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Financial Sense Newshour

The BIG Picture Transcription

October 4, 2008

Part 1

Past, Present & Future: A roundtable with Jim Puplava, Brian Pretti and Frank Barbera

JOHN: With all of the happenstance going on this week, we decided here on the Big Picture we would like to change the format of the first hour of the program and feature a roundtable discussion.

JIM: Well, if you turn on your television in the evening or watch television during the day or pick up the paper, obviously, you know we’ve got a few problems in this country to say the least. And of course, we’re having this conversation on a Thursday night, but we’re going to talk about all of these things: What matters, what happened and how did we get here.

Joining me on the program is Brian Pretti, he writes for Contrarian Investor – one of the best publications out there and recommend that you read it; and Frank Barbera.

Guys, let’s kind of put this in sort of sequential order. I call them weekend huddles, sometimes we don’t even wait for the weekends. We’re seeing some kind of dramatic shift in the financial system. We used to have brokerage firms – now they’re banks, or they’re gone or they’ve been taken over. You’ve seen the largest insurance company in the world go under; you’ve seen Fannie and Freddie (which guarantees almost half the mortgages in the United States) basically nationalized. Why don’t we pick up the discussion and say, how did we get here; and then go forward, what is all this going to mean for the credit markets, the economy and for investors. So let’s begin with the road to perdition.

FRANK BARBERA: Well, good afternoon, Jim and Brian – good to chat with both of you.

BRIAN PRETTI: Likewise, Frank.

FRANK: Jim, you know, basically I think a lot of us really have a – a lot of this has really come to light over the last few months with the loose lending standards in the housing market, the process of deregulation which led to securitization – mass securitization within the banking system – and now the situation evolving where really no one knows who has how much bad debt, and that’s leading to this really massive credit crunch that we see each day with credit quality spreads widening out to historic levels. [2:12]

BRIAN: You know, Jim, maybe we can just step back just a little bit and I think for any of your listeners and you know, if they have read what you have written over the years, they’ve read what Frank has written over the years, they may have read what I’ve written over the years – and Jim, there’s a lot of common parallels there and common themes. You know, one has been that we’ve been in a credit cycle of a generation. When we look back: in 1980, total credit market debt in the United States relative to gross domestic product was probably about 160 percent; today that number is 350 percent (or a little bit greater as the recent Flow of Fund’s statement.) And it’s been that buildup in credit that, number one, has been a concern for all of us throughout this period of time, but there’s really been, as we all know, a dramatic acceleration in these numbers decade to date. And that’s been accompanied by structural changes in the financial markets over the last 25 years, most noticeably the securitization of debt and credits, essentially, maybe bottom line basis, separating the traditional borrower from the lender. In essence, creating these products that were sold off to investors relied on rating agencies, credit ratings as per their credit quality. And I think the best view of all, Frank, was – I forget who did it, I think it was Moody’s, when they initially came out and blamed it on a computer glitch. That was a good one. That showed up really well in court.

Anyway, you look at this and part and parcel of that whole securitization mechanism was the growth in the derivatives market underneath them that essentially started out as an insurance product if you will – an insurance policy: How do I insure against bad outcomes vis a vis credit and or vis a vis interest rate movements over time? And these markets just literally took on a life of their own. The traditional interest rate markets grew up like mushroom clouds in the 1990s and part of this decade, and then the credit default swap markets were just an explosion in the current decade. We had a lot of folks to thank: we can thank our regulators for turning a blind eye to regulation, for turning a blind eye to transparency in financial accounting. I mean in one sense you can look at what’s happening with the bailout bill. Well, I’d to make a proposition and that would be: I’d be more than happy to participate in the bailout bill if every single one of these companies would open up their books right now and show us exactly what’s on their books, and you know, give us a chance to value these assets. Let’s turn all the cards face up on the table. [4:46]

FRANK: You know, that’s a pretty interesting point that you’re making there because years and years ago, Sweden in the early 1990s had a major banking crisis very similar to the path that the United States has moved in, and ultimately the real solution to that crisis was government nationalization where the government came in and basically got to take a look at what was going on and then basically forced the banks to give up ownership; at the same point recapitalizing the banks. I think that’s one of the aspects of this that hasn’t been really talked about in the sense that the Paulson plan may create a lot of liquidity or may create some extra liquidity in these bonds – these mortgage-backed securities – but it really does very little to address the basic problem right now which is that these large banks are very seriously undercapitalized; and as a result, handing them more money is just basically – it’s not going to create lending, it’s going to be redirected by the banks to shore up their capital positions. So I really have great doubts as to whether or not fundamentally this plan is going to work. [5:53]

JIM: Let me thrown something else out here too. Brian, you were talking about the debt ratios that we’ve seen in the economy from 160 percent, 360 percent, and we’ve seen derivatives that were taken out; and I’ve got two things that I would probably add to your comments is when I got in the business in the late 70s, if you looked at a brokerage firm on Wall Street, they might have been leveraged two to one, four to one, and I forget what year it was when we lifted the leverage ratios from 12 to 1 and we saw institutions like Goldman Sachs go up to 25 to 1, Citigroup go up to 30 to 1, and some of these institutions go up to 40 to 1. I mean 40 to 1! That’s insane, when you have fluctuating markets. That’s an issue. And then as you pointed out, you might have used derivatives if you were in international trade to maybe hedge a currency risk if you were an importer or if you were trying to hedge interest rates. But you know, today you can add up world GDP, that is around 50 trillion, the derivative market is 500 trillion. That’s insane. If you look at the total value of stocks and bonds at 100 trillion, derivatives at 500 trillion, you know, we allowed this almost inverted pyramid to be built on the real economy. You’ve got the real economy on the bottom and the way things work, and then you had this inverted pyramid up at the top where you have all these leveraged contracts which are contracts on top of contracts on top of contracts that may originate on maybe one mortgage. [7:33]

BRIAN: And Jim, it creates that unfortunate potential for, number one, unanticipated consequences as we know full well by now given what’s happened in the mortgage markets that basic assumptions that were put into these models and that were basically proliferated through the derivatives market through the growth of the mortgage-backed securities markets, they rested on a very, very simple assumption. The assumption was that the year-over-year rate of change in real estate prices had never gone negative on a macro basically since the Depression. That assumption was wrong. Well, within the greater derivatives markets themselves now – and whether it’s interest rate derivatives, forwards, swaps and specifically credit default swaps, there is another very, very basic set of assumptions that went into that that are now proving to be false. The assumptions were that markets would always be liquid, you’d have instantaneous access to liquidity at any point in time: and that secondly because you know, the US banking system has laid off 85 percent of its derivative exposure to counterparties, the second major assumption was that your counterparty would always and everywhere be solvent. Ask the folks at Lehman how that one worked out. [8:45]

FRANK: Wow, talk about a really bad set of assumptions.

BRIAN: Human nature.

JIM: And the same thing, Brian, where this comes home to roost you had, let’s take a company like AIG, the largest insurance company – a trillion dollar balance sheet. If you were to think of a blue chip company that would be one of them. And the basic business of AIG – their insurance divisions – they were profitable, they were making money but they had one little division called the Financial Products Division that was writing credit default swaps on these collateralized toxic securities and look what happened; they went from the largest insurance company to receivership in two days.

BRIAN: Exactly, Jim.

JIM: And that’s where I think that saying that Warren Buffett said many years ago that derivatives were financial weapons of mass destruction because when you can take a trillion dollar insurance company with a trillion dollar balance sheet and blow it up in two days, it just goes to show you how toxic and explosive some of these things are.

FRANK: While we’re on that subject just for a second, Jim, you know, listening to you outline – both of you outline that fine recap you look at this structure, this inverted pyramid that has been developed over the years you actually have to realize I guess one aspect of it that maybe not everyone in our listening audience really appreciates is just how much global involvement there was in this, and this basically has been spread out across Europe, it’s spread out across Asia. So as the underpinnings of that pyramid are starting to collapse and confidence is starting to collapse with it, you have this debt default problem which is undermining confidence on a daily basis. The real risk as I see it is: Does the problem continue to move as it progresses, does it at some point jump the tracks into the currency market? Because at some point, if you have the dollar host to all of this bad debt, does the rest of the world begin to turn into a dollar revulsion and just turn away from dollars? That’s the question that not a lot of people are talking about right now, but to me it sure seems like the kind of destruction of confidence that we’re seeing when big institutions like this evaporates from one day to the next that this could lead to a very serious dollar problem. [11:11]

BRIAN: You know, structurally, Frank, I think you’re right from a long term standpoint and what’s tough to deal with in the day-to-day of the last few weeks as we look at the markets everyday is that the dollar has actually been increasing in value, you know, relative to foreign currencies. It almost seems a complete irrational and illogical directional movement. But I’m wondering – and again, I don’t have the facts to back this up in front of me – as you go through this global deleveraging process, so much debt has been denominated in dollars over time that one of the ways to pay that debt back is first you’re going to have to sell an asset and buy the dollar. If you’re invested in foreign bonds, if you’re invested in commodities, if you’re invested in foreign markets to repatriate that money home involves buying the dollar. So one of the very serious questions – and you’re raising this right now – even though this seems completely irrational – we need to really keep our eyes on the value of the currency because this increase that we’re seeing at the moment maybe a very short term illusion. [12:13]

JIM: Let me throw something out here too because one of the things that we’ve seen the Fed do, we had 630 billion in repos, I think the monetary base – the Fed’s balance sheet – has increased – correct me, Brian, but hasn’t it gone from like 900 billion to almost 1.2 trillion?

BRIAN: Yes, that’s exactly right, Jim.

JIM: Yeah, it’s looking like a hockey stick. And if you look at what the Fed is doing and what it has said in terms of what it’s buying back, it’s telling institutions, whether it’s a brokerage firm, it’s a bank: We’ll buy bonds, we’ll buy preferred stocks, we’ll buy stocks. So the Fed can virtually buy anything that somebody has on their balance sheet, whether it’s preferred shares or what, they can buy that right now. So then the next question is: Okay, now if the Fed is already doing that and creating this money out of thin air as it is doing now, the 700 billion that they’re creating in this Paulson package, could this be that what we’re doing is we’re going to foreign entities – whether it’s China, Russia or OPEC countries – and saying, “look, your toxic debt that you have – I’m reading I think it’s David Smick’s book called The World is Curved, and he opens up his chapter with a Norwegian city that put its pension plan in a CDO that was sold to it by – I’m not going to mention the brokerage firm – and they lost 90 percent of their investments. So could it be that the dollars strength and also what we’re going to do with the Paulson plan because there’s – I forget how many pages it is, but a lot of people don’t even know what the details are, the fine print – could we be saying that in order to keep the fund’s flow here, “you know what, we’re going to help you guys out too”? For example, I know, Brian, you follow this pretty closely, but wasn’t it July China got rid of, what, about 30 billion dollars of Fannie and Freddie debt? [14:10]

BRIAN: It was the largest one month sale of government agency debt we’ve ever seen, Jim; and I think collectively among the entire foreign commodity it was pushing 50 billion dollars and they were scared. As you know, a lot of chatter appeared in the press and it was very, very shortly thereafter in fact, if I’m not incorrect, was a number of Chinese officials who had come out during the week prior to the theoretical nationalization of Fannie and Freddie and they were making noises about, look, if we don’t get paid back this is going to cause an international financial markets – I forget the exact words they used – I don’t want to make it melodramatic – I think it said something like ‘catastrophe’ or ‘incident.’ But that was a direct message to the United States to reassure us that we’re going to be paid back for every nickel that we’ve put up to buy this debt. [14:54]

JIM: And so maybe this 700 billion, because we’ve had since the beginning of the year we had the 150 billion dollar stimulus package, in July we had 300 billion and homeowners bailout package, now we've got the Paulson plan – that’s 700 billion – that’s you know, we’re talking over a trillion now – and there are many people, including Bank Credit Analysts that feel that this is just sort of like the downpayment that as the economy contracts, which I believe it’s doing now, that the government is going to have to step up to the plate. So whoever the next president is, you’re going to see public works programs, you’re got to see infrastructure building; all of that is going to cost a lot of money so if you think the budget deficit is bad now, the two most important figures, which are trade deficit or current account deficit and budget deficit, where do those numbers go, and if they get as big as everybody is talking about in Washington, where is the money going to come from? [15:55]

FRANK: Jim, it really makes you wonder how this is going to be stabilized. For what it’s worth, the other day –I didn’t get his name – one of the Republican congressmen who voted against the first bill was quoted extensively on cable TV talking about the foreign bailout provision as a stumbling block, and what he outlined was that under the original bill theoretically the Bank of China could take its toxic debt and after the deal was passed and then they could offload that toxic debt to the Bank of Shanghai, Los Angeles, which would then in turn be able to sell the debt to the Treasury. And so what basically the American people are not being told in what has been a very long discussion about mark-to-market and executive compensation and other issues, is that there is a big ramification within this package in terms of including foreign debt or not including foreign debt – at least one of the Republicans and not to get in any way political, but at least one of them voted against it because they felt that it was wrong to be saddling the American public paying back this foreign debt. That seems to me a pretty big issue and I think that’s an issue we’ve heard remarkably little about in this whole process over the last week or two. [17:17]

JIM: Let me ask about another element to that because at one time we had 20, I believe, primary government bond dealers. We’re down to about 16 of them and most of those 16 are foreign, meaning they’re foreign companies but they have domestics divisions that act as a primary government dealer, but when the government allowed Lehman to go under, you know, Brian, just to get some of your thoughts, what do you think if you were a foreign government primary bond dealer, what do you think you’re thinking in the capital right now?

BRIAN: It may even go beyond that in that we’ve seen so many weekend deals so to speak where the other issue of shareholder rights also has to be brought into question, where you can watch – and I’m not a cheerleader for Wachovia by any means – in fact, just the opposite, when you can watch them close at 12 dollars on a Friday and then the next Monday you’re opening up at what, a dollar, for a deal that was cut over the weekend? You know, there was really no auction process or anything like that. You know, Jim, I have to believe and all I can do to count the cards, so to speak, is to watch foreign flows of capital into the United States and into the US financial markets. At the current time, and this is just what the run rate looks like on a 12 month moving average basis, over the last year –this really began in July of last year – foreign flows of capital into US financial markets peaked literally in July of 2007. Since that time, they’ve gone straight down. Now, over that time just to characterize this correctly, foreign community has continued to buy US Treasuries – understandable. Their purchases of agencies have been very, very sporadic over time, but as of the latest data they’re showing us they’ve walked away. It remains to be seen you know, what happens ahead given that basically Fannie and Freddie paper is now quasi-US government paper; but in the corporate markets, there has been an implosion in foreign buying of US corporate bonds. We were close to the tune of about 50 billion dollars a month run rate – 12 month moving average run rate basis – in last July; we’re currently somewhere around 16, so that has dropped by almost two-thirds. It’s going to be a very big issue as we move ahead, Jim, because as you and Frank have both said, I think one of the really simplistic and key issues here is that we’re watching deleveraging in the private sector. Households will continue to delever; I think the process has just started at the household level to be honest. The financial sector – we’re watching without trying to be melodramatic – we’re watching in essence a structural calamity in that we’re watching the collapse of the ‘shadow banking system,’ I guess as Nouriel Roubini has characterized it over time. [20:02]

FRANK: Yes, exactly.

BRIAN: Everyone knows who we’re talking about, you know, where we’re looking at the investment banking firms, we’re looking at the non-bank lenders, the securitization markets – this is the first –

FRANK: The non-bank banks.

BRIAN: This is literally the first time in the last three-quarters where we’ve seen the year-over-year rate of change in the asset-backed securities market go into negative territory since 1990. They’re telling you they’re shrinking. So as you had mentioned earlier, Jim, and this is going to be a big, big issue –and I have to believe it’s a monumental issue from the foreign community’s standpoint – the US government balance sheet literally has to explode from here. There is no other alternative. And it will explode. We’ve seen it already with the Fannie and Freddie guarantees, 25 billion to the auto industry, you saw in the deal over the weekend – the Wachovia deal – where basically the FDIC is going to be on the hook for close to 280 billion dollars worth of potential losses. I’m not saying that’s a realized loss by any means. So we’re going to continue to watch the US government balance sheet expand and the big issue from the foreign perspective is going to be, okay, you’ve been funding this all these years, will you continue to fund it? And the bigger question is: At what price? [21:08]

FRANK: Brian, what would happen if we didn’t fund it. If essentially if the US government stepped back and made a statement – not a statement but basically through its actions, conveyed to the market the idea that it’s not going to back its money. Wouldn’t that lead to a pretty massive dollar devaluation, and wouldn't that then really kind of clear out a lot of this bad debt in one shot?

BRIAN: You know, again Frank, without reaching for melodrama by any means, and I’ll be the first one to tell you that I really don’t know, I’m just wondering if the problem is so big that there literally is no other choice but for the government to step in because we did stand aside and let the free markets work themselves out. Is there enough capital to really save the system so to speak? Again, I know that sounds like a crazy comment and might sound like the bear’s bear and I don’t mean it to be that by any means, but when we start adding up the numbers in the derivatives market and the leverage on leverage. And again, one of the really big issues here is – and this has been an issue for a long time – I think it continues to be an issue even in the bailout package – where is the transparency? If we would turn all of the cards face up on the table and admit we have a problem, identify the extent of the problem – I think part of the issue in the financial markets is the markets literally don’t know and when a market is faced with this intensity of uncertainty all it can do is act in panic mode because it has no way to see or quantify what that total risk is. And I think you’re seeing that being priced every day in the credit markets; they’re scared to death. [22:47]

JIM: There’s two points I want to add. There’s two publications: one is the recent issue of Forbes magazine and there’s an article by Bernard Condon and Daniel Fisher and it’s called Not This Time, and it goes:

In past downturns, American consumers have pulled the economy back from the abyss. Now they push into the abyss.

And they talked about this 17 year shopping spree is coming to and they go through all the statistics and they’re saying you know, what’s happened to the balance sheet, tapping out the home equity loans, that’s gone; credit cards, banks are tightening.

And the other article is Bank Credit Analysts – and these guys are fairly conservative and more on the optimism side – in their recent executive summary, they go: bailouts, deleveraging and the Debt Supercycle – what’s next? And basically they are saying what all three of us have been discussing here: you can’t rely on the consumer; the consumer is going to be deleveraging and is going to be deleveraging for quite some time and that the savings rate is going to have to go up. Corporations – if you’re a business guy right now, even if you could get credit you’re probably saying, “not a great time to build a new factory.” And they’re talking about: What’s left? And they said the next thing that’s going to have to happen is the government is the only sector that is able to take on more leverage. The government, for example, could guarantee all the assets of the banking system –which is what it’s looking like – and they said if that doesn’t work, the next option is going to be for the Fed to turn on the printing presses. And it said, in order to do all this that they’re going to have to turn on the printing presses, they’re going to have to get behind the banking system, as they were going to need – and I’m quoting him here – “an explicit attempt by the US to devalue its debt burdens via inflation would require the complicity of the Fed and domestic bond investors as well as calm reaction by foreign investors. One could imagine the Fed going down that road if the alternative was financial collapse.” Then they go on and they go, “right now they would like to make a few points on why they the Fed may have some leeway to do that,” and they’re saying that foreign central banks have no incentive to create a dollar crisis and collapse the system. The dollar, which is the international currency – you still need paper, fiat currencies to do trade, especially since we’re so interdependent, so maybe an orderly decline. And especially when you have private capital flight. And I can imagine the Bill Gross’s of the world who have 60 percent of their portfolio in mortgage debt, they might be cooperative; and certainly if you listen to Paul McCulley and Bill, they’ve been pretty cooperative lately – saying “do something here, we’ve got a lot of this stuff on our balance sheet.” And so maybe, guys, as we look at this, and you look at the consumer, you look at corporations and lack of credit, maybe that’s what comes next. You know, it’s back to the 1930s but this time with no gold-backing and inflation. [26:06]

BRIAN: Jim, it almost seems an inevitability we walk down this road, and we’re starting down this path right now, which started earlier this year with a lot of swapping. Swapping Fed balance sheet assets into the financial sector et cetera, et cetera. You hit on this a couple of minutes ago when you talked about the expansion of the Fed’s balance sheet recently; and I know your son Chris has put up some great charts recently on the site about the monetary base, the Fed’s balance sheet et cetera. Jim, we’re watching the beginning of this right now. Clearly again, you know, this has been a debate for a long, long time among many factions on the Street and it would be the debate between inflation versus a deflationary outcome – which one is it going to be? Well, it sure looks like we’re in the prize fight of a lifetime here between the two, but – and this goes back to your earlier question too, Frank – I think there is no way the government can stand here and not attempt probably the reflation cycle of our lifetimes. And Jim, what I don’t know in the bigger equation is: number one, would it work if just the US attempting this reflation cycle? I’m not so sure. This may need to be globally coordinated before it’s over. Because your absolutely correct; if we go into a cycle of reflation that ultimately starts to push the dollar down once this little period where so much money coming back home (as a process of deleveraging that’s pushing up the dollar right now) comes to an end, ultimately that’s going to come to an end and the dollar will express its true valuation. If we start down this reflationary road and the dollar starts to decline I have to believe the response from the foreign community would be to try to devalue their own currencies. [27:46]

FRANK: Absolutely.

JIM: This is Bloomberg story and maybe this is what we’re going to see, Brian, and it’s Trichet saying ECB ready to cut interest rates, citing lower inflation and stress in the financial and the economic system. So is that a harbinger or are they alerting in advance to maybe we may see a global coordinated interest rate cuts because you’re right, if the US was to proceed – right now we have one of the lowest Federal Funds rates or government rates in the world. If the Fed was to cut – and already the futures market is talking about a 50 basis point cut by October, what would happen if everybody else left their interest rates the same? In other words, the dollar would start to go down. However, but if we cut and they cut it gives the Fed cover and I think as BCA pointed out, it’s to nobody’s advantage right now to let the dollar collapse because trade between nations would come to a collapse. [28:45]

BRIAN: Completely, Jim. One of the things I think may not be getting as much air play at the moment that deserves some attention, and I think it will get attention over the next three to six months, is the condition of the European financial sector. And in no way am I anywhere near an expert or even semi-intelligent about what’s going on in the European financial sector, but we do know when we look at some of the numbers – you look at a Barclays, you look at a Dresdner –

FRANK: UBS.

BRIAN: They are levered well beyond what our banks were in the United States. So I think as you look at the magnitude of currencies, here the dollar is such a big, big magnitude globally, euro right behind it, Japanese yen right behind that; the two major players both have issues. Europe’s issues are going to come to light in the next six months or so and they’re going to be forced to the table. Forced. [29:30]

JIM: I want to move on to something that we’re also seeing is we’ve been talking about credit – this is spilling over into the real economy, whether you look at the Cleveland Fed Coincident Indicators, it looks like we may not have called it a recession but we’re in one. I want to talk about the disconnect that we’re seeing between the paper and the physical markets. On the day that we’re talking, gold got hammered and some of the headlines that I’m looking at here: ECB ready to cut, LIBOR soars; commercial paper slumps as credit freeze deepens; Fed loans to banks and dealers climb 60 percent to 348 billion as credit tightens; Lehman funds excluded from Neuberger sale; Treasury trading failures increased to a record amid credit freeze, Fed says; Derivative market is resolving the industry trades amid unexpected volume; new home equity is vanishing; Peru sells record debt; bond traders ogle spreads as credit crunch shifts business off Wall Street. I could go on and on and on. [30:37]

FRANK: And all of that is gold bullish.

JIM: What this reminds me of guys – and I’d like to hear your comments – but we know that for example when the dollar was under equal pressure in the 60s, a couple of professors came together and said we ought to pool gold together and keep the price of gold at 35. Well, eventually some guy by the name of de Gaulle said wait a minute, you’re getting a free ride out of this, United States, I don’t buy this. And eventually de Gaulle was pressing for going back to the gold standard. He lost the argument but I think he ended up winning the war because what happened is as France started to say “here’s my dollars, give me your gold” it eventually forced decoupling of the dollar and gold.

Now if you take a look at the markets today, you have a paper market in gold that is down in the low 800s now, given all this crisis, and yet I don’t care if you’re looking at Dubai, Mumbai, Johannesburg, any place; I just called up the largest mint in the country and they said that maybe 14 weeks if you ordered something right now, you could get it by Christmas. There seems to be – it’s almost like Brian we’re turning into Frenchmen. It’s like the London Gold Pool, except for it’s the world is reacting to this and saying, “here’s our paper money, give us bullion” because there is certainly a big disconnect between the paper price of bullion and what’s actually going on in the physical market. And when you see in the month of July to August – and Brian, you and I had this conversation earlier – the short position in gold goes up 10-fold, the short position in silver goes up five-fold equal to one year’s full production, and you’re seeing that take place and instead of panic selling, as one would expect as the price went down, you almost have panic buying. It’s just the reverse. Anybody want to comment on that?

FRANK: Jim, I definitely – you know, I don’t want to sound like a conspiracy nut either, but I think there’s been an awful lot of evidence unearthed in the last few years that point to some of the large investment banks as being pretty much behind holding gold down. And a lot of what we’ve seen in just the last few weeks in terms of the shorting of the COMEX contracts, the paper gold, to me it really strikes me as a bear raid. I think the big banks – the Morgan, the Goldman – and one of the headlines that you see today that Goldman is making a fair amount of money in this crisis – I think they knew this was coming, I think they had a great bird’s eye view of their books and knew what was out there. Basically, if you know you’ve got a big bad debt problem coming at you, and that it’s going to have to be reinflated away over time, the best way to position yourself would be to acquire physical metal, and that’s why I think we’ve seen this bear raid. This super bear raid between mid-March and September 11th which was the panic low in the metals, I think that decline was really engineered by the derivatives players, and I think what they’ve done is they’ve used paper gold to knock the price down and create a panic and then buy up all the physical gold in the panic and basically get themselves hedged and protected against what they knew was coming which was a bad debt problem. And now the rest of us are all seeing this unfold week after week with Wachovia and WaMu et cetera et cetera, and god knows who will be next, and it really smacks to high heaven of some type of manipulation and given everything we’ve seen it really wouldn’t shock me. [34:15]

BRIAN: I think all of us know because we all listen to him and read his material – Don Coxe up in Canada has spoken about this a while ago and laid out a case for why the commodity markets generally had declined from mid-July and how that might have been done. Frank, as you look back broadly now, it seems that it’s a common theme over the last three months or so that you’re seeing declines in paper. Everything that [has a] commodity orientation that’s represented by paper is being sold, but when we look at what’s happening when we call the local silver or gold dealers and/or – and this spreads across the greater commodity complex here – and Jim, I think you referred to this earlier – if you look at what the OECD has put out – and this is the Organization for Economic Cooperation and Development out of France, they’ve been around forever – but they track all of the major global economies including the emerging economies, we are indeed, yes, and we’ve heard this from headline strategists in the US, yes, we’re seeing year-over-year rates of decline change for crude demand, but non-OECD countries – and you know who we’re talking about; China, India, Brazil, Russia et cetera – the non-industrialized countries so to speak – their demand has more than made up for the decline in the developed world. Yet, at the same time, the paper asset, that is USO, that is UNG, that is crude futures – personally, I think we’re seeing so much deleveraging here on the part of the leveraged investment community, that it’s not necessarily transmitting correct pricing levels relative to global supply and demand. Mix that up a little bit and shake it with ice if you will, with a number of strategists who’ve come out and said, “oh, well, don’t you worry, the economy in China is going to collapse. All these wonderful emerging economies are just going to collapse into a dust heap.” I just can’t believe it until I see China come out and outlaw the sales of crude gasoline, outlaw the sales of cars. If we look down the road tough economic times, non-tough economic times et cetera, the message is clear that these economies will continue to grow at some rate – whatever it may be – over a period of years – but their usage of hard assets is going to go higher in the long run. Very calm. Hopefully very unemotional, very simple; and at the moment we’re watching that illusion of paper being sold that theoretically is suggestive of some big economic collapse. Indeed, I hope that’s not to come by any means. If the markets are correct here, I don’t think we want to know, but it’s the deleveraging that really is – in my own mind, anyway – creating an anomaly in price signals in the markets. [36:56]

JIM: Well, here’s an interesting statistic that kinds of back what you’re saying, and this is Jeff Rubin out of CIBC. And everybody who has been paying attention to economic news saw those horrific numbers for automobile sales that came out on Wednesday. But he said, if you take a look at second quarter sales in vehicles they were down 7 percent in the United States, Canada and the European Union and Japan. They were up 20 percent in BRIC countries such as Brazil, Russia, India, China. Since the beginning of the year, auto sales in China are up 40 percent. And here’s the remarkable thing – they’re not buying Yugos – what’s that 2500 dollar car from India? The Tata. SUV sales are up. Luxury cars are up. Midsize cars. The smallest increase in China is subcompact cars. And they took a look at vehicle for Russia which were up over 30 percent; Brazil, China and India. And the other thing that is remarkable that is – you know, if you take a look at Brian, as you just mentioned, there are two sides of the oil equation: there’s the demand side, so you’ve got OECD demand down, it’s down about a million barrels a day here in the United States or year over year, and then you have the other countries in the world, you have OPEC countries that are consuming because oil is subsidized, you have India, China and Latin America – and as Jeff Rubin pointed out in his article, not only is energy demand increasing in those countries but it’s more than surpassing the decline in OECD countries. So there’s the demand side.

What they’re not factoring in is on the other side of the equation which is the supply side. The recent IEA report said that world depletion rates have gone from 4 percent to 5 percent but at ASPO, Matt Simmons, his company put on a conference in Scotland where they had the oil service companies and he asked them, How many of you believe that the depletion rate is 5 percent. A few hands. And then he said, How many of you believe it’s 8 percent? A lot more hands – almost 50 percent. And then, How many believe it’s greater than 8 percent. And this was coming from guys like Schlumberger which works on these national oil company projects; it was coming from Baker Hughes, it was coming from Halliburton. We know for example year-over-year the depletion rate in Cantarell – the second largest oil field in the world – is 32 percent, and that in two years or three years from now, the United States will lose a source that will equal about 1 ½ million barrels. So even on the supply side – and I heard one analyst and I can’t think of his name – but I think he really expressed it appropriately; he said, “We in the West are looking at the wrong data.” [40:01]

BRIAN: Exactly, Jim.

JIM: Yeah, so if you look at OECD demand – let’s say vehicle sales in the United States, you’re saying demand destruction. But if there is demand destruction – Brian, you live in San Francisco, I don’t know what it’s like, but I drove up to Sacramento and it took me on a Saturday, two hours to get through LA through a traffic jam, and I’m thinking to myself, I’m going to ASPO, and I’m listening to that thinking in my head as I was driving even on the I-5 going up to Sacramento, where has the demand destruction been? Because I certainly didn’t see it on the highway.

BRIAN: You know, Jim, I’m glad you brought up that car sales issue because this is a really broad comment; it’s macro and it’s very long term in nature. What will it mean to us tomorrow at the open? And the answer is probably nothing. As a preface, I just want to say: one of the really important things – and this is me speaking to myself more than not – this is really a time to remain unemotional, a time to remain calm, it’s a time to remember that in markets like this, this is where incredible opportunities are born. Let’s put it this way: If the world is going to come to an end, who cares anyway? But, Jim, one of the big, big issues I don’t hear too many people speaking about is when you’re looking at the car sales in some of the foreign countries and you’re looking at some of the very big numbers – and admittedly, all of three of us would be the first to admit that they’re coming off of low bases – but what you’re looking is a whole class of new buyers. In the United States when car sales collapse as they have done – I mean again, simple question, who doesn’t own a car in the United States that needs transportation and can afford one? Everyone does. So it’s basically a deal where we’re a second hand buyer. We’re a buyer out of dramatic need, out of necessity because our former car has blown up. But when you look at the – call it billion and a half, two billion people globally who are going to become new buyers, and it’s the new buyers of these assets and whether that is cars that ultimately demand steel, rubber, crude –we can list the commodities – or on and on about new buyers that would be buying their first washing machine, their first television, whatever it may be. This is so powerful, I believe, over time that this is really the time in a market like this when it’s so tough amid the paranoia, the hysteria and the just sheer raw panic and emotion of the moment to get caught up in this and not realize that we may be being presented right here – and I’m not saying it’s today but we’re being presented during this period with potentially incredible investment opportunities if we just open up our eyes and look at the global community – the complexion of the global community and what is to come in terms of how powerful these new buyers will ultimately be. You saw Charley Maxwell a few weeks ago show up in Barron’s – everyone should know who Charley is – spent years, decades in the oil industry, more decades than that on Wall Street; Charley used to sneeze and people would react. At the current time he has absolutely no axe to grind whatsoever; he’s not out selling brokerage, he’s not out selling research and he’s telling us that by 2015 he expects crude to be 300. Whether the 300 number is correct or not, all we need to do is listen to the direction of where we’re going. [43:30]

JIM: And here’s something that I found that’s rather fascinating, Brian. When Don Coxe came out with his piece on “something’s funny here,” I was interviewed in Barron’s by the reporter who writes the commodity section and I said, Look, whether you want to believe it’s conspiracy or some guy – the Wizard of Oz behind the curtain – that’s not the story. What I see is the disconnect between the physical market and the paper market; and I’m just going to give you some examples here. And we were talking about base metals and the economy was slowing down and people weren’t going to have it, and I said, “you know what, I listen to the conference calls of the guys who run companies like Freeport, BHP – BHP Billiton just raised prices for their iron ore over 70 percent and they just increased their dividend in the month of August, payable in December by 42 percent. And I was saying, and I was talking to this reporter, now that doesn’t sound to me like a company that has financial problems. If you want to go to another company – Freeport Copper and Gold, they just increased their dividend twice this year; they just increased their dividend 61 percent. Here’s another one that will really drive home the point and let me just call this up here on my Bloomberg, and this is credit default swaps and if you look at Exxon which Exxon’s stock is down – I forget how many percent this year – it started out in the 90s, it’s down in the 70s – and if you look at credit default swaps on Exxon – and let me just call this up on my screen right now – it is 0.25. One-quarter. And let me just take a financial – we’ll take Wells Fargo. Less than one percent. Now I’ll take a credit default swap for let’s say Wells Fargo – a bank – and that credit default swap, and they’re one of the better capitalized ones, is 160. [45:39]

FRANK: I know, Jim, you and I were looking at some of the insurance companies earlier today – Conseco and Hartford and they’re in the hundreds, hundreds of percent.

JIM: Yeah, five and six hundred percent. And so you have these companies that have credit default swaps that are at 25 basis points versus financial sector that are five hundred, six hundred, 12 hundred basis points –

FRANK: I think Exxon’s credit default swap right now is below that of the US government if I’m not mistaken.

JIM: It is.

BRIAN: McDonald’s was a few days ago.

FRANK: We’re going to keep eating those burgers no matter what.

You know, Jim, you’re right about the – what is the totally irrational disconnect. As a portfolio manager that would be my take on it as well, I’ve seen some of these energy names come down, some of the mining names come down. I think we’re definitely in the silly season – there’s panic and irrational panic. That’s not to say that it’s going to stop any – you know, tomorrow or the next day, but I agree with Brian that when it does come to a rest we’re going to see a bottom that will be monumental and prices will roar back. That means that people need to be extremely [inaudible] about making sell decisions here because you may end up finding that a few weeks down the line, what you sold was a really good asset that is now roaring back past where you sold it and you don’t own it anymore, and that’s kind of the thing that can happen when you trade; and when you trade in very emotional markets you can get whipsawed very badly. For most people, if they’re not using margin, right now the thing to do is to really hunker down, understand what it is you own – whether it’s bullion or high quality equities and just clutch on to that idea and not let those stocks go because at this particular point in time we’re in such a fast market, yes, it could collapse and go further but it also could whipsaw back fairly quickly and that makes it a much bigger roll of the dice at this particular junction. At the moment I don’t see a sign of a bottom in this stock market; it still looks like we’re going lower, but again, that can change on a dime and especially in this kind of very fast market. [47:57]

BRIAN: So tough to gauge short term. You’ve lost a lot of valuation bearings and you’re just in a period of deleveraging where – and this may sound very sarcastic – it comes to an end when the last person that is forced to delever has sold their last share. So in one sense it’s very tough – you know, you probably saw this morning the fertilizer companies and it was sparked by Mosaic. Mosaic came out this morning and they announced they’re going to cut their forward production of diammonium phosphate – the price has been falling for awhile now – but they reported a quarter today that was close to 3 bucks a share. I forget what the exact number was. The stock closed at 39. Now, admittedly, it was down huge today – lost 40 percent of its market value, but if you look at these companies that have physical assets underneath them, they’re being thrown off the side of the ship because they’ve been held by a lot of the fast money, a lot of the hedge crowd who is absolutely in the middle of deleveraging – whether it’s problems with prime broker in Lehman and not being able to get their assets back, or you know, funds that made bad bets and lost huge in commodities during the august period which we’ve seen. Deleveraging plays tricks on our eyes and maybe on our emotions because they seem to lose their valuation underpinnings. That doesn’t mean those valuation underpinnings have gone away. [49:13]

FRANK: No, that doesn’t – and actually, sometimes it can be a really remarkable just how quickly the recovery can be, and that’s one of the reasons I think people need to really take a look at the fundamentals of what they own and try to have a little bit more of an investment point of view – something of a medium to long term point of view.

JIM: Isn’t that, guys, essentially what we saw two Mondays ago and I think the weekend before that where you saw gold pop almost 100 dollars in one day, and on a Monday you saw oil prices go to like 120, 130 and they had to close the exchange for five minutes just to balance out the trades and let everybody collect their thoughts. But in this period of time where you have emotional trading – and I use the analogy of somebody that owns a home. Let’s say you’re in a house, you have a comfortable downpayment, you have a good job, you’re making your payments and you plan on staying in that house for the next three-to-five years. And all of a sudden, you find out some bad news; your neighbor next door who had brought his house with no money down, was overleveraged, lost his job, couldn’t make his payments; he stays in house, he can’t make his payments and he’s moved out of the house because the bank repos the house. The bank turns around, sells the house through a real estate agent at distressed prices and the value of that house drops below the value of your house. If you are planning to stay in that house the next three-to-five years, if you’re comfortable with the payments that you have, you have a good job, would you go and say to your spouse, “oh my, Charlie next door, they sold his house for 50 grand below our house, let’s dump our house in a stress sale.” Would you do that?

BRIAN: Never in a rational world, Jim.

FRANK: Never in a rational world is right.

BRIAN: But we just happen to be, at least at the moment anyway, involved with an irrational world.

JIM: But that’s the point. In other words, if you own a good oil service company – a Schlumberger, you own an Exxon, you own a BHP – and you are not on margin so no broker’s calling you up and saying, “post more margin to keep your account,” or you’re not in a hedge fund that is deleveraging, you can afford to sit there and say, I don’t like this turbulence, I don’t like turning on the news and hearing what I see, but I know I own something that’s valuable, I know I own something that’s well managed, I know something that I own is tangible, it is real. The business – forget the price for a moment – but the business is doing well, and I would submit: Anybody that’s raising prices 60, 70 percent or raising the dividend at 60 percent or by 40 percent is a business that is doing well. And why would you want to sell that? [52:07]

BRIAN: Jim, even if you took a number of the current earnings estimates for a lot of these companies, and cut them in half, they’re still relatively attractive on a valuation basis here. And it’s tough in a period like this because clearly – and this is just my own thought – I may be dead wrong – what’s happening in the financial sector, what’s happening with deleveraging in the current time will make itself known and will express itself in the real economy. Personally, and this isn’t going to sound good, I expect an incredibly meaningful consumer-led recession dead ahead; probably the likes of which we haven’t seen since the early 80s, both in magnitude and depth. So it very well could be that we start to see some of the earnings estimates come down for some of these companies that are related to this industry, and you know the cry at the top is the valuations should be low on cyclical stocks at peak cycle, they should be very, very large at low cycle – but what I’ve tried to do and I know you guys have done the same thing – is when you’re looking at some of these companies, go ahead and cut the earnings estimates in half, take them down by 50 percent, and then take a look at what the valuations are. Would you buy those entities with 50 percent declines in earnings from here, yes or no? Some of them are still very attractive even looking at the numbers on that basis. [53:21]

JIM: And I think that’s what you’re seeing Warren Buffett do. I mean he’s buying energy companies and he’s buying companies because he’s taking a look at that and saying you know what, all right, we’re in a bit of a rough patch here, but based on the valuation and what I expect that could happen over a three, five or ten year period, would I buy this business? Is there enough margin of safety here at this price. And once again, if you’re not leveraged and you own these businesses already, and nobody is calling you up, you know, you don’t have to pay for a wedding, you don’t have to liquidate to pay for a college education and you can afford to take a longer term view as you said, Frank, rather than panic then I think there are some valuations here and some companies that represent some bargains. Because Brian, I go along with what you’re saying earlier about the emerging market – you know, we are so American-centric here and we think that what happens to car dealerships here is reflective of what happens to car dealerships elsewhere in the world. It may be true in Europe, it may be true in Japan, but I’ll tell you it’s not true in Russia, Brazil, many parts of Latin America, China and other countries; and you know, over the long run, I think that is going to be more significant when you consider there’s 300 million people in the United States, there’s 1.3 billion in China, another billion people in India and I don’t know how many hundreds of millions of people there are in Brazil. But you know, eventually those consumers and a new class of consumers who have never had some of the things that we have had, is I think you’re going to see a situation where maybe the standard of living in the United States comes down as the consumer deleverages and the standard of living elsewhere in the world goes up. [55:14]

BRIAN: Jim, I’ll tell ya, I think that’s exactly what happens from a longer term macro perspective.

FRANK: I agree with that as well.

BRIAN: It doesn’t come true on Wall Street by next Friday by any means. So for a multi year, half decade, decade long period –

FRANK: I think Americans are going to have to get used to dealing with an inflationary environment over a period of several years. That’s not to say that we might not see some kind of a really big financial shock. I think that’s where we’re heading next. We’re already in that. I think this crisis could intensify and actually lead to some kind of some real blow out on the downside of that capitulation, but then you know, maybe a v-type bottom where we come back up out of it and begin recovering at almost the same rate that we went down. So I think there’s going to be a lot of volatility in here, and people are really going to have to have to hang on for a white knuckle ride.

BRIAN: Always tough to do.

JIM: Yeah, it’s Mr. Toad’s wild ride and we’re right in the midst of it. And if you are on a rollercoaster, the last thing you want to do is unbuckle your seat belt and jump off. [56:15]

FRANK: That’s for sure.

BRIAN: Can I get a refund on my ticket, Jim?

JIM: Well, guys, any closing comments as we end here?

FRANK: One thing I would say to the general investing public is if you own bullion right in here, that would be the one asset of last resort that if you’re going to panic, the one thing I would definitely not sell at this stage of the game is physical bullion. I think that’s a powder keg. I think when you look at all the billions and billions of dollars that are being bandied around in terms of bailout money, folks, that’s just inflationary. Yes, there’s a big deflationary tide right now, but right now that’s – the process is that bad debt from the private sector is being handed off to the public balance sheet, the burden is being shifted, and that’s very bad for the dollar. So that’s the one asset I would really cling to above and beyond all else is physical metal – both gold and silver. [57:13]

BRIAN: And Jim, I’ll just leave you with a comment that maybe is more philosophical than not and again I’m probably talking to myself, during periods like this I have to remind myself every day – and especially if I’ve got the screen on – is remain calm, remain focused, remember to look at factual data as opposed to a lot of what we’re hearing in the financial media. Unfortunately, and I don’t mean this in any political way by any means, our fearless leaders here are doing us a huge disservice. On September 15th of last month, Paulson was running around the globe telling our foreign creditors the banking system is sound, everything is wonderful, don’t you worry, you’ll get paid, everything will be fine. Four days later he’s in front of Congress telling us we’re two days away from a financial implosion; Bush shows up on TV and says this could wipe out the retirement savings of America. This is throwing gasoline on an open fire. I haven’t seen – and I’m sure you guys may agree with me on this – we haven’t seen this type of hysteria, panic, paranoia – and I’m not saying it’s not for good reasons – it’s for good reasons, but, we have two choices here: The world comes to an end; or we’re ultimately going to be presented with some really great investment opportunities. Is it time to rush right down, put your net worth on the line and bet that today is the bottom? Of course not. It’s time, though, to remain very, very calm – average in if indeed you have the ability to do that and remain focused on the fundamentals and dynamics of the global economy that lies dead ahead of us. [58:38]

JIM: I’ll just add to that. On the calmness and the focus, you’re in a plane, you’re at 37,000 feet, the plane is dropping at a thousand feet, the last thing you want to do is ask for the stewardess to open the door and you’re going to jump out without a parachute.

BRIAN: Exactly, Jim.

JIM: You may not like the ride, but you know, that’s what the seat belt is there for, and you know that when you go through those periods of time, whether you know – you’re out on the ocean going through a storm you’re going through turbulence, you know that most cases the ship is there and it’s designed to take those kind of seas or the planes designed to take that kind of turbulence.

Well, gentlemen, listen, thank you for joining me here on this week’s Big Picture and sharing some of your thoughts at a time where I think there isn’t a lot of rationality – whether you’re seeing from our political leaders or even some of our leaders on Wall Street. I wish you all the best and thanks so much for joining us.

Part 2

Looking For Facts In All the Wrong Places

JOHN: Well, I’ve been trying for the last hour or so here on the show to figure out a delicate way to break it to all of our listeners – well, let me see if I can try this – Everything’s a mess!

JIM: That’s a simple way to put it.

JOHN: Yes it was. I thought it was very straightforward. You know, don’t beat around the bush. Everyone’s been talking about the mess for the last two weeks. What I have noticed however – and I’ve been reading editorials from the Asia Times to you name it, the Financial Times is people tend to button hole one thing or another; only a limited number of commentators out there seem to have grappled with the whole situation. And on top of that, as you well know, Jim, there’s a huge amount of static out there as to how we got to where we are and even better, where we’re going for that matter.

JIM: And that’s what happens when something as dramatic as what we’ve seen unfold here probably in the last two months unfolds. Everybody is pointing fingers and you can certainly see that in an election year; Obama is blaming it on the Bush administration, McCain is blaming it on Wall Street and greedy people on Wall Street and all over. And so what we do is what government does when it has to face the consequences of the failure of its own policies, the first thing they do is finger point because heaven forbid they would own up to the responsibility that, Hey, we goofed here, we really messed up here, we apologize, here’s what we’re going to do to fix it. Instead, they spend pointing fingers at each other.

There are so many milestones that we have gone through that have led us to where we are today, and one of those would have to be the derivatives market. Throughout the 90s we saw derivatives grow at double digit rates and if you take a look at the compound growth rate over the last two decades, derivatives have grown at almost a 21 percent compound rate; and instead of people like Warren Buffett warning people that these are weapons of financial mass destruction, you had people like Alan Greenspan said that these are just wonders of modern technology and innovation that allow us to transfer the risk and diversify the markets and all these wonderful things. And of course, that was all the happy talk in the 90s, because remember, Jens O. Parsson’s [saying] when central banks inflate and when inflation first starts to take off you get the good kind of inflation, so whether it’s rising stock prices or rising real estate prices everybody loves that; and as long as things are going well all this leveraging up which is what we’ve done over the last two decades then as long as things are going well, people are saying, Wow, these are just modern marvels of financial innovation.

But you know, there were a number of things that we did and it’s surprising, we talked about this last week on the show, and that was in 1999 and by the way, I watched the debates last night, it was a Clinton administration proposal and endorsed by both parties where they repealed Glass-Steagall in 1999 and said banks could go buy brokerage firms, brokerage firms could go into banks; and we got rid of the Chinese wall that separated these two institutions. And even more so, John, when I got into this business in 1979, when I got out of corporate life and got into the brokerage business, most firms if you were leveraged you might have been leveraged three-to-one or maybe four-to-one, then we put a limitation that the maximum limit in the 90s was 12-to-1; well, it’s amazing because there was an article in the New York Times on Friday and they were talking about a meeting that took place on April 28th in 2004 and really led to where are today – or at least helped lead to where we are today. And the SEC met with five of the major investment banks – Merrill Lynch, Bank of America – which was in the brokerage business at that time – Lehman Brothers, Goldman Sachs and Morgan Stanley. And what they were asking the SEC to do was give them an exemption for their brokerage units and get rid of the old regulations that limited the amount of debt that they could take on, and limit the amount of reserves they would have to keep to back up the debt, just as banks have reserves, so do brokerage firms. And what this enabled – the reason they were saying this – this would unshackle billions of dollars held in reserve as a cushion against losses on their investments. And leading the charge was Henry Paulson, who at that time was the chairman of Goldman Sachs, and they said, Look, we’ve got to modernize our financial industry, we’ve got to get rid of these regulations that kind of shackle us and make us less competitive and we ought to be able to leverage up; and that way we can deploy our assets more efficiently. And so there was a vote, it was taken and that rule was lifted. And that decision, which changed the net capital rules, was published in the Federal Register a few months later; nobody commented on that but it basically unleashed the investment firms to leverage up their assets; and so as a result, from leveraged 12-to-1, Bear Stearns went leveraged to 33-to-1; some of these firms went to 40-to-1.

Goldman Sachs, until Warren Buffett just injected capital, was leveraged 25-to-1.

And here’s the irony out of this: Now, if you’re going to be this leveraged, you would want close supervision, but instead, the SEC backed off and they said we’re going to rely on the investment firms’ own computer models for determining the riskiness of their investments. So essentially, the regulators outsourced the job of monitoring the very institutions they were set up to monitor to the very institutions themselves. [6:41]

JOHN: Which is the old adage of letting the fox watch the henhouse – nothing less.

JIM: Yeah. So what happened is these guys had these computer models and then another thing that they did during this period of time the commodities CFTC Act modernized commodities and derivatives and allowed the derivative market to basically everything from interest rate swaps to go to over-the-counter derivatives instead of exchange-traded derivatives. So you didn’t have any transparency, and worst of all, you had a lack of liquidity. So as a result of that you saw this increase in leverage on Wall Street, increase in leverage, derivatives exploded to the upside to the point when this crisis hit –to put this in perspective and you heard this in the last hour when we were talking to Frank Holmes, but world GDP is 50 trillion, world derivatives is 500 trillion – 10 times the amount of world GDP. And the value of all the world’s stocks and bonds are 100 trillion and the value of derivatives is 500 trillion; that’s why you could have a small minor division – actually, not a minor division, but one division of the world’s largest insurance company at AIG’s Financial Products Division get into these derivatives and those derivatives blew up the entire insurance company. So what we had going back to Greenspan who came in and replaced Paul Volcker; and Greenspan began to do away with a lot of the safeguards that Volcker had put in to try to protect the banking system, to make sure it was strongly capitalized and especially after getting through the Latin American debt crisis that we ended up at the end of the 1970s as a result of recycling those petrodollars.

And so Greenspan comes and what he does is he just enhanced the moral hazard; it became known as the Greenspan put: Anytime there was a crisis, a stock market crash, the Gulf War, recession of 91 and S&L crisis, the Peso crisis, the Asian crisis, the Long Term Capital-Russia crisis, the Y2K, 2001, 9/11 – every time that we got into one of these crises, the Fed would go loose with the money supply – and we’ll get to that in a minute because what Greenspan did doesn’t look anything close to what has just been done with the Fed’s balance sheet in the last six weeks. And so there was a moral hazard that is set up here and that is: Go ahead, Wall Street, leverage up your balance sheet, go ahead money center banks leverage up your balance sheet, go ahead insurance companies leverage up your balance sheets, and if you’re really big, we’ll put the American taxpayers behind you. And we’ve seen Fed policy go from what restriction of six percent down to one percent under Greenspan, and he kept it there. If you keep interest rates down at one percent, you are encouraging people to go out and speculate, go out and borrow; and instead of allowing – you know, once again, you go on a drinking binge – you’ve got a hangover, and the hangover is the body’s mechanism of getting rid of the toxins from all the alcohol that you drink. Well, the same thing when you go through these financial and credit excesses as we did in the 1990s – and that’s what the 1990s were – it was hailed as this golden age in America – it was nothing but money printing, leveraging; and the conditions that we’re seeing now, their genesis was in the 1990s in terms of what we were repealing. And so, when you lower interest rates as we’ve done, and as we’re doing now, and by the way, we’ll get to this in a minute – I would not be surprised to see a coordinated interest rate reduction with the Fed, the ECB, the Bank of England and other central banks to lower interest rates in a surprise move. John, you and I have called them weekend huddles, you never know – you know, it’s like – you know, on the weekends you used to turn off the news and you do family things – you go sailing or go to the kids’ soccer games or baseball games. Now you don’t do that. You’ve got to pay close attention to what the heck are they cooking up next. [11:17]

JOHN: If we take our timelines to this point – we got rid of the Glass-Steagall Act which was passed as a result of what happened in 1929 – that was at the head of the Great Depression, so we released that. We basically allowed banks to begin leveraging rather substantially. There are several contributing streams to this – it didn’t come down one stream, it came down several which all came together to make this storm we’ve been watching. So what were the other areas?

JIM: Then the other thing is to appease the investment banks which were involved in heavily shorting, they got rid of the uptick rule and then on top of that, they quit enforcing the naked short rule. So basically, you said, “Leverage up, and you know, we have these rules against naked short selling or counterfeiting shares, but we’re not going to enforce them; and also, we’re going to get rid of the uptick rule and make it easier for you to short sell.” And then on top of that, we came up with these mark-to-market rules which basically said that whatever the market drives the price of anything, whether it was a mortgage bond, a stock or anything else, if your bond drops 20 percent in a quarter, you’ve got to write that off for your quarterly reports. And so you had the combination of short selling, naked short selling, mark-to-market accounting, and then no supervision – no supervision of the investment banks in terms of the amount of leverage and risk that they were taking on, no supervision of their computer models in terms of how they were pricing risk, no supervision of short sellers; and then also, putting in this mark-to-market accounting. One of the things that we did when we bailed out the banks in the Latin American crisis is we let the banks write and take these loan losses over a period of time as they rebuilt the banks’ balance sheet and profitability. So the crisis coming out of the Latin American debt crisis out of the late 70s was not catastrophic and the banks were able to recapitalize themselves. But once again, once they recapitalized themselves – never underestimate a bank’s ability to get you in another crisis. So right after they finally got recapitalized from the Latin American crisis, then we got the S&L crisis. But I would say getting rid of the uptick rules, allowing naked short selling to go unsupervised, and just simply a lack of supervision from any of the regulators. And you know, now what will happen is they’ll probably go in the reverse direction, which will be over-regulating.

But here’s the real risk here is if you take a look at the derivative market in the US, almost 90 percent of the derivatives are held in three institutions: Citigroup, Bank of America and JP Morgan Chase.

And which three institutions did they just make a whole lot bigger? [14:25]

JOHN: Uh, Citibank, Bank of America, and JP Morgan Chase.

JIM: You got it.

JOHN: Now, let me ask you a question: why weren’t the regulators looking at this? Usually when that happens, it’s either a) for internal political reasons – meaning the bureau is just terribly disorganized, which is a possibility; or b) the good times are rolling, and the politicians don’t really want to see the good times stop because from election to election at that moment in time, this seems to be in their best interests. Now, what do you think played a factor here?

JIM: We had the Fed, which was reinflating the economy, markets began to take off after the summer of 2002; you had the real estate markets that were going up, you had markets around the globe going up, and so it was good times. And during good times banks said, “Look, we’ve got to be competitive, we’ve got to be able to leverage like our brothers do overseas and you got to just let us monitor our assets with our very sophisticated computer models.” And that’s what happens – you will find this repeated throughout the 20th Century, that during good and prosperous times the regulators go to sleep; they’re saying, “Hey, things are working out well, the nation is prospering, the markets are going up, the economy is doing well. Look what’s happening to the value of our homes, stock prices are going up. Happy days are here again.”

And then all of a sudden we find out – as we do with all monetary policy that creates these big booms – eventually comes the bust; and then when the bust comes, then with hindsight we look back, “This should never have been allowed to happen.” And then we get into finger pointing, and I know a lot of people have defended Chris Cox. I think he did a poor job. The fact that he allowed this to take place in the first place – the leveraging of these balance sheets; 2) unsupervised naked short selling – get rid of the uptick rule and then during this crisis when you had mark-to-market accounting with all of this heavy short selling, the only time he stepped up to the plate was when everybody began selling the investment banks, and short selling them. Then he said, Okay, we’re going to enforce short selling against the investment banks; and then he got a lot of criticism for that, and then he said, Well, maybe we ought to apply this to the rest of the market. I mean it’s just – I’ve never seen anything like it.

And remember, in all credit crises and booms and in the theory of credit it takes ever increasing amounts of credit to get yourself out of this mess. And so that’s why we have put up on the radio website – if you’re listening to this podcast, we’ve got three or four charts there: one is the Fed’s balance sheet and it looks like a hockey stock – and the Fed’s balance sheet has gone from roughly – and I’m just going to round it off – 900 billion to 1.5 trillion, and it’s done that in a period of six weeks. It’s up 67 percent in just one month. And if you look back at this historically, this doesn’t even come close to the events of 9/11 or the Y2K scares, or the Asian crisis or the Long Term Capital Management crisis. I mean I’ve never seen anything like this; and the estimates that I’ve seen out there –and these figures are looking more accurate now, given the actions taken by government – that it’s probably going to take two trillion dollars to get rid of all this toxicity that’s in the financial system. And one of the reasons that banks aren’t loaning to each other is we also allowed off balance sheet entities – these structured investment vehicles – SIVs – and everybody is saying they don’t trust each other because you don’t know which bank is sitting on derivatives or credit default swaps that could blow up and blow up the institution. And so that’s why they’re reluctant to lend. And so that’s why the Fed has had to sit there and say – you know, this goes back to the Fed papers that were written back in 1999 and the year 2000, saying that if we ever get into one of these crises, well, we’ll buy mortgages, we’ll buy real estate, we’ll buy stock, we’ll buy preferred stock. Well, the Fed hasn’t done the buying – they’ve just swapped it, and they go to these institutions whether it’s banks or investment banks or money center banks and say, “We’ll take your garbage and we’ll give you our Treasuries.” So they’re swapping all kinds of assets; they’re taking over companies and if you look at this credit spreads in the market keep widening. On the Friday that we’re talking, the TED spread is almost – it blew out through all previous crises that we’ve seen in the last couple of years here. You know, you’re talking about almost 387 basis points – a jump and a spike – and that was today; it was up 26 basis points even after the bail out. So the problem that we have when you have allowed institutions to leverage 20-to-1, 30-to-1 and 40-to-1, John, what we’re in the process of doing right now, and it’s mainly the hedge funds – a lot of this selling that is going on and taking place right now has a lot to do with hedge fund redemptions; when you’re in a hedge fund, I think October 15th is the date to pull money out of a hedge fund so that’s why you’ve got a lot of this selling and a lot of these premier names – whether you’re looking at the agricultural sector, the gold sector or even the energy sector a lot of this sell off, which goes beyond even what the values of the company are, are these hedge funds that are deleveraging. [19:57]

JOHN: If we were to rewind the clock and say, let’s take it back five, eight years or so, what should have been done to have headed this off or maybe not even have permitted it to happen in the first place?

JIM: I would never have got rid of Glass-Steagall. So let’s go back to 99. I would never have allowed the investment community to leverage up as they did in 2004 where they said, Look, the maximum limit is 12-to-1, now you leverage as much as you want. So I would never have gotten rid of Glass-Steagall; I would never have allowed them to leverage up the way they did; I would have never brought interest rates down and left them as low as they did when the Fed cut interest rates beginning in 2001 and left them there all the way to the summer of 2004. It just fed this crisis. I would never have gotten rid of the uptick rule and I would never have gone to mark-to-market accounting; and I would have also not have deregulated and allowed the derivative market to expand over-the-counter derivatives to such an extent – in other words, I would put more of these derivatives on exchanges where the values and the liquidity and transparency would have been there. And had we done that, we wouldn’t have been where we are today. Yes, we might have been in a recession, which we were in 2001, and it might have lasted a little longer. But companies learned a lesson from that, they rebuilt their balance sheets, they did not expand, they did not do stupid things and I think you wouldn't have seen homeowners where you had the president, you had the government, you had the head of the Federal Reserve telling people to take out adjustable rate mortgages; the president telling people to go out and be Americans and spend money and these consumers – you know, we added 12 trillion dollars of debt in this economy in this decade and now, we’ve got the consequences. The hangover is here and the problem is they’re giving us more alcohol. [22:07]

JOHN: But we’re headed to some kind of a collision point, not just with this, but if you’ve noticed – for the most part –Social Security and Medicare have fallen off the radar screen in terms of serious issues that we have to deal with – and of course we haven't brought the energy crisis into it – so where are we going? We take these consequences; where is this leading us to?

JIM: Kind of like a three-year old, our attention span is only of the moment. And right now, the only moment is just get us through this crisis. We’ll deal with the next crisis. And so right now, you know, this bailout plan of 700 billion, folks, I hate to tell you, but there is another bailout coming; and I don’t know if we’re going to do it between November and December – maybe Congress is not allowed to go into recess, or does the Treasury and the Federal Reserve have enough tools right now in coordination with other central banks to get us through till the next president assumes office. When that happens you’re going to see a massive trillion dollar stimulus package that is going to be put in place. There are going to be more bailouts; you’re going to have to put in another trillion dollar bailout package here somewhere, and then you’re going to have maybe another trillion dollars to start stimulating the economy. But right now, we’ve only spent about a trillion dollars and we’ve got another trillion to go; so this isn’t the last of this. It’s just a question of whether we can get through to the next president. And so the problem – like even right now in California, here’s where the credit crisis is California which took so long to get its budget act together, it doesn’t have access to the credit markets; it’s very difficult so you’ve got California is going to the Federal Reserve and asking for a 7 billion dollar bridge loan.

And this was sent to me by a reader of our website and it says:

I am a regular reader of your excellent FS website. We are a major farming operation in California, selling to major markets across the United States. We are receiving reports that credit has dried up for many of the food distribution wholesale groups. As a result, they are simply not buying fresh produce for shipment. This has been occurring for several days now. We are very familiar with the food supply chain, and it only takes about four days of disruption before supermarkets begin to become empty. This is a key indicator of daily working capital and available credit – something worth watching.

So this is where we are right now, and so we’re going to try to unfreeze this and the consequences of this is banks are reluctant to lend, they’re going to be come more conservative and banks are going to be deleveraging their balance sheets, brokerage firms are going to be deleveraging their balance sheet and insurance companies are going to be deleveraging their balance sheet, consumers are going to be deleveraging their balance sheet. So going forward this is probably going to be the toughest recession that this country has faced since 1981. And I think we’ll be in a recession – they haven't called it one yet, but even Larry Kudlow has gotten rid of the word goldilocks. And so this is going to go well into probably the second quarter of next year where by that time we will be pouring so many trillions of dollars into the financial system and into the economy; but now we’re in a recession, you’re seeing falling production, rising unemployment, the ISM manufacturing numbers – now part of those numbers were distorted to some extent by the hurricanes and also the strike by Boeing, but nonetheless, the retailers are saying this Christmas season looks awful. And so, we’re going to have move back to the financial regulators and pray that whatever they do, they do their job – whatever they cook up they don’t choke the economy because – I want to correct myself. I said in this decade we’ve added 12 trillion dollars of debt – I want to correct that: It’s 21 trillon dollars of debt between 2000 and 2007. The largest increase in debt that we have ever seen in US history. [26:12]

JOHN: The interesting thing is going to see when we get the next bailout how they explain that because it’s taken two weeks now to shove this bailout through, especially because of all of the public opposition to what’s been going on; people think things are out of control and they’re being made responsible for other people’s failures. But having said all of that, the way it was sold is if we just do this, it will get the economy back on its foot. If you listen to President Bush make the announcement after the bill passed Friday, I wonder how they’re going to explain it this next time around.

JIM: Well, if you just take a look at this year, remember, John, when Congress got together in February and within one month they came up with a stimulus package and seeing Congress work together and do something in 30 days is a remarkable feat in itself. But, remember the stimulus package? 150 billion that was going to go into the economy and then by the third and fourth quarter we would see strong economic growth in the economy again. Those were the words you heard from the president, those were the words you heard from leaders of Congress, those were the words you heard from the heads of investment banks, those were the words you heard from the financial media. And lo and behold, in July we got rumors that Fannie and Freddie maybe insolvent, that we may have another credit crunch and then all of a sudden we passed a housing bailout plan. That was 300 billion dollars. That was supposed to fix it, and that was July. Here we are in late September, now early October and we just passed another bailout bill of 700 billion. So we’ve had the stimulus package in February, we’ve had the housing bailout package in July and now the bailing out of financial or recapitalizing financial institutions package bill in October; and I would say that if this was a football game, we’re not even into half-time yet. [28:08]

JOHN: We have a long way to go on this. Well, okay, so here we take a snapshot of where we are right now. First of all, like you say, we’re in a period of deleveraging – let’s face it – companies out there are very, very reluctant to invest. Credit is tightening because the banks are reluctant to lend – talk about bailout, Governor Schwarzenegger, your state – you’re the next bailout, Jim. They’ve got to do something to give a short term…

JIM: I just want to thank the rest of the country for it.

JOHN: Listen, I swore when it came to that day I would be on the phone to my representatives threatening them or something because of the fact they built themselves into this; we are not bailing them out. But anyway, we will have to relay that for another day. So credit is very, very tight. Companies are having a hard time that need short term credit, which is the state of California’s issue by the way. They need short term to make payroll and other short term issues. Consumer’s pretty well tapped out – I mean I think that was something that you came back from ASPO on your mind. You know, every boom leads to a bust, and then in order to keep it going the government tries to create a new boom. Right now, we’re trying to force the system to take on more leverage, we have negative interest rates – the federal balance sheet is up 67 percent. What does that work out to? 601 billion dollars in just one month? And from August to – let’s see, that’s almost one fourth of a year – August through October if you look at the total span of this, this is, what, 897 billion, up 1498. It really looks a hockey – a classic hockey stick as a matter of fact.

JIM: Yeah, and I think one of the problems that you have right now, with consumers tapped out, businesses reluctant to invest, that only leaves the government. So the government is going to leverage up. And what they’re going to do is they’re going to pour dollar after dollar after dollar after dollar into this system. They may even end up nationalizing the banking system at some point, if they cannot turn this thing around; and then they’re going to monetize. They’re going to start printing money. There’s nothing left.

The government’s budget deficit – and when you talk about budget deficit’s you’ve got to separate it in two categories – the budget deficit that we report to the public, and then the real deficit which is all the stuff that we borrow because the Iraq war is off budget, the repair of New Orleans from Katrina and Rita, that’s off budget; if you have damage because of Gustav and Ike, that’s off budget. If you have the bailout of AIG or Bear Stearns or a lot of these other things, that’s off budget. So you’ve got that regular budget deficit, and then you’ve got the 150 billion dollars bailout, the 300 billion dollar bailout of homeowners and now the 700 billion dollar. I mean that alone, John, is almost 1.2 trillion and where is that money going to come from? Sure in the heck it isn’t going to come from tax revenues and especially as the economy heads into a recession, you haven't seen anything yet, folks. We will have, as we go forward, many more weekend huddles; and I would not be surprised if we’re going to have a weekend huddle this week and you never know, when you wake up on Monday, who’s been taken over, who’s gotten married over the weekend. You know, I call them Vegas weddings. Sometimes they don’t even wait till the weekends.

So a lot of this stuff – and it’s amazing to watch the debates – both candidates really expressed this when he ran for the presidency in 1980, and he said, “government is not the solution, it’s the problem.” Now, close to 30 years later we’re going back and saying government created the problem, but government can fix it. So I think, John, we’re going to have to go through a period like we did with Richard Nixon and Jimmy Carter where we reach the point where we say, “Government doesn’t work. We need to go back to some form of free market. Let the markets work.” And this nonsense that you hear from these pundits, “Well, you know, the markets didn’t work.” No! That’s not the case. If you would have left the markets to work, they would have worked. Instead of lowering interest rates from six to one percent as they did to try to stimulate the economy and encourage people to go into debt and then removing regulation of Fannie and Freddie, even though we knew they were cooking the books; and then to allow investment banks to leverage themselves and stop regulating and allowing all this stuff – government isn’t doing the job and it’s certainly not the answer to all of this. [32:49]

JOHN: Well, most of this is basically pulling the levers and trying to rescue a bad situation or see what will work. What is going to happen if it doesn’t work; or if it only works a little, and then something else is required – what can we expect to see?

JIM: Well, I think you’re seeing it right now. You’re going to see massive helicopter drops and B-52 runs. I mean they’re going to probably recall the air force and put them on full alert. And the consequences are inflation is going to be higher, you’re going to see a weaker dollar, you’re going to see higher interest rates, you’re going to see higher taxes and once again, with all of these bailouts, we have basically sent another message: the moral hazard. Yes, you heard the people talk about, well, we shouldn't have bailed people out – and we saw this in the debate – but you know what, we have no choice. Things are so bad right now, if we don’t do this it could actually even be worse. So now we are bailing out the system, we are putting shotgun marriages – the people that are leveraged the most - Bank of America, JP Morgan Bank, Citigroup – we are now putting those people together and making them bigger and you’re talking about the three largest entities in the United States with derivatives, and I think, once again, we did – what was this, when we came back from vacation, we said – you know, what I like to use the analogy of a teeter-totter and picture an upside down teeter-totter and let’s go back to July. On the bottom of the teeter-totter –on the downside – were financial assets, the banking system and the dollar. And that was July of this year. On the top end of the teeter-totter – riding high in the air – were tangible assets: oil, gold, silver, commodities in general, base metals, agricultural commodities. Now, if you look at where we were in July 1st, the dollar was at 70, it was ready to break a multi-decade low. We had a number of things going on at that time. You had oil prices over 140 dollars a barrel, you had gold prices at 960, on their way to 1000; the banking and broker index down to the lowest levels – crashing through the floor; you had the Dollar Index at levels we hadn’t seen; you had rumors that Fannie and Freddie were insolvent; you had the credit markets pricing in 75 basis points of rate hikes by the end of the year; and you also had the highest CPI and PPI ratings that we’ve had in three decades. Now, I think these guys knew at that time that they had to do something and they had to change the paradigm in people’s minds – the perception. So you had the largest short positions come in a period of six weeks in the oil market, the silver market and all of a sudden in a six week period of time, you saw the whole paradigm shift to deflation, the commodity bubble is over.

And then what did you see? August 20th, the Fed began to ramp up its balance sheet and the money supply and the monetary base began to explode. Now what I think they’re doing is remember the role of central banks is to manage currencies. You are facing a dollar crisis; the Fed couldn't raise interest rates with the fragility of the system itself. So, now, we got the dollar at 80, we’ve got gold back down to the low 800s, so now as they ramp up and go through this, what you’ve done is you are able to boost the dollar using every technique from currency swaps to comments coming out from people like Trichet to prevent a run on the dollar at the time there’s a crisis going on in the country because the G-7, the G-9 know that when the dollar collapses the whole international system collapses because how are you going to do trade? What currency or what means are you going to use to trade? While you’re trying to drive the dollar up, you cap the price of gold because gold is your barometer. 3) you start liquefying all these assets as they’re doing now. And as you’re doing this, as you’re ramping up the helicopters and turning on the engines and revving up the B-52s, you’ve got the whole world saying, “Oh my God, deflation, deflation!” And people are talking about deflation, deflation, deflation which is a good thing because they’re not talking about what you’re getting ready to do which is inflation. And at some point they’re going to have to create another asset bubble, and as we come through all these ramp ups, throughout all of history, whenever central banks do this, there inevitably is another bubble that is created and I believe this time the bubble is going to be in natural resources. That’s the big picture that’s been going on here. [38:26]

JOHN: So if we had to bullet this item by item, what are we going to see in stages – or at least running parallel?

JIM: I think they’re going to try to keep people focused on deflation, much like they did between 2003 and 2004 we had a deflation scare. I think they’re going to make every effort as they can – maybe after it takes two trillion to clean up the financial system, they’ll put another two trillion in on the economy, and they’re going to try to reflate the stock market. So what you’ve seen now is sort of a whiff of deflation – asset contraction – but out of this, you’re going to see another asset bubble emerge; and as we see with every bubble, it’s always different when the next bubble comes to play. Just like when the tech bubble burst, what did you get next? You got the mortgage and real estate bubble. And what I think the next sector that you’re going to see is the resource sector because as we have been pointing out here, when you take a look at the fundamentals, there are no glaringly large stockpiles of commodities. There is a lack of commodities – whether you’re looking at grains, or energy. And then, if you take a look at the areas of the world that will emerge and grow at a much faster rate than the developed world, it will be the emerging markets. So I think the next asset bubble is going to be in the resource sector and in emerging markets, but until we get to that bubble stage, it’s going to be like I say, Mr. Toad’s wild ride. And that’s certainly what we’ve seen and it changes every week, almost every day. And who knows how many more institutions will go under by the time this thing plays out, but I can say safely more institutions are going to go under in this. [40:09]

JOHN: Well, if that is the case, then there’s one question that we always ask here on the program and that is what should people be doing in that environment.

JIM: First of all, if you own gold and silver, you don’t sell it. If anything, you buy it while you can. As we have talked about here with some of our experts, some of the studies that we’ve been looking at, it’s getting harder and harder to get. The wait times and lead times are getting larger. As I mentioned, I was told 10 weeks, it’s now 14 weeks. If you have energy, hold and add because energy is going to get more costly. We’re going to go to 200 dollar oil, then it’s going to be 300 dollar oil, and at some point the price of oil will go up and it won’t matter what the price is because you’re not going to be able to get it. At that point it will be rationed. You should stay with food and water because they’re going to become scarcer. We are at the lowest inventory levels of grain that we have seen in half a century in terms of days of supply. And because the age of consumer spending, where consumers were the driving force behind the economy, are coming to an end – in fact, there was a recent article in the latest issue of Forbes, addressing this very issue. I think what we’re going to see coming next is going to be equivalent to the WPA programs of the Great Depression; we’re going to have to rebuild our infrastructure and hopefully other than building a ‘bridge to nowhere’ we’ll do something intelligent by putting in and rebuilding our energy infrastructure, which needs to be done as soon as possible if we’re going to avoid a catastrophe. We’re going to have to rebuild our transportation system. So infrastructure – I think that’s going to be the driving force in the economy as the consumer fades in terms of importance. [41:59]

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

JOHN: Jim, I don’t know about you, but a lot of times I sit during the day if I’m watching things coming down CNBC or C-Span or one of the other channels that are important, and a lot of times I want to start throwing popcorn at the screen. It’s what you do with a B movie, like the Rocky Horror Picture Show or something like that. And the reason is if you notice, we get a large stream of information, it’s pouring out of this every single day. But what you do notice as well is the fact that nobody seems to put them together in a comprehensive picture, so important facts frequently go overlooked or minimized and unimportant facts you’re wondering why they’re even bringing that up. Let’s look at this: the Atlantic Monthly had an important article come out this month, the largest oil field, North Ghawar, in Saudi Arabia – well, the Ghawar field is in trouble; North Ghawar is what, dry, is what they’re saying right now. This didn’t come out and make a big flash anywhere. Airlines are cutting back numerous amounts of flights and restructuring how they’re doing things there. Overall, people are looking for facts in all the wrong places and when they do even get the facts, in many cases don’t know how to put them together in a comprehensive picture. So let’s take a look at some of the facts that we think are important in painting a picture of where we stand.

JIM: Well, let’s take a look at something that you’re hearing repeatedly in the news is demand destruction, and there’s no question that if you take a look at driving habits over the last 12 months, the amount of miles driven and consumption is down roughly about 4 percent in the United States. And then of course we have statistic that came out this week, I think it was on Wednesday, automobiles sales just fell off a cliff in the last month; they were down around 30 percent and people were saying, “Look, demand destruction. Cars aren’t selling, Americans are driving less.” And I saw one prominent economist lay out the case why oil was going back to 50 and 60 dollars a barrel. And he said his worst case scenario, it would at least go to 75. And in this crazy market, with perceptions what they are, maybe they could be right. Maybe it goes there for a day, and then bounces back. But what they were citing – once again, it’s like the center of the universe is the United States. And it is true that if you look at automobile sales – and I hate to tell you, folks, where we’re going – I mean the average number of automobiles sold in this country a year have been around 17 million; we are now below 14 million, and I think that as the price of gasoline goes up, and as we get to 200 dollar oil and 300 dollar oil – and it’s not just Jim Puplava saying this – you’ve got respected analysts like Charley Maxwell, who has predicted higher prices and he said, even looking at his earlier predictions he was way, way too conservative.

I told this story. My parents came from Europe and I can remember my grandfather came from Europe, went to work for John D. Rockefeller in the refinery in Gary, Indiana and had a job during the Great Depression. When my parents got married they lived with my grandparents who had – I don’t know what you’d call it, an apartment or a flat – and my grandfather lived on the bottom floor and there were three stories, so my aunt lived on the third floor and we lived on the second floor. And then we moved to Arizona because my dad was in construction. And I remember, John, our first home. It was a three bedroom home, it had a living room with one black and white TV, and the living room – that’s where you lived. If you weren’t asleep, you were in your living room. There was a little area right off the kitchen with a table. That’s where the family sat and had dinner, we had a car port that fit one car, and at the end of the car port was the laundry room. And it wasn’t, you know, washer and dryer; no, it was a washing basin – you remember the old washing board, and then we had a clothes line in the backyard. This was middle class America.

And if you look at where we are today, the size of homes have doubled and tripled. Instead of a one car carport, you have three and four car garages. I’ve seen neighborhood I live in that has six car garages, and you know, it’s mom, dad, each have a car – sometimes maybe two cars – mom my have a car that she hauls the kids around, and the kids, when they get to sixteen, they have cars. So we’re going back to an age when we only maybe have one or two cars. And so the auto industry is going to shrink, but don’t mistake that for demand destruction if you’re only looking at one component of demand, which is the United States or let’s say it’s Europe. So we are going to be moving to mass transit, and that has certainly taken place over the last year – more people are using mass transit. But the other thing that’s even remarkable about this is we’re not only going to have fewer cars but we’re going to have to rebuild our automobile fleet because the US automakers are making the least fuel-efficient cars in the world. So, if you look at this from the United States’ perspective and wow, we consume 25 percent of the world’s oil, so if we’ve seen a 4 percent decline in the United States in terms of demand, then gosh, that’s demand destruction; we’ve got to have lower oil prices. But if that’s all you’re looking at, you’re only looking at one part of the puzzle; if you look at – and Jeff Rubin, one of the best economists out there, he’s done a piece on this – if you’re looking at the BRIC countries – Brazil, Russia, India, China – car sales – and let me give you a comparison here – in the OECD countries – the developed countries – car sales were down 7 percent in the second quarter; they were up 20 percent in the BRIC countries. Furthermore, China saw its car sales were up 40 percent since the beginning of the year, and John, what kind of cars do you think they’re selling in China – just curious, what would you think? [48:26]

JOHN: Well, I would think that they’re probably economic cars in terms of Toyota or something like that.

JIM: No. Just the opposite.

JOHN: Really!

JIM: Yeah, the biggest selling category was SUVs.

JOHN: So whatever we’re trying to make up by conserving in one part of the world, is being consumed in another part of the world. Very much the same with CO2 emissions, if you notice – you know, this whole global warming issue and cutting CO2 back. You can cut all you want in the western world, but if China and India aren’t going to do it – nor is Russia for that matter at this stage – they’re making up the difference. So a zero sum game.

JIM: Yeah, but if you look at China’s vehicle sales; SUV sales were up 40 percent; compact were up a little over 20 percent; micro cars were up over 20 percent; luxury cars up nearly 20 percent; mid-size cars up about 17, 18 percent; sub-compact cars were up only about 6 or 7 percent. And so if you’re looking at the United States or Europe, you might say, yeah, we’re seeing demand destruction. As I mentioned talking with one friend that I have in London – in London, gas prices are so high it’s a major decision: shall we drive across town to go see our friends. And so demand is up for energy nearly 4 percent in non OECD countries. So if you’re looking at the world collectively, at the 5.7 billion people that live outside the United States and add them into the picture you get a different perspective of the whole energy market. Now, that’s the demand side.

Now here’s the one they are not also talking about, and that is the supply side. The real depletion rate which even conservative organizations like the International Energy Agency are reluctantly admitting that, hey, the depletion rate is much higher than 4, we think it’s 5.2. But if you talk to the oil service companies, the people in the industry, they’re telling you that the depletion rates are 8 percent, and some of the old worn out fields like Cantarell and some of the others, that depletion rate is even bigger – where we know, for example, in Cantarell it’s over 30 percent. And it was amazing because when you look at all of this, and anytime we’ve had a crisis in the past – whether it’s the Gulf war, there was an interruption for whatever reason, politically, we could always rely on Saudi Arabia; and when you look at the IEA, the EIA – that’s the Energy Information Agency in the United States – they all look at Saudi Arabia; and why that’s important is Saudi Arabia accounts for nearly 20 percent of the world’s exports.

And if you look at – there was an article – it was called Running Dry – you made reference to it – you can get at this article at the www.theatlantic.com – it’s an article by James Hamilton – the article is called Running Dry – it’s got a geological map of Ghawar – the largest oil field in the world that stretches roughly about 150 miles underneath the desert sands – and it also has a picture of the price of oil, Saudi oil production and a graph of Saudi rig count. And what is amazing is over the last two years production in Saudi Arabia is down by one million barrels a day over the last two years, yet new oil rigs in Saudi Arabia have tripled in the last three years. Oil production in north Ghawar has probably peaked. And unlike the eras of the past, where we had this huge, huge cushion of oil within OPEC because if you’re talking about a cushion now, you’re only talking about one country basically and that’s Saudi Arabia. But Saudi Arabia doesn’t have the large cushion that it needs, so that if you have oil prices spike like they did in July to 147, you could call Saudi Arabia – and you remember this, John, in the Gulf war when oil prices shot up to 140 Saudi Arabia would hold a press conference: “we’re going to produce an extra 2 million barrels a day.” And boom, the price of oil came down. Now, they have a press conference, we’re going to increase production 200,000 and people say, Show me. And once again, you have this perception right now, because Americans are driving less, the price of oil is going to drop precipitously because you have demand destruction. That may be true if we were only a self-contained society and there weren’t these other basically 3 ½ billion people that live in the developing world who are growing and wanting western-style lifestyles. They want to buy cars; and once they own cars you now have a consumer that is using up fuels – meaning that we are drawing down our stockpiles of reserves of existing oil at a much faster rate than we ever have before. [53:55]

JOHN: One of the telltale signs that may war against this “we’re going back to cheap oil” ideology – maybe it’s an ideology, I don’t know – is the fact that look at what the airlines are doing right now. They’re radically cutting back flights and operations, and the reason is that now for – what, this is a record, isn’t it, Jim, as I recall? – that for the first time the cost of fuel has exceeded the cost of labor as a factor in running the airlines. So this is a change. And if it doesn’t get any better, then we’re going to see this as an ongoing trend.

JIM: Sure. And in fact, in one of the slides of the presentation I gave at ASPO I showed that if you take a look at airline costs – and I have a graph going back like over three decades – the largest cost of the airlines was labor which paid the pilots, which paid the stewardesses, which paid the mechanics, the people that worked on the plane, the ticket counter people – that was the largest cost. In 2006, we had a crossover – at the end of 2006, you now had fuel costs exceeding –and as the president of one airline said, we have cut everything that we can and now my largest cost is something I have absolutely no control over, which is fuel. And it was amazing because the Wall Street Journal did a story on this: the downside of cheap fares and they talked about at one point we had these discount fares which we had in the 90s, and the early part of this decade when energy was cheap; and it led to a giant trend in aviation. This November, and this is the paragraph, it was called Grounded Flights:

Oakland, California will have 28 percent fewer departing seats than it had a year earlier, the largest decline among the nation’s 50 biggest airports. AMR – American Airlines, Continental Airlines, both have decided to pull out completely from Oakland.

Here’s another one:

US airlines are going to ground 512 airplanes by the end of the year, according to analysts at JP Morgan.

We are going to larger fares, less convenient schedules, loss of service at some airports, and maybe the good side of that is that the terminals will become less crowded, we will have shorter lines. And it’s not just the bigger airlines, discount carriers such as Southwest airlines are cutting back 14 to 15 percent of their capacity in the markets where Southwest flies. You’re seeing, for example, Southwest expects to cut flights to Vegas, Chicago, Phoenix, Houston, Baltimore; the United Airlines is closing up in Ft. Lauderdale; and West Palm Beach – its flights from Denver, Chicago and Washington DC to Ft. Lauderdale all non-stop from airlines such as Southwest and Jet Blue are being eliminated. Even LAX – one of the biggest airports – will see a 13 percent reduction in seats in November airline flight schedules, according to the OAG. That translates to 411,048 fewer seats to sell on flights leaving Los Angeles, or the equivalent of almost 13,700 seats a day. Fuel costs are too high. Vacation destinations – San Juan, Honolulu, Las Vegas, Orlando – they are being cut; flights to places like Savannah, Georgia, Pensacola, Tucson – small hub cities – Cincinnati, Cleveland, Pittsburgh – and even cities dependent on Turboprop planes, many of which are being taken out of service, are also going to suffer. Thirty-six airports that had commercial airline service last year, won’t have any this year, according to OAG. And even on some of these off areas like Ontario, California, Kansas City, Oklahoma, Orange County, Spokane Washington, Reno, Tulsa, Hartford, Connecticut, Raleigh, Durham, Las Vegas, San Jose, Chicago Midway airport – all of these are being cut back. Now, does that tell you, John, that we’re going to cheaper fuel costs? [58:22]

JOHN: Well, if they’re basing their fuel on what they see, (and I don’t know how much they’re getting involved in looking at speculation in terms of fuel supply), but it would seem to war against that, you know, as you look at it. And it is going to change the whole face, as you say, of the way society looks and functions and you know, what that means politically of economically we’re not too sure yet.

JIM: And so if we were going to cheaper fuel costs, I don’t think you would see this take place. These are the first warning signs that peak oil is approaching us, and yet we’ve got pundits telling us why oil is going to 50, 60 dollars. If it does go to 50 and 60 dollars and stays there, it will only be because the world has gone into a full-fledged depression, and the economies of the world have collapsed. And I’m just not buying that right now, especially with what I’m seeing taking place in China right now. [59:22]

JOHN: It took the pundits such a long time to get around to finally saying something to the effect of: It looks like we have a v-v-v – they couldn't quite get the word out – a recession. You know, they fought that even when it was pretty clear that’s where we were plopping ourselves. Even the goldilocks people out there who keep talking about the goldilocks economy aren’t looking as sanguine as they did before. So we finally got to this stage where at least they’re saying, All right, we’re in something right now. However, as this recession moves forward, it probably is going to be pretty rough recession, and as you’ve been want to say on the program, I would estimate if we’re not careful it takes a politician to turn a recession into a depression – and that’s really the question now is we are going to go through this recession – we know that – but how bad is it going to be? And that is yet to be determined.

JIM: You know, if I was to sum it up and I was to look out, I would say recession, recovery, depression. And the one thing that all these credit cycles and booms have in common is once the bust comes, you have the government and you have the central banks and they try to reinflate again and get the credit cycle going; in other words, get the people to go out and borrow even more money. The problem is we’re not in the same condition – as I mentioned in the last segment, we’ve added 21 trillion dollars of debt in this decade to our economy; and this 17-year binge that we’ve seen with consumers and you really saw this everybody hails the 90s, but you know, a lot of these problems that we’re seeing today had their genesis in the 90s. In the 90s, the savings rate from the 91 recession went from 8 percent to zero percent by the time we got done with the 90s. In addition to the savings rate going from 8 percent to zero, we also had debt levels begin to rise and climb in the 90s. And what happened is it worked out for a while because what you could do you got rid of your savings – I mean why save when the stock market was going up 20 percent a year. You didn’t need to save. The bubble was doing it all for you.

But the other thing people were doing, in addition to lowering their savings rate, they were also going deeper into debt. They were running up their credit cards, and guess what you could do? You’d run your credit cards up, and then what you’d do is go take out a home equity loan, pay off the credit cards, pay off the car loans, and you’d refinance – you’d probably get a lower interest rate and at the same time, the value of your house kept going up. And so, MEW –or this mortgage equity withdrawal – kept the consumer going in the 90s, and all the way up until 2007. And it was a nice thing. I mean you could go out, rack up your credit card debt, refinance your house or you know, pull out mortgage equity and so then you could start the whole game over. The trouble is mortgage equity – that is coming to an end as banks tighten credit now. It’s very hard to get credit, banks are reluctant to lend, housing prices are going down, a lot of people are sitting – I forget what the figure is now – 8 or 9 million homes that have negative equity in this country, and at the same time home equity ownership is the lowest that it’s ever been. So if you’re going to try to revamp the economy, which I think they’re going to do, I think they’re going to come up with a super-big stimulus program, maybe one or two of them next year and they’re going to have to be massive because the 150 billion dollars stimulus package, you know, that lasted for a couple of months and its over, and look what’s happening now. And so, as we go into this recession, which will probably last into the second quarter of next year, then they’re going to try one stimulus package after another and maybe what we get is a very shallow recovery leading into the end of next year. [1:03:33]

JOHN: Amid much crowing and cheering, I should point out, by the media and the politicians.

JIM: Yeah, and say, look, with the change in administration, look at the wonders that we’ve got. We’re out of the Bush recession et cetera, and happy days are here again. And the only problem is, all of the things that they’re going to do – it gets back to like the stimulus package that we talk about in February – instead of teaching a man to fish, they’re giving him fish. The problem is when you give him fish, once he’s eaten his meal, well, guess what? You’ve got to give him another meal. And so what will happen is the composition of the economy is going to change radically. Savings rates are going to go up, mortgage withdrawal syndrome is going to go away, debt levels – personal debt levels – now are equal to 100 percent of GDP, and at a time when you’ve got real estate and stocks going down and credit contraction and job losses. So for the consumer, you’ve got the perfect financial storm that is taking place. And right now, you’re still seeing the rise in credit card debt, but I think that’s only going to last – I think we’re coming to the tail end of that because banks are going to tighten up even more, and it’s getting harder for these banks to take these credit card debts, package them into some kind of security and sell them to Wall Street because that’s going out. So the consumer is tapped out. You’ve got businesses hoarding cash, so if we we’re going to pull out of this, it’s going to have to go back to a different kind of lifestyle, and I think that’s what will happen when the depression hits. We’ll try to hyperinflate our way out of it, and once we’ve hyperinflated the debt away because that’s what’s coming next because no politician is going to sit before the voters – of either party – and we’ve seen that demonstrated in this campaign, we’ve seen it demonstrated in this bailout bill – no politician is going to say, I’m going to cut your spending, I’m not going to give you Social Security, I’m not going to give you Medicare. In fact, what they’re going to do is they’re promising – you know, Barack Obama is promising universal college, universal healthcare. Where in the heck are we going to get the money to pay for this? I don’t know. The real issue they’re also talking about is Social Security. They’re trying to avoid that issue. So the only thing that we have left right now is government, and as many policy makers –as the Keynesian economists that teach at the universities, that have taught generation after generation how to run policy, it’s going to be government spending, monetization and that’s what’s coming. That’s what we talked about in the last segment with the hockey stick. So right now, the debate has changed from inflation to deflation, while the helicopter engines are warming up and the B-52 engines are also warming up. So the message coming to the politicians from the economists, from the policy experts is: Inflate or Die. If you listen to these people on television, and you listen to the subtle message, “well, the Fed’s got to do this” “well, the government has got to do this” what does all this add up to? It adds up to one giant wave of inflation. But it’s good because right now they’ve got people worried about deflation. [1:07:08]

JOHN: You know, we talk about the static all the time that you hear coming down, and people are generally confused right now because they see things happening, there’s a plethora of jabber – that’s about the best way I can put it because it goes on for 24 hours straight – and as a result of that confusion, there’s also another factor in the mix and that is things don’t seem to be running according to what should be fairly normal rules. And that’s probably because one way or another, directly or indirectly, there is this governmental hand interfering in the markets, which of course just increases the mess in the mix so to speak; and one of the things would be central banks intervening in the currency markets to prop up the dollar. But sooner or later the whole thing is going to go down and one of my own secret suspicions, you know, we’ve talked about the amigo – meaning the amero as being the new regional currency which has been discussed quite a lot – I’m beginning to have the suspicion that we may bypass that and jump right to some kind of new, globalized medium of exchange when everything starts to unravel. They’ll try to fix it with that.

JIM: Yeah, because I think one of the issues in addition to a recession is going to be currency turmoil, and also counter party risk. Those are two themes I’m looking at for 2009. And it’s like we have talked about when we did a show on the London Gold Pool. We’ve got prices of gold falling, at a time it is getting harder and harder to get delivery of bullion – whether you’re talking about one ounce silver rounds, silver eagles. I mean, you know, you look at the price of silver –and let me just do this as we’re speaking here – you’ve got spot silver at $11.14 here. And I’m going to go over to my computer screen here and just go to EBay – okay, I’m at the EBay website and I’m going to type ‘2008 silver Eagles’ click on that – John, we’ve got silver – spot silver at 11.14 – what do you think silver Eagles are going for? [1:09:17]

JOHN: I think I checked it earlier in the day, they were somewhere up around what 16 or 17.

JIM: 16, 17 bid. Here’s two bids. Here’s one for 2008 silver Eagle dollar coin and flag case: 23.50. Here are two bids for a silver Eagle reverse: 839 dollars. 2008 Eagle –“brilliant, uncirculated” – 9 bids at 21.50. Silver Eagle 22 dollars. Here is a roll of 20 at 405 dollars, so roughly about 20 dollars. Here are 3 for 50, a couple of them for 41.50. Here’s another roll – 8 bids so far for a role of 20 Eagles that’s 390 – so let’s call it about 18 bucks. Here’s just one – somebody is trying to sell theirs and there are already 6 bids at 20.51 – so there’s a disconnect already between gold and what is happening in the paper market.

And I think that’s what’s happening is we’re seeing right now is we’re seeing a classic replay of the London Gold Pool where the government is artificially trying to drive down the price of gold through the paper markets, but what people are doing are turning in their euros, they’re turning in their dollars, they’re turning in their loonies, they’re turning in whatever currency and they’re turning it into real money and there’s a run on the bank just as there was a run on the US gold reserves; and that’s what I think you’re seeing play out right now. And I think, also, part of the reason you’ve seen this sell off take place in resource stocks is October 15th is a very important for hedge funds and hedge funds you can pull out once a year and that’s where these hedge funds are getting liquidations. So a lot of the big sell off that you saw this week I think was attributed to a lot of that, and what I think we are now is close to the bottom – what I call that whiff of deflation that they’ve been talking about – and now the serious effort of reflation has really now begun; and that’s why we have put on our website – we’ve got charts for the Big Picture and if you look at these charts, you’ve got China, the purchasing manager’s index of new orders is over 50, it dropped down, we’ve got copper inventories and copper prices, we have got the Federal Reserve’s balance sheet over the last decades, and we also the rate of change in Federal Reserve bank asset changes where it’s showing it’s gone up by almost 67 percent. We’ve got gold lease rates which are spiking up, we also have Mexico’s exports – and that’s important here if you’re living in the United States; we have euro denominated CD rates, the spread over 5 year Treasuries – just look at those charts, folks, and you’ll kind of see the very things that we’ve been talking about, things that you will not hear spoken on the mainstream press. [1:12:40]

JOHN: Coming up next, we are going to take your calls on the Q-Lines as we always do every week, and we’ll give you information on how to call that line when we get back. You’re listening to the Financial Sense Newshour at www.financialsense.com.

Part 3

Q-Calls

JOHN: [John humming intro music] I think I know that one in my sleep. Time to look at the Q-Lines right now, and the Q-Lines mean the question lines we take your calls or comments on the program here. Q-Lines are open 24 hours a day to record. Since this is a recorded program, obviously, we can't do it live, but we do record your comments and if you would call in to 800-794-6480, that will set the wheels in motion. That’s toll free from the US and Canada. It does work from everywhere in the world, but it's only toll free from those two countries.

And I should remind you, please just leave your first name and where you're calling from. We like to know where our listeners are, and keep it to a minute and concise because if it goes too much longer than that, we can't include it in. We have too many callers.

Please remember as we answer your calls here, radio content on the Financial Sense Newshour is for your informational and educational purposes only. You should not consider it as a solicitation or offer to purchase or sell securities or commodities or whatever. Our responses to your inquiries are based on the personal opinions of Jim Puplava; and because we don't know a lot about you, we cannot take into account your suitability, your objectives, what your risk tolerance is. As such, always seek a qualified advisor before making some transactions; and Financial Sense Newshour shall not be liable to anyone for any losses that result from investing in things that we profile or discuss here on the program. 800 794-6480. First caller is in, gee, a place called California, Jim. Hold on.

Jim, this is Tommie, from Newport Beach, California and just listened to your show this weekend September 27. And it looks like Robert McHugh was talking about a ‘trickle-up’ bailout that he was proposing and it sounded as though you agreed with him and I’m a little puzzled if that's the case: Does that mean I should go out and buy the biggest house I can find or maybe two or three and then not pay my mortgage, so that I can get wealthy that way? Just curious. Love to hear your answer.

J:: Tom, you're kind of catching on. That’s the way it works in this country. Get yourself in hock, vote for a politician and have him bail you out. They are going to throw so much paper money at this stuff, and by the time they are done, they are going to be rolling some of this stuff. If you're going to buy a house, you want to do it through a real estate auction where you're going to have banks auctioning off property for 50 and 60 cents on the dollar, and if you can afford to buy something, and you have a good job, you have a dependable income, if you don't own a house, that's the way you're going to want to buy it, but I don't think the worst is over yet. I think even though this bailout is coming, we know there is a lag time between the peak and these adjustable rate mortgages that were resetting which peaked in, I think, June of this year and almost a nine month lag time between the time they go into foreclosure, the bank puts it on an auction and then the real estate agent sells it at a steep discount to market value, but that's the way to do it and that's the way to participate in this. [3:17]

Hi Jim and John. This is Doug from Spokane Washington. I have a quick comment and two questions. The quick comment is the local coin dealer that I deal with has stopped taking orders for silver as silver is almost impossible to get. Question number one – has the perfect financial storm moved up its landfall to the fourth quarter of 2008; and question number two, given our country's mess, what's still available to the individual at this stage to protect themselves?

JIM: We talked about this crisis window from 2009 to 2012, and I think you're absolutely right. It's probably moved in from to the fourth quarter. Well, actually, it started in the third quarter. It arrived a little bit early than anticipated. And what can the individuals do to protect themselves? I still think they are going to inflate massively and while we are talking about a whiff of inflation here in the market and real estate, I think the next asset bubble is going to be resources and emerging markets and if you can't get it from a local dealer, go online, check a couple of places even if you have to wait three months or four months to get it, if you can lock in the price today, do so while you can because spot silver at 11 dollars and gold at 835, I can tell you you're not going to see these prices remain here because it's all disappearing. [4:36]

Jim and John, this is Wayne from Delaware and I'd like to thank you both for all of the work you do, the information that you put out on your Saturday programs. And I want to make a comment but ask you a question also. I'd like to know why the question is not being asked where this money has gone. Where it's going to wind up, this bailout. Me, I think these people, these bankers are totally evil and this money is going to be filtered through the system and is going to wind up in their pockets. And the question is why aren’t people asking – why aren't our representatives; more so than that, why aren't we asking as a people where has this money gone?

JIM: You're right. If you listen to the first section that we did when we talked about the investment banks going to the SEC and asking them to lift the limits on their capital structure so they can leverage up, but the one unfortunate thing is if you listen to Axel Merk, as we talked about this crisis in the first hour, I would prefer private recapitalization of the banking system. Then some kind of safeguards that were put in that places a limitation on how much a financial institution could leverage itself, and if any bank loaned to either a hedge fund or an investment bank that would allow them to leverage up, then the banker’s credit rating should drop. There are a whole number of things that we can be doing from the private side to improve this, but you know what -- and there were some legislators that were asking some very important questions here. The problem is have you ever watched a Fed hearing on Capitol Hill and watched the people that ask the questions? Some of them don't even know the name of the people they are talking to or where they are from. The system has become so complex they simply don't understand. So unfortunately, it is only knowledgeable people in the private sector that are asking the appropriate questions. [6:40]

This is Norm from Colorado. First, thanks for the show. It's very informative and I listen every week. I'm just wondering if you could comment on what's happening with the Central Fund of Canada. Is this not an opportunity to buy gold and silver at a 10% discount? One would think that issuing a stock offering by Central Fund of Canada would be a non-event, but maybe there is something else to it. Could you please explain. Thank you.

JIM: No, I mean if you take a look at it, looking at the net asset value today and the percent the central fund is selling at a low premium. It's about a 5% premium now, and that premium, I've seen it as high as 15 and 16%. They had a large offering, but, you know, some people say it's diluted. No, the money is just going to be used to buy more shares. It did take the premium down which they always do in an offering, but given where the price of silver and gold is right now, I would be buying the central fund. [7:38]

Hi Jim and John. This is Matt in Oklahoma. My wife and I greatly appreciate your tips on investing in energy, food, and precious metals. You've also discussed investing in water, but how can we invest in water? Are you talking about investing in desalination equipment or municipal water supplies or what? Also, are there any such things as water ETFs or water stocks? Should we be investing in foreign or domestic or does it matter? As you can tell we're just not sure where to start. Any information you could give us would be helpful.

JIM: You know, Matt, what I would do because there are several water ETFs out there that invest in companies that are investing from water utilities to companies that make filtration system to desalination plants. I would google ‘water ETFs’. You'll see that Barclays has one and there are several other companies that have a water ETF. You can google that, take a look at the kind of companies and it's probably the better way to invest in that sector right now for most individuals: An ETF where you're going to get a good diversified portfolio of the number of companies that are in the sector. [8:50]

John from Michigan. Say, you don't suppose that Greenspan was the evil genius that set this up to force the world back onto a gold standard? I also have it on good authority that after this bailout package passes, that Paulson will transform into Darth Treasurious.

JIM: Thanks for your sense of humor, John. [9:13]

JOHN: You shouldn't tell him that. He's going to want to do a spoof on it now, and I'll have to think it up and write it, so don't do that.

Hello, Jim, this is Frank calling from Seattle, and, you know, I was wanting to put in a special request with the financial crisis that is at our door step, I would think it would be Peter Peterson would be a good guest to have on your share. Appreciate your show.

JIM: You know, Frank, he's written a book and we tried to get him on the show with the book but we just had no luck. Very very busy guy, multi, multi millionaire, one of the founders of the Blackstone Group has talked about this deficit crisis that we're in right now, and it's amazing that David Walker, the former comptroller of the currency who left office last year in 2007 and is now at Peterson's foundation. We'll keep trying. Sometimes we get them, sometimes we don't, depending on their schedule. But thanks for the recommendation. [10:11]

Hi Jim and John. This is Mike in Minnesota. I'm 27 years old and I have 5% of my paycheck going into my 401(k) to get all the matching my company provides. Currently, it all goes into the Vanguard Institutional Index Fund ticker symbol VINIX. Should I get some international exposure? My 401(k) only has one option for international investing with the Julius Baer International Equity Fund – ticker symbol JIEIX. Would reallocating half of the 5% I invest in my 401 into this international fund be a good idea. My 401(k) fund doesn't offer any options for commodities or other sectors you mention often on the program.

JIM: I'd probably go with the Julius Baer international equity fund. Just simply I'm looking at their holdings. They owner a lot of companies that I like. They’ve got Rio Tinto, BP, they’ve got Gazprom, Petrobras, Nestle, Potash, BHP Billiton, Suez. So they've got water, they've got agriculture, they've got energy, they've got base metals, Stat Hydro, let me just take a look here, Dragon Oil. I like what they have. They've been hit because of the selloff in resource stocks. They are down 33% year to date, but if you're going to be putting money into this on a monthly basis over a five year period, this fund has beat the S&P 500, so I think this would be a better approach. I would go with Julius Behr. [11:45]

JOHN: I thought Dragon Oil was an aphrodisiac.

JIM: Good place to invest.

JOHN: People will be looking for something to do if they can't go anywhere; right?

JIM: Yeah.

Hey Jim and John, this is Rocco from New Jersey. I'm a bit concerned around the area of SIPC. I've got a brokerage account with a pretty well known entity and it looks like they are next on the list for a situation to occur. And I know SIPC insures up to 500,000 and then I believe Capco is another firm they use to insure beyond that. It's not a margined account, or shouldn't be a margined account. Everything is owned outright, but I'm beginning to wonder if it makes sense just to transfer all assets –the book entry – to the transfer agent in my name. My question is: What does SIPC exactly insure? Does it insure the actual theft from someone who hacks into the system and steals your shares or does it in the event of some sort of collapse is my account intact, if it’s not the transfer agent or does that go onto the books of the bank until things unravel I sit around and twiddle my thumbs?

JIM: You know, the SIPC insures against theft or it could be a situation where let's say your brokerage firm may be not in your shares but someone has a margin account, they loaned out the shares to another entity that went under, so that's what it protects you against. The unfortunate thing, sometimes you can get a swift takeover and we've seen that happen. Other times it may take awhile to work out like take a look at Refco where you don't have access to trading. Personally, I like Fidelity, Vanguard and Schwab. [13:23]

Hi Jim and John, this is Rob from Niagara Falls, Ontario, Canada. Guys, great program, I miss your Andy Looney and I miss that climate lady, so I'd like to hear them on the program again. I've got a question for you. Jim, I bought some junior metal stocks back in February of this year of 08, watched them go up a little bit, got really excited and now I'm watching them go down. And I know we're supposed to buy and hold, but I'm wondering looking at these stocks if I had sold them back in April, I could have bought twice as much stock as I have now and been much better ahead and I'm wondering if you ever back off of your buy and hold strategy, if there’s ever a scenario, ever a time when you need to reassess that and maybe you do sell once a year and buy again in August or sell in May and go away type of thing? Just curious.

JIM: You know, Rob, I think it's easier for an individual going into juniors because as a fund manager, we take large positions in companies. It takes us time to build those positions, so it's more difficult for somebody in a fund position to trade in and out of juniors because by the very nature of the positions we take, we could drive them up or down. So I mean on an individual basis, sure, you could trade them much easier. When we look at a junior and we have always upgraded our portfolio, but one of the things that we look at are defined deposits that are growing, that have the ability to either, one, go into production or become a large enough deposit to become attractive to takeover; and then the other thing we look at is access to financing which is becoming very critical and important here now especially with the credit markets tightening up because a lot of these juniors are simply not going to survive. So that's the thing that we look at this market a little differently than let's say an individual investor because of the positions we take.

And then also too, you've got to be careful trading in and out of things because sometimes juniors can trade on their own cycles where you – you can have a company that all of a sudden makes a major deposit discovery that is just a barn burner like what Aurelian did in their release of their drilling results on Fruta del Norte in March of 2006. And then all of a sudden the stock goes from 40 cents to 40 dollars, or you can have a company like Canplats that makes a discovery and it goes from, you know, next to nothing all of the way up to 4 dollars. So juniors can travel on their own cycle and you've got to be very careful of that, but I would say as an individual investor, it's much easier to be nimble.

But I would suggest, rather than trying to trade in and out because the nuances of this market are so tricky and you're going to wake up one day just like we did two weeks ago and you're going to see gold up $90 or oil up $30 a barrel in the flicker of an eye, so you might be better off to pick a basket of high quality juniors and I would say at least ten that have all of these characteristics and then rather than putting your money in all at once – like you said, you came in February, gold prices rose, the juniors went up, you're happy, and then all of a sudden they pull back, but rather than going in all at once, pick maybe ten good quality juniors and average into those juniors over a period of time. [16:39]

Hi Jim and John. This is Andrew again from Colorado. I asked a question last week about why the deflation in Japan would not happen in the same way as in America. And I just had another question about your answer because you said in Japan there was an excess of real estate, that people as they saw their investment dollars and their real estate value go down that they hoarded that money and also with low interest rates that a lot of money that was created was exported to the carry trade. As I see it in America, there is also an excess surplus of real estate and if the stock market crashes and obviously with the lowering housing value, couldn’t people also be hoarding their money in America or start to do that, and also if the Fed really lowers interest rates perhaps down one or even zero percent could we not also be creating our own carry trade here in America and lending them out to foreigners and thus exporting the money that's created. If you could explain a little bit more on that that would be great.

JIM: One of the things I said is when you have money creation as we did in Japan, they were increasing the money supply but money velocity was offsetting the increase in the money supply. Also, Japan had all kinds of excess of goods whether it was manufacturing capability, real estate or even stock. And the other thing is Japan was a saving nation, a creditor nation. We are a debtor nation and the impact on debtor nations throughout history has always been inflationary because debtor nations inflate their way out of things. Creditor nations save their way and on their better ability to spend their way out of it. But I think the main factors with Japan's deflation was number one, a severe drop in money velocity, the hoarding of money and the exporting of those dollars. If we were to drop our interest rates done to 1%, what would make us attractive to the rest of the world where money, you know, you could say people could borrow in dollars, but when you have borrowing in dollars and you have a country that has a huge current account deficit and budget deficit, you always have the problem of currency devaluation and that's really dangerous.

[19:08]

Hi Jim and John, this is Craig calling from Toronto. I love your show and I never miss a week. Jim, as you know, it's been increasingly difficult if not impossible to purchase bullion through any of the regular channels. Would you consider a monthly purchase of units of the Central Fund of Canada to be a good alternative. The second part of my question has to do with underwritings that Central Fund has recently entered into twice in the past two months, and underwriting has released at the end of the trading day and then the stock is whacked by around 10 percent the next day. According to their press releases, the additional stock is not dilutive. If that is the case, then why does the stock drop?

JIM: Well, one of the things if you look at the underwritings, there is a discount on the net asset value to encourage people to come in on the offering. There is also a commission that is paid to the underwriters; and so take the commission and the discount and that probably adds up to why you see the drop in the share price, but you notice it quickly recovers. [20;06]

Hi Jim and John, thanks for the show. This is Kevin calling from California. Listening to your roundtable, I'm wondering what you think of this idea: Why don't we take the 700 billion and instead of giving it to the bank, let's look to the people who have actually paid their mortgages like me, responsible, good guy, not taken on too much debt, just living within his means simple just kind of eking along and give me the money and then let the prices collapse, let people go out of work and then all of the responsible people at a good point will walk in and buy some houses and maybe rent them to the people who bought them and couldn't afford them but snatch up a few good deals and then things will turn around. I just can't believe it. Another thing is, Jim, you've seen this whole thing coming. I'm still waiting having some patience here with gold to take off to be rewarded and with so much manipulation, I wonder are they just going keep at that, is it going to break eventually because it seems ridiculous with all that’s going on that gold hasn't exploded already?

JIM: Kevin, listen to my comments about the teeter-totter analogy in the first part of the Big Picture that John and I did in terms of what they are going to accomplish. Secondly, why don't they give it to people that are responsible? Kevin, you don't do that in a socialist system. In a socialist system which is where we are heading, you take from those who are responsible, productive and produce and you redistribute the assets to those who are unproductive and don't produce. That's the way socialism works. [21:37]

JOHN: You're sounding like Ayn Rand. Where is John Galt when you need him?

Hi, Mr. Puplava and Mr. Loeffler. My name is Leanne and I'm calling from Ontario. My Dad and I listen to your show every Saturday. Mr. Puplava, you haven't talked much about your Oreo cookie theory lately. Do you still think that the gold stocks will be higher by the end of the year?

JIM: Leanne, we've been talking about the Oreo theory. We're into the hard crust of the outer shell. Do I expect gold stocks to be up by the end of the year? I would. Could they not be? Given the invisible hand that we've seen here lately and who knows, maybe they are going to do this until the election. I just find it hard that they are going to be able to keep the price of gold here given the expansion of the Fed's balance sheet. Remember the Oreo? There is two parts of it. Thick harder shell, the beginning. The end, and then the middle we had a creamy filling which we already put it out wasn't much of a creamy filling. [22:37]

Hey, Jim. Mara from North Carolina. Quick question. I know this might be over simplifying but I'm curious: Was AIG bailed out by the government in order to save Goldman Sachs; was Washington Mutual and Bear Stearns were they fed to JP Morgan to bail out JP Morgan and was Merrill Lynch sold out to Bank of America to bail out Bank of America? Just curious.

JIM: Mara, there is a lot of speculation. In fact, there is an article I downloaded out today that gets into why this might have happened with JP Morgan. You may be on to something. It may be merging counterparties to a transaction all into one entity. [23:19]

Hello, Jim and John, David in Washington. First I have a question. What do you know about this Lindsay Williams, the guy that says that a bunch of oil and just hasn't been taking about it? I looked it up and all I find is things that say what he's doing and I don't see anybody opposing him. The second is a comment. I just happened to hear somebody talking on the radio – I think it was NPR – that said that the folks that are voting on the bailout are going to go home for R&R pretty soon. That's rest and reelection. So I was just thinking. For those folks would have been dissatisfied the way people voted on the bailout, once we find out what that is, they have an opportunity with the ballot box to do something about it.

JIM: You know, David, let's get to Lindsay Williams. He's the pastor that says there is a gazillion barrels in Alaska and we've got more than enough oil there to last us 100 years. I've read his book. I just don't buy it. [24:09]

JOHN: Part of the problem in news gathering too is it's okay to look for people who may be breaking inside information, but if you can't corroborate it, you can't run with what I call single source journalism. Watergate was a single source thing for a while, but ultimately, you have to be able to corroborate it and that's the problem that you have in this situation. It's a single source piece of information difficult to corroborate.

JIM: The other thing I want to add to that. You've got to be very careful now. We're in a period of panic where people are reacting emotionally to markets. They are not thinking logically. They are not asking questions. It's jump first, ask questions later. And any bit of rumor all of a sudden gets circulated. I arrived at the office Friday morning based on somebody – I'm not even able to get into what this person’s rumor was – and it had made it around to quite a few financial sites, and to say the least, our trading department and everybody was exercised; and I spent the first part of the morning talking to people in the banking system, talking to people at the top, talking to somebody that runs a very large bank and trying to put out these rumors. And that's the problem, John, when you get into these situations, all of a sudden somebody puts out a piece of information, it's taken as gospel, it spreads across the internet and you have people reacting to it. [25:34]

JOHN: Remember earlier in the week Congressman Michael Burgess was talking on C-Span and he said.

Mr. Speaker, politics is a full contact sport and I understand that, but it is a full contact sport in the light of day, in the public arena. Since we didn't have hearings, since we didn't have markups, let's at least put this legislation up on the internet for 24 hours. That's what Thomas was made for. Let's do that and let the American people see what we have done in the dark of night. After all, I have not gotten anymore mail, anymore emails on any other subject than this one that is before us today. Mr. Speaker, I understand we are under martial laws as declared by the Speaker last night. I think it's ironic.

JOHN: I know we're under martial law now, as spoken by speaker Pelosi last night. That thing hit YouTube and, boy, did the urban legend and rumor mills just light up instantly. Now, what he's referring to is a procedural status inside the House, not martial law pertaining to civil disorder here in the United States. So people didn't bother to check it out and wham, boy did it hit, we got the emails here and everything else. So before you hit the forward button on your rumor mill, please check out what it is your forwarding.

JIM: And along the rumor mill there was also the 1st Division that was brought back from Iraq. They took the 1st Division coming home, we’re now back to pre-surge levels now that the situation has improved, so you have a division coming home and that was mixed in, John, with martial law. I hate to tell people, but one division of the US army wouldn't be enough to contain Los Angeles much less the major metropolitan areas of the United States. But once again, the rumor mills were flying, “martial law, the division coming back from Iraq, it's going to be coffins.” I mean some of the rumor mills and I've gotten some calls from people in the business and these people were credible people and some of them manage a heck of a lot more money than I do asking me have you heard this, have you heard that, what do you think about this? It's amazing, John, but in this kind of excited period of time of emotional panic, of deleveraging and that's what you're seeing, a lot of this selling right now is forced deleveraging – people are getting margin calls, liquidation of hedge funds that were leveraged ten to one, twenty to one and it's causing a lot of forced selling of things that – I think we'll look back, you know, and in two years from now, we won't be talking about this. We'll be talking about something different. [28:04]

Hi Jim and John, this is Mark calling from Vancouver Island. My family has followed broadcasts for years, so first I wasn't to say thank you for the entire Financial Sense team. God bless you guys. Here is my question. With all that has been said about peak oil and America's dependence on foreign oil and the need for secure production close to home, the recent criticism of Canadian oil sands by American presidential candidates, municipal mayors and radical and environmentalist groups seems nonsensical. It seems to me that oil sands constitute a major investment opportunity for astute and patriotic energy investors and yet the shares of current producers and future producers in western Canada continue to take a beating. Simply put, what is your opinion of the oil sands sector as an investment prospect?

JIM: You know, Mark, a part of this, yeah, I hear you, Barack Obama has called it dirty oil and he won't touch it. That's just playing to the voters in a campaign. I would ignore what Barack – I don't think he means that because we're going to be is desperate for oil especially as we lose one and a half million barrels from Cantarell. So I wouldn't take too seriously what these candidates are saying for president. Remember, you’ve got to appeal to a broad group of people. I've seen some of the candidates say they are for clean coal in Pennsylvania. The following day they are against coal in Ohio. So this is an election year, and they are going to say whatever they can to appeal to the most popular views of any group they are speaking to, so got to take with a grain of salt what politicians say during an election campaign. At least Sarah Palin does understand energy, she comes from an energy state; but I think Canadian oil sands is going to be an excellent investment. And the day you turn on your television and they say peak oil is here, anything that has to do with energy whether it's uranium, whether it's electrical power, natural gas, oil, tar and, shale, wind power, whatever it is, it is going to go up, and it's going to become a mania as people panic and money pours in. Right now you've got a selloff in the resource sector, a deleveraging and that's accounting for a part of it, but if you're a long term investor, the oil sands are a good place to be. [30:27]

JOHN: We should also point out that anything that tries to stand in the way once that wave begins will probably be flattened as well.

JIM: Yeah. It's just like a year ago nobody would ever, even talk about drilling. Now, what do you hear talk about? Drill, drill, drill. And believe me, when oil is at $200 a barrel, and it will be, it will be, you're going to want to see drilling all over the place.

Jim and John this is Woody calling from Atlanta where I just want to let you know if your listeners want to experience the future of fuel shortages you’ve predicted, just come on down to Atlanta or north Georgia where about 80 percent of the gas stations haven't had gas every day. When you drive by, usually most stations don't have gas. When they do, it goes pretty quick because the lines form and word gets out and everybody fills up. And on the weekend, it's been almost three weeks since Ike hit. Last weekend I was up in the north Georgia mountains and drove for about 40 miles and didn't find one gas station that had gas. Fortunately, I had a mostly full tank but like most other people, I wanted to have enough fuel for the rest of the week. So my advice if you're traveling through Georgia, make sure you have a full tank before you hit the state line. Have a good week and thank you for your show and input.

JIM: You know, Woody, you’re talking about what you're going to be dealing with –I mean, you're dealing with it, or we're seeing spot shortages and we've seen spot shortages around the country. Our gasoline stocks are the lowest that they’ve been since 2000 and it's dropping like a car driving off a cliff; and you're going to see more of this in the next two years, and as I've said here, you’re going to see rationing in this country, probably the next 24 months at some point, and you're experiencing that in real time. So appreciate your input and it's good to hear stories of that to remind people that these are the real bigger issues our politicians have put on the back burner, and unfortunately, that mean a crisis. [32:21]

Hi Jim and John, this is Randy from San Diego. A question about credit default swap value that I see is about almost 60 trillon dollars, and the M3 money supply the way I see it it looks like it's 14 trillion dollars. Can you help me understand the relationship, if any, between the total money and the total value of these credit default swaps. Thank you.

JIM: I don't know if there is a direct correlation. Credit default swaps are basically derivatives. These are paper contracts that are insurance policies that were just a very profitable area to get into and their size dwarfs the bond market and they've grown out of proportion to it. And unfortunately, a lot of people were writing these credit default swaps as a means of making money without basically putting any money aside to account for the eventuality that something would basically default, and that's because the industry uses dynamic hedging; and that is the markets of which you've insured begin to go against you, you just go into the derivative market and maybe get a credit default swap with somebody else and hope that you have yourself covered. There is -- I don't think a direct relationship with credit default swaps and the money supply. [33:46]

Jim, this is Pete from Philly. Jim, with the Congress not passing the bailout bill, does this change your inflationary scenario to a deflationary one, and have commodity prices being crushed since July, have they been forecasting this bill would fail. Thank you.

JIM: You know, Pete, first of all, I guess this call was from earlier in the week because we're doing this show on Friday, the bailout bill passed and if you want to see inflation, please look at charts that we put on the website right underneath the Big Picture Part Three charts and just take a look at the Fed's balance sheet. And then if you want to look at where commodity prices are going, just take a look at some of the inventory of base metals, grains and other things that we've included with this week's show. [34:33]

Hello Jim and John, this is Jay from Pennsylvania. Jim, it would seem as if there was a move to allow a mark to model accounting for a lot of the financials now. Understandably, this will value the financial entities higher than they otherwise would be, thereby perhaps delaying the true value realization for silver, gold and other tangible assets. Do you see this as having a long lasting impact, or is this just a temporary effect to delay the true value of the metals?

JIM: You know, Jay, you're talking about the mark to model. I think it's going to be marked to market because a lot of these assets on the balance sheet – let me give you an example of marked to market. Let's say that you had a hundred mortgages all at 100,000 a piece and they were written on homes with a 100 percent loan to valuation ratio; in other words people didn't put money down. Let's say all of these mortgages were put into a mortgage pool and that was sold as a security out there. Now, the value of these homes have dropped from, let's say, 100,000 per home down to 80,000. I'm just using this for illustration purposes. Now, let's say that all 100 homes in this mortgage pool go into default. The homeowners, they have no money down, they can't make up the mortgage payments. So the bank takes repossession. Now, the homes have a market value of 80,000, but the banks, in order to liquidate in a hurry instruct the real estate agent to sell them at a discount and move the market, so let's say the bank only recovers 65,000. The problem is in the markets right now, many of these mortgages or mortgage pools are priced at 20,000, not 65,000. Now, if I have those mortgages on my balance sheet and the market price is 20,000 because either people have sold it or shorted it and driven it down to 20,000, if I have it on my balance sheet, I have to market down to 20,000, even though in reality, I think this asset is worth 65,000. And over a period of time, let's say a five or ten-year period, the value of that asset may be greater than 65,000 because not one hundred percent of all of the homes in that mortgage pool are going to go into default. And so I think the real problem here is mark to market and especially at a time when you've got short selling that is run rampant and at a time where you have fear in the market that prices assets down to 20 cents when you know they are way below market values and that's one of the reasons why they are hoping that if they buy these assets and stabilize the market, eventually these assets will be sold at higher prices because you're just never going to see 100 percent of a mortgage pool go bankrupt and the recovery rate would only be 20 percent. Statistically, those recovery rates are much, much higher and I think the problems mark to market accounting. [37:35]

Hi Jim, how are you doing. This is Mike from Wisconsin. I have a couple of questions for you. What are your thoughts on Everbank? I've been looking at switching some of my money out of a regional bank locally here in Wisconsin and I'm wondering about if you've heard anything about instability about Everbank? I want to look at getting some of my money market assets into something that's yielding higher without taking as much risk. I just think that Everbank because I don't really ever go to the branches anyways. Secondly, what are your thoughts on like bauxite and moly producers. Some of these base metals producers it seems they are just getting left out to get killed here in this marketplace, yet the supply and demand fundamentals are great for these things. Are they going to make it if we go into a bad recession in 2009? And lastly, a lot of these junior developer's are selling for under $25 an ounce right now of proven reserves. What do you see when gold does cross over ultimately 1500 or 2000 dollars an ounce.

JIM: Let me see if I can get all of these questions in order, Mike. In terms of Everbank – not a bad place especially if you're in strong hard currencies. Some of these base metals – don't look at what's going on here. Take a look at what's going on in the developing market. And take a look at the graph of the purchasing manager’s index of China. Also, take a look at by the way some of the inventory levels of these base metals that we showed in this week's charts. When things improve, they will go up. There has been a deleveraging and selloff in the market that's gone to extremes. And then finally junior developers where you've got a large defined deposit in a safe region with access to capital when gold takes off -remember the way it happens, when gold takes off and goes up, the first place people go are into the majors. They do it for liquidity and they also do it because of the leverage in price. And then if it's sustainable, then the buying goes down the food chain to the junior producers and then eventually to the juniors themselves. [39:34]

Paul from Nevada. My question is that now they are saying on television Sunday morning and they are saying that the sentiment has changed. They engineered the drop on Friday to scare people into going with this bill. I can't believe that people are going to be such ‘fraidy cats that they are not going to stand up to Wall Street. That's my statement. Question: What are we going to do?

JIM: You know, unfortunately Paul, we're moving in this country and we've been moving in this direction for a long period of time to socialization of risk. When the markets are going up, the boom is in full force, everybody wants free markets. When the bust comes, everybody wants socialism; socialism for Wall Street, socialism for the financial system. And if you listened to the first hour on some of the mistakes that the SEC allowed to take place, it's unfortunate but I think we're going to have to go through a terrible time here where a lot of these socialistic policies are going to have to be discredited, but they'll be played out like Keynes’ famous quote: in the end we're all dead because that's the end result for all fiat currencies. But that's the direction we're heading in. [40:53]

Hi Jim and John, Bruce here from New England. I'm sure there would be a large number of your listeners who would be interested in you going into detail here regarding the actual mechanics of buying and selling gold and especially silver bullion. In addition, I’ll just make a few comments here, I'm sure many of us have encountered the current bottleneck in purchasing silver for example, 100 ounce bars are simply not available anymore, although I do notice 1000 ounce silver bars are available from online bullion dealers – although I've also read they might exceed postal Fed Ex weight limits and need to be delivered by a Brink’s truck a highly expensive and onerous proposition. Is that actually the case? And then there is buying a mini futures contract where one takes delivery off the COMEX for a 1000 ounce bar of silver which translates to about 70 pounds of metal. Could you briefly explain, please, how that might work assuming one actually takes physical deliveries and doesn't store it in somebody's warehouse somewhere else. You should also point out that there was a 28% capital gains tax currently due at today’s rates on any sales of bullion, although who knows what that tax might be in the future.

JIM: You know, Bruce, in terms of taking mechanics on the exchange, I mean, if you were to buy the bars on the exchange, you would have to facilitate some kind of delivery, which means you're going to have to either go there yourself to pick it up or some kind of security which could be quiet expensive, so that becomes impractical. We're actually working on the solution to this right now, that's going to involve out-of-state storage in buying bullion at spot prices. I don't want to say anymore on that. It's in the works and I hope to announce that within the next four weeks. [42:51]

Hello, Jim and John, this is Matt calling from the UK. I wanted to take a minute and extend a deep thanks for of if both of you for putting this show together for us. I was wondering if you could expand on your ideas or what would happen with the mining shares during this period of increased volatility. It seems like they’re really being taken down very, very hard and they’re not really participating in the rallies of the metals. If maybe you could expand on that a little bit because a large portion of my assets about a third are in the mining shares, another third are in physical bullion and then another third in energy service companies. And I’ve taken quite a few hits and I feel like I've been mangled over by a lawnmower, so if you could tell me what you think, if I should just hold still out, wait it out, or perhaps sell half of it and then rebuy when it gets lower?

JIM: You know, Matt, what you've seen here is deleveraging. It was orchestrated beginning in July. Listen to my teeter-totter analogy in the first part of the Big Picture that I did with John. At this point, you know, first fall when you get these upsurges in bullion and then they are knocked down again, you know what happens, people get skittish. It's like when you see something this volatile, people become afraid and if they do go back into the market, let's say bullion moves up, they are going to go into the most big and liquid stocks first, and then we saw that ninety day up-move in gold and then, boom, they whack it, so it's not until you get a sustainable move that you'll see the shares move alongside that. In terms of energy service, your shares, I don't know what kind of mining shares you own, if you own large cap producers, juniors or anything like that, at this point, just stay where you're at. Don't jump out the window because gold prices are going higher. Yes, they are trying to cap it right now as they try to, know, artificially prop up the dollar during this crisis, but this too will pass. [44:29]

Hi Jim, this is Burt in Yuma. I think you asked a rhetorical question a week or two ago and you asked if somebody borrows a bank borrows money at 10%, how can they lend it out at six and make a profit, and I'm asking you if the answer might be fractional reserve banking, which certainly in the case of somebody like why they've just issued preferred shares to Warren Buffett at 10%, can't they take that money and lend it out like ten to one and it becomes extremely profitable in spite of the fact that they are paying a high rate of interest.

JIM: In a fractional reserve banking system, Burt, the only way that would work for a bank is if all of these loans were in the bank itself. In other words, they make a loan if you deposit $10, they loan out nine to an individual and then deposits and keeps it at the same bank and then they make out if all of those loans stayed within the same bank, then you can expand it by fractional reserves but that's not necessarily the case. You may make a loan to an individual that individual will spend the money and that money will be deposited with another bank and then when it's deposited to another bank, they will make the loan to an individual who will take that money and spend it and deposit it at another bank, so it’s expanded through the system itself, not just one single bank. [45:48]

Hi Jim and John. This is from Emil in Virginia calling. Jim, I've been going back and listening to the Michael Panzner interview on your website from March 2007, where he commented on the deflation versus hyperinflation debate and he made the distinction between money and credit money and what we have now is credit money, and if that doesn't get paid back, there will be a deflationary downward spiral; and it seems like that is in fact what's going on and according to him, then we'll reach a point where people start giving money away. So it's like there’s a dam that’s being set up and there is this reservoir of liquidity that's building and right now the fields are dry, but the dam will eventually burst, flooding the system with liquidity and then we'll get the hyperinflation. The question is how will juniors hold up until the dam breaks? So physically one like Tyhee I’m obviously interested in, do you see the juniors being able to wait out this dry spell before the dam breaks?

JIM: The ones that have access to financing –Tyhee does –and they have a defined deposit in a safe jurisdiction, I think they are going to be around, although the one thing that you are seeing right now because of this selloff, the producers –and you're hearing more of them talk about this – that some of these juniors are just looking very appetizing in terms of their valuations and you may see some of these juniors being taken out. But as long as a junior has a defined deposit, they are coming along with that deposit, they have access to the capital markets. I know the people at Tyhee are very frugal in the way they handle money. That's a very important thing. But remember it's not going to be until gold takes off, you know, the juniors are at the bottom of the food chain in the gold business. First its the move in bullion, sometimes it's the move in the gold producers signaling the move in bullion and then from the gold producers, the majors, it trickles down to the junior producers; and then it trickles down from the junior producers to the junior developers and the juniors themselves and remember, the juniors are always on the bottom of the food chain. But when the money does trickle to the juniors, it becomes explosive because the liquidity and the amount of shares in the float are not that great and it doesn't take much of large buying to trickle down to that sector to set these things off explosively. But you talked about earlier about this dam in the liquidity. Look at the charts of the Federal Reserve that we've included in the radio broadcast and you can see a dam building up. [48:32]

Hello, Jim and John. This is Altaney [phon.]from Iceland. I've been listening to your show for just over a year now and it has changed my view of the financial system. I called in to thank you for recommending gold; half a year ago I transferred most of my savings to GoldMoney.com as I did not trust the financial system here in Iceland. On Monday my bank was taken over by the government; it could not refinance itself. If it had not been taken over by the government almost all of my savings would be gone. Not only were my saving possibly saved, but since I exchanged all my Icelandic Kronas into gold, the currency has dropped almost 40% and 15% just in September. Inflation is high, people are worried there is a home loss bound to the inflation index, credit is scarce and corporations are unable to get money. People also have over extended themselves by taking loans in foreign currencies and now that the Krona has collapsed, monthly payments have skyrocketed. As you called it so often on your show: everybody enjoys the initial stages of inflation – as we did – but in the latter stages everyone suffers, like we do. Thank you.

JIM: Altaney, thank you for bringing that up because it's a lesson and that lesson is being played out here, and the US is the financial Titanic and what you did and what preserved your net worth was that you put your money in a secure life boat which was gold. And so when your bank went under, it was taken over by the government, when the economy and the boom turned into a bust and your currency lost 40% of your value, you have maintained your purchasing power and I'm so glad to hear you say that because this is the message. We've been trying to tell people as everybody knows the story of the Titanic: There weren't enough life boats, and there isn't enough lifeboats called gold and silver because when the ship sinks there is only going to be so many lifeboats and those who have those lifeboats will be the ones who preserve and protect themselves just as you have, given the circumstances of what had happened to your bank and your country. Thank you for sharing that with my listeners. [50:49]

JOHN: Now that the financial storm is here, I'm going to guarantee, Jim, we will have no lack of anything to talk about over the next three or four years. But for now, let's look at what's coming up over the next couple of weeks on the program.

JIM: Stay tuned. Next week we have an explosive show, Bud Burrell is going to be joining me. He's going to talk to me about what's been going on with short selling, derivatives, with the SEC, all of this stuff that you've seen unravel here. He's been in the thick of it, he understands it, so Bud Burrell will be my guest and also on the 18th of October, John Waggoner BailOut and then also coming up on the 25th, Mark Taylor called Confidence Games. And then Daniel Amerman, the topic will be credit default swaps and deflation and inflation. That will be coming up on November 1st. And then of course, we have the annual gold show which will be doing again on Thanksgiving weekend. A lot of great stuff coming up on the show. Bud Burrell –probably some of the biggest response we have got on any guest that we have had this year; Bud is going to be my special guest next week as we get an inside look of the mechanics of what's been going on in this credit crisis and with derivatives, with short selling. All and that much more coming up in the weeks ahead.

On behalf of John Loeffler and myself, we'd like to thank you for tuning into the financial sense news hour. Until you and I talk again, we hope you have a pleasant weekend.