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Financial Sense Newshour

The BIG Picture Transcription

October 18, 2008

Part 1

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Part 2

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Part 3

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Part 1

Depression vs. Recession

JOHN: Well, for quite some time as we began rolling into this, people were avoiding using the R word – talking about a recession out there. It’s getting pretty hard for most of them to deny that we're in a recession. Now the question is: Is it really going to pitch down into a depression?

And you know what I was thinking as we started this thing, we always get emails from people saying what’s the difference between a recession and a depression. So maybe we should start with that and go from there.

JIM: Well, why don’t we talk about recessions because that’s typically what you’ve seen occur in the United States and around the globe probably for the last half century, and essentially what happens is the economy starts to heat up and a recession is a contraction in real GDP and is brought about by a central bank tightening interest rates. And the recovery begins when the central bank begins to ease interest rates, and it’s essentially what you've seen occur probably for, gosh, we've had about what, six or seven of them – maybe this one is the eighth recession in the last half century – and usually a recession is very easily managed by a change in interest rates. When the central bank (in this case the Fed) begins to lower interest rates, that stimulates the economy in a number of ways. One, it reduces debt service burdens. So if you had, let’s say a mortgage at 7 or 8 percent, and the Fed lowers interest rates what that enables you to do is go out and refinance your mortgage, you bring the interest rate down. So the first way it stimulates the economy is it reduces debt burdens because interest rates are lower. If instead of paying 1500 dollars on a mortgage payment, you lower your mortgage payment to 1200, you now have 300 dollars more to spend each month. Secondly, it stimulates demand for things that are bought with credit by lowering the monthly payments as I just mentioned. If you cut the interest rates down in half as we did from 2001 to 2003, it makes buying a home more affordable, it makes buying a car more affordable, it makes buying, let’s say, furniture more affordable – so what it does is by making credit available at a lower price it enables you to buy things you couldn't buy when interest rates were much higher.

Now, in terms of what it does for the financial markets, it also raises the value of income producing assets. For example, stocks get reevaluated because you’re discounting future earnings at a lower interest rate. So lowering interest rates ends the recession and it produces the expansion that accompanies it. And also prior to entering into a recession, a lot of companies build up inventories and then what happens as the recession works its way through, companies get rid of the excess inventory. Once inventory levels are back to a more balanced level, then you get expansion; you start seeing an increase in production. [3:31]

JIM: Well, the Fed has been lowering interest rates but we don’t see that happening what you’re describing, Jim, so I guess I could safely conclude that something else is happening here. I think what you’re having here, and you’ve seen it in the financial markets, you’re seeing it in credit markets, you’re seeing it play out in the economy, is more like what occurs during a depression; and a depression is much different than a recession because a depression is a deleveraging process in which asset prices decline and they’re caused by over-leveraged entities, whether it’s homeowners, investment banks or money center banks. And what happens is as this deleveraging process takes place, all of a sudden cash becomes hoarded, it’s hard to get a hold of and this leads to a cash squeeze and it creates a credit tightening condition where banks are trying to hoard cash because they’re taking losses, businesses are trying to hoard cash, and this leads to an economic contraction in which monetary policy ceases to work.

And this is exactly what’s happened, John; we've seen interest rates slashed from 5 ¼ percent to 1 ½ percent and yet what happens is because these interest rate cuts don’t stimulate the previously mentioned situations that you have with a recession. In other words, it does reduce the debt burden but people aren’t willing to borrow because they’re trying to deleverage, they’re trying to get out of debt. If you have a hedge fund or an investment bank that is leveraged 30 to 1 or 40 to 1, it doesn’t matter if the Fed has lowered interest rates; they are deleveraging, they are trying to get rid of the amount of debt on their balance sheet. And so because you don’t see the same effects, what happens is in the credit markets – which is what we've seen and this has especially held true if we go back to September when the government allowed Lehman to go under, it triggered a number of mechanisms: it caused money market funds to break the buck, it caused derivative and counterparty risk to come into the market. So even though the Fed cut interest rates – in fact, central banks globally cut interest rates – credit spreads actually went in the opposite direction; it became more expensive to borrow. And the best example of this is at one point if you took a look at the TED spread, you had the TED spread get up almost 460 basis points. In fact, if we look at the peak which was reached on October 10th, the TED spread got up to 4.636; that is the interest increase over the 3 month Treasury bill rates. (Now we’ve seen that TED spread drop down to roughly about 3.57.)

So what happens is these debt service burdens on assets actually becomes a self-reinforcing downward spiral because asset values and incomes fall, and so, so does credit worthiness; banks, as they’re tightening right now are saying, “You know what, no more no-doc loans, no more 100 percent loan-to-value loans on real estate. We want to see higher credit scores, we want to see higher downpayments.” And all of a sudden this shortage of liquidity relative to the need for it (for debt service burdens) has to be resolved by some mix of either, 1) writing down debts or 2) producing more liquidity without lowering interest rates. And if we look at what the Fed has done – and this is just absolutely remarkable – if we actually look at the Fed’s balance sheet it has gone up – let me just take a look at these figures here, we have gone from August 20th when the Fed’s balance sheet was 897 billion; any idea what it was on the 15th of this month? [7:43]

JOHN: No.

JIM: 1.8 trillion. In other words, the Fed has expanded its balance sheet by 875 billion in just two months. And in a one year period, the year-over-year rate of change in the Fed’s balance sheet is 103 percent. Another way to look at it is it’s up 254 percent over the last 10 years for an annual increase of 13 ½ percent. We have never seen anything like this. You would probably have to go back half a century to take a look at anything similar to this. [8:22]

JOHN: You know, if you look at this as far as history repeating itself, we are going step by step through what went on in the past. Look at what we had in the 1920s and Japan went through in the 1980s. There was an expansion of debt and then just like in 1929, the bubble burst and this deleveraging process that you are speaking of begins unwinding and everything starts resetting. But politically that doesn’t work – it doesn’t sell at the polls – and so once again here, just like Hoover was trying to do back in 1929, we doing everything we can to fight this deleveraging; and I think ultimately it just delays the day of reckoning.

JIM: Sure, because what you have in a depression is you have wealth, economic activity and prices all falling together, which increases debt burdens more onerous. In other words, let’s say, John, that you bought a house for 300,000 dollars and you put 10 percent down, so you have a 270,000 dollar mortgage. The problem is your house now has fallen by, let’s say, 20 percent, so your house is only worth 250,000 dollars or 260,000 (and if you probably had to sell it, you probably even get less for that); but the problem is your mortgage is 270,000 so your debt burden is much greater because your asset value no longer supports your debt burden. And so what you have is when you get into a situation like this where you have too much debt in terms of access to cash to make these debts, you’ve got a process that begins to take place and the only way that you go through this is 1) you either reduce the debts (you already have Congress talking about bailout packages; we had the bailout package – 300 billion dollars in July; you have Congress talking about using some of this 700 billion dollars to maybe rework mortgages); 2) and then the other thing that you have is you have massive defaults which is exactly what we're seeing right now. Worldwide as of to date – and this figure keeps increasing every week – we have written off 660 billion dollars in losses and we're probably going to go through a lot more of that; already in the third quarter so far we've been averaging somewhere between 168 to 165 billion dollars of losses worldwide in the quarter – most of that in the third quarter; of the 167 billion that has been written off in the third quarter, 164 billion is in the Americas, mainly the United States. And that’s probably going to get a lot worse.

So what you have very similar to the depressions of the 30s is the central bank comes in and tries to increase liquidity; you’re seeing this occur in the United States today with the Fed’s balance sheet, it’s occurring in Britain; it’s occurring in Europe. However, what eventually this is going to lead to – and this is very important when you’re a gold investor and you understand – we have this deleveraging process that took place between 1929 and 1933. You could see it; it was reflected in economic activity. If you look at the manufacturing index from the 30s, manufacturing inventories, factory employment, the unemployment rate which got as high as 25 percent, the drop in personal income, the drop in the commodity index, the drop in the inflation index – if you looked at all of these indicators that we were using to measure what was going on in the economy and the financial markets, they‘re playing out in very much the same way today. And what happened is there were a couple of things; the government responded and one of the first things that Hoover did, which basically just killed the economy and let’s just hope that the next president doesn’t do the same thing; John, any idea what the tax rate was in 1931? [12:37]

JOHN: I think it was over 60 percent by that time. 63 percent, is that a good guess? I can’t remember.

JIM: No, it was 25 percent.

JOHN: Oh, it was only 25, but it got up to 63 at some point.

JIM: Yeah. Hoover came in, in 1932, and he raised the income tax rates from 25 percent to 63 percent and virtually killed the economy and sent it into a tail spin. [13:01]

JOHN: What was his motivation for doing that? I mean there had to be some public reason for it?

JIM: You know, you were hearing deficit spending, and the government was beginning to run larger deficits because 1) the economy was contracting, people were losing their jobs (in 1932, the unemployment rate got up to 25 percent and so you have one quarter of the workforce unemployed), you’re paying out more social benefits, the government was spending more on programs and they were getting less tax revenue; so the idea was, “Gosh, we're getting less tax revenues because the economy is contracting. The way to get more tax revenues is raise more taxes.” And what it did is it just sent the economy into a tail spin; and you could really see this from 1931 to 1932 we had a precipitous drop not only in manufacturing activity but also if you take a look at the unemployment rate, it just basically shot up. In 1930 we were at 10 percent unemployment and then Hoover put in tax rates and the unemployment rate went from 10 percent to 25 percent. And of course, he lost reelection to Franklin Roosevelt. [14:14]

JOHN: All right, so what did Roosevelt do because he actually ran, if you recall the political campaign back then, he ran against Hoover as a tax and spender, so you would think he would have reduced the tax rates and said This isn’t working, it’s choking everything down, we've got to get this whole economy going. So what did he do?

JIM: The first thing that he did is he repudiated the policies and what happened is he first did a number of things. He severed the dollar from gold and made it illegal to own gold, and then he declared a bank holiday and said that when the banks opened people would get their money because the government was free to print whatever money it wanted. And then the third thing he did is he devalued the dollar by 40 percent. Now, if you look at the activity – and by the way, Roosevelt kept the 63 percent tax rate and he kept at 63 percent until 1936 – and we’ll talk about the 1937 recession. But if you look at manufacturing activity from January of 1933, it began to go up until 1937; if you look at inventories, they began to rise again; if you take a look at factory employment, it began to increase; if you take a look at the unemployment rate, it began to decline; if you take a look at personal income, it began to go up; if you take a look at commodity prices, they began to expand. And then things were going well, except for the government budget deficit was increasing, and then Roosevelt did the same stupid thing that Hoover did.

In 1936, Roosevelt raised tax rates from 63 percent to 79 percent and then in 1937 we had a recession; and in 1937, in response to the higher tax rates, the manufacturing index dropped; the inventory levels dropped; the order for durable goods dropped; the unemployment rate went back from a low of about 16, 17 percent, it went back up to 20 percent; personal income fell; you had a drop in commodity rates. And then he even did something stupid: in 1940, Roosevelt raised income tax rates to 81 percent, and then when the war started, he raised the income tax rates to 95 percent. And there were a number of things that the government was doing; people who lived through that period of time, the economy went on rationing; you had ration cards for sugar, for flower, for coffee, for gasoline. The government was choking off all domestic demand – which another way of doing that is saying, Look, we’re not going to give you the money to spend because we're going to confiscate it all. When you have a 94 percent tax rate at 100,000 dollars of income, they virtually confiscated income at that point and then they diverted all the productive capacity of the economy to the production of war.

And we’re going down this next path and at some point in the next 12 to 18 months, we’re going to devalue the dollar; either it will be forced upon us by the international community or hedge funds or it will become a de facto policy (you’ll wake up one morning and the dollar will be devalued). But this is the route that we're heading. And as we get into one of the segments in the next hour where we talk about the presidential candidates, we’re going to get into Barack Obama’s policy tax rates to 60 percent. And we’ll talk about this: there are articles in Barron’s, the Wall Street Journal that talk about his tax rates. In fact, even in the debates that we had this Wednesday, the very famous Joe the Plumber which the Obama camp is now attacking, but you heard Obama, he said we're going to spread the wealth; we're going to take some of Joe’s wealth and we're going to spread it around. So it’s very likely in an Obama presidency with a Democratic-controlled Congress, we will go back up to those 60 percent tax rates – not counting state taxes. So, we’re progressing and we’re following the very same mistakes that we made in the Depression; we're going right down that route, as I mentioned, with the exception this time the Fed is expanding its balance sheet at a rate that we've never seen in the history of the last 100 years of the Federal Reserve. (Well, not quite 100 years because the Fed was formed in 1913) But we are sitting here following that same path with the exception that the Fed itself is expanding its balance sheet, we’re committing the same sins, John, and the outcome this time is that it’s occurring at a much faster pace; it’s not going to take three or four years to go through this process, we’re going to do it in a 12 to 18 month process, including a massive devaluation of the US currency. [19:13]

JOHN: Then you’re going to see I would say at some point there, inflation is going to come roaring back with a vengeance. You know, we may go through this period here, what, 2009, when you’ll be hearing about the great Obama economic recovery, or the great McCain economic recovery – I don’t know. Business as usual. You know how we've gone through these patterns of “no problem; okay the problem that didn’t exist we fixed it; rosy times ahead now” only to have another thing blow up. That’s been the pattern over the last five years.

JIM: We're going head full steam into a depression. And like I said, one thing that the government doesn’t understand is the deleveraging process that’s taking place. I mean this is almost like a retake of the stock market crash of 1929, the depression that followed and the policies that followed. Remember, the difference between a recession and a depression is policy mistakes. The Treasury and the Federal Reserve made a gross mistake when they allowed Lehman to go under – Lehman being a primary government bond dealer. You saw money market funds have a run on the bank where the Fed had to come in within two days and the Treasury to backstop and guarantee money market funds. You now have the Fed moving into the commercial paper markets; you have the Treasury now investing 250 billion dollars in ownership of nine banks. And so, John, we’re following exactly down that – the difference being is this is a different country than what Japan was like in 1990, or what the United States was in 1930. [20:52]

JOHN: We know back then the US was a creditor nation and today we're a debtor nation. Back then they had much more of an independent spirit and let’s help each other. Today, it’s more of a communitarian spirit in which everyone looks to government to solve the issue. There are radical contrasts both from a sociological position and an economic position; could we contrast some of those so people understand today, even though we're following the same path, the circumstances are different as we go through this.

JIM: Yeah, if we take a look at either the United States in the 30s or Japan in the 90s, first of all, the US in the 30s was a manufacturing powerhouse. We were the manufacturing kingpin of the world. We were self-sufficient in manufacturing; we made almost everything that we consumed. Secondly, the United States was a creditor nation; we had savings, we were the world’s largest creditor, which is one of the reasons we accumulated the world’s largest holdings of gold. Third, we were self-sufficient in energy; we were, in the 1930s, the Saudi Arabia of the world. We produced most of the world’s energy output, our reserves were as big as Saudi Arabia’s reserves if not bigger; and we had so much energy, so much commodities that we had surpluses and the government was coming in with price supports. That’s when you had the Texas Railroad Commission. You contrast that with the United States today where we import most of the things that you buy or see in the stores; whether it’s a department store, electronics store, even a hardware store – the stuff you see there isn’t made here. And so we're no long self-sufficient at manufacturing, we're reliant on the rest of the world to produce the goods that we consume; and then we're also reliant on the rest of the world for the money to pay for those goods since we run a trade deficit. We're no longer a creditor nation. We are a debtor nation, so we're reliant of the rest of the world for payment of the things that we buy from them. And third, we are no longer an energy self-sufficient nation. We now import 70 percent, or nearly 700 billion dollars of our energy needs, and that number will get bigger, and our reliance on imports will get bigger. As we get into the next hour, the position of both candidates on energy – both of them, in many ways, are clueless. So the conditions today are worse; and the outcomes for debtor nations, creditor nations, is always hyperinflation. The unfunded liabilities of the United States today are now 70 trillion dollars. This reflects once again Laurence Kotlikoff’s article Is the US going broke: who will bail out the US out? And certainly, they’re already talking next year of a trillon dollar deficit for the United States, we’re talking about even a current account deficit that is going to be 700 to 800 billion dollars, and that’s why at some point in the next 12 to 18 months you’re going to see a major devaluation of the dollar. That is one of the ways you solve your debt problems, one of the way that you solve your asset deflation problems: A massive devaluation of the US currency. And that’s what’s ahead of us. [24:12]

JOHN: Right, but that has impacts too from a political and a sociological standpoint because everything – yes, it solves some of the budgetary issues and the debt problem, but for the average person they’re having this balanced on their backs by erosion in what they’re saving, what they’re earning and the investments that they’ve made.

JIM: Absolutely, because if you devalue the currency by 40 percent or 50 percent – don’t know what that number is going to be – you just reduced the purchasing power of the person making 10 dollars an hour, he’s going to be making six dollars an hour in terms of purchasing equivalent. So the things that people need and have to have for living will go up by an incredible amount. You’ll see commodity prices – whether it’s energy, food or base metals or anything – it’s going to go up by an equal amount by the amount of the devaluation of the currency. So that’s exactly where we’re going and it’s one of the reasons why I disagree with the deflationists. You can’t have the Fed increase its balance sheet by 100 percent here in just a six week period of time without this money showing up somewhere; and eventually the outcome – we’re going – I mean if you take the recession pattern and government response of the 1930s, that’s why, John, I think its very important that if you want to find out where we're heading, I highly recommend you pick up a book called America’s Great Depression by Murray Rothbard. It’s available on Amazon. You read that book and then you’ll understand the headlines you’re reading today and government response. It’s almost like these guys have never read a history book and we're taking the Keynesian prescription. Two economists who were very prominent at that time, one was John Maynard Keynes, another one was Ludwig von Mises; and they were two policy prescriptions. And what happened is our leaders went with the Keynesian response rather than the von Mises response to the Great Depression, and that’s why it lasted as long as it did. But we're going right down the same path. It’s almost like we took out the Great Depression playbook and the response, and we're adopting everyone of those same responses. It’s absolutely amazing to see this thing unfold. [26:41]

JOHN: So we learn from history that the majority of people are condemned to repeat history because they do not learn from it and that’s another historical fact. You’re listening to the Financial Sense Newshour at www.financialsense.com. More to come in the Big Picture. Do not go away; that’s an order. We’ll be right back.

The Credit Crisis: Is It Contained?

JOHN: It would seem in looking at the current credit crisis, everyone is trying to get through this with the bailout – we're being assured that by Bernanke and Paulson – and that once we get through this, this so-called crisis, then we’ll be back to basically business as normal. Are we curing this credit crisis, Jim, or are we simply in round one of an ongoing series of dominoes which are going to continue into the perfect financial storm?

JIM: I really think that we're going to go through a series of stages in this, and once again, going back into something that we talked about in the first segment of this program is that we're making the same policy mistakes. And I would suspect that whatever the outcome is in November, if we raise taxes to 60 percent as one of the candidates wants to do, or for that matter, if we just simply – let’s say McCain gets in and he is forced to allow Bush tax cuts to expire – we’ll get the same effect because we’ll have a tax increase going all away across the board. So I think it’s a matter of policy prescriptions; our leaders have misread this crisis in terms of treating as if it was sort of an ordinary recession crisis with monetary policy; I think what we’re heading into is this is more of a depression than a recession. [29:02]

JOHN: So the tinkering that we’re doing right now, these are actually I would say what would we call them, band-aid efforts? They’ll bail us for a while, but ultimately no solution to the problem.

JIM: Basically what we're going to do here is we're going to patch band-aids and it’s sort of like we're making this up as we go along; we put in one policy prescription – take us back to the beginning of the year when remember the rebates that were passed in February and remember the testimony of the Federal Reserve that growth in the second half of the year will be much stronger as a result of the bailouts. Well, you know what, everybody got their checks and once the checks are spent, now what do you do? So they’re talking about rebate number two, perhaps before the end of the year. And then of course, we've mentioned the housing bailout package in July which was 300 billion. That wasn’t enough, so now we have a 700 billion. And I suspect that they’re going to come back to the well next year with the next president. We’ll take a look and see – then we’ll get bailout number three. But you know, all of this is going to play itself through the economy. [30:09]

JOHN: So ultimately what are the effects of all of this – the federal funds rate, the GDP and especially the thing that everybody on the street is concerned about, unemployment. And we might put a footnote in there, how do you read through the government’s unemployment figures and follow what the real figures are given the fact that we've been saying for a long time here on the show that those books are cooked.

JIM: You know, I think the one obvious thing is we’re in a recession; you know, if they throw enough economic stimulus and monetary reflation at it, what I could see is recession, recovery and then another recession and then the policy response to that recession will be ultimately a depression. So if you want to look at GDP growth, I think it began to contract in the fourth quarter of last year, particularly around September. So you’re going to see I think in retrospect as we look backwards – in other words, if this was December 31st, we would see two quarters of contraction in the economy. Who knows, maybe they’ll pull miracle and say the inflation rate went to zero and nominal GDP will equal real GDP. But given that, I would see a contraction in the economy; I think the year-over-year comparisons with the way they jigger CPI, I think in the short term a lower inflation rate. I also think that the federal funds rate will be at one percent or less by the end of the year; I think they’re going to cut again. I think the unemployment rate, which is over 6 percent, is probably going to 8 percent or more as we head into next year. I also think that the home prices – we’re not done with this; in other words, the decline in home values will continue into next year, probably another 15 to 20 percent, maybe 20 percent would be on the extreme side, but at least a 10 to 15 percent further decline in housing prices. So I think we’re going to be looking at that. So I think credit - the age of credit is going to become much more difficult for companies and for individuals.

I mean if you take a look at the latest fed survey – banks tightening lending standards; I don’t care if it’s for mortgages, if it’s for commercial or industrial loans, if it’s for credit cards, or other consumer installment loans, everybody is tightening. They want to see better and higher credit scores, they want to see verification of income, they want to see more money down and so I think that is something that we're going to see going forward. I also think that the consumer is retrenching as the recent retail sales numbers; you know, John, I make Costco runs. I do the grocery shopping in the family and so about every two weeks I go buy the protein, the chicken, the fish, the meat at Costco because the prices are so much cheaper. And John, I don’t know if you shop at Costco, but my goodness, you try to get a parking spot – I usually try to go towards the end of the day on Saturday when the parking lot is a little less full, but even then, if you go at 4:00 or 5:00 on a Saturday to a Costco or even on a Sunday, the aisles are packed with people as Costco is now competing with grocery stores. It’s not just bread; it’s meat, protein, chicken and fish; they’re selling produce now in addition to their packaged goods. But I think you’re definitely going to see a decline in consumer expenditures very reflective of a recession.

I think another thing that you’re going to see too, and you’re already seeing this with businesses in the energy patch, the mining patch and the manufacturing sector is that you’re going to see a contraction of CAPEX spending. So I think that as a result of that, we will be in a recession and what you’re going to see take the place of the consumer and take the place of business, the government is going to leverage up its balance sheet as we discussed in the last hour that we're already seeing with the Federal Reserve’s balance sheet. So I think you’re going to see more interest rate cuts coming, the Fed’s balance sheet – and the latest figure is what, about 1.7 trillion; I think you’re going to see the Treasury get involved in a number of programs, this Troubled Asset Relief Program or TARP as they call it, the acronym; you've seen this week the Treasury has invested 250 billion dollars in equity in large banks, so we're already seeing them change the way the money is being spent. And I also think that in the developed world, you’re going to see economic contractions; in Japan, which you’re already seeing; and then I also think in Europe. And believe it or not, as bad as we are, I think some of the European nations are even worse off than we are because their financial institutions are more leveraged than American institutions. [35:01]

JOHN: Do you see the same thing happening in – I guess we’d call it Euroland – Europe, or in Yenland, in Japan because they’re facing similar issues.

JIM: Oh sure. I think by the end of this quarter or the next quarter, you’re going to see Europe go into a recession. I think you’re already seeing a sharp pullback in consumer spending in Europe; you’re seeing the same thing with capital expenditures by business and so Europe is going through much of the same thing. And remember, they were a little bit smug at first and saying mainly, well, this is a US problem. Well, guess what? It’s rolled over into Europe and it’s hitting Europe in a very, very strong way. [35:41]

JOHN: How much of a spillover now is there into equities? How do you view that compared to the other areas you’re talking about?

JIM: You know, I think we're close to a bottom here. And you’re already seeing people like Warren Buffett step up to the plate. I think you’re seeing some of the institutions . The values in some of these areas, especially the resource sector, the agricultural sector, I mean it’s amazing to see what’s happened to the agricultural sector. I mean many of these stocks were the must-hold stocks that people were paying significant premiums for all the way up to July; you know, you take a company like Monsanto which was up 30, 40 percent this year, at this point it’s down 26 percent. If you take a company like Mosaic that was up at 50 and 60 percent, it is now down 62 percent. You take a company – even the must hold stock like Potash which was up I think almost 100 percent for the year, well, if you take a look at Potash it’s down now 50 percent. So, a lot of the things – in the oil sector you can buy stocks – I mean, even if you believe that these oil prices are going to stay here permanently (which I don’t) and take these oil stocks and takes their earnings and cut them in half or cut them by 60 percent, you’re still buying companies at 6, 7 and 8 times cash flow. I mean it’s incredible. So I think there are a lot more buying opportunities. If people owned these sectors, I would encourage you to hold onto them. The last thing you want to do is sell them in panic mode just because people that have been on leverage have been forced to sell. And so we're looking at almost historical extremes, that you would have to go back to 74 and 75, back to 1981, probably 1987 and so we're at extreme points in the history of the market where I think that if you look at where we're going forward from here, I think the equity market is – remember, when the central banks inflate, they can inject capital into the system. The question is: where does it go?

Now, one of things that we're starting to see is the credit markets are starting to function, the TED spread has dropped by almost a full percentage point here in the last week; the LIBOR rates are starting to come down; credit market spreads are starting to narrow so we're starting to see some positive things occur in the credit markets and I think that’s going to have a positive effect. In other words, we’re moving closer to short term stabilization and I think as more confidence is restored – and I think particularly when you get a change of administration because, John, you've seen it, every time that the president, Hank Paulson or Ben Bernanke get on TV to speak, it’s almost like the markets plunge. I think the best thing that you could do is keep these guys away from the camera. So I think even if it’s an Obama presidency, I think the fact that people have lost complete confidence in this administration’s ability to handle this crisis because it’s been done on such an ad hoc basis.

And what was it, John, what’s that comment that Harry Reid made, he said, Look, nobody’s doing anything here because nobody knows what to do and you know, even Paulson and Bernanke don’t know what to do, but they’re coming up with some ideas. And so it is new territory in many ways. It’s been, what, 75 or 80 years since we've had an equivalent crisis; you’d have to go back to 29 and the early 30s and I think that that’s what you’re having to deal with this, but the monetary tools and the fiscal tools that they have to deal with the crisis today are much greater and they have much more leeway. The only difference is they are getting into what we call ‘tinkering’ where there are all kinds of interventions that are going in the market. Remember, two weeks ago when they passed the bailout package, and then all of a sudden, this week they said, you know what, we're changing our mind and what we’re going to do is we're going to invest 250 billion dollars of this money in the banks. Now they’re even talking about taking some of that money and buying mortgages. So it’s like back to the future. And the thing that people have to be prepared for – a lot of people are seeing – and I see this debate over and over again: The stock market went down, real estate prices are going down so that’s deflation. You know, you’re talking about symptoms rather than causes. Deflation is when the money supply contracts and even if you look at what the Fed still publishes and you take a look at a graph of M2, I mean M2 has soared when we were at a low point in September before this crisis hit, M2 was, let’s round this off to about 7.7 trillion and now we're roughly at 7.9 trillion. So even M2 is expanding. Take a look at a graph here of M1 has shot up tremendously from almost 1.4 trillion to a little over 1.5 trillion. So even the money gauges are expanding as the amount of money and credit that the Fed is creating and through the Treasury is working its way through the system. [41:02]

JOHN: Well, coming up next we’re going to talk to Frank Barbera. The subject – Is this the bottom of the market? You’re listening to www.financialsense.com. And in the next hour here on the Big Picture, important topic, the presidential candidates on three subjects: taxes, energy and spending. We will get rid of the nonsense and glop you’ve heard and look at some hardcore figures about what it is these two gentlemen are proposing. Later on, how the gold market has changed, and finally, a national energy strategy: Richard Loomis will be joining us and I’m sorry to tell you, it’s a little worse than you think. There’s a 90 page report out but we need to talk about that in the next part of the Big Picture. Financial Sense Newshour continues right after this.

Is This the Bottom? with Frank Barbera

JIM:Well, I guess the number one question on people’s minds given the pain that has transpired in the markets over the last three or four weeks, joining us on the program is Frank Barbera. And Frank, I guess the question that people really want to know at this point: Is this the end of pain; is there more pain ahead of us? You had a New York Times opinion by Warren Buffett saying that he’s almost one hundred percent invested in America again; he’s buying American companies, he hasn’t sold any of his holdings that he currently holds now. And it is a situation, you know, here we had Friday one of those days where we were up a couple of hundred points; we’re down a little over a hundred points as we speak; Thursday we were down 400 points and ended up up 400 points; on Monday we were up 10 percent. So what’s going on here? Are we forming a bottom, close to a bottom – what’s your take?

FRANK BARBERA: Well, good afternoon, Jim. And certainly far be it for me to disagree with someone like Warren Buffett, but you know, he comes at things from a fairly fundamental point of view. As a money manager I do as well I might add, and on that score I would also add that it’s certainly true there are a lot of companies out there right now –more than I have seen in years – where you can go right down the list of PE ratio, PEG ratio, you know, a lot of different valuation metrics and, wow, a lot of stocks really look attractive at these levels. So on the fundamental approach I can totally see – just take a gander through some of the oil service stocks (names like Schlumberger, TransOcean), those stocks have been beaten down to levels that just make no sense at all on the fundamental level. I mean they’re really discounting in 40 dollar oil, 45 dollar crude oil; and I think right now there’s certainly a major component that is in a tremendous overshoot, so investors really do need to step back, take a look at the fundamentals.

I manage a hedge fund here in Los Angeles. I always like to use what John Bollinger once described as rational analysis; sort of the overlay of two sets which is one set being the fundamental side, and then the other side being the technical side. On the technicals they tell us a lot more about timing and the ‘when’ question, and you know, if you go back and you go back to the top in this stock market that we made in July, September of last year, we had this huge double top on the S&P 500, up around 1550 or the neckline at 1400; we then broke down out of that neckline in January. So far the market has moved down in a really classic ABC bear market decline in Elliott terms, and I believe right now that on October 10th we bottomed the panic Third Wave, which is the really forceful crash like wave within the Elliott theory. And what normally follows that is you get a Fourth Wave triangle; you get a series of five very violent moves which get labeled A, B, C, D, E and they tend to form a contracting triangle which makes lower highs and higher lows. And what I see this week is we came up and we made a rally up to about 1040 on the S&P on Monday – that was the high of Wave A of the triangle; we’ve come back down across the range, back towards the vicinity of the lows yesterday, that’s probably at this stage of the game likely Wave B as the bottom; and now what we’ll probably do is see one more swing up back towards 1000 over the next few days, then one more swing back down towards the 860 area for Wave D, and then the last little push up in E Wave, back up to 960 would complete the triangle and that would complete the Fourth Wave.

So I basically believe that for the next few weeks, you’re going to continue to see these very volatile sudden and erratic moves in the stock market back and forth between the trading range of roughly 860 and 1000 on the S&P; and then after that’s done, we should still have one more sell-off in front of us, which is the Wave 5 – the Fifth Wave down. That’s the last wave that’s a potential bear market ender, and that could easily take us down to the 780 to 800 area on the S&P 500, which is the vicinity of the 2002 to 2003 lows. If things go well and if the tremendous monetary reflation that is being put forth by the central banks right now, which has essentially doubled its balance sheet in just a matter of a few weeks, if that takes – and I would add to that, we are seeing signs now that the credit markets are slowly starting to unlock, so that’s a good sign – if that takes, then I would expect that probably some time in December or early January, the stock market will come to an important bottom and then the outlook for 2009 would be exceptionally bullish. I think we would see stocks roaring back up across the range, especially led by stocks in the resource area – a lot of the oil service, the large cap oil, certainly the natural resource – the mining stocks; we could see a banner year next year. And against that scheme of things, essentially where prices are now, looking back on it you would say, “well, that was a great time to buy.” I think it may be still just a little bit early, but I think ultimately there’s a pretty good shot that we could be in the 7 to 8th inning of this bear market decline, you know, maybe heading into the 9th inning in a couple of weeks and a point where people will have to step up to the plate and get a lot more bullish on things. So I certainly see the value in many, many names especially in the energy and the mining area; the gold stocks have been devastated over the last few weeks; and I see a lot of evidence right now that both the price of gold and the price of silver, along with the mining stocks, if they’re not at a low yet, they have to be awfully, awfully close. I think a little upside strength in terms of the gold stocks we could see the right ingredients for a major reversal. So I would tell people right now if you’re holding stocks at a loss, the last thing in the world you want to do at this moment is sell them. Give it a little time – the situation is beginning to stabilize. We've seen maximum downside momentum the week of the 10th at that Third Wave low; the chances are pretty good that within a couple of weeks what we may see is a lot of stocks essentially retesting those lows, but with a lot less downside momentum – that’s the key ingredient for a double bottom and the kind of ingredient that is exactly the flip-side of what we saw at the top last summer in July and September of 2007. I might add those were back during that period I was pretty bearish and I’d been pretty bearish the entire time – taken a few hits along the way for being negative. But at this stage of the game, Jim, I can definitely maybe look out a few months and see the possibility where things could be improving. Right now that’s not a certainty, but I think it has a pretty good shot. [50:15]

JIM: Frank, I guess a question to follow up, some of these sectors in the gold sector – the juniors have been hammered, we see a lot of little manipulation games that take place so often with these stocks where you see a stock up 10, 15 percent and the last 10 seconds of trading you have three or four hundred shares trade between in-house brokerage firm and they take the stocks down. We've seen some of these things. I mean even if you look at the major producers today, where you’re buying these companies at four times earnings and dividend yields of five or six percent. What kind of advice would you give to somebody that owns these stocks? I mean some of these stocks have been pummeled pretty hard. I know you own some of them, I own some of them, and you almost, like…

FRANK: They’ve been decimated. [51:04]

JIM: Yeah, you want to kick a soccer ball.

FRANK: It’s terrible, and it’s very easy to get dejected and come to the conclusion that, oh well, this is never going to come back. The problem is that’s really mistaken thinking. I think right now a lot of these small cap mining stocks, given the situation they’re totally bombed out, I really would not be surprised to see some of these names double and triple in the period of a few short weeks coming off these lows, and even at that they could have – I think there’s a pretty good chance that the next big thing is going to be a mega bull market in small cap resource stocks. So if you go back and you look at a lot of the individual companies, and I won’t get into names, but there are a lot of them where they’ve pushed various projects from really the very inceptive phases two or three years ago, to the point where over the last few months to a year or so a lot of these companies have advanced stage projects that are either in production or approaching production, heavily drilled out. There’s a lot of CAPEX in the ground in the small cap companies and I believe that given the likelihood that we will ultimately come out of this in some kind of an inflationary overshoot, in that environment the juniors will be likely takeover targets and b) they should perform very well – I think money will be attracted to metal and resources in the ground.

I might add just to throw in my two cents on the deflation-inflation question. A lot of people have been talking about deflation right now and it is very true when you look at a lot of the outer symptoms that you've had a tremendous credit market deflation. There’s really no argument about that. I think the key element though for most people to understand is that if the government were standing back and government central banks were standing back and not doing anything about this, then, yes, this is a situation that could evolve into a classic deflationary depression, but I think the fact that – and as we've seen over the last several months – Uncle Sam has bellied up to the bar and is opening up his wallet, he’s creating money out of thin air right now and that is a major red flag for investors to understand that this is probably going to be a deflationary scare that we’ll come out of it with a big re-inflationary cycle and a cycle that ultimately will probably morph into a runaway inflation a year, a year and a half down the road. A lot of people won’t make that connection of how did we get here 18 months from now when prices are rising; they’ll be sort of surprised but the action that has been taking place – the bailout, other bailouts that are probably going to come – those are really laying the groundwork for what is likely to be a re-inflationary cycle. That could be devastating for bond investors; and I would counsel bond investors to think long and hard about those positions because I think that’s a market about to enter a severe bear market. I think we’ll see a falling dollar and rising yields. The equities – since they have the ability to raise prices through their balance sheet and maintain profit protection, equities can be a pretty good hedge in the early and middle stages of an inflationary cycle, so the stock market may bottom out in here and may end up a beneficiary of a re-inflationary cycle. So that’s – I just wanted to throw that out there because there’s a very big swirling debate on the whole subject; and not to really antagonize either side, but the way I think, the way I would view it: When you start seeing big government involvement, start thinking about a lower currency and start thinking about reinflation. [55:10]

JIM: Well, Frank, I’m just looking as of October 15th, which was Wednesday of this week, the Fed’s balance sheet on August 20th was, let’s call it 899 billion; as of October 15th, the Fed’s balance sheet was almost 1.8 trillion, an increase of 875 billion in just two months. Or, if you want to look at it on a year-over-year change, the Fed has expanded its balance sheet by 103 percent. I have never seen – at least in my time in the business and even looking at charts going back to 1971 of the Fed’s balance sheet and year over year – I have never seen anything like this, Frank, in terms of what the Fed’s doing now and if they continue at this rate which many are expecting, we could see the Fed’s balance sheet double again. In other words, if we were having this conversation next year at this time, Frank, we could be talking about a Fed balance sheet at 3.4 trillion.

FRANK: That’s insane and you know, probably Jim the last time something like that happened you’d probably have to go back to 1922 and the Reichsmark with Germany. That’s a really scary reality and for the listening audience that is a real nightmare that’s potentially in front of us if we end up in an inflationary economy. You know, there’s a tremendous amount of risk; the currency market upheaval could be huge. The only way you end up fixing that kind of a situation and reining it in is by going back to what Paul Volcker did in the 1980s by jamming short term interest rates through the roof to the point where short term interest rates get back to positive real rates of interest, and I hate to think what would have to happen if we had a dollar crisis and the government has to go that route – That will be oppressive. So this is not to say that the economy is going to get better: inflation is a nightmare, it will make things worse. You can have all the symptoms of a ongoing recession even as the economy is going through price increases. That’s called an inflationary recession or an inflationary depression. It’s different in the sense that nominal prices are going up, but other than that it has all the symptoms of a classic serious economic contraction – people losing jobs, rising unemployment, businesses going broke et cetera. So this is no walk in the park. We're not talking about things getting a lot better or return to normalcy. We're just talking about an intervention that’s being put forth that may have the effect of altering the outer manifestation of the problem that we're seeing right now and also having the effect of stretching the problem out over a longer period of time and allowing the system a better chance of surviving. But that will come at the cost of putting in all likelihood a lot of average folks through even more hell. So you definitely have to be on guard for both, and I think there’s a really strong case here for people to be holding at least some percentage of their assets in precious metals because basically precious metals are an insurance on the purchasing of money. The same way you would take out a life insurance policy on your life, or healthcare insurance or insurance on your car, when you put a certain amount of money into precious metals, you’re really taking insurance on the future purchasing power of the dollars that you have earned. [58:45]

JIM: I would urge anybody listening to this program why they keep knocking down the paper market where on Friday, Frank, we had gold prices below 800 dollars, silver down to 9 dollars. Get your bullion while you can because there is such a major disconnect between bullion prices at the paper level and trying to get – I am now told that it’s going to take four months to get delivery if you want a large amount of silver, Frank. So if it doesn’t matter –

FRANK: I’ve heard that from countless people that I talk to in the business as well, Jim. So, you know, what you’re saying is it’s a problem investors will run into very quickly when they walk down that road.

JIM: You know, one of the things that I’m looking at is there contracts on silver. A contract in the futures market is 5,000 ounces for silver. So if you take a look at 5,000 ounces times 9 bucks, it’s 45,000. But also, Frank, there’s a mini-contract which is for a thousand ounces of silver and one of the best games in the currency right now is you could go to the COMEX, take a mini-contract and take delivery and demand delivery and pick up your silver because like I said, if I go on eBay right now, silver Eagles are going for 21 bucks for a silver Eagle at a time they are driving the price of silver down into the 9 dollar range, you know, I would go on the COMEX.

FRANK: That’s exactly right. And that may be the fact that a lot of people may be doing that may account for the spike in lease rates. At least the fact that the physical shortages are there, I’m not exactly sure why there’s an acute physical shortage but one thing is clear to me there is, and that is definitely manifesting itself in the higher lease rates. So, you know, Jim, I think those are good insights on your part. [1:00:35]

JIM: All right. So listen, Frank, I know you have to get back to work, but thanks for joining us and filling us in on your take on the market, and have a great weekend. If our listeners wanted to contact you, two things: how can they do so, and 2) where are you and your wife having dinner tonight?

FRANK: They can reach me at Frankbgst @ aol.com. I don’t know. We have a new puppy so we're going to find a little dog-friendly restaurant maybe, some place that we can sit outside and take the puppy.

JIM: All right. Well, listen, we’ll talk to you later. Have a great weekend.

FRANK: You too. Take care.

Part 2

The Presidential Candidates' Positions on Energy, Taxes & Spending with Richard Loomis

JOHN: I'm holding my breath, but it's going to be a big sigh of relief. Seventeen days left to go in silly season. We began watching this 24 months ago, Jim, and I'm not sure how much more of this electioneering I can take. One of the things that I am frustrated with and it happens always during political discussions is when you get candidates in debates – we've had three presidential debates and one vice-presidential debate – and they all begin slinging facts and figures around about what their policies will do and how it's going to effect various income groups and why they should do it and how we should spread the wealth and what we're going to do to bail out the economy. All of these facts and figures have a certain amount of quid pro quo all built into them and it makes it very difficult to analyze anything that these gentlemen are saying (or the gentlemen and lady are saying if you look at vice presidential debates). And then what happens is if you listen to the talk shows the next morning around the country, and I usually jump around to stations around the country to listen, it's the same thing. These facts get repeated over and over and over again, until you dissect what does this mean, what does that mean, “well, yeah, that only affects this if I have that much.” Then you finally know what is really going on. So that is what we're trying to do in this segment is look at the three areas for the two candidates: taxes energy and spending. So let's kick off. I don't know which of those you want to take first. I don't care. Taxes is my favorite gripe, so --

JIM: Why don't we start with that. There was a key portion of the debate this week. It was Joe the Plumber.

I wanted an honest question. Me and my friends talk about politics a great deal. I mean they were spinning them and we always talk about if I had McCain in front of me, if I had Obama or if I had Bush, we always think, man – because we think some of these commentators just let them off easy. So I really wanted to ask him a question and I wanted a good answer. I didn’t want what he was repeating for the last couple of months. I want a solid answer that I know how it's going to affect me.

JOHN: That was the now rather famous voice of a gentleman that is actually Joe Wurzelbacher, who is being known as Joe the Plumber, and as everybody said on television, he's got so much fame right now, if he doesn't change his business signature to Joe the Plumber, he's silly because he'd be getting gobs of business here. But he and Senator Barack Obama had a face off (it wasn't really a confrontation) during a campaign stop here earlier this week and the issue is: if we say we're going to tax people over a certain level like tax the rich – you always hear this – or avoid taxing the middle class, you have to ask the question what does it mean to be rich, what does it mean to tax the middle class, what is the middle class. Bear in mind, Jim, that inflation now is taking what was ordinarily somewhat really well off and making it somewhat normal because of the devaluation of the dollar, and this affects the – we're talking about the inheritance taxes as well because that's going to reset if the Bush tax cuts expire. That comes down to 600,000 dollar threshold. Jeepers, Jim, in many parts of the country, that's just a home, so anything else you pass on to your children after you pass on is going to be taxed. It almost depends on the rate, but I think the top rate there was close to 40% or something like that. So what does this mean? Small business men – there is Joe the Plumber, he's got a small business that makes $250,000 a year profit, what does that mean? [3:30]

JIM: Well, the Wall Street Journal did a comparison of both candidates. What McCain has advocated he would leave the current Bush tax cuts in place and we'll talk what that means for ordinary individuals, but if you take a look at the Obama plan as he would allow the top rates to go back up to 39.6% which is where they were under Clinton. Then you would have the phase out of itemized deductions which would change under Obama. That's another 1.2. So now you have additional taxes that come in. One is a 4.6% tax that would be imposed on incomes over $250,000. In other words, there would be a surtax. In addition to that, Obama would lift the cap of Social Security. So you would have to pay additional Social Security taxes. Right now, they've lifted the cap off the Medicare tax, so if you're self employed, even after you reach the social security threshold, which is $102,000 this year, you pay 1.45% over that $102,000 if you work for somebody; if you're self employed, the rate is double that. It's 2.9 because you pay both the worker portion and the employer portion.

So, you know, if you take a look at what happens under Obama, as you get to a marginal tax rate of roughly about 70%. You have the 40% under Clinton, you have the combined Medicare and Social Security tax of 15.3, so that gets you 55 and then you add roughly another 5% surtax for incomes over that amount, so you're at 60. And then here in California, you would add a 10 percent state tax. There is a 9.3, which everybody is in, and then there is a higher marginal rate on a certain level income of 10 percent, 10.3. They actually wanted to increase that to over 12% and thank goodness Schwarzenegger vetoed that or put that to a stop, so you're talking about for the average American you're going to see tax rates go over 60%. Less than that, if you work for somebody else because the employer-paid portion of Social Security and Medicare is 7 ½, so let's take 7 ½ from let's say a little over 60%, so you'd be going over 52. So we're doing exactly the Herbert Hoover, and you saw in that debate where he basically said, he didn't back down, he said, Well, Joe, we're going to take a little bit of that wealth and spread it around.

Now, in addition to that, you have to look at the stock market, which is one of the reasons a very well known sage of the market, Geraldine Weiss, responded that part of this response that you may be seeing in this October selling is people figuring an Obama presidency because there is also a different tax on capital gains. Under the Bush system right now dividends are taxed at 15% and then income is also taxed at 35% at the corporate level and of course here in California, you would pay as much as 10.3. So the combined marginal rate on dividends is 50.4%. Under Obama, the personal tax rate on dividends can go up to 39.6 because they would get no special coverage under the Obama plan. You would have 10.3% here for state income taxes in California you have the itemized deduction phase out of 1.2% and the corporate tax rate at 35%, so the marginal rate on dividends, both corporate and individual is 65.6%. And so you take a look at that, the difference is considerable. I mean just forget state taxes. Maybe you live in a state Nevada, Washington, Florida, Texas, Tennessee where you don't pay state income taxes. The difference, John, between a 15% tax rate, which is what dividends are taxed at now and a 39.6% tax rate is rather considerable. So you think a lot of people that are retired that are relying on a lot of this income from dividend to live on or supplement their income, you know, you could talk about maybe they won't be in the 39.6, but they certainly aren't going to be in the 15% tax bracket. So there is a considerable amount of difference in the two tax proposals.

There was an editorial in Barron’s. It was a rather lengthy article and it was called Dueling Visions and they were talking about, this was an article done back in late August leading up into the conventions. What was remarkable about this, they polled leaders on Wall Street, fund managers, and they said, you know, Who do you think would be better for the markets, Obama or McCain? And what they found that was almost astonishing to them is that all though most would be more comfortable with a Republican candidate and I'm quoting here from Barron’s directly, they said the vast majority didn't think either man would affect the economy much differently than the other; and then Barron’s responded: The vast majority, however, is wrong. And they put: “In McCain and Obama the electorate is presented with dueling visions of how to shape the economy, and particularly the nation's tax structure. Raising taxes on the rich, redistributing wealth and also taxing businesses, versus cutting taxes, would have a profound effect on the economy.” That's why we were covering the depression.

Now, I'm going to quote here directly from Barron’s and it says: it's almost as if Obama wants to repeat the mistakes of Herbert Hoover. During the Great Depression, Hoover raised the top marginal tax rate to 63% from 25%. He hiked corporate taxes. And he said it siphoned needed investment capital out of the markets and into the hands of bureaucrats delaying the turn around, and this is until Roosevelt devalued the dollar by 40% and started printing money, this goes back to John, one of the things that the tax rates that we talked about in 1931 they were 25%, he raised them to 63% and the unemployment rate went from 10 to 25%. And it's like if you see some of these interviews of Joe the Plumber, if Obama's plan was to go through, when they interviewed him, he said, you know, We'd probably get laid off, some workers would lose their jobs, there would be cut backs, and so to say that this would not have an impact on individuals including – and here's another Wall Street Journal editorial Obamanomics, a recipe for depression. And people think that if you raise taxes on somebody that's making that kind of money that they are not going to do anything. They interviewed one restaurant owner, he said, You know what, I'm going to have to lay people off and I'll probably have to work more hours myself in order to make it. And then of course you also have, what is the UN tax that Obama sponsored, the global tax? [11:04]

JOHN: It was supposed to be a certain percentage of our GDP to alleviate global poverty or something like that.

JIM: I think it was like a 1% tax on GDP. So if people think that raising taxes on a business are going to create jobs – I’m putting together a piece that I'm probably going to write for an internal memo to our clients where we're going to show the economic impacts of these policies during the Great Depression and then show the devaluation of the dollar and the various things that took place – but John, you know, when you take a look at these tax increases – and the other thing you really don't know is you remember Bill Clinton ran on a policy of middle class tax cuts and then when he got in office, he said, The budget deficit is too big, I'm going to have to actually raise your taxes instead of lowering your taxes. And you remember when he did that, he raised marginal tax rates to 39.6%, he raised them on people that were making $26,000 a year in income and people that were making $63,000 worth of income. Would Obama not do that? You don't know because as an election as many people know, I mean look at all of the things that they are promising and we'll get to the spending issue, but I can tell you if you look at where the tax rates were, back under Clinton, if you were a married couple filing jointly, you were in the 15% tax bracket with $43,850 worth of income. Let me just go back to a married couple now. You are in a 15% tax bracket if your income is 15,650 to 63,700, so if you make $63,700, as a married couple you're in a 15% bracket. If we get rid of the Bush tax cuts, on the first $43,000 you'll be taxed at 15%. Anything over 43,850 to 106,000, you're taxed at 28 percent; versus today, from 63,700 to almost 129,000, you're taxed at 25%. So you would not go back to the 28% tax bracket until your income exceeded 128,500 and you're in the 28% bracket from 128,500 to 195,850. And then you would hit the 33% tax bracket on income from let's say 195,000 to $350,000 and then anything over $350,000 as a married couple, you'd hit 35%.

Now, if we go back and we repeal the tax cuts, on income over 105,000 you go to the 31% bracket. On income over 161,000, you go to the 36% bracket and on income of over 288,000, you go to the 39.6%; and then you've got to add anything over $102,000 gets taxed at 15.3% if the caps on Social Security are lifted (or half that tax if you work for somebody else). So you can see there is a considerable difference here between what happens to people and you can almost see this just like Clinton when he promises middle class tax cuts, you might have Obama saying, Look, I've looked at these spending programs, I've looked at the budget mess the Republicans left me and I'm not going to be able to cut taxes, and he lets the Bush taxes expire and he raises the surtax and the taxes on Social Security. So John, I mean there are two completely different visions of what's going to happen here that's going to be determined in the next three weeks, and if Obama was to become president and if he was to enact, there is no sign that he's backing off because he sure in the heck didn't back off on the debates with Joe the Plumber that he is going to back off from those tax increases. [15:07]

JOHN: And it was taxes as you recall back between both the ‘read my lips, no new taxes’ and the Clinton administration, between those two presidents, that really created some of the earthquakes in the presidential elections that he we saw in 92 – not the presidential but in all of the elections between 92 and 94. Although I heard somebody on CNBC say it was the increases of taxes in the early 90s that gave us the great tech revolution and tech bubble.

JIM: What we're talking about here, John, is making a smaller portion of Americans pay all of the tax. I mean as of 2006, the top 10% of the country (these are people that make incomes over 103,900 dollars) paid 17% of the nation's taxes; and those individuals, the top 25% of tax payers, (those individuals making over 62,000) paid 86% of the nation's taxes. And so what you're talking about is creating a class of people that have no stake in society where they would pay no taxes under the Obama plan; and then you would take those that work and pay taxes, they would pay all of the taxes and that, I think, is very disturbing. [16:23]

JOHN: That covers the concept of taxes. You know, in all of the times we keep hearing about budgetary issues, remember going all of the way back to FDR and his first inaugural address in March of 1933, he talks about getting their own house in order (meaning balancing the budget, they couldn't spend more money than they had brought in) and in all of these discussions of budgetary issues, almost never is the concept mentioned about maybe we have to do what everybody else does and we need to just start chopping down massive amounts of spending. And most people today, I think people who are 20, 25 years old don't remember the J Peter Grace Commission report. Remember that? That he funded out of his own pocket, studied the whole government situation.

JIM: Sure.

JOHN: And said basically you could cut out about 50% of government operations, we probably wouldn't notice any difference. But that never enters into the factor here and when we keep talking about budgetary difficulties.

JIM: And you know, it was amazing because both candidates –although I think McCain is probably more credible on this because he's a big opponent of earmarks – but the one thing they talk about, we would cut these programs, John, since I've been following politics, since my college days, I have yet – of course I didn't pay much attention to spending programs, but since I got in the financial business and following the government's budget – you see these programs –John Stossel has done a number of exposés on them – they have stuff going back to World War Two where they had these subsidies and various programs and they've yet to be cut. Have you seen any politician come on and say, You know what, if I am elected here are ten things – they always talk about government spending and they talk about it in kind of like a broad brush about cutting: “Well, I'd look at inefficiencies…” Clinton did cut the budget. He cut the military spending. He cut the military's budget by almost a third. So he did cut military spending there, and perhaps if Obama is president, he would slash military spending in half, so that would be a budget cut. But as far as any other kind of program of government, have you ever seen a politician suggest they are going to cut? I mean we're talking about a national health care system. That's going to be a cost of a trillion dollars. [18:33]

JOHN: Right, when we're already having trouble with Medicare. All this is is Medicare on steroids. You've already got doctors that won't even take Medicare because of the complexity of the documents that they have to fill out, the delays in getting paid and the risk they run for being accused of fraud in trying to comply with the bewildering series of regulations. And that's what you've got already, and we're talking about moving that – it's almost like CS Lewis said, Jim, once a spending program in Narnia, always a spending program in Narnia. They never go away.

JIM: You know, that is the amazing thing about this because, I mean, I have a group of cardiologists, John, that have more staff members dealing with paperwork with insurance companies and Medicare than they have nurses. So here is just a good example of government bureaucracy run amuck in our health care system; and anybody would believe that the government would run things more efficiently has never studied government. And all of these programs, whether it's, you know, McCain's ‘let's take 300 billion and buy down people's mortgages’ or it's Obama's national socialized medicine, all of these programs, this is at a time before any of these problems are adopted, they are already talking for fiscal year 2009, which began in September, they are talking about next year's budget deficit is going to be a trillion dollars and we're not even talking about the current account deficit. So I would ask the question: Where is the money going to come from? It sure ain't going to come from taxes. Taxes aren't going to deliver a trillion dollars of extra revenue to the government. [20:40]

JOHN: You know, it's interesting you mention that. We have a doctor here in town who will not take insurance and he will not take Medicare and he gives you a much lower rate than the other doctors do per office visit. He doesn't want to deal with the paperwork and have the staff on required to do that. He'll give you a statement for what your services were so you can submit it to your insurer if you want, but he will not do it. So it's interesting – a lot of physicians you hear them talking, Got to get out of this, got to get out of this, we can't handle it anymore.

JIM: In fact, my physician who used to be Richard Russell's physician, it’s the same thing, you pay either credit card or cash or check and then they will give you the bill and you submit it to your insurance company; or if you're receiving Medicare, you submit it to Medicare but they won't deal with this anymore because, you know, my doctor told me that it would cost him probably a quarter of a million dollars to have the staff to deal with this and he goes, When you have to pay that money, he said, I've got to recoup it some way, so I'm going to have to raise, you know, my office visits and everything else. And they are talking about making this even worse. And they are talking about computerization of medical records. I mean, I don't know if most people realize that if you renew your passport now there is an imbedded chip in your passport, so they are talking about some kind of chips that they might use for medical records. And that's exactly what they are talking about – this sounds like right out of the book of Big Brother.

I think the realities, John, that whoever is president, whoever we as a nation elect in, what, 17 days from now, I think they are going to have the cold realities of dealing with an economy that's in a recession, which means that tax revenues go down because there are more people unemployed, profits go down for businesses, so less tax revenue comes in. At same the time, government outgo through social programs goes up, so the budget deficit and particularly all of these bailouts; I mean the figures have become so staggering, they don't even make sense anymore. You know, 150 here, 700 billion there, 300 billion here, now we're talking about another 150 billion dollar stimulus program before the end of the year and now we're talking about all of these new programs like the rest of the world is going to pay for our prolific spending. I just don't think that's going to work. [22:42]

JOHN: Maybe what we need to point out is are some very cold hard facts of political life right now. Number one, politicians will continuously promise you lots of candy for free as they are reaching into your back pocket through taxes or inflation to pay for it. But invariably what they siphon off from you is not enough to pay for it. And what we're doing here is making all sorts of promises that there is not a chance anywhere that ultimately we're going to be able to pay for it. And we are not talking now about a day of reckoning that's 40 or 50 years in the future. It's in the very, very, very near future. And so we're in a game of musical chairs here. Who is going to be left standing when the music quits? And who can get their pension and get out before it does so? So I'm not sure what that really means ultimately except for the fact that when I think people are planning their future, by the way, Jim, as far as retirement, realizing what may or may not be there in line with these promises, that is a fair estimate of what you're going to have to look at in addition to what inflation is going to do to your income. We've talked about that a quite a number of times in the past when we did series on preparing for retirement here on this show. And these are facts. [23:52]

JIM: I don't think I have to tell anybody listening to this program if they take a look at they're talking about deflation, other than your house going down in value, maybe your stock portfolio is going down in value, I mean where are you seeing your costs go down? I mean yes, gasoline has come down at the pump if I look at, let's say, the last two or three months, but I don't expect those gasoline prices to remain there; and I think as we head into winter, we're going to see higher prices. And so, you know what, we are going to pay for it and we're going to pay for it through the stealthiest tax of all which is inflation even though we never address it or really want to speak about it. [24:35]

JOHN: The last thing we'd like to investigate here on this part of the program today, Jim, is the candidate's position on the area of energy, and this is one which has not been as prominent. Yes, people are talking about energy, security and independence, but the question is, do they really have a comprehension of what the energy situation is right now? Richard Loomis joins us, right now. Jim. We'll let you lead this one off.

JIM: You know, Richard, we've been doing some comparisons here between the two candidates because I think this is a very important election going forward. We've hit taxing issues between the two candidates, we've talked about spending issues, but, you know, as Americans are focused right now in this credit crisis, this stock market, I don't think that's going to be where we're going to be focusing our attention in terms of a real crisis that this country faces going forward. So I would like, I know you've done a comparative analysis of both candidates –both Barack Obama and John McCain – on their energy policies and it's rather insightful, so why don't we begin, and what were some of the most stark differences that you found between the two candidates?

RICHARD LOOMIS: Well, I mean if you look at the candidates’ energy policies, there are some things that are similar between the two and there are some pretty good differences. The first difference that I see is that McCain is definitely ready to go offshore and to develop more domestic oil supplies. Even in the debate, Obama said he was going to look at it. The other stark difference is that Obama favors a windfall profits tax from the oil and gas companies to fund a refund back to the tax payer of $500 for the individual and $1000 for a married couple to offset the cost of gasoline. Now, for those of us in the business who know something about what a windfall profits tax does, you're going to see oil companies take on fewer projects. So we're going to have less domestic oil, so a policy like this would actually shift us toward more imports from the foreign countries – Probably not as good a deal. In addition, we spend a lot more than $1000 per person on gasoline currently. On the McCain side, he's saying he wants to open these things up and increase domestic supplies. Conversely, they both have, I guess together they have automotive initiatives as well. If you look at McCain, he's got his 300 million dollar battery prize out there and Obama wants to put a million plug-in hybrids on the road by 2015. [27:09]

JIM: Richard, you know, the car fleet’s 220 million cars. What's one million hybrids going to do?

RICHARD: It doesn't do very much, but it has some other aspects to it. Right now we don't have a plug in hybrid and the one that can be kind of classified there as the Volt, it won't be here until 2010, so what you're really doing with a policy like this is you're sending our automotive manufacturers down that path. You guys will create a plug in hybrid, depend the money, get one to market and get a million of them on the streets by 2015. And as far as for the consumer, it doesn't do very much as you point out. We have 220 million cars. One million isn't going to make a lot of difference.

Another difference between them also is the SPR –the strategic petroleum reserve –which isn't automotive but it's back on to oil. Obama want to use the SPR to help regulate price. It wasn't designed for that, but that's what he's planning to do with it. If you look at what McCain wants to do, he's saying he wants to give on cars flex-fuel vehicles so that 50 percent of their cars by 2012 will be flex fuel. Obama wants to go 100 percent flex fuel vehicle. Now, since we know a lot about ethanol, we know that's probably not a very good idea. When the car gets heavier, it goes less distance and we don't have a distribution network for the ethanol which needs to be blended into that fuel to make E-85. So both of those policies don't make a lot of sense.

Both of them do want to do clean coal technology, but if I look at who wants to invest more in green power, it looks like Obama. One of his initiatives is a 10% renewable standard across the country. The kicker in that is he wants to do it by 2012. The only way to do that would be to throw cost out the window, so if you don't care what it costs, you could probably do it. But since the consumer would be bearing the majority of that cost, probably not such a good idea under that kind of time commitment.

Both of them want to do cap and trade, so the cap and trade system under either plan is also going to increase the cost on power.

As I was starting to do this analysis, I thought okay, who does this actually benefit because both of them are talking about decreasing imported oil? They've targeted the Middle East and Venezuela as being where they want to decrease the oil the most. We now get somewhere around 28% of our oil coming from either the Middle East or Venezuela. So if you're going to knock that 28% out, where are you going to take it from. Demand is continuing to rise. None of these initiatives would actually increase imported oil and certainly they don't decrease demand, so you have a very odd mix there. But who does it actually benefit? Probably the only one who benefits under a plan like that would be the Middle East and Venezuela because you would force them to make a conscious decision to move their refining fleet. So I imagine you would see refining capacity opening up in China and in India that could handle those crudes, so we'd actually be forcing our supply into those other markets while not providing a replacement in ours. If you look at power, I think McCain is talking about 45 nuclear power plants. Unfortunately, in the debate, he used that as how he was going to get us off of imported oil, where the two have nothing to go do with each other. Obama focuses on clean coal and green technology. The clean coal isn't here and the green technologies can't produce enough power to offset what we need. Really, both of their plans seem to head towards higher prices on the consumer – either direction. Maybe a little less with McCain because he does want to increase some domestic supply and he does have the base load generation coming in nuclear. Obama is looking green on power supply. The cap and trade system from both of them is going to cause prices to go up on power. Under Obama's plan, we do not increase the domestic supply of oil and we attack the oil companies, so you're going to see less domestic output and higher prices. So we've got energy policies that don't do very much as far as providing power for the planet, and certainly for the United States. [31:00]

JIM: You know, that was one of the comments that I heard over and over from speakers at ASPO, that neither of these candidates understand that if you take a look at most of our consumption of oil, Richard, is liquid fuels, it's a liquid fuels issue. It's like McCain talking about building nuclear power plants. That's great if we all drove electric hybrids, but it's not going to help us from now until when we do get electric hybrids. I think neither of them understand or have a comprehensive understanding of the entire energy picture, yet I think this is going to be probably the single biggest issue of their presidency whoever gets the voters’ choice come November. That is what is surprising. You and I are probably familiar with the Hirsch report that was given to each one of the presidential candidates in the primaries and there was only one guy that was really interested and unfortunately, he didn't make it through the primaries, so it's really kind of disturbing. Have you seen this, Richard, new report by the Energy Security Leadership Council, it's called the National Strategy for Energy Security. It's written as a report to the next president and Congress of the United States and the American people?

RICHARD: Yes. I've read the summary of it. It points to what the gravity of this issue is. If we don't get our hands around this issue, we're going to get left behind. And the two things are tied together: the economy and the national security. If we do what certainly the Obama plan suggests or some of the things in the McClain’s plan, we are actively working acting against our national energy security. It's something I don't think either one is focused on. [33:09]

JIM: You know, that's the thing you find most disturbing. It sounds great in a debate, the sound bites, “I'm for clean energy and I'm going to create nine gazillion jobs and we're going to be energy independent 10 years from now,” and what bothers me about this is how people in the media let these guys get away with it and nobody is – I think the American people, the American voter now understands more about energy than either of these two candidates who are running for the presidency.

RICHARD: Have you noticed that the price of gasoline, and I haven't looked at power prices but certainly the price of gasoline is coming down right at this moment, so even the consumer is not being sent the price signals that go in and demand that these characters focus on energy. As I was starting to write these two comparisons and I've actually got a very detailed article that we're publishing right now on Obama's plan and I'll be publishing my McCain plan summary here shortly. I think what you really see is a lack of understanding that energy, a lot of energy, is required. It is not optional. We're at a 100 quadrillion BTUs in the United States between power and transportation. This isn't a case of maybe we can get enough demand disruption to offset the increases. You can't. You'll drive the economy into the ground.

So if I just look at what we've got here, you've got the base load generation in an ever growing economy. You must provide the power. You have an ever growing transportation fleet and there is a lot of inelasticity in how much we can drive. Sure, we can decide not to go on vacation, but we've still got to drive to work, we've still got to come home, so people are going to drive. They've got to have the fuel. If you look at even the Pickens plan, he divides and says we'll run natural gas cars. That's at least a diversification on the fuel source. Is it the best way to do it? It's still up for grabs. We don't have a natural gas car fleet out there. But it's something. And these plans, we look at diversifying to flex-fuel vehicles which we've already shown that ethanol is very difficult to get enough supply. One thing that McCain did say that I thought was good is that he was going to get rid of the tariff on imported ethanol, but that's kind of trading the same thing. I mean right now we import oil, now we would start importing ethanol. So if we're going to use ethanol and these flex-fuel cars come on board, we still don't have an infrastructure to deliver the ethanol. Rather than looking at something like a natural gas where we all have natural gas coming into our houses, there is an infrastructure in place. You've got a possibility of doing it. When you look at the efficiencies, it's not bad. It's about 50% efficient. Not nearly as efficient as burning it for power and then plugging in, but it's there. As these guys look forward over the next two to three years, our energy demand is going to be huge. We have OPEC talking about cutting back supply. We're out here sending signals that we don't want their oil. You've got all of the things that we've discussed around power. We are going to have to keep growing. If we go with a cap and trade system, you can take coal off the table. You can take some of the natural gas fired generations off the table. It's simply not going to happen. So you're going to start running short on power. As we start running short on power, I can see the American public insisting that something change. I think it will be very interesting to see what kind of change that is. [36:35]

JIM: Well, the one thing that you've seen despite even when oil prices were getting up to 140, the American public finally said drill, and our Congress said no. It seems like they have their own agenda, and it's not until, and I think you'll know who I'm talking about here where somebody in the industry, a prominent player been approached by some members of the Senate about how to put in place a rationing program that this person said, Hey, we had one in World War Two, why don't you look at that. But this is some of the things that they are considering because you've got Obama who doesn't want Canadian tar sands oil because that's called dirty oil. Both candidates have basically told OPEC and Venezuela, we don't want your oil. Believe me, if we don't want it, I know there is a big country out there called China and another one called India that will say we'll take it all, and then the things that we're talking about Richard whether we go to a cap and trade system or we go to a windfall profits tax, both of those measures are going to drive the price of energy up. They are going to drive the production of energy down and they are going to drive our imports up. And I don't know how OPEC or our dear friend Hugo is going to react to the fact that, Well, we don't like you, we're trying to get rid of you, but I guess our plans didn't workout, now we need you, we'd like to get some oil from you. I don't know how well that's going to work out. [38:01]

RICHARD: With demand rising globally, it doesn't work out because if Hugo Chavez gets told by the United States, “we do not want your oil,” he works out another deal with either China or India, they build the refinery and while we're trying to stop taking his oil, he's shipping it over there. Once he's got an option, he doesn't need us. Right now, he didn't have an option. He needs us. Also the Middle Eastern crude; we've got refineries that were built specifically for those. If you say I don't want it, you will have them who are cash rich building refineries to service other markets. Why wouldn't you? I mean if long term you're losing a client, you need to find another one. We basically forced their hand. If I were in the Middle East and I was looking for a way to reduce US influence, this is exactly what I would do is I would insist that we go and build a refinery elsewhere and send our crude there, really relieving them of any burden of trying to satisfy the US on policy. [38:58]

JIM: And it gets even worse than that, Richard, because what we do import, we import in dollars and then we have countries like OPEC and Asia who turn around and recycle those dollars and finance our trade deficit, so not only are we telling them we don't want your oil, go sell it to somebody else and you know that once you sign a contract as Hugo has done (I mean we used to get 300,000 barrels more oil from Venezuela than we do today), once those barrels of oil go to China and India wherever they go, they are lost, we don't get them back. And by the same token, I'm not sure how it's going to work when we say not only do we not want your oil, but by the way, continue to finance our deficit. [39:39]

RICHARD: That's absolutely true. And in addition, we have not diversified the fuel base for the automobiles. So while we're doing this, saying we want to cut out 28% of our oil supply, we are not actively swapping out the fuel source in this 220 million cars; a million plug-in hybrids is not going to make a difference on our imported oil demand. It just isn’t going to do it. Going to flex fuel isn't going to do it either because we have already decided we cannot grow enough ethanol to run our transportation fleet. So we're hitting up against two areas, your power bill at home, and this is where the cap and trade affects it, and your car; and that's where you're getting into imported oil supplies and domestic supplies. If you buy into what Matt Simmons has been saying that we are at peak oil, that means there is only a limited amount of production going around the world. We're there. There isn't a lot of flex.

I just did an interview with Clayton Williams who is one of the old time independents, and he estimates global decline to be somewhere around 5% annually, which means we’ve got 5% more to make up. Domestic drilling in the United States could be very effective in controlling price. I don't think we can drill our way out of this problem, so we'd better be looking for another fuel to run cars on, but we need something that will work today. And I've seen some interesting technology, the battery packs used in the Tesla, certainly natural gas. There is a guy in Dayton, Ohio that figured out how to make a hydrogen machine that you plug in the wall, plug a hose in it, it produces hydrogen and uses less power than a 500 watt bulb; he can also convert a car for $1000. So there are solutions out there that show promise. These policies, McCain’s less than Obama's, don't take us toward energy security and they don't take us toward energy supply. At least on the McCain plan we will do some domestic drilling, not just look at it; he does have a plan for base load generation which are the nuclear power plants. They both want renewables. If McCain wasn't going to push cap and trade system, I would give his plan better marks than Obama's. Under the Obama plan, you've that 10 percent renewable power standard. If that didn't have a 2012 deadline on it, that's something to strive for. To do that by 2012, you're really hurting yourself. You're going to use today’s technology, what we have presently, and you're going to just have to spend to get it there, both difficult things at a time when the economy is starting to falter. Windfall profits has never worked, so why do we think it will work this time is beyond me. [42:20]

JIM: Well, Richard, let's just hope whoever we chose this November will be much smarter than they've exhibited throughout this campaign because like I said, whoever is chosen, this is going to be the number one issue. I want to thank you for joining us in this segment of the Big Picture, Richard, give out your website, would you and Richard, do you want to talk about something you and I are going to do, or do you want to leave that until we can arrange it?

RICHARD: Well, Jim, we also should mention an upcoming television show that you and I are going to do together on energy policy and what's happening in energy on the finance side and on the business side. Hear it on World Energy television and people can receive that. We're up too 50 cable channels across the country. You can download the list from my website, which for the TV show is www.worldenergy.TV, and of course our main site www.worldenergysource.com. And I'm looking forward to sitting down with you, you on the West Coast, me in Houston, talking about what's happening in energy and being able to show people what we're looking at. I think it's going to be very exciting. [43:20]

JIM: We're really looking forward to that. It reminds me of the old days when I was insane enough to have a regular job and go to the television studio and become a financial anchor in the early part of the 90s, but I think television and the video media is a great medium in which you can discuss and show things that you can't do obviously with radio. Well, Richard, as we close, give out your website if you would.

RICHARD: Our website is www.worldenergysource.com, and of course we have www.worldenergy.TV and when you come into www.worldenergy.TV today, I have a video of nine CEOs talking about energy policies, the presidential candidates and which one knows something more about energy, so we can look at Clayton Williams, Matt Simmons, the CEO of Ngas and others all having the same discussion you and I are having right now. [44:12]

JIM: All right, Richard. Once again all of the best and I'm sure we'll be talking to you shortly and I look forward to producing that television series, so all of the best.

RICHARD: Thank you very much.

FSN Humor: Andy Looney

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

What is all of this stimulus they are talking about? Jumping into a cold lake in winter is stimulating, but I don't think that's what they mean. All I know is they say we've got to hurry or it won't do any good. When politicians get in a hurry. I get worried. Don't you? I do. Because no one's money or property is safe then.

Did you see Ben Bernanke this week? He looked really worried. Seems he's running out of things to say, but everyone is really anxious for him to say something and it better be good. That's funny because no one understands Ben anyway. But when he doesn't say anything, they really get nervous. Poor Ben. I bet he wishes he was Alan Greenspan and could retire and get a lucrative contract from all of the hedge funds who made money on the mess he caused. After all, I'm just an ordinary guy trying to raise his family and get through life. And the politicians just keep throwing themselves in my way and taking what little I make. I'm Andy Looney for Financial Sense. [46:11]

How the Gold Market Has Changed

JOHN: Confusion is the order of the day, it would seem like right now in the area of the gold market. There are discrepancies that are confusing people. The price has gone down despite the fact that the demand worldwide has gone up rather astoundingly. Try to go get some gold and silver and look at prices even on eBay and the premiums riding on some of the non-bullion coins. The HUI was up 30 percent and now down 50 percent. Same for the XAU. So what I'm hearing in emails and phone calls and everything from listeners, Jim, is, “What's going on. We don't understand all of this.”

JIM: Well, just as there is a big disconnect between, let's say, the paper market of bullion and the physical market, I mean it doesn't matter what they take the price down of silver and gold to, try getting your hands on it; but we're going to have a recommendation here at the end of this program, and it's going to be a strong recommendation. But you also have a disconnect between the physical market and gold which is down 5 percent for the year and silver is down 35 percent and compared to what's going on with gold stocks; and what we have done is we've broken up the universe of the gold market into four categories. Category number one are producers. These are people that are large producers and even at $800 gold, they are making money, they have cash flow. So those are your top-tiered gold producers, that's your Newmonts, that's your Barricks, your Yamanas, your Goldcorps, et cetera. Those Kinrosses, those companies are making money, they have cash flow, they have income even at today's prices. That's category number one.

The second category is your emerging producers or your smaller producers. And as long as they have positive cash flow where they can sell their silver, they can sell their gold at above market prices, generate positive income so they don't have to tap the capital markets, these companies are going to be survivors, so that's your second tier. And in these emerging producers that also includes companies that are either in the process of moving to production like Minefinders or companies that are close to production, so that's your second category of the gold market.

The third category are late stage development plays that either have a well defined deposit, they are getting close to the critical mass of two to three million ounces that are going to make them a viable candidate; and a third component of that that I would add that have access to the capital markets because I know one company that could be – it's a junior right now, it's a company that we own, I know, and they are going to have or amassing the largest silver deposit in the world, they just tapped the capital markets, they have access to capital even though at lower evaluations. And there are also some juniors. I'm involved with a couple of them. One of them just had a capital raising where they brought in a mining company that took a second or increased its position in the company and they were able to raise money at above market prices and also other companies that have either a lot of money in cash. I was talking to one CEO who is sitting on quite a bit of cash, sitting on close to $8 million of cash and they said, “Look, if we trim and maybe get down – drill here or there and maybe cut our drilling in half, we have enough cash to weather this storm for the next two years. We're in the hunkering down mode.” And what they are trying to do is, unfortunately for this company, they had one large hedge fund that blew up that has been selling heavily every day in the market and the owners of this company, which I'm glad to say are through their own family members are massing enough capital to buy out their hedge fund’s remaining position in the company, and it would be poetic justice because this hedge fund did a financing with this company many years ago and they smashed the stock down 80 percent and then financed at a lower price. So the fact that the owners of this company might be able to buy shares from this distressed hedge fund, so we call this third category of mining stocks the “survivors.” These are going to be the companies that have well defined deposits, they are in friendly jurisdictions, they have access to the capital markets and they have strong management teams, a strong board of directors, they are going to be the survivors. These are going to be the companies when the markets turn around that are going to go up 200, 300 percent. You can see that happening in a two- or three-week period.

The fourth category is what we call the Titanic and these are going to be the juniors that, one, they are not far enough along in their deposit, they don't have the experience in the market and more importantly they don't have the board or access to the capital markets. These companies I’ve put in the category called the “Titanic.” They are not going to survive. They are not going to be around. They will lose their projects because they won't be able to raise capital in the markets and somebody else will end up buying the deposit, if it's worthwhile to develop over the next couple of years, for a song. I know of one junior right now that has a deposit that has one of the largest companies in the world that is interested in taking this early stage project from them because they are aware that this project if developed over the next couple of years is going to be a substantial project, so they want to buy this project from them at this point. It's just a question of negotiating at a fair value price and if that happens, this junior will be cashed up with a significant amount of money.

So, John, those are the four categories, the large producers, the small cap producers or emerging producers is the second category. The survivors in the junior sector is the third category and the Titanics and these are companies that won't survive, they simply will not be able to access the capital markets. [52:22]

JOHN: Well, if we are looking at the conditions like you're talking about, the economics where it stands, what should individuals do?

JIM: Well, first of all, you know, as painful as it is to see the HUI, if you own a large producer, if you own a Barrick, if you own a Newmont, you own a Yamana, these companies are selling at extreme bargains, you hold the position. Especially if Obama comes in and is talking about doubling the capital gains tax rate, so you want to have a long term capital gain potential, so if you keep trading in and out of these, you're never going to establish a long term capital gain. The way these markets are going -- I mean you can wake up like we did this week where on one day you had the energy sector go up 30 percent in a single session. And Friday before the markets pulled back at the end of the day, you had some of these energy stocks up 10 and 15 percent before a sell off towards the end of a day, so you hold those positions.

Two, you want to make sure that you have, in your portfolio, either large producers, intermediate producers or soon to be producers and survivors, and those are the three that you want to hold in your portfolio. If you own them, you keep them and then if you believe in this story, then what you do is just dollar cost average. That's what I do. I buy the same companies I buy every single month that I'm accumulating in these positions. Am I happy that they are down? No. But I'm even happier that I'm buying them at a cheaper price. There are three of these companies that I'm going to be building substantial positions in that are going to be rather significant, so you have the opportunity to do that because they are just actually throwing the baby out with the bath water. They are just giving these thing away. You can pick up reserves in the ground at 10 percent. You can pick up producers at four times earnings with 5 percent dividend yields. And so you add. But if you have your Titanic, get rid of your Titanics now because you can use the capital losses maybe to offset some capital gains; but these are the companies that aren't going to survive, and that's what you want to do: You want to make sure your portfolio consists of the producers, the smaller producers or soon-to-be producers, that's the second category; and the third category, survivors; and then get rid of your Titanics. [54:38]

JOHN: The biggest question, Jim, that you still hear is the discrepancy between what we call the paper price of gold and the physical price of gold. Let's face it, gold and silver, look at the prices right at the end of the week here being knocked down and if you go on to eBay and you want to buy something like silver Eagles, you're paying huge premiums. I would say double of what the value is.

JIM: You're paying more than double the price of silver.

JOHN: Yeah.

JIM: I'm looking, as we're speaking, John, I'm looking at eBay. Here is a silver Eagle. It's a 2008 silver Eagle, a one burnished box set for 23.95. Here is a roll of 20 silver eagles at 389.99. That's 19.50 an ounce, so if we take 9.39 and we take 19.50, you're paying a 108 percent premium over the spot price of silver. So that just goes to show you what a disconnect there is and huge shortages, so there are people selling silver that have it, but they are commanding over 100 percent premium. But that's why I say, folks, get it while you can now, because probably in the next 12 months and especially as reflation kicks in, you're going to have difficulty getting this unless the price spikes so high that you get more sellers that come into the market. [56:00]

JOHN: I guess what I would ask here, is there any way you can play what's going on to your advantage? And I know you don't like to make recommendations but let's just throw that on the table.

JIM: Yeah. There is. And I'm making an outright call and buy signal here and what you want to do is establish a relationship with a commodity broker and what you want to do is buy a mini contract on silver, that's 1000 ounces of silver. You're basically buying a thousand ounce silver bar, and I would buy a mini contract (and if you're actually more affluent, I would buy a full contract which is 5000 ounces of silver) and take delivery. And that's what is happening and get it while you can. And if you were a hedge fund and came in and tried to buy a vast amount of silver, they would stop you because they would call that manipulation. Never mind the fact that they allow short sellers to sell one year's worth of production that they could never even deliver into. But I think what I would do if I wanted to arbitrage this right now, if you're in that position, let's say you have silver Eagles, you can sell those Eagles on eBay and get $20 or more or close to $20 for them and what I would do is take the money and buy mini contracts or full contracts on the COMEX and take delivery. That's the play I would make here because there is such a discrepancy that these figures that they have in the paper market are being manipulated, they are being controlled. So if they are willing to manipulate this market, take advantage of it and buy a mini contract and buy a full contract here.

And that's only if you believe in this. If you believe in silver, you can afford to buy your bullion and you expect to be a long term holder of this, this is how I would play it. If you don't like volatility, if it bothers you the price of silver could drop, if you're too much of a nervous Nelly, then you don't do this. But I can tell you right now, there is such a great discrepancy between the physical market and the bullion market, going out and trying to buy -- in other words, I would not be going on eBay and paying a 110 percent premium or 100 percent premium to get silver Eagles. I don't think that's the smart play here. I think the real smart play here is depending on your degree of affordability, a mini contract which is a thousand ounces would cost you right now roughly about $9,500, 9600 with commissions and then just arrange to have delivery. I don't care if you have to pay for shipping on a thousand ounce bar to your house or wherever you're going to store it, the bank, et cetera, but I would play and I would start going with mini contracts here and I would do it while you can because I don't know how long this is going to last, but this to me is the play of the decade right now, is to do this as it is. [58:44]

A National Strategy for Energy Security

JOHN: There was a report that emerged in September of this year, about a month ago, entitled a National Strategy for Energy Security, “recommendations to the nation on reducing US oil dependence.” The Energy Security Leadership Council has quite a number of names on the roster, Jim, including a lot of former military and other people who have been involved in this entire issue looking at what the emerging energy shortage means for security in terms of the country itself as well as our ability to keep functioning. It is a very sobering 100 page report, approximately 100 pages, so we're going to talk about this one, because as I see it right now, yes, people are concerned about the upsie-downsies of oil as far as what it means at the pump, and everyone is focused on this bailout, but the energy situation as it intensifies through this crisis window really threatens to broadside what's going on in the economy. And I don't think people are watching both of these together. Very, very few people seem to be observing these.

JIM: The amazing thing is this report was bipartisan and the opening of the report is a letter to the president, the Congress and the American people. In other words, the next American president, the next Congress of the United States and the American people. And John, when you take a look at this, the co-chairs of this Energy Security Council includes General Kelley, he's a former retired general with the US Marine Corps, 28th Commandant of the US Marine Corps; Frederick Smith who is chairman and president and CEO of FedEx. You have General John Abizaid, former commander US central command, Admiral Dennis Blair, Edgar Bronfman, retired chairman of Seagram, you have the president of Royal Caribbean international, you have the former general John Gordon, former homeland security advisor to the president. You have the general John Handy, former commander of US transportation and air mobility. You have people like David Steiner, head of Waste Management, you have Eric Schwarz, CEO, Goldman Sachs asset management. You have John Lehman former secretary of the US Navy, Herbert Kelleher, founder and chairman of Southwest Airlines. I mean, it's like a who’s who. These are both people coming from the military side and the civilian side and they are saying: This is a very important issue and you'd better get this right and you'd better start focusing on this, because if you don't, we're not going to have an economy that's going to be able to function. [1:02:07]

JOHN: It's interesting to read just the statement of purpose on this report, Jim, here's what it says:

Hostile state actors, insurgents and terrorists have made clear their intention to use oil as a strategic weapon against the United States. Steadily rising global oil prices add to the danger by exacerbating tensions among consuming nations; and even in the absence of full blown geopolitical crises, oil dependence, with its incumbent exporting of American wealth, exacts a tremendous financial toll on our country. Last, but not least, excessive reliance on oil constrains the totality of US foreign dependency and burdens a US military that stands constantly ready as the protector of last resort for the vital arteries of the global oil economy.

JIM: And you know, it's amazing too because they were talking about in the letter to the president and Congress, they said Russia is leveraging its energy resources to project national power, Iran is poised to interfere with tanker traffic in the world's most active oil transit corridor, and Venezuela has threatened to curtail oil production to inflict economic damage on the United States. And they were talking about these and other challenges to energy security to this country which compel us as a nation and our allies to confront an inescapable and disturbing reality. Oil dependence poses a threat to America's national security and economic strength. It constrains foreign policy, it limits military options and threatens the core of the US and the global economy. You go to the store, I don't care if you're going to WalMart, if you're going to Costco: Where are the goods made? Outside food and even sometimes in the grocery store, a lot of the food you see in the grocery store where you get fruits and vegetables all year round, some of that stuff is flown in from Latin America where when we're in winter, they are in summer or harvest season. And so they address a number of issues and they said this is what you have to do to get this out. And they have an outline in the report. In fact, we're going to post a link to this report if you're listening to the program so you can download it for free and become more informed because these aren't a bunch of fringe people. These are people that are very much concerned about what they see as threats to this country and what our lack of response or leadership and that's what they are recommending. [1:04:31]

JOHN: Obviously, Jim, we don't have time to go through this entire report here on the program. That's why we're going to put a link on the website so you can go and get the PDF yourself and print it out and read it, but we should at least address here some of the salient points of this report to give people an idea of what's in it.

JIM: Well, the first issue they address, it's called electrification of the transportation sector. And as we mentioned, neither candidate, Barack Obama or John McCain, really understand that this is a liquid fuel problem. Windmills are not going to drive the cars or power the trains or the ships, so they recommend a number of things. Number one, establish development of advanced battery technology as the top research priority and spend at least five hundred million a year towards that development; and what they are talking about here is moving towards electric cars. Replace existing vehicle tax credits with new tax credits up to 8,000 dollars per vehicle for the first two million domestically produced highly efficient vehicles. I disagree with that; two million vehicles out of 220 million is not going to really do that, but it's a start. The federal government should help create a market and exercise leadership by purchasing highly efficient vehicles. Well, the government can do that for its own fleet. In other words, if you're a government employee and you drive a government car, that's what they should do. Establish production tax incentives to aid in the retooling of US vehicles and manufacturing facilities. Encourage business participation, extend and modify federal subsidies for hybrid medium duty vehicles, that's class 3 and 6 and heavy duty vehicles, class 7 and 8 to 2012; and remove the cap on the number of eligible vehicles; and then grants to municipalities and tax credits to commercial real estate developers to encourage installation of public recharging stations.

In other words, as we move from let's say a carbon transportation system of carbon fuels, we know for example right now, there is the technology and they are working on it –very close to it – where you can get, let's say, electrical plug-in cars that will be able to go maybe 60 or 70 miles, so for the average person going to and from work, you can drive an electric car and then what you do is you pull it into the garage at night, plug it into the system and recharge it, but they are also saying for longer distances, just as we have gas stations, we're going to have to build recharging stations, so taking a look at the transportation sector is one avenue. [1:07:00]

JOHN: Something that truly, truly has to happen is the fact that our grid is getting old and it is not well suited to transfers of power to where they are required, so they have a whole series here on enhancing the nation's electrical system, increase in nuclear power generation and addressing waste storage. They are talking about continuing the licensing process, say, for Yucca mountain, while at the same time coming up with a program of interim storage; applying advanced coal technology, which would involve significantly increasing investment in advanced coal R&D, including development of carbon capture, storage technology and the policy frame work. They should promote renewable energy. I don't think anybody is disputing this. The only question you have is how fast this can come online. Development of a robust transmission grid to move power to where it is needed; and transforming consumer demand for electricity, which would be something like you can implement time of day type of pricing. My father-in-law worked for an electric company for a long time, was always the guinea pig, say for example, Jim, and he has a device in his home which limits peak demand at any time of the day. You set what you want your peak to be, you sign a contract with the power company that you'll never exceed that peak and then as you approach that, it begins shedding unnecessary circuits, usually heating circuits until the excess is shed or used up and then it goes back to that, so that's the type of thing that they're talking about and they have the technology today to do that, which is transforming consumer demand. So those are some of the things you're talking about in terms of domestic energy. [1:08:34]

JIM: And the other thing that they are talking about is reforming the biofuel system. I don't know if it makes sense to take a third or even more of our corn crop and turn it into ethanol. That's not going to get us through there, so they are talking about enhancing R&D for biofuels to make them commercially viable and using different forms whether it's switch grass or other forms; also increasing flex fuel vehicles much like they have in Brazil, accelerating the Department of Energy and Environmental Protection Agencies testing and performance validation of unmodified gasoline engines – I'm not sure of that one. Replace the 45 cent per gallon ethanol tax credit with a smart subsidy and eliminate tariffs on imported ethanols; so in other words we can get ethanol that's made from sugar cane from Brazil much cheaper than we can produce it here.

Another thing they're talking about, and once again I want to point out, they are not talking about we cannot drill our way out of this. We do not have enough oil reserves offshore or in ANWAR, but they say, you know what, until we arrive at the point where we're all driving hybrids, electric cars and we can change our transportation system, we need to start working on expanding our domestic supply. So they are talking about federal policy to expand the use of oil recovery; support investment and technologies that can limit the environmental impacts of oil, shale and coal to liquids because we're going to start going to that next. Already the military is working on that. Increase access to US oil and natural gas reserves on the Outer Continental Shelf where we know we have probably another 30 billion barrels of oil. Increase coal to gas liquefaction, gas liquefaction. Increase access to resources in the arctic and Alaska and you're talking about the Arctic Refuge, which is what, 2000 acres out of 1 million acres of postage stamp on a football field. Expand R&D initiatives studying the opportunities to exploit methane hydrates. Zapata George has talked about that on our program; and various other aspects.

And you know one of the things I forgot to mention – most people were unaware there was a terrorist attack on an Encana gas line. There were two terrorist attacks by an environmental terrorist group, one last Saturday and one, I believe, on Wednesday of this week. And so this just goes to show you even in safe areas such as Canada, you can see terrorist attacks on some of these installations, which is what this report talks about is it how vulnerable our system is; whether we see things like how vulnerable we are to weather as we saw with Gustav and Ike or Katrina and Rita in 2005, or even a terrorist attack. [1:11:24]

JOHN: Then there is the whole issue of new energy-related technology. They are talking about accelerating the development and employment of this. Remember, the first part is developing it, and the second part is making it feasible on an infrastructure basis, so they are saying that the annual public investment in energy R&D should be increased by roughly an order of magnitude to about 30 billion dollars a year to reform the existing institutions and processes governing the spending as well for R&D in this area; and a new federal R&D investment strategy needs to be developed, which would include establishing new institutions to provide funding for early stage R&D, and then for late stage deployment and commercialization. And so we also have a next generation work force issue because we have people coming up through the college system who need to be focused on what the next generation is going to be all about and currently we're not doing that.

Also, reducing oil demand and improving efficiency; this is pretty obvious. Aggressively implementing fuel economy standards and increasing the allowable weight on tractor trailer trucks to 97,000 pounds that do have supplementary six axles installed which would allow for more transportation in a given vehicle, so it's more bang for the buck so to speak in terms of efficiency per gallon of fuel; and also requiring the FAA to implement and fund improvements to commercial air traffic routing in order to increase safety and decrease fuel consumption. That's something which all of the pilots up there will know has been getting more and more overloaded through the years and has always been the subject of writing and articles and aviation magazines and somehow, yeah, there are some improvements but a lot of it never seems to happen. Well, that has to happen in order for energy efficiency. Of course even right now, Jim, it used to be that planes were allowed to take off, if you recall, then they spent a lot of time in holding patterns and now they don't even have sometimes gate release or sometimes gate release until they know the slot is open and everything is ready for them at the destination airport, which really only makes sense in the matter of the whole thing. [1:13:24]

JIM: And you know, the other thing too is get rid of the environmental red tape. We were looking at using some form of solar. We were looking originally at using solar tiles on our home, but the cost of the solar tiles would be so expensive, so the types of solar collectors we'd like to use wouldn't get approved by the homeowners association. The other thing that they are doing too, John, is they are making these wind machines where you don't have to have wind towers, but they are almost like cylinder type wind collection vehicles that they are putting on some vehicles. I know WalMart is using some of these right now where you can put these on commercial buildings and they are going to soon have these available or something similar to it where you can put it on homes. I mean where I live, I'm just three or four miles away from the ocean and every afternoon, we get a nice ocean breeze that comes in the afternoon, so we have plenty of wind. But in my community, if I was to do something like that, first of all they would think I was a wacko, and second, the Association wouldn't approve it. So there also has to be as you come up with these technology that can either create electricity for the home, make your home self efficient in energy –in other words, make each home part of the power grid generating its own electricity – you're also going to have to wade through the environmental permits and all of the just junky bureaucratic red tape that just drives you absolutely crazy. I mean we were going to do this in 2001 and I think I probably told this story where I’d bought a ranch and we were going to be self sufficient, I was going to raise cattle, we had a 100 gallon well which is like striking oil, we hit 100 gallons at 450 feet, we were going to have wind and we were going to have solar and the environmentalists stopped me. It's just absolutely crazy. You're going to have to move through the environmental red tape. Everybody will give lip service, “yeah, we want wind as long as we don't have to look at it,” “yes, we want solar as long as you don't disturb a rat or a squirrel” or some of these other regulations that they have. But here I was trying to be environmentally responsible on a ranch and they stopped us, so you have to get through the red tape as well. [1:15:35]

JOHN: So if you would like to have a really comprehensive overview of what it is Jim and I are talking about here, go to our website and we do have the link to the entire report contained on that website so you’ll be able to do that. It's about 100 pages but it's a worthwhile read because like I said, it's comprehensive, and we haven't had a lot of comprehensive overall purveys of exactly where it is we stand right now. You're listening to the Financial Sense Newshour at www.financialsense.com.

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