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Financial Sense Newshour

The BIG Picture Transcription

January 19, 2008

Part 1

Back to the Next Depression, Part 1

JOHN: Remember in our opening show of the year, Jim, you made a number of forecasts. One was going out to 2010, whereby you forecast another depression. So what we're going to do today is to start a four-part series laying out the case of why, if we continue on the track that we're on right now, the US is headed into a depression.

So the first thing we should do is frame the issue, set the stage and give our listeners some background material on why you believe we are genuinely heading into, not a recession, but a depression.

JIM: Let's talk about setting the background for this kind of a forecast. And by the way, John, we're not the only ones that see this happening. There are a number of individuals, Harry Dent being one of them, he's basing it on demographics. Other people are basing it on debt. So we're not out there just by ourselves, but there are a few of us that see this happening. But what I want to do is discuss why it's going to happen, the policy mistakes that were made, let's say, going back to the last depression and then draw some parallels to the same mistakes that are being made today.

And if you're listening to this broadcast and would like to follow along with us over, let's say, the next four weeks, you can pick up a copy as a good background book on the Great Depression is Murray Rothbard's America's Great Depression. Probably one of the best books ever written about this calamitous event. [1:41]

JOHN: I think it's important too to understand that there never should have been a great depression. This is something if you talk to people who lived through the period, I’ve talked to my mother extensively about it. I wanted to see what it was like to be in that time. She was 14 years old in 1929 when the stock market blew out. What was a market correction and a recession –which is interesting, by the way, a number of the voices on the air on radio around the country today were saying, you have to let it happen, you have to let this blow off or you won't do anything – but what should have been a market correction and a recession turned into a depression (and really what was a great bear market), generally by the policy mistakes made by politicians, both Republican and Democrat.

JIM: That's the surprising thing and we'll get into, for example, the Hoover administration and the New Deal, and then we'll fast forward to where we are today. But the amazing thing, and there are some parallels here, we had a very explosive bull market in the 20s. The economy was growing rather strongly especially with the technology wave that the country was experiencing. Think about it; we had the automobile, we had electrification of homes and cities. We had the airplane, we had radio, talking pictures, all of this great technological innovation that was coming in at the time. So a stock market correction (given the huge rise in stocks that we saw during the 20s) was way overdue. And the economy had slowed down significantly, John, by the summer of 1929 as a result of the Fed rate hikes that began in 1928. Especially after Benjamin Strong had passed away and we got a new Fed chairman that came in.

So a stock market correction, maybe a small bear market and a recession was inevitable given the run up and some of the excesses that we had seen in that time. It was what the Hoover and the Roosevelt administration did that turned this correction and a recession into the Great Depression. [3:45]

JOHN: It's really important to explain the cleansing process for people because when you distort the economy, which is what happens on these cycles, the economy becomes distorted and at some point it tries to correct. And what politicians will typically do is to fight that correction, which never succeeds ultimately; it only gives a little more prolongation of the inevitable. But the country experienced one in 1920 as the government balanced its books after the end of World War I. That was supposed to be the ‘war to end all wars,’ remember.

JIM: Yeah. Business and stock market downturns serve an essential economic purpose. They need to be sharp, but they don't need to be long and that's very key. What they require is on the part of government, business and the public is patience. Had the recession had been allowed to adjust itself, just like in 1929 recession, it would have ended, John, probably within a year. Confidence would have returned, the markets would have recovered and the Great Depression never would have occurred. But you know, politicians today and back then are, like, everybody knows if you go on a drinking binge, you're going to have a hangover. And the hangover is your body trying to get rid of the toxins of the alcohol and cleanse itself so the body can recover. But what we do today is rather than let the economic body recover, we give it more alcohol and keep it juiced up because we don't want to go through a hang over.

JOHN: Right. But if they had, the Great Depression would never have occurred. I mean that's the important thing to understand. It would have corrected, it would have come back out of that. But as such we prolonged it for another 10 years, actually until World War Two broke out.

So if we look at the situation then and now, history doesn't repeat itself, but it does rhyme, we seem to be singing off the same music sheet.

JIM: The one common thread between the 1920s and 1990 and where we are today, the parallels are excessive money and credit expansion in the 20s, which made the economic and stock market boom more robust than they otherwise would have been. So this led to excessive valuations in the stock market and in the economy. And what did we see in the end of the 90s with all of that money printing and the excess money creation is stock valuations got excessive, the internet craze. And so similar to the gains that we saw in the economy in the 20s, similar to the gains that we saw in the US economy in the 90s, we also saw similar attributes: The technology boom spurred on by massive money and credit expansion; like 1928 and similar to 1999, the Fed began to drain the punch bowl through a series of rate hikes to bleed off the excesses. They did it in 1928 to 29. We did it once again in 1999, in the year 2000, and then we began and did it again through 2004 and 2006. [6:47]

JOHN: So as the Fed did this both in 28, 29 and also in 1999, 2000, remember how the market went flat right in the middle of that presidential election. As a matter of fact, the stock market will correct during this time, the economy goes into recession and then it begins to cleanse itself by getting rid of really what are artificial excesses. But that always means economic pain and there is the political issue. So rather than experiencing the cleansing process, politicians begin to meddle with the cleansing process because the government, business and voters don't really have the patience for the cleansing process to just heal where they are at and go for another round of prosperity. They want the prosperity to continue all the time.

JIM: You know, you are exactly right, John. The slide in stocks, the free fall in the economy continued in 1929 and 1930s, not because the government interfered too little, as many experts would claim, but just the opposite. It was because it interfered too much. Hoover began to micromanage the economy, and remember, this is a guy that came up through the 20s managing relief schemes and he began to immediately meddle, order and exhort all kinds of schemes. In fact, many of those schemes only made matters worse, so by 1932, the Dow lost 90% of its value, the economy had gone from a recession to a depression for which basically Hoover lost the election; but the New Deal program was nothing more than a continuation of the Hoover programs. [8:25]

JOHN: Yeah. It's sort of an irony of history because Roosevelt ran against Hoover as a tax and spender, but essentially, the New Deal just perpetuated Hoover's programs; and then added on to that, Roosevelt is calling it a goal to try to finance parts of the New Deal, which was a raw deal really for people who had the gold.

JIM: Absolutely, because he immediately took it and revalued it. But here is the thing. The difference is two fold. Roosevelt actually came in, spent more money, raised taxes even further, but I think he was more successful in many ways because he managed the public relations much more effectively. The real tragedy of the Great Depression was that it wasn't a failure of capitalism, but it was a failure of a hyperactive state, as many people acknowledge today. It would take a world war to pull us out of that recession. The New Deal programs were a complete economic failure. They only made the Depression worse and prolonged it. What started out as a recession and a bear market correction turned into the largest selling wave that we've seen in the history of the markets. I forgot get what unemployment figures were, but wasn't it like almost 25% or 30% of the nation was unemployed? [9:38]

JOHN: Yeah. Somewhere between a quarter and a third depending on where you sampled and when.

JIM: Yeah. So why work? I mean tax rates got up to as high as, I believe it was 94%. Why work? And that's what the rich did is people quit investing. They quit making capital investments. A lot of people just simply put their money in tax-free bonds and rode out the depression collecting tax free checks. Why would you want to invest capital when the government takes 90% of what you make, not counting what the states were taking at that time? [10:23]

JOHN: Yeah. So if we run a mental clip of where we are today, the tech boom bust, if you recall it happened toward the end of the 90s, was followed by a massive amount of money printing. And it should be pointed out, the tech boom really sort of goosed us through the 90s; didn't it? After the Reagan cuts sort of wore off, remember Bush I increased taxes, Clinton increased taxes, and then what coasted us through that was really this extra boom that we experienced with the tech boom; right?

JIM: Well, it was not just the tax increases. They countered the tax increases. If you look at a graph of M3 before they stopped publishing it, take a look at where it starts to spike up, which is in November of 1994 all of the way to the year 2000. The money supply just began to grow at rates twice the economic growth rate. So the tax increases were countered with money printing and the outlet for that money printing became the stock market, which gave us the tech boom. [11:15]

JOHN: We had the tech boom. That was followed by massive money printing with Greenspan slashing interest rates from 6.5 to 1%, and then that gave us the real estate and the credit bubble which coasted us into the (or drove us really, it's more than a coast), drove us, into the early part of this century after we came around the turn of the Millennium. And the subprime mess, which we're dealing with right now, was the result of that. Instead of allowing these excesses to cleanse, they are back at it again and they are going to tinker with the cleansing process. Obviously this is an election year, there is no tolerance for pain; the public, if you talk to them, don't understand why we are where we are and there is a lot of flack and noise in the system that actually prevents them from understanding that.

JIM: Yeah. I think the choice that we're facing because we keep postponing and postponing and postponing –we've been doing this for nearly three decades now – so \what we're facing are two choices: 1) either a massive deflationary 1929 type depression to cleanse out all of the debt, get rid of it; 2) or a massive inflationary bail out by the Federal Reserve and the government. So what we are going to be seeing in our future is not what occurred in 1929, but an inflationary depression of massive proportions. I mean just take a look at, and we'll get into this later on in quackonomics, but all you have to do is just pick up the headlines. What are they talking about that? What do you see coming from the Fed and coming from politicians. The Fed is talking about monetary stimulus (and substantial monetary stimulus); politicians are talking about bailouts and substantial fiscal stimulus. So we've now embarked on what I call the road to perdition. [13:09]

JOHN: Well, I guess anybody who has been condemned to hell, it reminds me of Dante’s Inferno; right? Is there any way of avoiding this path at this stage? Could we stop it?

JIM: No. I don't think there is anything that can stop it. You just take a look at the debt levels, both at the consumer level, the government level, the state level, from Washington to Wall Street, basically quackonomics is the prevailing economic philosophy. And that's our new word for economic philosophy as practiced in the US. It's this quackonomics that's driving our economy. It's taught first at our universities, and then those that graduate get jobs go to work in government or the private sector, then it's practiced on Wall Street and in Washington. So conventional economics, John, is basically bankrupt. [13:57]

JOHN: Okay. So basically what you're saying is we're condemned to walk this path. There is no hope.

JIM: Not unless we are going to restore the free enterprise system, allow the market to function unencumbered by government interference. Also, we need to place a limit on the chronic expansion of the money supply by the Federal Reserve. That's what gets us these big booms and busts. So you need to go back to honest money. You need to keep the government from debasing the currency. Just listening to government and Wall Street speak and you know that isn't going to happen. And unlike 1929, today there are no limitations in terms of the amount of money the government can spend and print. So this process needs to be carried out to its logical conclusion. Either we allow the debt to collapse and deflate, or we inflate it away. I'm betting on inflation. [14:52]

JOHN: Well, you must admit, history backs you up. In other words, each time a government has ever gotten into this condition, the response is always the same. Let's face it. We're in the silly season. We're just under 300 days here to go until the elections. And the next topic sort of in the Big Picture, the tables have turned rather quickly. Remember we were saying at the beginning of the year and coming out of the last year that suddenly we were going to see radical changes in what the topics of conversation were going to be as these things washed across the candidates. And that's what we're seeing: We've gone from worries over inflation to worries over recession. Even the Democrats have changed their tune from draconian tax hikes and ‘let's get big business’ to tax rebates. And it's amazing when you look at how quickly the presidential debates have changed. Now the R word, recession, is drifting through the air. To rephrase, we're 290 days away from the next election, only less than 12 months away from that crisis window we've been discussing here on the show which spans over the years of 2009 to 2012. I had somebody call me this week and say, “well, I think that stuff may all happen earlier.” And I said you need to understand this is a window in which a whole series of factors are all coming together. You can't quite predict where inside that window they are going to collide. We just know that's the window.

JIM: Yeah, what is an irony here of history is that a man who did his PhD thesis on the Great Depression will actually preside over the next Great Depression. Bernanke is going to have a chance in real time, John, to prove his thesis of a great depression can be avoided by massively printing gigantic amounts of money and debasing the currency. Every time I see him testify before Congress or hear him speak, you know, I immediately get this compulsion within me to go out immediately and buy gold and silver.

Just think of it this way: When you see him on TV, start thinking gold and silver. [16:45]

JOHN: Yeah. There are classes for that by the way, “hi, my name is Jim Puplava.” “Hi, Jim.” “I'm addicted to gold and silver.” “How long have you been troubled with this?” All right. So this is going to be a four-part topic we said we would do over the next few weeks. Where do you think we're going to take this? This is stage one. We framed what the issue is and where we're headed and then where will the series take us?

JIM: Next week, we're going to cover the business cycle, how it works and then we're going to cover the Keynesian response, both the 1929 depression and what our fellow politicians and Wall Streeters are advocating today. Our politicians are leading us right down the same path, committing the same mistakes. If you want to follow us through this process, once again, I recommend you pick up a copy of Murray Rothbard's book. It's called America's Great Depression. It's one of the best books written on that subject. It's going to give you a lot of insights as to what caused the Depression. You'll see a lot of parallels to what's going on in the economy today and it’ll give you some insights in terms of where we're heading. [17:52]

JOHN: So if we had to sort of do a barometer here and your weather forecast with a percentage of probability level, how confident are you that we're actually going to experience another Great Depression? As seen right from now because things could change, but we're saying here is where we're going on this course.

JIM: I would say over 90% confidence. About the only thing I think they can do is perhaps delay its arrival by a year or two depending on what happens in the elections in November. So possibly a delay, but in terms of its eventuality, 90% confidence it's going to happen. [18:30]

JOHN: So basically we're there, we can't avoid it and I'm assuming at some part in the future part of the series you're going to tell us why we need to put our seatbelts on and how we're going to survive the hard landing; right?

JIM: Yeah. Like I said, you might want to make a run to Costco. But this year I expect, believe it or not, as grim as things look right now, I'm optimistic in terms of the outcome this year. What happens after November, like I said, our theory this year is the Oreo: Hard dark outer shell in the first quarter and fourth quarter of the year with a creamy filling in-between. [19:02]

Here Comes the Bad Stuff

JOHN: Well, it seems like bad language has now assumed the definition of a nine letter word. Everywhere today, you're hearing the R word, recession, which is really ironic because if we just kicked this back six months, this was not in the air; was it? I don't remember hearing it much at all on the talkies.

JIM: No. It was going to be the goldilocks, the soft landing theory, and as you know, John, even like this week's plane landing in Heathrow, these landings are never soft.

JOHN: Well, there is an old expression in flying. Any landing you walk away from is a good landing. A great landing is one where you can reuse the airplane, unlike the landing at Heathrow.

Anyway, the politicians are worried about recession and you mentioned last December in our first program of the year a couple of weeks ago, the Oreo theory of 2008: sort of hard and crunchy on the outside followed by a creamy center – which you usually lick off and eat with milk; that's sort of a ritual – and then it's going to be hard and crunchy as we get to the end. So let's look at what this cookie looks like for the year.

JIM: Well, let's begin with the write downs, which we knew were coming. We saw them last year. We're getting more of them this year. By the end of the third quarter of last year, I think we were up to about 100 billion of writedowns. Now we're getting the next 100 billion. You saw it this week with Citigroup writing down the value of their subprime investments by 18 billion. They are also setting aside 5.2 billion to cover loan losses for home equity loans, auto loans and credit cards. Remember we talked about two of those risks? Also we saw this week, Merrill Lynch wrote off 9.9 billion of its CDOs or collateralized debt obligations, have written off 1.6 billion on its subprime, and then 3.1 billion on exposure to shaky bond insurers. It amounted to roughly about close to about 17 billion. I think they were anticipating 15, so that was higher than expected. That rattled the market.

Other institutions, John, are going to follow as we see writedowns of another 100 billion or so this quarter, or 100 billion for the fourth quarter, that is. So expect more of these writedowns in the first quarter as we move to take that even into the second quarter, you'll continue to see these write downs. But the write downs are going to accelerate, but this is part of that cleansing process that we talked about in the first hour. We should be a good deal through that process by the end of the first quarter with about maybe another 200 billion in writedowns coming the rest of the year. [21:43]

JOHN: Well, we know the write-offs are going to just get worse. Especially as more subprime mortgages get reset. I mean that's in the mill and it's in process right now. What about other bad stuff? Is there anything else out there waiting to spring upon us some dirty laundry out there?

JIM: Well, what are we seeing all of this week? We saw the politicians talking about an economic stimulus. The President came out Friday after coming back from his Middle East trip. You've got Congressional leaders meeting and talking together. So we know that a slow down in economic growth is the other thing that we're going to hear a lot about. We saw a little over a week ago, the ISM numbers went below 50 indicating the manufacturing economy’s contracting. And we're also going to see some GDP numbers. We know that GDP slowed in the fourth quarter. The unemployment rate jumped up to 5%. And there is probably going to be a little bit more than that: The Bureau of Labor Statistics is also going to be making its adjustment to its birth-death model this month, so look for them to report the job market wasn't as robust as originally reported last year.

So I expect to see much lower economic numbers for the fourth quarter of last year, and for those numbers to get even worse in the first quarter and the second quarter of this year. That's one of the reasons why they are scrambling right now because I don't care if you're a Democrat or a Republican, if economic conditions in your sector of the world are deteriorating, you don't want to be seen like you're not doing anything. So if you're a Democrat and your area is hit very hard on the economy side, you can get thrown out of office; if you're Republican, the same thing. So that's why you're seeing this bipartisanship because the wrath of the voter at the polls in a recession is not something that politicians want to face. So that's why they are scrambling right now.

And one of the key things they keep talking about is the stimulus package needs to be quick and immediate because they know that we're heading into a recession.

So, as I said, I expect to see that the numbers will get worse in the first and second quarter of this year and that's why they are going to have to come up with, you know, unless they come up with some miracle statistical adjustment that hides these facts. For example, last year we saw a weak first quarter of last year, and then the economy picked up in the second and third quarter as a result of the lowest inflation rates since Eisenhower was president. So maybe we get, I don't know, Woodrow Wilson inflation rates or something. But this is an election year, so, you know, they are going to play a little bit fast and loose with the economic and inflation numbers. And that's why you're going to be hearing in just a moment from John Williams in Other Voices on what's really happening with the money supply because there is a lot of disinformation out there saying, “the money supply isn't really growing.” Well, it's growing at over 15%, the highest level of increase in the money supply I think in history. [24:49]

JOHN: And part of this game too, by the way, is for each party to take credit for the bailout or the rescue, so to speak. So not only do you have to arrange a rescue in the midst of all of this, then you have to be sure that the credit, of course, goes to the right party making the right decision there, and who the right target people are, say, for these rebates that we're talking about that.

So we've got financial writedowns, the economy is heading into a recession, we've got both the Fed and politicians talking about doing very silly things. Okay. Anything else that might give us a Maalox moment here along the route?

JIM: Well, this sort of goes along with the economic numbers: When the economy begin to slow down, concomitant with that economic slow down is a slow down in corporate earnings. And we're heading into the Q4 earnings season. They are going to be upon us next week. Now, the good news is recently analysts have been slashing earnings estimates before the companies start reporting. So they have moved the profit bar considerably lower. It's kind of like, picture a pole-vaulter. We started out the bar is set at 10 feet. The analysts have lowered that bar down to three feet, so there shouldn't be any major surprises on the earnings front. We even had, for example, in the Friday we're talking, GE came out and announced their profits increased by 15% as a result of international sales. So I don't expect any major surprises there, but nonetheless, we're going to see a drop in earnings. That happens when the economy slows. Corporate earnings have already peaked. And there may be a chance that there could be a few surprises that maybe catch the market by surprise. So earnings slow down is another thing you're going to see besides economic slow down and the write downs that we've been talking about that. [26:32]

JOHN: So as we discussed during our first show of the year in the Oreo theory, all of this stuff represents the dark outer shell of the cookie, large financial writedowns, the economy heading into a recession, lower corporate earnings. And of course, then, this gets followed by massive monetary and fiscal stimulus both by the Fed and the government which eventually sets us up for the creamy filling during the second half of the year. And this was going to be what? about second and third quarters, which of course coasts us right into the elections. So do you anticipate some kind of “phew, we dodged the bullet everybody, isn't that great! The action on the part of the Fed and your government did this,” and of course by the time we get into the hard crunch on the other side, the elections are over.

JIM: Well, you know, you're right, John, because that's why they are moving quickly on all of the economic fronts, the monetary front, the fiscal stimulus. I mean, when have you seen this administration and Congress cooperate since 2006; they haven't cooperated on anything. Virtually, there has been no legislation passed in the last couple of years that has been meaningful – and maybe that's a good thing. [27:38]

JOHN: Yeah. But here there is common survival at stake. You must admit that.

JIM: Yeah. I mean, here they are all saying, “we could lose our jobs if the voters get ticked off.” So you're going to see massive stimulus. Originally you saw some of the guys –and we'll get into this in the second hour – as we get into the silly season here, they were talking about stimulus packages, 70 billion, 75 billion. What does it tell you when they are now talking 145, 150 billion? So you're going to see on the government side of the ledger, massive stimulus; and then you're going to see interest rates head down to 3% or below. It could go down below 3% if we head actually into a recession. And with the sentiment this negative that we're now seeing in the markets, we're now setting ourselves up for a rally. Sentiment is definitely decisively bearish. We've got oversold conditions. And historically, whenever you get the earnings revisions slipping into negative territory as we have for the fourth quarter, you're usually close to getting to a market bottom. You also have now massive reflation about ready to kick into high gear, and you're also starting to see some very attractive valuations here. [28:49]

JOHN: You know, if the interest rates go down and assuming you could, the whole loan industry has become real skittery right now, but assuming you could qualify for a loan, are we going to see better loan rates than we did, remember, when there was this rash of refis going on a couple of years ago? Will that be back with us?

JIM: Oh, absolutely. In fact, the latest refinancing is up considerably on the credit side because everybody is ditching their adjustable rate mortgages and locking in, I think the fixed-rate mortgage has now fallen to somewhere around 5 ½%. I've just talked to a client who got a loan last summer who is already refinancing at a half a percent lower than what his loan was last summer. So you're going to see a lot of that, and that's going to be positive. Now, assuming that you have good credit. I mean if you've lost your job and you don't have good credit, these low interest rates aren't probably going to do much for you depending on the bailout package that they come out from Congress. But you're right, John, these interest rates are looking very attractive right now because on the Friday that we're talking, the 10 year treasury note just hit 3.6%. You're talking about the 30 year Treasury bond below 4.3%. So obviously this is spilling over into the mortgage market. And I'd also think that as more and more people are able to refinance and those that are capable of refinancing, that's going to be good news, and that will sort of help in this recovery process. [30:10]

JOHN: Any other bright spots? I mean obviously there will be places where people could be to their advantage. So if you had to name some of these bright spots what would they be?

JIM: You know, if there is a bright spot on the economy right now, it would be the corporate sector which is generating healthy returns on capital, profits, although slowing down somewhat, are still very healthy; and you still have positive international growth rates in the emerging world. I mean a good example is the day we're talking, General Electric reported fourth quarter earnings. They were up 15%, and General Electric cited a good bulk of that was coming from their overseas sales where they are just basically growing and growing at double digits, especially in their infrastructure division. So that's a very positive side, and investment business spending, those are the positive elements, I think, in this economy.

And it's going to be important if they do come up with a stimulus package that does something besides try to buy votes, that they do create incentives for businesses to go out, build a new plant, maybe buy new equipment. It's interesting with the dollar’s fall over the last five or six years, you are now seeing a rebirth in the beginning stages of American manufacturing. You even have companies like Airbus that are considering relocating here. Look at the number of foreign firms, whether it's BMW, Toyota, Honda, Mercedes, that are building new factories here. So that's the positive thing we're seeing here. [31:43]

JOHN: Yeah. Is there anything that you like in this area? I guess what I'm saying is if you were investing, where would you be buying things right now?

JIM: Well, what do we have? We have massive monetary stimulus and fiscal stimulus. That means I would be buying precious metals. Any time you hear the US economy slowing down so everybody is saying, “oh, that's going to mean less demand for energy,” and we'll get into the fourth segment, buy them while they are cheap, I would be buying energy right here because they are basically just selling the energy sector off in a panic; and I expect higher energy prices this year. So precious metals and energy are probably the top of the list, large cap technology stocks look very attractive to us. And another sector that I think that is going to be very attractive, if you haven't done so already, is the agricultural sector, which is correcting now. And if that continues, I'd look to add some of the agricultural stocks.

JOHN: Anything that would be a screaming buy? I mean something where you back up the truck or you lie awake nights thinking you've just got to have it?

JIM: Oh, absolutely. I see three things that you want to almost back up the trucks here. Right now, one of them of course is going to be juniors, but why don't we save that for the final segment? We'll get into what I think are just screaming buys currently as we look at the markets. [33:03]

JOHN: And you're listening to the Financial Sense Newshour at www.financialsense.com on the internet. Our files are posted usually by about 7:00 a.m. Greenwich meantime on Saturdays, and so you make your own time adjustments. That works to somewhere about 3:00 or 4:00 a.m. on the east coast depending on whether you’re on daylight or standard time. Coming up next, Other Voices.

Other Voices: John Williams, Shadow Government Statistics

JIM: There’s a lot of talk on Wall Street these days: They’re talking about the core rate behaving moderately; they’re talking about inflation expectations well-anchored; that the Fed has room to move aggressively. There’s also talk that the Fed really isn’t injecting that much money into the system. Well, we’re going to clarify that for you today with my guest John Williams from Shadow Government Statistics.

And John, I want to talk about an article you wrote for the Financial Sense website called Near Record Money Growth Threatens Monetary Inflation; and this is a line from the opening that you wrote: You haven’t seen this kind of monetary growth since August of 1971. Monetary inflation pressure in the US on top of existing pressures from oil and food prices and a weakening US dollar, all of this foreshadows inflation is going to get much bigger than what we’re talking about today.

JOHN WILLIAMS: It sure is.

JIM: John, one of the things I think your article goes into and maybe this is perhaps the best way that we can start this conversation. Why don’t we talk about the three M’s: M1, M2 and M3, and how if you look at the monetary base (or M1) it looks like it’s shrinking, yet M3 is exploding. I wonder if we might distinguish between that for our listeners.

JOHN WILLIAMS: There used to be three primary measures of the money supply: M1, M2 and M3. M1 being the smallest – M1 is basically cash in the system and checking accounts; M2 is M1 plus savings accounts, money market funds and such; and then M3 had the large time deposits (you have the small time deposits in M2), institutional money funds. What happened with M3 was that back in March of 2006 the Fed ceased publishing it, which is extraordinarily unusual. They claimed at the time that the money supply numbers M3 were no longer relevant, too expensive to compile. That’s absolute nonsense. M2 – which is now the broadest measure that they publish has in it small time deposits, but M3 had in it the large time deposits – the jumbo CDs. And how can the small time deposits be relevant and the large time deposits not be? Or the money market funds that they had in M2; in M3 you had the institutional money funds. They’re saying that’s irrelevant. But those two items alone in M3 were worth something like $4 trillion which is something like half the M2 that’s being reported right now. So saying the numbers were meaningless is absolute nonsense.

I’ve been working in building econometric models, making economic forecasts over the last 25 years using these numbers, and I can tell that if you’re trying to forecast inflation what you want to use is the broadest measure of liquidity in the system, which until recently was M3. The narrower measures have their uses, but the broader the measure the better it is as a predictor of inflation. Now, the problem of what we’re seeing right now is that you only get the M2 number; it’s going along around 6% growth; M1 which is just the cash and the checking deposits is actually showing slightly negative growth. In between the different levels you have cash that switches. I think the Fed was aware of what was going to happen in the year ahead when they made the decision not to publish M3 anymore. What happens when you come to a peak in rates is that people try to lock in the jumbo CDs and such. And with that you’ll see cash flows from the lower M’s into M3. So the M3 growth is the best measure overall of total system liquidity.

We’ve tried to estimate M3 using other numbers published by the Fed; and the Fed still publishes most of the components. Right now we’re seeing that M3 growth is over 15%, which as you mentioned earlier is the highest level of broad money growth seen since 1971. And whenever you’ve had double digit M3 growth, which we have now, usually within a year or two you’ve seen double digit consumer price inflation. [38:21]

JIM: Something that I think, John, that we need to clarify for people is there are two ways that you can expand the money supply: 1) you can do it through the domestic banking system – the Fed injects money into the bank; or 2) you can do it through central banking. And I think one of the points that a lot of analysts miss is the huge injections that have come into the United States through foreign central banks. I think in your article just in the last 12 months it has grown by 287 billion (or 16.2%). And I wonder if you might explain that if a central bank does not sterilize that you’re basically expanding your money supply. And I wonder if you might address that issue.

JOHN WILLIAMS: One of the jobs that the Federal Reserve has is control of the money supply growth. And when a central bank puts cash with the Fed and says “hey guys, here we have a couple of hundred billion dollars in dollars we’re not going to try and cash in, so buy Treasury bills or Treasury bonds for us and hold them for us,” the Fed acts as custodian. And what it does is it goes out and it buys the T-bills or the bonds. Well, that going out and buying Treasuries is one way that the Fed normally goes out and injects liquidity into the system; it buys the Treasuries and the cash goes out into the system.

Now, if the Fed does not sterilize that transaction – effectively reverse it – to keep the extra cash from being pumped into the system, it’s exactly the same thing for the system as if the Fed went in there on its own account and bought that couple of hundred billion dollars worth of Treasuries. It has exactly the same effect. That’s what’s been growing so rapidly and has been helping to spike the broad money growth. What you’ll see in some of the day-to-day transactions just on the Fed’s account in the open market may have been relatively neutral over time. You have to look at the full picture. And if you look at the full picture, you’ll find, and indeed, there’s been a very significant pumping of liquidity into the system. [40:27]

JIM: It almost relates back too because I know in the 70s we used to watch those M numbers religiously. In fact the bond market or the stock market would move on the announcement of those numbers; and especially, for example, the M3 figures where all of this high powered money that you’ve been talking about exists. And I find it rather strange that they would say that first of all we’re going to save money, it’s too costly. You’re talking about an organization that prints money. But more importantly, if we didn’t have those central banks inject $287 billion into our system last year, basically they’re doing the Fed’s dirty work in a way; they’re monetizing, because if those central banks didn’t do it wouldn’t the Federal Reserve have to step up to the plate?

JOHN WILLIAMS: The Fed absolutely would otherwise be doing it itself. No question. Mr. Bernanke is a student of what happened back in the 1930s and he has expressed a very open desire not to see any kind of a liquidity collapse similar to what happened in the Great Depression with the collapse of the money supply. So there’s sort of an implicit promise there that he’s going to make sure that the liquidity keeps flowing into the system, that you don’t have the money supply collapse. And indeed, if you look at the broad measure, far from collapsing it’s actually showing the strongest growth it’s seen in 36 years. [41:52]

JIM: And it shouldn’t come as any surprise then when we look at, for example, the headline inflation numbers on the day you and I are speaking which is Wednesday that we saw these numbers go up year over year, and even though we know they’re jury-rigged they’re still up over 4%.

JOHN WILLIAMS: They’re talking about a 17-year high there. We also work on trying to estimate what inflation would be if you took out all the gimmicks that have been added in over the last couple of decades. And amazingly enough, you put it back it in and you’ll find yourself back in the early 80s, late 70s, in terms of parallel level of inflation. There is a relationship there between money supply and inflation despite claims to the contrary. [42:33]

JIM: So while you might have some analysts saying, “look, basically the rollover money that the Fed is doing in the Repo Market, they’re really not expanding the money supply,” but I just looked at the information that came in on foreign capital flows in the month of November and they’re still at very large levels. So whether it’s the Fed doing it or it’s the Bank of Japan or it’s some Asian central bank doing it, it’s accomplishing the same thing: it’s expanding the supply of money.

JOHN WILLIAMS: Yup. Well, in fact, the numbers in the article are up through the first week in January as reported by the Federal Reserve in terms of what they’re holding for the foreign central banks.

JIM: So now we hear talk that given Mr. Bernanke’s speech last week, and he’ll be before Congress on Thursday, that the Fed is going to get more aggressive. That to me says more monetary inflation, and higher inflation as a result down the road.

JOHN WILLIAMS: Yes. I think that’s a safe conclusion. What you’re seeing here there’s a systemic crisis right now in terms of the solvency of the banking system. And if you think the Fed is going to stand by and watch any major bank fail, or any major financial institution, you’re going to have a surprise there. They’re going to spend every last dollar that they can print to make sure the system stays afloat. They don’t want the system to crash. They don’t want the money supply to crash. And the error there, the effect of what they have to do to keep the system afloat, the cost is higher monetary growth, higher inflation. [44:09]

JIM: Now there’s been a number of articles lately with the debt crisis that we’re in, we have mortgage problems, we have Citigroup reported they’re having problems, they’re setting aside reserves for credit card defaults; there was an article in the Wall Street Journal on Wednesday talking about banks basically just walking away from home equity loans (in other words they’re not going to foreclose because it just isn’t worth it.) So we’re in a credit problem. And my definition of deflation is a contracting money supply, and I don’t see anything that I’m following – and I’m following the figures that you report – that shows despite the 100 billion we’ve written off (maybe another couple hundred billion) the money supply is still growing. It’s not contracting. [44:56]

JOHN WILLIAMS: It is. And the banks may be losing some money but they’re getting more capital pumped in to keep them afloat. You do have a circumstance here which is a little unusual but not as unusual as Wall Street would like to have you think, that is we have an inflationary recession. We’ve had inflationary recessions before including back in the 70s. As contradictory as that may be we’re seeing inflation pressures here that are not driven by strong...they’ve been driven by the oil prices, they’ve been driven by the weakness in the dollar – now we’re beginning to see the monetary pressure.

One thing about the money supply and as it relates to the economy as well as to inflation: when you see sharp money growth, sometimes you can have strong economic growth with it, other times you don’t. It doesn’t always work on the upside. It always works on the downside. If the Fed wanted to drive the economy into recession it could contract the money supply and that would do it, but oftentimes when they pump up the money supply in terms of the economy it’s like pushing on a string; it doesn’t happen. And that’s what we’re seeing right now. We’re in a long term structural economic downturn, but at the same time we’re beginning to see increasing monetary inflation on top of these other factors. You really have the worst of all worlds for the financial markets: it’s an inflationary recession by its nature as bad for both the equity and the credit markets. Of course, there are things such as gold which tend to do well in that environment; and being outside the dollar is another area where generally the results will be much more favorable. [46:32]

JIM: The thing that just fascinates me, and of course we’re seeing it now in terms of an economic stimulus package, they’re talking about helicopter drops where they’re going to cut checks. So here comes the helicopter money. What is amazing, John, and I don’t know if you share this view, I feel the route that we’re going you’re hearing...I heard a speech by a politician talking about freezing interest rates for five years, which is basically price controls. And you know, this almost right out of Murray Rothbard’s book America’s Great Depression. It’s amazing, 80 years later our politicians are marching us down, making the same mistakes that the Hoover administration and Roosevelt made in the Great Depression. I think we’re going to have a depression by 2010 and this time it’s going to be an inflationary one. Any thoughts on that idea?

JOHN WILLIAMS: I’m in agreement with you. In fact, I think it’s going to eventually evolve into a hyperinflationary great depression. But the depression part of it is already in play. One thing which is clear even in the government statistics today with the inflation that they reported – this is the official inflation, CPI – the real average weekly earnings for the average fellows out there working day to day didn’t keep up with inflation this last year. Now, there are a variety of problems with that including for the person who’s not able to keep up with inflation, but when you put it on to a national scale you’re in a circumstance where it’s physically impossible to have sustained economic growth. In order to have sustained economic growth, you have to have sustained growth in inflation-adjusted income. They measure the economic growth adjusted for inflation, and if your income net of inflation is shrinking you can’t sustain continued growth in consumption which is two-thirds of the economy. The only way that you can do that is by taking on more debt or liquidating savings. And both of those factors are short lived. And in fact both have been pushed to extremes; we’re at the limits there. So there’s really very little the government can do in the short term to come up with a stimulus package that will give you sustained economic growth going forward.

Beyond that, the government is fiscally bankrupt. If you look at the government’s financial statements published a couple of weeks ago prepared using the Generally Accepted Accounting Principles as though the government were a corporation, we’re still seeing an annual deficit there on a GAAP basis of something over $4 trillion when you take out some of the gimmicks they still have in the statements. That’s $4 trillion! That’s not the 168 billion that they were talking about officially as the deficit for the last year, but an actual shortfall of four trillion, including the change in the unfunded liabilities for Social Security and Medicare adjusted for the time value of money. And the significance of that magnitude is that the system is out of control. If the federal government wanted to bring the deficit under control to actually show a surplus, or just a balance, if it raised taxes to take 100% of everyone’s income and corporate profits, it would still be in deficit. It’s beyond containment. That’s the current political mess. On the other side, they can always cut spending but I’ll challenge you to find more than one person in Washington who’s talking about cutting Social Security and Medicare. [50:10]

JIM: No, they’re talking about adding a new healthcare benefit at a time when we know Social Security and Medicare are bankrupt.

JOHN WILLIAMS: And they’re going to add a stimulus package and send everyone a check. They don’t have the money! It’s not funded. And it’s just a matter of time before the foreign investors who have been kind enough to put all of these dollars into our system to buy the Treasuries throw up their hands and say, “here, Fed, you can take the Treasuries back.” That’s when the problems really begin. And I don’t think we’re too far from that happening. [50:37]

JIM: Well, John, I’m going to recommend our listeners go to the site, our Financial Sense website. We’re going to keep John’s article, it’s called Near Record Money Growth Threatens Monetary Inflation. And John, if our listeners would like to get more information about your newsletter, why don’t you give out your website because a lot of this stuff that you and I are talking about you publish stuff that you don’t see elsewhere. And if a person wants to become informed, reading your newsletter would be one way to do so. So why don’t you give out your website.

JOHN WILLIAMS: The website is www.shadowstats.com. On the site we have a lot of publicly availably information, including series of articles describing the problems with the government reporting. We have archives of materials written more than six months ago. We show graphs of our alternate measures on the CPI, the Gross Domestic Product; we publish a graph which shows you where M3 growth is going. And of course if anyone would like to become a subscriber, we’re also very happy to take subscriptions. So all of the material anyone would look for is there on the site at www.shadowstats.com. [51:50]

JIM: A very informative newsletter at that. Well, John, as always it’s a pleasure to have you on the program and I appreciate you writing an article clarifying why we have this explosive money growth because there are a lot of people out there talking about, “well, gee, the money supply just isn’t what people say it is.” And I think they’re missing out on something you clarified, which is foreign central banks basically bringing it in to the system. It’s the same effect whether the Fed was doing it.

Part 2

Quackonomics

JOHN: [sound of ducks quacking] Quack, quack, quack, quack, quack. Well, Jim, there you have a live recording right off of C-Span of our congressmen in action. Very obviously, somebody must have told a really good joke judging from the response of some of them there. We are going to talk about quackonomics today because it is real clear that as you listen to what's going on on C-Span, I would say well over 90% of our elected representatives do not have a clue when it come to monetary policy. Just even based on their responses and the questions they are asking in some of the Congressional hearings. Only a couple seemed to really grapple with it.

JIM: I don't think any of these people know or understand what creates jobs in an economy. It gets back to the theory that we talked about last week: Do you want to give people fish or build your fishing industry? Building the fishing industry creates more jobs. Just giving people fish, once they consume that fish, what do you do next? So why don't we set the stage here because when Bernanke was on Capitol Hill this week, I think one congressman said: “All right, summarize it for me, are we heading into a recession what do you think economically?” Let's go to the Bernanke clip.

CONGRESSMAN: To sum it up, what is the Fed's overall diagnosis of the course of the economy over the next year to 18 months?

BERNANKE: Well, we currently see the economy as continuing to grow, but growing at a relatively slow pace, particularly in the first half of this year. As the housing contraction begins to wane, as it should sometime during this year, the economy should pick up a bit later in this year. But we believe we'll see below trend growth, certainly in 2008, and probably early into 2009 as well.

CONGRESSMAN: You indicate in your testimony that conditions appear to be worsening in 2008?

BERNANKE: Yes. The latter half of 2007 was actually reasonably good. The third quarter we saw a growth of about 5%. Growth slowed significantly in the fourth quarter but is still moderate. Recent indications suggest, though, that the economy has softened somewhat and that growth prospects for 2008 are certainly below that of last year.

CONGRESSMAN: But as I listen to you read the first several pages of your testimony describing the conditions in the financial markets, in particular, the swollen non-conforming mortgage portfolios, the lack of investor confidence in the valuation of their investment and then the lack of confidence and institutions holding those assets – a long litany of fairly distinct and unique problems – it doesn't appear to be your garden variety business cycle recession of the kind we were used to in the years after the end of the last war.

BERNANKE: Well, again, we're not forecasting a recession, but rather at this point, slow growth. But you're absolutely correct, Mr. Chairman, that there are a number of characteristics of this period that are somewhat unique including the financial market turmoil we've seen, pressures on the banks. We are hit on the other side by these rapid increases in oil and commodity prices which create some inflation risk and create a problem on that side. The housing sector, of course, has been in a very sharp contraction and relatively unusual pattern that we've seen there as well. So there really is a confluence of different events that makes this a difficult combination of circumstances. [3:45]

JIM: So there you have it, John, he's given his assessment, “nope, we are not heading for a recession.” But remember, these are the guys that can't even spot a bubble much less spot a recession. So one thing you need to do is take with a grain of salt open comments made by a Fed chairman or anybody in the FOMC meeting. Most of the stuff of what they forecast, whether it's on the economy, inflation rates or unemployment rates are almost meaningless and worthless. Let's put it this way. You wouldn't have politicians scrambling in the same way that you have right now if we were not heading into a recession. Why don't we go to the clip with the president's opening speech on Friday where he's talking about that we need to get working on this, do it quickly and it needs to be big.

PRESIDENT BUSH: After careful consideration and after discussions with members of Congress, I've concluded that additional action is needed. To keep our economy growing and creating jobs, Congress and the administration need to work to enact an economic growth package as soon as possible. As Congress considers such a plan, there are certain principles that must guide its deliberations. This growth package must be big enough to make a difference in an economy as large and dynamic as ours, which means it should be about 1% of GDP. This growth package must be built on broad-based tax relief that will directly affect economic growth. And not the kind of spending projects that would have little immediate impact on our economy. This growth package must be temporary and take effect right away so we can get help to our economy when it need it's most. And this growth package must not include any tax increases. Specifically, this growth package should bolster both business investment and consumer spending which are critical to economic growth. [5:48]

JOHN: So basically if we contrast what Ben Bernanke was saying versus what President Bush was saying, Bernanke is saying a slowdown but no recession. (Although I think he coined the term growsession this week. I heard that one floating around there). But at the same time, the President is jumping in there and saying crisis, we need a stimulus package; and both parties normally at each other's throats are willing to work together on this one. That's quite a contrast between the two.

JIM: Yeah. Especially if you contrast the presidential debates going on in both parties just last year. Nobody was talking like this one month ago. And so I think the drop in the ISM, the jump in the unemployment numbers that we got at the first of the year is all of a sudden people are saying, “holy cow, this is serious.” And the other thing too is even within both parties, we had earlier in the week, we had testimonies before Congress of Larry Summers who was a former Clinton economic advisor. He was saying, you need to cut taxes and get a stimulus program. Let's go to the Congressional testimony of not only Larry Summers, but even more importantly, I think his name was Beach because that will tell you where we want to go with this. [7:08]

SUMMERS: Stagflation, big issue. Part of the reason why a balanced program of fiscal and monetary stimulus is, in my judgment, a better idea than relying only on monetary policy is because it's less likely for a variety of reasons, particularly involving commodity prices, to be inflationary.

BEACH: There are stimulus packages that work. There are stimulus packages that sound good but are empty. And the ones that we have tried where we have stimulated demand just haven't delivered as much as one would have hoped for them. On the other hand, those that are targeted on the investment side, building new plant equipment to create jobs and improve incomes and thus through improving incomes stimulate demand tend to perform very, very well. If you're going to suspend PAYGO rules, do it for programs that have a proven record of success rather than ones that don't have a proven record of success; and it doesn't cost you a thing today to signal what you're going to do on taxes in three years. That doesn't even qualify for the PAYGO rules. And your speech is important. I am very concerned about spending. Spending is a drag on the economy if it is for non-productive purposes or purposes which have less productive purposes than similar money used for private concerns. You're right to be concerned about it. I would hope the Congress would find a way to get this done without having to depart from a discipline and a signal, which was so important at the beginning of this year, that Democrats and Republicans are really going to be serious about spending. [8:42]

JIM: You know, John, that is the heart of the matter because he said “I hope you don't do something and spend money for something that doesn't do anything to really help the economy.” And you remember when we were in the recession of 2001, initially Bush when he came into office, his first tax cut was let's give them a little rebate; and they found out it really didn't do anything for the economy. And that’s what this economist was talking about that. And unfortunately that's what they are going to want to do. They are going to want to make a good majority of this a large amount of money that they are going to give to voters because number one, that buys votes. Number two, it stimulates spending but it's like I don't know what the check is going to be, whether it's going to be $300, 600 dollars, 800, 1200, whatever the figure is, John, what happens after you spend the money? Then what? And that's why this economist here was saying, “look, if you really want to help the economy, you have to have stimulus that is going to actually go out and create jobs.” You want business entrepreneurs to go out and say, “you know what, we're going to buy a new piece of equipment to make or help us manufacture widgets and do it more efficiently. We're going to build a new factory.” That's what creates jobs. And it gets back to the fish analogy. You know, you want to build your fishing industry, not just give people fish. And that's what Beach was talking about when he was saying, “I hope you don't do a dumb stimulus package where you're really not going to get any bang for your buck.” I mean somebody goes out and spends a couple of hundred bucks and then it's over.

You know, I can see were you may want to extend unemployment benefits to help those who have lost their job, but the rebate stuff, you know, we know it didn't work in 2001. It didn't work with Jimmy Carter. All it does is buy you votes in a election year. It's a short term remedy that doesn't really fix anything. The real remedy, and you remember the reference there, it doesn't cost you anything to talk about tax cuts three years out. Basically he was saying, “look, we’ve already got these tax cut in place. Keep them in place because what are businesses going to think about when you know that, for example, the tax rates are going to go up at a time when the economy is weakening?” The marriage penalty comes back, the child tax credit comes back, people that were off the tax rolls now go on the tax rolls. People that were in a 10% tax rate go into a 15% tax rate. People in a 15 go into a 25. And that's what he was referring there. He said make those tax cuts permanent. It doesn't cost you anything because they are already in place, but you need to build something here because otherwise people are saying, “wait a minute, you're going to raise capital gains taxes back to 28%, you're going to double tax dividends again and get rid of the 15% tax on dividends. You're going to raise the tax rates, you're going to penalize...” – all of that stuff. That's what's weighing in on the market. And I think he was making a very strong case here: Don't do something stupid just because this is an election year because if you do, you're just going to drive up the budget deficit and you're not going to get a real increase in the economy. And it's the real increase in the economy when jobs are created, when people invest in plant and equipment that brings in the tax revenue that pays for these cuts. [12:22]

JOHN: Yeah. But reason doesn't tend to carry that in politics. Do you understand? In other words, politics is always – the German world is shein (appearance). It's always more done for appearances than for reality.

JIM: There is going to be some kind of rebate. There they are just going to do it. This is an election year. They need to buy votes. They are probably going to extend the unemployment benefits. But what they really need to do here is create some incentives for businesses because there is a great uncertainty right now. For example, if you look at estate taxes, the exemption, I think, is a little over 3 million right now and I think in the year 2010, we get one year with no estate tax rates and then things go back to the way they were when Ronald Reagan was president. The exemption goes back down to 600. The tax rates go up. I mean, so people in the industry are individuals that are trying to plan their estates are left with a quandary right now in terms of, “my goodness, what are we going to end up with?” If you are an investor, long term investor or a business, they are talking about allowing the capital gains rates, if they expire, to go back up to 28%. And no wonder the market is nervous. So those are the things that we should be doing. Whether we're going to do them, that remains to be seen. The one positive thing right now is both parties are talking to each other because I think they both know that, hey, look, the entire house is up for election, one third of the Senate. And so nobody wants to be seen here as “no, I want to raise your taxes instead of cutting them.” But whether these guys do something foolish – in fact, some of the news talk shows were talking about that. Let's go to the Lou Dobb's clip that says basically, “I hope these idiots don't do something stupid.” [14:10]

LOU DOBBS: The fact is this administration has not done anything. It has been aware of the crisis in terms of our credit markets for the better part of a half a year at the very least. They understand what is happening to this middle class. This is pure politics. It's got to be removed from the issue and we've got to start talking about how we're going to move ahead.

KITTY PILGRIM, CNN CORRESPONDENT: You're absolutely right, Lou. The evidence has been plain for quite some time. Certainly they cannot be thinking about it for the first time right now.

LOU: In terms of monetary policy, Ben Bernanke, the chairman of the Federal Reserve, he now has come to the conclusion that perhaps we might think about dropping interest rates. I mean across the board there has to be some intelligence. One of the things that is driving these markets and investors nuts worldwide is the United States is exhibiting a lack of leadership. Irrespective of the program or the approach taken by this administration and this Congress, the fact is we have such befuddled leadership in this country, the rest of the world has got to be looking at us, and our markets and wondering what in the world are those fools going to do next. None of which helps in terms of the credit market crisis, none of which helps in terms of interest rates or the strength of the dollar. And these befuddled fools in this administration and leading this Congress all very well understand that what I'm saying is the abject and absolute truth. So try to do a little thinking, folks, if you will, out there on Capitol Hill, Pennsylvania Avenue, wherever you may be tonight. [15:31]

JIM: And another issue, and we'll go to another clip here is don't come in at a time the economy is weakening and strangle it with taxes, strangle it with regulation, strangle it with new welfare give-away programs that just place major burdens on this economy, because, John, it's a debt ridden economy and that is not what we need right now. [15:55]

JOHN: One of the things that has been banging around in the back of my head listening to you here is, you know, we talk about giving these rebates. Who is going to pay for this? I always ask that whenever a politician says anything. Who is paying for this? This money is coming from somewhere. Is the Fed going to create it, or are we looking at another wealth transfer here?

JIM: You're looking at a wealth transfer. You're looking at a budget deficit. I mean the official budget deficit numbers are probably going to go up by a couple of hundred million. We'll probably be back up into the 300, 400 billion deficit range, which given the size of the economy, would probably put that somewhere in the neighborhood of 2 to 3% of GDP, which is actually much lower than other countries around the world.

When an economy goes into a recession, what happens is tax revenue falls. That's number one so, the government gets less money. Number two, government spending goes up because transfer payments go up; unemployment benefits go up. All of the things that we do in our welfare-type state, all of those costs are to go up because people are losing their jobs, business is less robust; the government is getting less revenue from individuals because they lose their jobs; they are getting less tax revenue from businesses because profits are down. And at the same time, their expenses are going up. So what you really want to do, if you're going to do something, is encourage what drives an economy. And what drives an economy is the private sector. It's when entrepreneurs invent an idea and take that idea and turn it into a business that hires people. That's what creates jobs right here. That's why I think that one economist was warning and what you don't want to do is turn this into a nanny state and then come in with all kinds of regulations and tell you this is what you're going to do, this is what you can't do. Let's go to the Glenn Beck cut right here.

GLENN BECK: It's my house. I know it's wasteful, going to be bad for the economy, it will be bad for energy, it will be bad for, you know, the trees and the little seals that are crying, but it's my money and my house. Mind your own damn business. It's none of your business. It's none of Arnold Schwarzenegger's business. It's time to take our country back, America. More and more politicians want to play nanny to the American people. Well, I don't want a fricking nanny. Take that father-knows-best approach and shove it right where the sun doesn't shine. It is interesting that liberals are always the first to say, “there is Big Brother, look at how evil Dick Cheney is. Get Dick Cheney out of my bedroom.” But you don't mind, as long as Dick Cheney is there just with his hand on the thermostat watching away.

[SPEAKER]: I have blood shoot out of my eyes when I hear this stuff. We are – we are entering a state where both left and right want to haul us into fascism, want to, with a smiley face say, “oh, look, we know what's good for you.” They want to tell us every step of the way what we can and cannot do because it's good for us. You know what? I have a right to die from emphysema. I don't have a right to drain everybody's coffers because I want government assistance for emphysema, but I have a right to die in my home alone with emphysema. Get off my back.

JOHN: That was a conservative opinion there on the part of Glenn Beck. But strangely enough, remember Ron Paul was saying that a few weeks ago. People are saying, “leave me alone.” And Glenn Beck echoed the same sentiment. Both parties are dragging us this way. Each one blaming the other for doing it, and as far as violating constitutional rights, etc, they are both doing it.

JIM: This is the thing that the Ron Paul campaign is addressing. Get government off our backs. And this goes back to Ronald Reagan where he said, government isn't the solution. It's the problem.”

But, John, once again, how did we get here? We got here by loose monetary policies – Going back to a topic that we covered in the first hour. When the tech bubble began to bust and began to cleanse itself, yes, we went into a recession. That recession, you know, maybe it lasted a year, but they were saying, “oh, no, we can't have a recession. We have got to slash interest rates. We cannot have any pain and we can't allow any cleansing process.” So Greenspan slashes interest rates from 6 ½ down to 1% and it created this artificial stimulus that encouraged people to go out and buy more real estate than they could realistically afford. It caused lenders to get really silly in terms of the type of loans they were making. It got Wall Street to get even sillier saying, “you know what, we can take these things, these subprime loans, we can dice them up and we can turn a junk mortgage into an AAA security, and sell it to somebody thinking that they are buying high quality debt.” And this is the stuff that we get when we have loose monetary policy.

And here we are, the cleansing process is beginning. Corporations are cleansing their debt. They are writing off, getting rid of the bad stuff. This is all part of the recovery stuff. But rather than allow the economy to go into a recession, to cleanse itself, they are going to fight it.

Now, if they do things that are productive, if they come up with a stimulus package and say, wait a minute, the private sector are really the horses that pull the wagons, so let's do some smart things, as that economist warned the Congress. Don't do something stupid. Actually do something that will help businesses to expand and create jobs because when you do that, when more people go back to work, that's more tax revenue for you. When businesses expand and make more profits, that's more revenues that come back to you. So the tax cuts, in a sense, are paid for.

And John, we saw this. When the first program that Bush came in was the tax rebates, it didn't work, so they had to come back in 2003 and slash the income tax rate, create the stimulus and that's what got economic revenue going again. And as we know, the government collected actually more tax revenue, which is one of the reasons why the actual deficits went down.

But the real danger here is, as you know, Washington is all about compromise, so we're going to get some very dumb and stupid things, probably weaved in with some things that will be smart. So it will be halfway measures and that's what gets us to what I call the creamy filling in the Oreo theory. [22:40]

JOHN: Looking at the economic proposals of the various candidates, I’m trying to remember, Jim, who has come out with one. Senator Clinton has established one. I can't think of any on the Republican side –aside from Ron Paul whose whole platform, a large part of it, seems to rest on sound economic policy from a Libertarian perspective.

JIM: Yeah. I would say, let me see, John Edwards is supposed to be coming out with an economic program. Hillary Clinton has got one out, so why don't we go to the Hillary Clinton clip because she was one of the first out there. Give her credit for it. I disagree with just about everything in the program, but at least she has one. The Republicans haven't come out really with one, but I would suspect in the next couple of weeks and with the country talking about stimulus, you're going to see the Republicans jump all over each other to come out with who can out stimulate the other. So when they come out with some programs we'll be critical of them as well. So let's go to the Clinton economic program. [23:32]

BILL GRIFFITH: It is clear that since the last time you were with us the economy has taken center stage in this campaign. You have an economic stimulus package, $70 billion on the table. Senator Obama has a similar package on the table in terms of the amount of dollars. Senator Edwards has talked about stimulus as well. Robert Samuelson writing in the current issue of Newsweek magazine is not impressed, the economist. He calls it lollipop economics saying of a $14 trillion economy, $70 billion is at most nothing –more political symbolism – and at worse a small drop in the bucket. What do you say?

HILLARY CLINTON: I've been talking about the economy. I’ve talked about it with you some weeks ago because I could feel that we were going to end up where we are today sliding into a recession. The president going hat in hand to the Saudis basically saying please help us out again. We have to get focused on what we need to do short, medium and long term. And that's going to require new leadership.

GRIFFITH: Quickly, let's be clear though. Are you saying that you can – you can avoid a recession with a plan like this, or do we just let the business cycle take its course at this point?

CLINTON: No. I don't know that we can. Some economists, as you know, say we already are. In fact, the government of Nevada says that his state is already in one, but we can certainly do what is necessary to try to make it shallower and less long lasting. And I think we've got to do that because we're really in a different environment globally right now. We know that we've got the huge spike in oil prices over the last several years. I mean look at spike in oil prices since George Bush became president. We know that we are increasingly indebted to other countries and now we are not only indebted to them, but our private institutions are borrowing from sovereign wealth funds so that we’ve got it kind of coming and going. We don't have a sensible energy policy, and I think that's one of the biggest problems in the economy. The fiscal stimulus that Bush pushed so hard in 01, and beyond, has gone primarily to people who are going to weather this crisis because they are so wealthy and they are so much better off than the rest of us. So I think we need to say, look, we've got to take some short term action right now. That's what a stimulus is for. Then we've got to do a much better job in getting back to fiscal responsibility. Let's make investments that will make us richer and safer and smarter and stronger, like in clean energy for example. Then we've got to take stock of the indebtedness, the $9 trillion debt and the rest of what is happening now in the global economy that I believe can undermine our fiscal sovereignty. And I take that very serious. [26:25]

JOHN: You know, Bill Griffith made at the beginning of the interview that he did on CNBC with Senator Clinton was talking about the fact that if you analyze what's going on, he calls it lollipop economics because there is nothing substantive here. It's all just candy.

JIM: Once again we get back to the “give a man fish or teach him to fish.” And what you really want to do is build the fishing industry, not just give people fish. I mean she talked about 30 billion in tax rebates here with the reserve fund of 40 billion if that doesn't work. Well, we know it doesn't work. It didn't work with Jimmy Carter. It didn't work with George Bush when he put that through in 2001. So that's not going to build the fishing industry. All you're doing is giving people a few fish. Once they eat the fish, then what do you do. And that's why a lot of these programs put out by the candidates are getting harsh criticism.

I have not seen, John, at least yet, any of the Republican candidates. I think Rudy Giuliani is working on permanent tax cuts, and he's going to outline that. I'm not sure about the other Republican candidates, but at least, you know, when you listen to Huckabee, there is nothing that he says that makes a lot of sense to me. McCain was against the tax cuts. Now he's for tax cuts. So he's flip-flopped on that issue. About the only guy that economically that makes a lot of sense out there is Ron Paul. It was amazing. I was watching a television program and I think you saw it, and some weird group was endorsing him, but they were talking about his economic philosophy as being extreme. And if you listen to what Ron Paul says: we need sound money, we need to adhere to the Constitution; we need free markets and unencumbered markets; and we need to get government off the backs of the people. Now that is considered right wing. It's absolutely amazing where we've gone in this decade in terms of our economic and political thinking. [28:18]

JOHN: Well, okay, so we get to this point, they are talking about stimulus. I guess there is a plus here in that the parties are talking to each other, but it's sort of like a couple of prima donnas in an opera. (I don't know if that's a plural of prima donna or not. Two primas donna in a opera.) They both want the key role in this whole thing, and so we are likely in the midst of it to see a lot of silly stuff because of this jockeying for position here even though they are still talking to each other.

JIM: What you're going to get, as you always get from Washington, which is compromise. So you're going to have maybe three quarters of the billion just giving people fish, and maybe one quarter of benefits trying to encourage to build the fishing industry. And unfortunately, there are people losing jobs, so maybe extending the unemployment benefits...But I would be more in favor of things that are designed to encourage companies to build factories here, to encourage companies to go out and buy plant and equipment to modernize their business, to make them more competitive in a global marketplace. That's why I go back to that comment made by the economist, Beach, who said, “you know, whatever you do, folks, do something that's smart here.” To go out and just give a bunch of lollipops to the voters in an election year isn't very smart. All you're going to do is drive up the deficit and you're not going to get a return on your investment. But if you do something that actually stimulates business to go out and build factories and buy equipment, that's going to create real jobs and you will get the tax cuts back in the form of added tax revenues as the economy expands.” And that's why he was warning them. But you know, once again, John, this is an election year and that's why probably what we're going to get is a lot of quackonomics than anything that makes sense here.

JOHN: Listening to the Financial Sense Newshour and a part of the program called the Big Picture right here at www.financialsense.com.

Other Voices: Eric King, Metals Analyst, Trader

JIM: Well, as the markets head down to single digit losses (we’ve got the Dow down roughly 8%, S&P down 9%) the gold markets have been doing rather well –in fact, all commodity markets – the HUI Index is up a little over 7%, and we have the XAU up about 3%. Gold prices are still up for the year even though they’re pulling back somewhat. There are some technicians that are saying, “well, the gold market has topped out. It’s all over.”

Joining me on the program is Eric King, a private investor.

Eric, why don’t we start out with the gold market. We’ve seen a bit of a pull back here in the last week. Do you believe the top is in? I don’t. Do you?

ERIC KING: No, absolutely not, Jim. This is a secular bull market, prone to corrections. I was looking at the HUI, at top to bottom in just a few days, it had a 12 ¼% correction –so not for the faint of heart but certainly. And again, and we’ve talked about this many times, people just need to stay away from the computer if they’re long term investors during that time. We always joke about “go kick a soccer ball” or go have fun with the family because these shake-outs are kind of brutal. But also remember, and I always like to talk about this, stick with the fundamentals. And when you stick with the fundamentals it really is a situation where the United States is obviously heading into a situation of turmoil that will accelerate because that’s the cycle. And as the crisis continues to worsen and spread and over time magnify, I think we’re going to see dramatically higher gold prices than what we have today. [32:29]

JIM: It’s interesting because there’s been a dramatic shift here since the beginning of the year. If you were following the presidential debates they were talking about raising taxes, they were talking about all kinds of programs. Now the debate is shifting: Fiscal stimulus; the Fed is talking about lowering interest rates and keeping the markets injected with liquidity at a time that we have high inflation rates. All of this just tells me that we’ve got higher inflation coming down the road.

ERIC: You’re right about that. Of course today, it came out from Bernanke that they want to do this $150 billion stimulus package; and I think there are some tax breaks in there that Bush wants to present.

Again, and we really are not in a position, people talk about deflation in the United States, but frankly folks, we are not in a position to deflate in the United States. We’re not. There is not going to be long term deflation in the United States. It will be massive inflation because we have to print our way out of these debts. And I think that’s something people forget.

Jim, you did a great interview, and I mention this from time to time on the show, but you interviewed Lawrence Parks in 2002, and you asked what the Fed Chairman has been saying in the last three years, because he talked about financial collapse in his book. And Dr. Parks said –he was very forthright in this lecture, I think he just wanted to get some issues off his chest which is maybe why he did it in Belgium where nobody in our media covered it, it wasn’t picked up by the Wall Street Journal, not by the New York Times, not by anybody – but he talked about instability in the financial system that we could all lose our savings in the blink of an eye.

And the problem is, at that time anyway, the banks make off-table bets. So in the case of banks worldwide they have roughly $110 trillion worth of derivatives bets. And Lawrence said if they win those bets they keep the winnings. If they lose those bets, systemically, tax payers will bail them out. Mr. Greenspan is very explicit about this. He says we are subsidizing the banks. Part of the subsidy (and he repeats this five times – I take it as a warning) is that the Federal Reserve stands ready to create money quote “without limit” end-quotes, to bail the banks if the need arises (and he repeats that five times in different places in the lecture), creating money flat out of nothing, without limit. So what that means to ordinary people is that your careful savings of a lifetime, and pensions, could be wiped out in the blink of an eye.

And he goes on to say that if we had gold as money the possibility of this kind of collapse would be virtually eliminated. And I noticed in a central bank survey of derivatives for 2007, that they talked about the fact that positions in the over-the-counter derivatives market grew at an even more rapid pace than the turnover. So the notional amounts outstanding went up by 135% to $516 trillion dollars at the end of June of 07. And of course, Mr. Parks was talking about, I think, 110 trillion. Open positions in interest rate contracts increased by 119% by $389 trillion. And the highest rate of increase was reported in the credit segment of the over-the-counter derivatives market where positions increased to $51 trillion from under 5 trillion in the 2004 survey. So you’ve got Buffett, who said that these derivatives are our financial weapons of mass destruction in 2003, and that some of these derivatives were devised and created by madmen; and that basically he compared the derivatives business to quote hell because “it was easy to enter and almost impossible to exit.” So when I hear these technicians or these folks out there who are talking about the end of the gold bull market or you know, it’s time to blow out of your stuff and look for the next thing, again, you’re going to have these type of corrections in these bull markets.

But again folks, stick with the fundamentals. And the fundamentals are basically saying quite clearly that gold and silver will be dramatically higher. And that’s based on fundamentals not charts. [36:38]

JIM: Well, Eric, I think one of the problems, 1), we have a media and Wall Street is ignorant to gold and silver as money –that’s one problem. 2) They don’t understand what causes inflation which is the very things that we’re talking about. What Mr. Bernanke is talking about doing, what Congress is talking about doing, that’s what brings about greater inflation.

But here’s something I want you to address because one of the issues, if we take a look at, for example, last year, gold bullion was up 31%, the gold stocks were only up roughly about 20% and even then that’s misleading because you had 6 or 7 stocks in the HUI which accounted for most of that performance. It was a terrible year to be in junior stocks; small caps did not do well. I think it’s these corrections that we see, that you know can be very swift, they can be very violent, that maybe scares people. How would you address that?

ERIC: And again, I think – I hate to go back to fundamentals again and again, but it is fundamentals. If you looked at the October Bloomberg piece from Jimmy Rogers he talked about, quote: ““I’m in the process in the next few months of getting all my assets out of US dollars. It’s the official policy of the central bank in the US to debase the currency,” said Rogers.” And he talked about the fact that the pound lost 80% of its value, top to bottom, as it lost its reserve status. He claimed the bull market in stocks and bonds was over. And he basically said, “I reiterate, the big fortunes are going to be made in the commodities side and it will be for the next 5, 10, 15 years.” And that the current bull market is going to last until somewhere between 2014 and 2022. So platinum, gold, silver and palladium will be, quote, “much higher during the course of the bull market.”

So when these corrections come – and they always come – you just have to basically again look at the fundamentals, stay with the fundamentals. I mean late last year you had the Comptroller of the United States, David Walker, running around and issuing downbeat assessments of the country’s future and what he called quote “the chilling, long term simulation” end-quote that included dramatic tax rises, slashed government services and the large scale dumping by foreign governments of holdings of US debt. He said, “I’m trying to sound an alarm and issue a wake-up call. As Comptroller General, I’ve got an ability to look longer range and take on issues that others may be hesitant, and in many cases may not be in a position to take on. They need to make fiscal responsibility and intergenerational equity one of their top priorities. If they don’t, I think the risk of a serious crisis rises considerably.”

Again, when these corrections come, try to tune the noise out, try to stick with the fundamentals, gold is going to be much, much, much higher. And what’s interesting, I think, is I sat in a room with a group of individuals two days ago and here was a junior presenting to them. There was a quarter of a billion dollars of net worth in private money in this room. And you know what this company wanted, Jim? They had a cap for these fellas at 2 million in dollars. So they could take $2 million. So, folks, look, when the oceans of paper money that are out there really begin to go into gold and really in earnest begin to go in the tiny markets of gold and silver, you’re going to see a mania. And we are nowhere near that mania. That’s Phase 3 of the bull market. So you’re going to have all these shakeouts as we go along but you’ve got to remain calm. Don’t panic! Put money into a fund like Jim’s, and just go kick a soccer ball when times get bad. [40:22]

JIM: It was rather interesting, you saw this headline I think it was in late November or December, Goldman Sachs put out a piece saying that one of their top 10 trades for the year was to short gold. And of course we were up, right out of the box! Now they’re turning around and saying that they think gold is going over 1000.

So one thing: You just made a comment, it is very appropriate for the investor, so much of what we hear on a daily basis whether you’re watching the cable channels, whether you’re reading the press, or you’re listening to politicians or Wall Street pundits, it’s just background noise. I mean, you know, a month ago, two months ago they were talking about how things were okay, now they’re talking about a recession; a month ago, Bernanke was saying that he wasn’t worried about the economy and look where he is a month later. And that’s what people have to understand: What people say on Monday will change on Thursday or Friday.

Looking at this market, I know you’re a big bull on the gold market, the silver market, what’s your favorite area of investing. If we know that gold is going up –and you just covered numerous reasons why gold is going up, which I agree with – where would you be putting your money? What do you like in this market? Would you be buying bullion, are you buying large cap stocks, are you buying small cap stocks, what are you doing?

ERIC: I think that people need to look to juniors. And you know, I’ve told people to put money with John Embry and the guys over at Sprott in Canada; and Jim, I’ve said people should put money into your fund. And part of that is that the junior market, if you don’t know what you’re doing, is a bit of a minefield, to say the least, so you need a professional I think to watch over that; or you need to be very serious and be able to go and spend quite a bit of your time (which most people don’t have) to really look at these investments. So I think the junior market is the place to be.

You have to be looking at value. And in the large cap stocks, you know, 5-, $600 an ounce that doesn’t really excite me at this point in the gold market. But you’ve got some juniors for say 20, $25 an ounce for gold in the ground; and that’s where the value is. And of course, later on, there won’t be any value when we’re in the mania. But right now, there are some extraordinary values out there.

And in a Barron’s interview they were talking to John Hathaway about this and this gets back to what your question is, Jim, which is where is the value going to be, and he says: “Gold’s bubble lies ahead. It’s got a long way to go to inflate.” And he talked about the disparity between the amount of paper that’s been created since 1980 and the amount of gold that’s been produced since then is just enormous. But what he basically said is that when you look back to 1980, and look at gold, and the gold markets, and compare it with the stock markets and the global bond markets, I think the figure he said was in the mid-20% range for 1980. And I think gold today represents around 3%, he was saying. So, again, we’re very early in this cycle of the bull market in gold which is why you have to understand those fundamentals so that you can sort of identify, when we’re in the mania, some exit points.

And right now, it’s still very early. But he said, gold is a good value. Certainly at these prices, just based on the considerations we’ve discussed, even if you think the worst case outcomes are in the cards, gold is still rare and hard to find. And believe me, these companies are having the toughest time trying to maintain production, much less build it. So here you have this market where it really doesn’t really matter if gold goes to $2000 tomorrow and silver goes to $50, it doesn’t make any difference because the production doesn’t change overnight; you have five to seven years to get a mine up and going. So with this inelasticity, it’s not like they could reprice gold and all of a sudden take care of the demand that will come in from these investors because it really isn’t there, Jim. So these companies that are struggling with this production – and a lot of them have had declining production, except for the guys like Yamana over there, with Peter Marrone, which has been expanding and doing some acquisitions; you’ve got Agnico-Eagle which has been real bright. You do have some companies that have been on the upswing, but having said that, a lot of these companies are struggling, are losing production, and they’re going to have to go out and buy these quality juniors.

And so when you look at like the Sierra Madre gold belt and I don’t know what Palmarejo went for, probably $250 an ounce or whatever the number was, but if you can find good companies in quality zones and get them for $25 an ounce for gold in the ground or somewhere in that neighborhood I think the upside is staggering just based on transactions we’ve seen today. And that doesn’t really factor in the future growth on the prices of gold and silver which, before this is over, will also be staggering. [45:28]

JIM: The amazing thing about this though, and once again, you know, you talk about fundamentals, you can have a junior, as you know, Eric, that can be sitting there, they’re drilling, they’re finding ounces, they’re adding ounces to the balance sheet and the stock doesn’t go anywhere. In fact, it may actually go down. In addition to those fundamentals, don’t you think there’s another important characteristic, and that is the word patience. You know, we live in a fast-food society, and along with that people want instantaneous returns on their investment. And you know what, you may get lucky; maybe you pick a junior stock and you buy it the day before they announce a major discovery. But the odds of that happening are one out of a gazillion. But more importantly, if you’re going to be in this sector, something that I think all good investors have, at least I’ve observed, is the element of patience.

ERIC: That’s absolutely key, Jim and that’s the problem. We did an interview, a roundtable, (and John Embry was there, Bill Murphy) and I think you were talking about the 70s bull market, and so I ended up doing a piece called Gold Bull 70s Versus Today after that, that had a lot of charts from the 70s bull market versus the bull market we’re in today because they’re very different. And of course, I think a lot of that has to do – and Bill and I talked about this – with the Federal Reserve being more active in the suppression of gold. They sort of let it go up six-fold very quickly at the beginning of the other bull market, and now I think they’re trying to sort of walk it higher which, you know, that won’t work when it’s over.

But the bottom line, to address the patience issue, is in that article I had a great quote from Jesse Livermore and he said the following, quote:

It was never my thinking that made big money for me. It was my sitting. Men who can be both right and sit tight are uncommon. I found it one of the hardest things to learn.

So when you’re in a bull market (and you have these stocks, and you might have some people, “I’m in Aurelian and it just wobbles around between 40 cents and 60 cents,” and they sell it and it goes on to $40 – a hundred-fold move in a short period of time) you really need to have patience. You need to go into this sector and basically say I’m going to be in this sector for the duration of the bull market.

And you also have to understand that the bulk of the gains are going to come in the manic phase. So we have to get the public involved and then we have to have this big explosion at the end. And we’re on the way there, but it’s a ways off. So I think, like you say, Jim, it’s really important because it’s easy for people to sit there and be patient and take their time, and I’ve looked at some stocks that recently were in bear markets for almost two years on the junior side. So this is right about the time, Jim, that you’ll get the person who calls into their broker or into their gold fund and says, “I’ve had it. Punch me out, get me out, I don’t care what the price is just get me out of this thing.” And that’s a big mistake if it’s a quality project and a quality product because that’s right about the time after they shake you out and you’re the last guy that they turn that stock around and start to have these really dynamic moves to the upside.

So again, I say to people that whether it’s a correction or whether you’re just tired of something you’re in, you’ve got to stay patient. There will be astronomical gains; and fortunes, as Jimmy Rogers said, will be made in this sector. But you have to have that patience. You have to be right, you have to sit tight. So whether we’re in a correction or you’ve just been in a stock that’s cycling on its own timeframe, and maybe it’s going to go up when the HUI’s going down, or maybe it’s going to be going down when the HUI’s going up. But it’s on its own timetable. And people need to understand that. Some of these stocks will have very violent moves to the upside, maybe at a time when the HUI is struggling, so you can’t necessarily correlate junior activity to precisely what the HUI market is doing, because when these juniors are ready to go we’re not going to need to have a gold show and talk about it and ring the bell for people because they’ll be going, they’ll be screaming for attention. [50:08]

JIM: Yeah, and everybody is going to want to buy them after they’ve gone up ten-fold. Well, Eric, as we close, you’re a private investor so you don’t give out your phone number, you don’t take emails, but we have gotten a lot of requests to have you on the program. And one of the things that you may ought to consider one day is perhaps writing your own newsletter. I know there’s plenty of people who’d like to hear more from you.

ERIC: Well, I know you’ve asked me to do that for years, Jim, and I think that this will probably be the year that I’ll do something like that. It’s amazing to me how many people have been in and around this sector for a long time, but they’re just not making money because they seem to have some timing issues or they seem to get scared out. And it’s gut-wrenching. It’s a tough sector. And I’ll be real honest with you, I don’t like the gold and silver mining sector, but that’s where you have to be and that’s where the bull market is going to be for years to come. So we’ll probably start a newsletter this year, get it going, launch it on your show at some point and sort of take it from there. [51:11]

JIM: All right. Well, listen, Eric, as always, it’s a pleasure and please stand on call in case we get another major dip, so you can come back and tell them to go kick the soccer ball.

ERIC: All right. Thanks, Jim.

Buy Them When They're Cheap

Hi. I'm Andy Looney. I have absolutely nothing to talk about this week. But I've got to say something, so I guess that would make me a great politician. Politicians are always saying things, even when they have nothing to say. Don't you think? I do. Speaking of politicians, have you noticed the candidates have suddenly decided it's ixne on the axte because every time they say "taxes," the market needs a defibrillator, and gold looks like it's headed to Jupiter. Whoops. I mentioned taxes, but I think I got away with it. That makes me a politician then; right? I don't think so. Do you?

What is all of this stimulus they are talking about? Jumping into a cold lake in winter is stimulating, but I don't think that's what they mean. All I know is they say we've got to hurry or it won't do any good. When politicians get in a hurry, I get worried. Don't you? I do. Because no one's money or property is safe then. Did you see Ben Bernanke this week? He looked really worried. It seems he's running out of things to say, but everyone is very anxious for him to say something, and it had better be good. That's funny because no one really understands spin anyway. But when he doesn't say anything, they really get nervous.

Poor Ben. I bet Ben wishes he was Alan Greenspan and could retire and get a lucrative contract from all of the hedge funds that made money on the mess he caused. After all, I'm just an ordinary guy trying to raise my family and get through life, and the politicians just keep throwing themselves in my way and taking what little I make. I'm Andy Looney for Financial Sense.

JOHN: So now here we stand as the investors, and based on everything we've been discussing here on the Big Picture, there has been a market correction. But obviously, there are heavy duty reflationary efforts under way, so we expect the market to go back up. In this environment, what is it you like in the way of possible investments for people?

JIM: Two of the areas that we've been talking on this program, John, going back since you and I started doing radio together is precious metals. Let's begin with that.

The Fed is talking about that monetary reflation. The government is talking about fiscal stimulus. So we've got monetary and fiscal stimulus that is going to be done massively. We already have the money supply growing in the United States at the highest level that it's ever grown before. So that's why we've got the inflation rates, the headline numbers, even the core numbers where they are. But what that tells me – I mean every time I see Bernanke, I mean literally, I just say, I want to buy gold. And the one area of the market that I would be looking at – I love precious metals because of what is coming.

Remember the latter part of the Oreo theory is inflation comes back at higher rates at the end of the year, and I expect that to happen along with higher interest rates. So I would be jumping on. If you haven't bought gold, if you haven't bought silver, please do so because gold is going north...Even Goldman has reversed itself. Goldman Sachs is saying gold is going north of a thousand dollars. They are even talking about $1100 and $1200 in, I think, 2009 and 2010.

And the one area, John, that just gets absolutely trashed, absolutely trashed and they are just throwing them away. Now, part of this could be deleveraging, but the cheapest area in the market right now is the juniors. And the juniors, you can buy gold in the ground $15, $20, $25. And these juniors are expanding. Their drilling programs, they are adding to reserves.

You know one of my favorite companies this week just announced great drill results on a project that they have in Canada, and the stock goes down. People are just trashing these stocks. There is another situation that's a turn around.

And one of my favorite areas this year –and I think this is going to be the outperformer –is silver juniors. And silver is probably my favorite play for 2008. And I expect that silver prices are going to be over $20. Maybe as high as $25. Maybe even $30 if we get a spike in gold. And if you look at silver and gold ratio right now, it takes about 55 ounces of silver for one ounce of gold, so if you look at that ratio alone from a value perspective, silver is definitely more undervalued than gold is right now. So I think you're going to see a lot more upside. You may even see that ratio drop down to maybe 40. So I think silver is going to have a lot more upside.

So precious metals is one of the areas that I think you've got to have that given the inflation. I mean I don't need to tell you if you're listening to this program what you see when you go to the supermarkets, what you see when you pay your service bills, what you see when you get your utility bills. Everything around you for the things that you need to live are going up, and you might as well protect yourself. [56:50]

JOHN: Maybe I should ask something here. I know you tend to favor juniors, but they really tend to be a lot more volatile. Let's face it. And that can make people sort of nervous if they are investing. Why do you still favor those?

JIM: I just think those are going to be the top performers in a bull market, and when you expect prices to go higher, we talked in the Eric King segment where we talked about these big large cap intermediate gold producers, they are not replacing their reserves. And if you take a look at a mining company that has to go out and discover – let's say they go out and start drilling and they discover gold. From the time they are at the discovery stage to the time they go into production, that's probably closer to seven to ten years today with all of the environmental permits and things that you have to go through. So what you're seeing is you saw, for example last year, with Agnico picking up Cumberland, they will be able to pick up and short circuit that process. In other words, Cumberland will go into production in 2011, so instead of seven to ten years from discovery to production, you can cut that by almost two-thirds depending on what you're doing.

So that's why I expect that once you get, you know, a lot of these companies, and especially as the market caps increase tremendously, as we've seen in the large cap sector, that they are going to use that large market cap to start buying other companies in the late stage. And I think that, you know, a couple of years ago, the criteria was, “Well, we are not going to look at anybody unless they have five million ounces.” Well, once a company hits its two million threshold, they start going on the radar screen. And if you can find a company that gets two million plus ounces, is in a politically-secure jurisdiction and has furthered its process, especially if they are close to getting all of their permits because that's a big issue today. I mean Northgate ran into some problems. They were working on a mine, and they got turned down for environmental reasons, so they were scrambling. So they immediately had to go out and make a purchase.

So if you have a company that's in a political friendly jurisdiction, they are close to getting all of their permits by the government, so you know that if they got the stuff they can find it. If you find a deposit today that not only has the ability for, let's say, open pit mining but also a underground potential where the ore grades tend to be much greater, that is going to be attractive.

And it's simple, John. Let's say I'm a president of a big mining company. I could say, well, we're ramping up our exploration budget. But I know if I'm president of that company, even if we go out and make a discovery, that's not going to impact my bottom line for about probably another 10 years. Whereas, if my market cap has gone up as it has, because it's mainly been the large cap gold stocks that have done well recently, I can take that market cap, go out and buy somebody that has two million ounces. And with the money that I have coming in from cash with these gold prices, I can take that junior into production within a three-year period, so I can short circuit that. So then when I'm speaking before investors and analysts, I can say, you know what, we have 250,000 ounces of production, but as a result of this purchase, we're going to increase our production to 400,000 ounces in the next three years. So now you have a growth story to tell, so that's why I think the juniors are going to be such a compelling story.

And the great thing about juniors is so many of these are so incredibly cheap. Your money goes a long, long way. I mean you can buy stocks for 48, 50 cents. You can buy juniors for 75, 80 cents. You can buy them for a buck. I mean your money goes a long way. In other words, you can have a lot of shares if you make this commitment and especially if you have the money to diversify. The one disadvantage of juniors, because of their volatility, is you don't want to put all of your money into just one junior. So if you don't have the capital to diversify your junior holdings, then you're better off with a professional or with a mutual fund where you're going to get greater diversification. [1:01:09]

JOHN: Okay. That having been completed, let's talk about other areas.

JIM: I would be buying oil here all day long. Oil service stocks, which I think are the titans of this energy bull market. I would be buying the oil companies that are capable of increasing their production and their reserves. One of the things that comes in – and we talked about this last year – with the economic talk of recession or a slow down in the US economy, they are talking about that's why oil is weak and that's why it's gone from $100 to $90 a barrel as we speak on this Friday.

But there was an article that came out in the Wall Street Journal. We have talked about this on the program, and it got very little attention. And it was a report that came out by CERA, and they said that we took a look at the world's oil fields and depletion of our large oil fields are happening around 4 ½% a year.

Well, what that means is, John, we are losing 4 million barrels a day of oil production because fields are going into decline. That's like losing an Iran or two Iraqs a year. And on top of that, demand continues to increase, both in OPEC, and in the emerging world.

For example, in this year alone, the more relevant question is not about the economic slowdown in the United States, but China alone is going to need one million barrels more a day of oil. So you're going to lose 4 million barrels a day due to depletion. You've got an increase coming from China of one million barrels a day. Where are we going to find all of that oil?

And that's the missing question that people are failing to ask here. That's why I think oil prices are going over $100 a barrel. And especially as we head into that crisis window in 2009 to 2012 where the demand coming from OPEC and the inability for them to increase their production significantly is going to mean that they are going to export less. It's happening to the United States right now with Mexico, where depletion rates at Cantarell (which most of that production goes to the United States in the form of exports from Mexico to us) are running around 18%.

And another factor that is happening is we are seeing delay after delay of many fields that have been discovered that were supposed to have been brought into production. Whether it was the largest oil find in Kazakhstan at Kashagan where there has been one delay after another. They were supposed to be in full production by now, but now it doesn't look like it's going to be until 2010 or 2011. So there are almost five million barrels a day of production that was supposed to be coming online in the next two years that's not going to come online.

So you have depletion running at around 4 million barrels a day. You've got increased demand coming from the emerging world, and then you have delay after delay of all of these new construction projects.

And remember, a lot of this oil that we’re finding is in the deep oceans, which is much more difficult to get. And also these underwater plays tend to deplete at a much faster rate. So energy is going to be a mania candidate and, you know, they just don't get it.

Now, we don't know whether the selling that's occurring in this field right now is a result of hedge funds deleveraging, or it's a matter of everybody buying into, “oh, okay, the economy is slowing down, there is going to be less demand.” We're looking at oil inventories in the US right now that are at levels that we haven't seen in three or four years.

The other thing we're seeing in the last year, there were only about three or four countries out of all of the world's producers that were able to increase their reserves. And the other thing that we have is we don't have data coming from these national oil companies to really verify [their reserves]. The world has made an assumption as demand increases: We'll just get it from these guys. And these guys aren't giving as good data on what's happening to decline.

There is a story: one of the reasons the Saudis have been unable to increase their production in the last 10 years is because Ghawar has gone into decline. And you're talking about the largest oil field in the world that accounts for nearly 50% of Saudi Arabian production, if not more.

So as these large oil fields go into decline, as depletion rates accelerate, as demand accelerates and as delays continue, we're going to have a crunch. And that's something that we'll be discussing at the end of the month with the energy roundtable with Matt Simmons, CIBC analyst Jeff Rubin, one of the best analysts in the oil industry, who sees oil prices heading higher; and then Robert Hirsch who did the peak oil study for the US government. He'll be joining us on that table. So energy is a screaming buy, and as you mentioned when we talked to Bill Powers in the first hour, this is your chance to load up.

JOHN: You know, you have a double wedge here, I would think too. Number one, regardless of all of the talk of global warming etc, the West is pretty well married to a hydrocarbon economy for at least the next 5 or 10 years. There is no getting around that at this stage of the game, so there is investment there; and the second thing is, too, that's the period of ramping up of all of the alternatives out there, which will not be able to come online, but there is investment to be had there. So there is a double wedge in the whole thing. You know, we're talking about a period of pain here between 2009 and 12. But in reality, it's going to be an interesting decade, I would say, beyond that. What do you think?

JIM: Oh, absolutely. And this brings up, you were talking about energy and we live in this carbon society. Another area that I'd be jumping all over right now is uranium stocks because right now, John, globally, even though only the real smart people in the United States get this, but we still haven't gotten it. There are 340 nuclear power plants either in the planning stages, up for submittal or in construction right now. 340 that are going to be added to something like, I forget what number is, it's 400-something-34 nuclear power plants that we have now. Imagination the demand that's going to be coming for uranium. Now, uranium was a real hot sector last year. It sold off with the hedge fund deleveraging, and a lot of these uranium stocks are just absolute screaming buys right now.

So if I was looking at three area and I'd probably throw in a fourth area: Precious metals with an emphasis on silver; the oil sector –you can't go wrong anywhere you go on this sector; a third area would be uranium; a fourth area that I love, it continues in GE's announcement on Friday which supports this theory, is infrastructure. You've got China building 100 airports. You've got roads, bridges, dams, power plants, not to mention the decay in Western countries. I mean look at airports in the United States. They are terrible. They are horrible. The rail system needs to be rebuilt. Bridges, roads. And that's what GE, that's what they are getting all of the growth in their sales internationally is infrastructure, which would be another area that I would just be hopping all over right now, especially with this correction that we've seen in a lot of these blue chip stocks. So here is a company like General Electric that have seen its sales grow every single year. Their international component has grown at double digits and their net income has grown each year. And John, here is a company that has increased its dividend, it's five-year dividend growth rate is 10 percent. The large cap growth stocks are the cheapest that I've seen them in probably seven, eight years. So if I was to back up the truck right now, I'd be backing up on precious metals, I'd be loading up on juniors. I mean this is the time to back up the truck on juniors. Two, I'd be backing up the truck on energy. Three, I'd be backing up the truck on uranium juniors. They are being just absolutely trashed right now. And four, I would be backing up the truck on large cap growth stocks, especially the infrastructure plays.

Part 3

Q-Calls

JOHN: Welcome to the Q-line section of our program for today. Q-line means the question line. It's open 24 hour a day to take your phone calls from around the world. We ask you to record the call, make it brief, concise, to the point. You can just leave your name and where you're from. We just need a first name. We like to know where people are calling from. The number is toll free US and Canada, 800-794-6480. That number does work from the rest of the world, but it is not toll free from any place but the US and Canada and probably some abstruse island in the Pacific that I don't know about, but other than that that's not important.

Please remember the information that we present here on the Financial Sense Newshour, especially response to your queries are for informational and educational purposes only. You should never consider that as a solicitation or offer to purchase or sell securities etc, etc. Our responses to your inquiries are based upon the personal opinions of Jim Puplava; and because we don't know you well enough, we can't take into account your suitability, your objectives, your risk tolerance. You always need to consult a qualified financial advisor when you're making investment decisions, and as such Financial Sense Newshour should not be liable to anyone for financial losses that result from investing in companies profiled or other areas discussed here on the program.

Hello. My name is John from California. I want to thank you for educating the public here, keeping us informed on what's going on. It’s kind of an enlightenment as of a few months ago. Anyway, my question is: In the event that we go down a path of depression and gold, of course, does not get confiscated is this an opportunity to pay off our mortgages? Thank you.

JIM: You know, John, I expect that the outcome from for the depression, which I think we're going to head into by 2010 is going to be a hyperinflationary depression. I mean here is an example. We just had economic weakness. We know we're going into a recession. You had the President and Congress talking about a $150 billion stimulus. You've got the Fed talking about lowering interest rates. As the economy worsens next year, depending on the outcome of the election, and as we slow down there is no way that they are going to renege on promises that they made. So they are going to be printing more money. There was the government financial report was released about a month ago. If you take a look at it, as there is almost $715 billion of the government's budget that they can't account for. In other words, they can't get somebody to write off. If you look at the unfunded liabilities each year that accrues on Social Security, government pensions and Medicare, it's about $4 trillion a year. Our unfunded liabilities are $54 trillion. That just goes to tell you, and it's not just us. It's going to be other governments around the globe. So if you have a secure position, I wouldn't sell gold to pay off the mortgage because they are going to hyperinflate, which means the debt that you owe is going to be made worthless in terms of purchasing power. So assuming that you have a good job, you can maintain it, your gold if they hyper inflate will be worth so much more. Now, that aside, the only way that I would pay the house off would be is you're in a position, your job is somewhat precarious, you don't know if you'll have a job, then that's where you might want to consider paying off your house and removing some of those financial liabilities. [3:40]

Hi, Jim and John. This is Rob calling back from Niagara Falls, Canada. I have a question about the stock price of juniors. If I'm following you correctly, we're going to have a recession in the US, or a slow down at least that would drive stock prices down. You’re also saying that because of the Fed printing in the US that the price of assets, and especially the price of precious metals, are going to go up. Because of the leverage story of juniors, that means that their stock prices should go up. I guess what I'm trying to ask is the stock prices of juniors going to go down in your opinion because of the recession that's looming or the slow down, or will it go up because of the inflation that the Fed is creating? Thanks and appreciate your answer.

JIM: Rob, I think eventually the gold stocks were going to decouple. Right now they've been going down because of deleveraging in the general stock market, but they are also holding up much better than the general stock market. The HUI index is still up 5% this year. What I think you can see happen is what we saw happen in 2001. Remember, in 2000, the stock market was down, gold stocks went down, but not as much as the stock market. 2001, the stock market went down again, but in the summer of 2001, the gold market began to decouple from the rest of the stock market, and juniors and gold stocks in general began to climb. And that's what I expect this time around. [5:08]

Hello. This is Doug from Spokane. My question is given the hyperinflation you mentioned that you expect perhaps 2009, 2010, what can one person do to protect their wealth during a period of hyperinflation? This is a question that concerns my relatives. Thank you very much and I appreciate your show. And I also appreciate the transcription service you run on the Big Picture. Thank you very much.

JIM: Doug, in periods of hyperinflation what you want to be is in the ultimate safety investment, and that's gold and silver. Gold and silver works in a depression. Gold and silver works in hyperinflation and also works in deflation. But especially in inflation. And if you look at all currencies, I mean one of the things that I think people have been misled by is they think that, for example, the European Union is going to be a strong currency. It's no different than ours. It's a fiat currency. Money supply in Europe is growing at over 12% and I think the Europeans are going to cut interest rates despite what they say. Never believe what a central banker says. Watch what they do. And because all currencies are deflating against gold, the ultimate hedge in a period of inflation is gold and silver. So you either buy the bullion and also you might want to consider buying some of the stocks, but if you want to be ultimately safe, then what you do is you buy the bullion. [6:37]

Hi gentlemen. This is Gary from Pittsburgh, Wisconsin. Great job by the way. I really appreciate your show. I'm an investor in Tyhee, and I noticed the stock is bouncing around all over the place and I wonder if it's a victim of the naked shorting phenomenon, if people are trying to push that stock down to accumulate it. I don't see any negative news on the company, and with gold close to 900 or actually closing over 900, at least intra-day it was over 900, I can't understand why Tyhee is trading at 48 cents. Is there something going on we should know about. Thank you so much.

JIM: No. I don't think so Gary. If you take a look, it's not just Tyhee. It's all across the spectrum of juniors. There has been some selling since the beginning of the year, so that's not unusual. Towards the end of the year, there was also year end tax selling that came in, but I think right now maybe one factor might be you have a bunch of warrants that are coming due. In March typically, a lot of investors will sell the original shares to get the money to pay for the warrants. You always see this before a warrant expiration. There is probably a little short selling too, whenever you have a bunch of bashers that start showing up on a chat room and staying stuff that obviously they don't even know what the hell they are talking about that. They are trying to discourage people.

But I would say there were three broad trends in terms of what's going on. Number one, you had year end tax selling. You've got general stock market weakness right now and then you have warrant expirations. If you look at the company's drill result that they've been posting, I mean just take a look at the drill results they posted this week on Nicholas Lake. Spectacular. So they are delivering. Fundamentally, this is going to be an economic deposit that is going to be a producer some day – whether Tyhee goes into production or somebody picks them up.

So sometimes things happen like that and you just – that's just the way the market is with juniors, so there is nothing wrong with this company. It's fabulous. Just take a look at the information in the press releases of their results. [8:48]

Hi, Jim and John. This is Howard from New York. I love the show. I've been a devotee since the summer of 2003 and never miss a week. I want to run a situation by you. I am considering at these low interest rates a refinance of my mortgage. I currently have $250,000 outstanding on my mortgage and my house has been appraised for $600,000. I was thinking to borrowing up to the jumbo mortgage limit of 417, taking the money and investing it as you have described in gold and gold commodity related investments to try to take advantage, I guess, of the situation of maybe the last time of these low, low interest rates; locking them in at a fixed rate and reinvesting it in assets that should appreciate in the future rather than American real estate which looks like it's pretty much dead in the water. I'm considering doing this. I've been getting quotes in the area, 5 ½% 30 year fixed, and the cash flow differential which I'm paying now would be less than $500 per month which I think I can afford rather easily. I guess the only thing that stops me is when I read things about, like Jim Sinclair will go on and say things like just have no debt, own gold, get your paper certificates from your brokers and basically batten down the hatches. So that gives me pause to reflect because Mr. Sinclair certainly has been accurate in his gold forecast. I just want to know what your input is as to my idea and what you think would be advisable going forward. Thank you.

JIM: Howard, I'm not a big fan of going into debt to go into the investment markets. Because I believe gold prices are going higher, if you borrowed money and invested in gold, the gold would probably go up versus your house. But you said you can afford the payment which in terms of the increase would only be $500 a month given current interest rates, but I don't know enough about your other savings, your other investments, how secure your job is. Typically, I'm not a big fan of leveraging your house to go into the investment markets. So what happens if you lost your job, for example, and you didn't have any cash savings and then all of a sudden let's say the gold market corrects. If you have plenty of savings, six months worth of living expenses in the bank, your job –maybe you're fortunate enough, you have a government job that's secure or some kind of profession where you know you're always going to have a job – maybe I would be more positive about doing that. Certainly not borrowing as much as you're considering. But generally, I'm not in favor of going into debt to go in the investment markets. [11:27]

Hi Jim and John. It's Mark from Toronto. I'd like to thank you for a great program. I've been listening for three years now, and I've learned quite a bit. You are part of my financial renaissance. Just something I’d like to pass along to your listeners from Canada. If you wish to buy gold in your RSP or gold itself, there is an easy way that the bank of Nova Scotia offers. It's called a gold certificate. This is held in their vault. It's allocated and it's against the certificate that you can easily hold in your RSP and it's cheap, cheap, cheap. You can hold this for a total cost of 0.03 cents per day per hundred ounces, and you can look at that at the bank of Nova Scotia website at www.novascotiabank.com. Thanks for a great show and keep up the great work. Thank you.

JIM: Mark, thanks for bringing that to our attention because we do know we have a lot of listeners from Canada, so if you want to accumulate some gold, here is another way to do it. Thanks, Mark. [12:22]

Hi, Jim. This is Ram from USA. Thank you very much for answering my question last week. I have a comment and a question. I listened to your naked shorting episode. It just opened my eyes. A few months ago I concluded that palladium prices would go up because Russian supplies seem to be depleting, so I invested in a palladium mining company. And ever since, the stock just started going down for no good reason. It dropped from $10 to $4 while palladium metal prices were going up. I thought what do I now. So I sold out my position for a loss even though the company financials and surrounding macroeconomics were looking just good. Then what happened in the company was a soap opera, it played out word for word just the way you mentioned would happen with the mining company trying to raise capital in your naked shorting episode. Unbelievable. The company just did a placement on January 9th and ever since the stock took a U-turn and is getting ready to shoot for the stars. At least I hope so. I took some position now. That is my comment and here is my question, Jim. I'm just wondering how does the valuation of the exploration companies work? Let's say gold is $1000 per ounce. What part of the price is the cost of digging the gold out. I know it may be different based on the location, but what is the average cost for a mine based in the US, Canada or Mexico. Just for argument's sake, let's say the cost of exploration and extraction is $500s per ounce. Let's say there is a company that creates a million ounce discovery. Is it safe to assume the value of the company at $500 million or at least 250 million dollars? How does this work? If Newmont mining wants to buy it, would they be willing to pay at least $100 million? I'm asking this because there are companies like Vista Gold which has been accumulating gold mine since the year 2000 without extracting a single ounce, but they are hoping that the big shots will come and buy those lands from them sometime soon paying a premium as gold prices skyrocket. Is this a good strategy. At the same time, is this a gold evaluation. I'll be really interested to know your perspective. Thank you very much. Thanks for your program and I look forward to your answer.

JIM: You know, Ram, the best way to value an exploration company is market cap per ounce of gold reserves because generally measured and indicated ounces are going anywhere from 75 bucks to $100 an ounce. Usually in a take out, if a company has a very rich deposit, you may see the take out offer being even higher than that. And especially if it's an area that the ounces can be extracted economically, for example, an open pit. So if you look at what happened last year, you had Coeur D’Alene take out Palmarejo at almost $250 an ounce.

But what happens right now, you can figure this and these are just some general numbers. If you can pick up ounces, depending on how rich and attractive the deposit is, take out prices are anywhere from $100 to $250 an ounce depending on the size and richness and location of the deposit. Add a couple of hundred dollars an ounce for extraction cost and mill cost. So today a lot of these juniors can be bought at less than net asset value which makes them very attractive. But the best way to evaluate a junior is to look at market cap per ounce because they are not producing, so you have to take a look at what's the market value of the company and how many reserves and that's probably one of the best valuations. [16:06]

Hello, Jim and John. This is Kipling from Vancouver Island, British Columbia. You have a great show, but, Jim, you need a refresher on Joni Mitchell. I recommend you listen to her new CD, Shine, her first CD in a decade which came out in October. One of the cuts is called big yellow taxi, 2007. Her voice is deeper and richer with a haunting smoky texture. She's still the ultimate goddess. The highlight for me is the last song, an adaptation of Rudyard Kipling’s poem, If. I listen to it every day and it's been a huge assist in my commodity trading. It's highly recommended as is your work. Keep it coming, gentlemen. Whatever you're doing, it's great. [17:04]

JIM: Kipling, I just want to tell you as we speak I'm moving my mouse over to Amazon and I am ordering the album. Thanks for bringing that to my attention.

Jim and John, this is Richard calling from Chang Mai, Thailand. Jim, will the price of gold be able to keep up with rising energy costs so that intensive open pit mining operations can remain profitable when the price of oil goes through the roof.

JIM: I really think so, Richard, because one thing I expect this year is a catch-up price in gold. If you look at gold at where it is today, close to $900 an ounce or silver close to $17 an ounce, that starts making a lot of these deposits very attractive. I mean last summer when we saw the price of gold do down to 675, 650 with rising energy costs, that hurt a lot of the miners in the second quarter and the third quarter.

However, since August, and I think it was where we spent most of the year of last year, going back to January, we were in that 600, lower-650 range for gold, and with energy costs, that really cut into mining profits. But look at a chart of gold after August 31^st when we went from 670, 650 all of the way up to where we ended up at the end of the year when we got close to, you know, we spent October, November and December above $800 an ounce. Here we are in January close to $900 an ounce.

If we start getting to $1000 gold, these producers are going to be very economic. And that's another key thing I think is very strategic when you're looking at these companies is access to power. One of our favorite companies, I'm sure you're aware of is located next to a power plant, where they can run all five different zones that they have to target. That's going to be very important too because a lot of these companies, one of the costs of going into mining if you're going to run a mill, especially if you're going to do any underground work, that takes a lot of energy. And so having access to energy...But in answer to your question, at $900 gold and $1000 gold, these companies are going to be minting money. Listen to John Doody in the first hour where he addresses this issue where he thinks that could be one of the big surprises this year, where you see a lot of these producers make a lot of money. [19:35]

Jim and John, this is Art from Calgary, still listening religiously. Love your guys's show. Keep up the good work. Jim, I wanted to suggest that maybe I think you might have flubbed on the in-process goods as not being measured in GDP. The problem would be if you measured in process goods in the current year and then when they were finished in the following year measured them again, those goods would be double counted. So you have to have a cut off somehow such that all good are measured once. I totally agree that it could lead to some distortion in the statistics, especially in the case that production declined dramatically in the following year. It would give a boost to GDP in the year that production is declining as they finish off the goods that are in process, but I think the way that they do that is right to exclude goods in process from GDP. The reason being that you can only count them once and they count them when they are finished.

Also I want to talk about raising taxes. Doesn't it seem maybe that the way to control inflation within an economy, when you want to have interest rates near zero, is to take everybody's money away so that they don't have any money to buy gold, to buy the goods they need that they are short on cash because of taxes. This allows the government (would allow the government maybe if it was a strategy that they are using) to have low interest rates on the debts that they are paying and driving the interest rates down while making sure nobody has enough money to bid up the price of goods and services. It's kind of a stealthy way to go about it. Probably, you know, evil or underhanded, but that might be something that they are thinking. That may be while you're seeing all of this talk by the politicians to raise taxes because they don't want to raise interest rates. And if they don't raise interest rates, then the flood of money as you’ve discussed in depth on your program will eventually impact goods and services and drive the inflation number up. So what you need to do if you're a crafty politician is take the money away from people before they can do that. Just a thought. I don't know if the mechanics of that work perfectly, but it's an idea.

Love your show. Keep up the good work. There is no doubt I'll be listening again next week and into the future. Thanks.

JIM: You know, Art, let me address the in-process goods. In fact, corporations today measure desire that very same thing. When a corporation takes a look at inventory, you've got goods in the raw stage, in process and finished goods and they all get added together to make that number, so you're not really accounting for it. In other words, if I have a $50 item that's in process and then the following year I add another $25 in the production process it bring it to completion, well, then all I'm counting the following year is the $25, not the 50. So it already takes place in public corporations and accounting.

As far as the theory of taxation. No. I disagree with that concept because governments inflate to stimulate an economy to make it boom, to bring it out of recession, so if you raise taxes and you're trying to cut interest rates because you want to increase consumption, you want people to go out and borrow more money. If you turn around and cut interest rates and take it away in the form of taxes, you achieve nothing. [23:15]

Hello, Jim and John. This is Joe from New Jersey. I'm reallocating some of my portfolio to include some more precious metals, and I was wanting to know what your recommendations were. What proportion of gold versus silver? And unfortunately, as we all know the price has risen sharply while I was liquidating some other investments, so I want to know what I should do now: Invest it all as soon as possible because prices will only continue to rise; or is there going to be a correction so I should wait and invest it all at that point. Or should I begin dollar cost averaging beginning now or wait for a correction to start the dollar cost averaging? And if you do recommend dollar cost averaging, is there a time frame of which I should be fully invested up to my available funds maybe spring, by summer, by the end of summer, so forth. I really appreciate your recommendations and your thoughts on this matter and I look forward to hearing your reply. Thank you very much.

JIM: Joe, we're seeing a bit of a selloff in the precious metals sector. Gold has pulled back from what was it? around 920? Silver is holding on strong. I would definitely be looking at buying silver now. In terms of allocation, I like 60% silver, 40% gold because I think silver is going to outshine gold this year. Secondly, I would be dollar cost averaging over the next three months, and then I would keep part of your reserves for the seasonal selloff that we typically get during the summer months when the gold market is weak because of international buying. So probably 50 to 60% of your allocation in the next three months here, primarily oriented towards silver; and then keep some in bay for any pull backs because we will certainly get them, as John Doody talked about in the first hour. We've had four in the last 12 months. [25:00]

Hello, gentlemen. My name is Ho, and I am calling from Anaheim, California. Last week somebody called up and asked about a book about America's Great Depression and one of the books that you recommended was Murray Rothbard's book America's Great Depression. Well, I went to Amazon and I looked it up and I started reading the reviews and basically it seems to be an economic book on how the Depression started. And I still may get that book, but it's about 364 pages and I was thinking that I was looking for a book that talked about how people got through the great depression. What was life like? And I wasn't sure if this book covered it or if you could recommend a book that might be even better. I've been listening to the show for two years, love you guys, never miss a show. Thank you so much.

JIM: Ho, I would still recommend you get Murray Rothbard's book, The American Great Depression because it's going to tell you how we got in this mess, how the politicians made one mistake after another, whether it was on taxes, regulation, trying to control and elevate prices of goods or labor. And we're going to be using that over the next three or four weeks here. And the other thing that I would recommend is there are a couple of books. One is by Adam Ferguson, which is When Money Dies: The Nightmare of The Weimar Republic because we're going to head for a hyperinflationary depression and Ferguson goes through a lot of details of what life was like living during that period of time. Another one is Dying of Money by Jens O Parsson. And there is a book by the Gutenbergs that talked about what life was like living in Germany during that period of time when you really were going through sort of a boom-bust period in the economy. But for most people it was a bust period because they were having difficulty getting by. I think reading Rothbard's America's Great Depression and trying to get a copy in the library of Adam Fergusson and Jens O. Parsson’s book is a great starting point. Another great book is am Amity Shale’s book. In fact we've had her on the program. She's written a book called – excellent book by the way – it is called The Forgotten Man: A New History Of The Great Depression. There is just a couple of ideas. I think if you can get through those books, you're off to a great start. [27:37]

Hey, good afternoon, gentlemen. Craig calling from Ontario, Canada. Just a quick opinion. I have a gold holding. Love your show by the way. Been listening to it for a long time. In my gold portfolio, I have 500 shares of Goldcorp that I'm in at about 17 bucks and now it's trading close to 40. I'm looking at the price to earnings ratio and it's at 105 times earnings. Should I look at maybe lowering the amount of Goldcorp I have and maybe picking up some Yamana or something like that? The balance of my portfolio: I have a junior mining exploration company in northern Ontario in the Timmons area as well as gold mutual funds. So I'm wondering in your opinion if you feel that has a broad enough diversity. Thank you very much.

JIM: Craig, you can't really value gold companies on PE ratios. It's more on terms of asset value. Two measures that would be more appropriate would be, for example, market cap per ounce of gold in the ground. Another one would be market cap per ounce of production. If you look at Goldcorp, it's valued roughly about 547. It's a little bit higher than some companies, but also it's a growth company, just as you would expect to pay, see a higher PE ratio on a company that can grow its reserves at a much faster rate. I mean Goldcorp has gone from a 1.5 million in production in 2005. It's gone to almost a 1.7 million in 2006. Then it went to 2.25 in 2007. So I think you're pretty well diversified. You've got a mutual fund which means you've probably got a lot of juniors in that mutual fund. You have an exploration company and gold majors. So I would keep where you are. [29:31]

Hi, Jim and John. This is Trevor calling from Connecticut. Great show. I'd like to get your opinion on the silver industry. It seem that although I do expect decent growth over the next decade, some of the stocks are priced as if they are already 10 years in the future. What's your opinion on the industry in general and evaluations you currently see. If you were to play the industry, what areas would you consider? Thanks a lot. I enjoy your show.

JIM: I think a lot of these silver stocks are still pretty cheap. If you look at some of the market caps per ounce, which is one of my favorite ways of looking at this area. And remember, there are very few pure silver producing companies, so there is still a lot of value out there in terms of I would probably have some of the well known silver producers. I would have probably some of the smaller producers that have the potential to increase their production because I think there is going to be a consolidation here in the industry. I'd look at some of the larger development companies, especially the largest one that has the most reserves that's going into production. So look for also some of the companies that are about to go into production. So I love the whole silver area and you also might want to look at the silver royalty company as well. [30:43]

Hi. This is Steve from Toronto calling. You read one of my letters on the air about five years ago. I had purchased a home with a 102.5% mortgage and I just wanted to let you know that my house has increased from 143,000 to 220,000, so things couldn't really be better there. However, the advice of yours that I have followed is that I invested in the physical gold I bought several ounces of that.

I wanted to discuss with you and sort of get your thoughts on the political impact on hyperinflation. And just as an example, all of the revolutions really that we've had in the 20th Century were preceded by hyperinflation, whether it's the collapse of the Soviet Union or Argentina in the early 80s after the war with England where the generals were thrown out and democracy was brought in; or even the East German collapse in 1989 there was hyperinflation. One of the key things if you're going to have a revolution is that the government loses control of the money. And this is something actually that my grandfather taught me, which is that the average citizen, the only contact they really have with the government is through the money. And if you open your wallet right now and you look at it, you'll see there is money there that has, for example, a picture of Ben Franklin on it, and other important people who help found the United States. It mentions the Constitution somewhere on the money and there are pictures of important buildings and the Supreme Court and so forth and so on. And when the government has inflation what happens is that those pictures and those symbols and those people become worth just a little bit less and when you have hyperinflation, they become worthless. And it's important because in the 1930s when the states went through deflation, Roosevelt confiscated gold. And the reason he was able to do that, at least it's my view, is that the judges and police were willing to accept United States dollars in order to do their jobs and to confiscate that gold because in the deflation, the money that you have in your wallet becomes worth a lot more. It has more power. Anyway, Jim, that's about it, and thank you.

JIM: You know, Steve, you're bringing up a question here, something that you said that, you know, all the revolutions in the 20th Century have been proceeded by hyperinflation. It's amazing. I'm studying hyperinflations. I've studied that when I came to sort of an epiphany in the summer of 2004 when I wrote my Great Inflation. What I'm really studying right now is Roman history and especially the fall of the Republic because when you have these revolutions that come about from hyperinflation usually you have a complete change in government. And hopefully, you have a better outcome. Sometimes you go to dictatorships as in the case of the Roman Republic. You went to the era of the emperors or you go to military dictatorships to bring order from chaos. It's usually not a good outcome and that's one of the big questions going forward. When this hyperinflation arrives, will the American Republic survive? It's probably one of the things that keeps me up at night thinking. [34:18]

Jim, I just heard a guy ask about unemployment in the Great Depression. I've got some statistics here. Starting with the marriage rate which was down 15%. The divorce rate was down 25%. The gross national product down 50%. The Dow Jones industrial average down 90%. Total wages paid down 60%. The unemployment rate went from 3% in 29 to 25% in 33. Total Farm income: 6 million in 29, two million in 32. New business investment in plants and equipment: 24 billion in 29, 3 billion in 1933. By 1933, 1300 bankrupt counties and cities had defaulted on all of their obligations. 600,000 homeowners lost their homes and 5000 banks had failed.

One thing I would like to ask, I'm trying to find a really decent book on the inflation of the Weimar inflation but I can't find anything. Do you have any books that you know of that have a good description of that era? Thank you.

JIM: You know, my two favorite books on the hyperinflation are When Money Dies by Adam Fergusson and Dying Of Money by Jens O Parsson. And another great book is the Economics Of Inflation by Bresciani-Turroni. He was on the War Reparations Committee following the surrender of Germany and he wrote about the economics, how inflation unfolded in Germany. Those are the three books if you can get a copy of them that are an absolute must read. [36:19]

JOHN: You know it's also interesting to note that the reparations actually set the stage for World War Two, created conditions in Germany along with the great inflation there that made it possible for the rise of Hitler. So in reality, World War I and World War Two were simply different chapters in the same war.

Hello, my name is Robert. I'm calling from Toronto, Canada. I have a question in regards to central banks and basically charter banks. I think there is a false assumption that if the central banks lowers interest rates that charter banks also have to lower their rates and that's not necessarily true. Yesterday Toronto-Dominion released a memo stating that they actually possibly are going to not lower interest rates; and there is a possibility that interest rates may go up at the charter banks. And my question: Wouldn't that have an effect on all businesses including juniors and basically gold would go down because interest rates would be going up for consumers and businesses, not necessarily down. Thank you.

JIM: You know, Robert, that is a common myth about rising interest rates and gold going down. If you look at the 70s where interest rates went from its mid-3’s and low 4%, they went all of the way up to almost 21% with Paul Volcker; and during that period of time, gold went up. The reason interest rates are going up is the same reason that is driving the price of gold and that's because inflation rates are rising. [37:54]

My name is Leif. I'm calling from New Brunswick, Canada. And my question is I had all of my money in gold and resources. And I took my money out and I sold my gold 2007 in December. Missed the big run up. Crying crocodile tears. And I am retired. I'm 46. I had all my money, like I said, in gold and resources and I'm 100% cash now. Now, you're an advocate of dividends and the question I'm asking you is: What percentage should I put in gold, which I am a gold nut, and energy? And what percentage of dividends at the banks... what I’m saying is when would you start nibbling at the banks? So for people like me that do not have a PhD, can you help me out on this? Thanks. And I appreciate if you can help me out.

JIM: You know, Leif, you're going to need at least 15 to 20% minimum in the precious metals sector to protect you against even your own currency deflating against real money. And I'd recommend you just hold this stuff. Now, I also like another 15 to 20% in energy. Now, if you're looking for dividends, you might seriously take a look at some of the royalty trusts. Especially some of the natural gas ones. A lot of these have been beaten up because they'll be forced to pay taxes. I think it's 2011. But if you take a look at the dividends that are coming from these trusts, they are very attractive. They are double digits, which more than offsets even the tax you may have to pay. And if you think oil and gas prices are heading higher as I do, this would be a great day to not only enjoy current income, but see that income go up over a period of time. And if you're going to be living and you're retired, listen to last week's show that I did on dividends because what you need to find are companies that have a good business model, that can increase their dividends every single year because as inflation goes up, now that you're retired, you need a larger income stream that's going to be coming in so you’ll be able to enjoy the same standard of living.

So in summary, 15 to 20% gold minimum, probably another 15 to 20% in energy, and I would look at probably dividend-paying stocks in good, solid businesses rather than putting your money in the bank. In a period of inflation where you have today negative interest rates meaning that the rate of return that's offered on a safe, or what I call traditional fixed-income, investment, it's not even covering the rate of inflation. So every year that you own that investment, you lose money. [40:57]

JOHN: Jim, that wraps it's up for the program today. As we've said, it's going to be an interesting year with rough at the beginning, smooth at the center, rough at the edges. It sounds like a diamond that needs work or something like that, but there will be plenty to talk about as we go through the year. And talk about talking about things, what are we going to be talking about that?

JIM: Let me see. Coming up next week, Dick Davis will be my special guest. He's written a book called The Dick Davis Dividend. And the first week of February, you're not going to want to miss that show. We're going to have an energy roundtable. Joining me on that round table will be Matt Simmons, Robert Hirsch, and CIBC energy analyst Jeff Rubin. Vitaley Katsenelson, he's written a book called Active Value Investing. That's coming up on February 9th. Steven McClellan, he's written a book called Full of Bull. That will be February 16th. Mike Stathis Cashing in on the Real Estate Bubble. Also a gold roundtable featuring James Turk, Jean Marie Eveillard, Bill Murphy and LeAnne Baker. And also Lila Rajiva Mobs, Messiahs and Markets in March. Sy Harding Beating The Markets The Easy Way and Alex Doulis Lost on Bay Street.

So a lot of great stuff coming up, John, and we're going to try to do a lot more roundtables. We're going to come up with a couple of creative ones that we're thinking and working on right now. but some great stuff coming up. And don't forget, we're going to continue our Great Depression series, four part series, and if you want to pick up Rothbard's, the Great American Depression, I certainly would encourage you to do so. It would give you a lot of insight.

In the meantime, 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.