become wealthier that the demand for gold will increase. The country of India is already a significant factor in the gold market. In fact, one of the most significant factors. I expect that to continue. The only difference is buying of gold as an inflation hedge against depreciating currencies is now becoming a global event and it's catching on around the globe, so I expect it to accelerate. [33:19]

Hello, Jim and John. This is Ira calling. I had a question about asset allocation. I currently have invested my savings in mutual funds as follows: Large caps, 25%; international funds, 25%; gold, 25%; natural resources and technology, 25%. I’m in my late 30s. I wanted to be relatively aggressive. Do you think my current fund of allocation should change and how? I'm looking forward to your answer.

JIM: Ira, I like your asset allocation, especially energy and precious metals. Two things I would probably add to your allocation if you could: food and water. Listen to the first part of the second hour as we talk about “living with uncertainty, thinking strategically.” [34:21]

Hi, Jim and John, it’s Grant from Toronto calling. A couple of quick questions. One has to do with the recent budget situation in California, its effect on the potential for the alternative energy. I know California has been a big proponent of solar power and other alternative energy resources and they’ve been giving out subsidies to these solar power manufacturers or installers. I wanted to know if there is going to be any threat to that situation and possible ramifications for some of these solar companies? And the second is also your thoughts the fiscal situation in Washington, especially if the Democrats get control of the White House. I've been reading commentary regarding the Bush tax cuts being repealed. That's going to be a negative for the US stock market. I know, Jim, that you’re looking for a pullback followed by a big rally. Any thoughts on that and the whole valuation metrics if the situation changes if the Democrats get into power.

JIM: I think if they gain control of Washington, they will accelerate the movement into a depression by doing exactly what you just referred to, repealing the Bush tax cuts, adding other taxes on top of that, more regulations, lawsuits. I mean just listen to the topics that they are talking about in terms of regulation. We're looking at a situation where the United States’ unfunded liabilities, I think it's 54 trillion. And if you look at our budget deficit numbers, I think last year they were 164 billion and yet the national debt increased by half a trillion, so they are not telling us the whole fact. And we know that Medicare and Social Security are bankrupt. You add socialized medicine at a time when we can least afford it and force higher prices for this, it's just going to accelerate. I mean we're living well beyond our means. If we were to perhaps come out of this and thrive, it would be to slash government spending, cut taxes, cut regulation, create incentives to build and invest. I mean this country's infrastructure is falling apart. But that's not what we're going to do. And unfortunately, just as a previous caller asked about a good book to read about the Great Depression, I'd definitely read Murray Rothbard's The Great Depression because you'll understand as you read through it of the fallacy of various government programs. And all you have to do is pick up the headlines or watch the evening news after reading Rothbard and we're repeating the very same mistakes that led us into a depression. It's just absolutely amazing and maybe that's why I think what Mark Twain once said: history doesn't repeat but it rhymes – and I'll say we're doing a lot of rhyming right now. [37:09]

JOHN: Jim, we have some great shows that are coming up in the very near future. Looking forward to them myself, and they are going to be involving?

JIM: Well, next week Louis Vincent Gave will be joining us from GaveKal Research. He will give us his views about the economy, the markets and Louis is more optimistic. We've had some caution coming in from Paul Kasriel and Dr. Marc Faber. We're going to counterbalance that with Louis Vincent Gave. He'll be my guest next week. Following that Dick Davis, the Dick Davis Dividend. Also, you're not going to want to miss this: February 2^nd, we're going to have an energy round table between: Matt Simmons; Robert Hirsch, he was the gentleman that started the peak oil study for the government and issued the Hirsch Report in 2005; and probably one of the best analysts and brightest analysts in the energy firmament is Jeff Rubin from CIBC. He's going to join us in that round table. Finally – Vitaley Katsenelson, Active Value Investing, February 9^th; Steven McClellan Full of Bull, Michael Stathis, Cashing In On The Real Estate Bubble.

Also in February we're going to have a gold roundtable. We're trying to get that for the third week in February with Bill Murphy, James Turk and probably one of the best value investors in the world who is buying gold. Got him. I want to save that as sort of a surprise, but that will be coming up in February. Lila Rajiva is going to be joining us March 1^st Mobs, Messiahs and Markets. Sy Harding Beating The Market The Easy Way on March 8th and Alex Doulis Lost On Bay Street. If you want to understand some of the things that we talked about, crimes of the Century and all of the shenanigans that are going on in the financing of the mining sector, you don't want to miss that. Alex Doulis has got a new book called Lost On Bay Street and he was an insider. He was a guy that actually worked in the brokerage business. He's written a new book. He'll be my guest. So a lot of great stuff coming up on the program.

Meanwhile, on behalf of John Loeffler and myself, we’d like to thank you for joining us here on the Financial Sense Newshour. Until you and I talk again, we hope you have a pleasant weekend.