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Financial Sense Newshour

The BIG Picture Transcription

November 8, 2008

Part 1

Obama Nation

JOHN: We have 1,459 days to go until the next presidential elections; 73 days to go until the change, 724 days to the intermediate election. Why are we looking at it across this broad spectrum? Because the presidency of Barack Obama will span inadvertently, I guess you would say, the crisis window we have been talking about for some time here on the program. And Jim, as we predicted on this show, the country has made its first move here in this election cycle making a hard lurch to the left and we’re thinking that if things go on the way they are, given the amount of pain we think is heading our way, people will make a large lurch to the right in 2012; but that remains to be seen. We have 1459 to go during this.

So where do we start with this whole thing now?

JIM: On the positive side, John, I think that the fact that Barack Obama has become the 44th president of the United States just goes to show in the United States we can overcome race, religion and various other factors. It’s unlikely you would see this kind of an election outcome elsewhere in the world. So on the positive side, as he gave his acceptance speech the – or his victory speech that is, is that where else but America could something like this happen. So I think on the positive side – and that’s where I want to begin this discussion – we're going to talk about the crisis window; we’re definitely in that crisis window. It began much earlier – we thought it would start in 2009; it began really in the late summer of 2008. [1:50]

JOHN: Recently I was listening to a talk by former speaker of the House Newt Gingrich, and he was laying the blame for this entire fiasco at two feet, I think if we had to look at it: 1) he was looking at the fact that Congress made banks abandon safe lending standards – that was number one; but he said, 2) the quantity of what I would call economic or financial incest between Treasury and the Fed and the Wall Street people, notably Goldman Sachs, is really extremely troubling and problematical. Those are the core issues. But as President Obama comes in, we have to remember that Congress had an approval rating of less than 10 percent; now it’s been a Democratic Congress for two years, prior to that it was a Republican Congress. But Bush took the blame, so there’s only a limited amount of blame time left and our crisis is deepening. This would have affected any president who stepped into this office, but now Obama is going to have to deal with this.

JIM: The other thing too that is rather amazing when you look at this whole election cycle, there’s no other president that has stepped into office that will control two branches of government decisively. The Democrats have now firm control over both houses of Congress, they now control the White House and there are a lot of people who have said the government governs best when there is sort of a divide – some kind of controlling influence. Let’s say one party controls the White House, but there’s a balance in Congress. Well, that’s not the case. So Obama walks in controlling two branches and assuming over the next four years that he’s going to make some appointments to the Supreme Court, he could actually control three branches of government. Most presidents enter their first day in office never having this kind of control; most presidents never achieve this kind of control in terms of their entire tenure. So if he wants to put his stamp, if he wants to get things done, John, in his first six months or year in office - because remember, in 2010, we begin the midterm elections and depending on the outcome of what happens in the economy and the financial markets that really shapes what happens in midterm elections. (Bush, in 2004, being one of the first presidents that actually still controlled Congress.) Normally in a midterm election you see the Congress shape in the opposite direction; go to the other party based on happiness in terms of what happens in the first couple of years of the new president. So Obama comes in and he now has decisive control over the various branches of the government, but unlike previous presidents, I think Obama’s presidency is going to be defined more by external forces that are going to both limit the shape and constrain Obama’s options – in other words, how much room is he going to have to maneuver given the constraints that we have. And if we take a look at his presidency faces two wars, a recession, probably the worst recession that we've seen since 1981 when Reagan assumed power, and a credit crisis and financial crisis unlike anything we've seen since the 1930s.

And I’m just looking – let me see, we're doing this show before lunchtime and this is just off Bloomberg: GM says it may not have enough cash to finish the year, suspends merger talks; jobless rate in the US jumps to 6 ½ percent, 240,000 job losses, highest unemployment since 1994; Ford has 3 billion dollar operating loss, burns through 7.7 billion cash in the quarter; Goldman cuts 2008, 2009 S&P 500 profit forecasts, citing the worst economic slowdown in nearly several decades; Treasury probes into two and five year notes as trading failures reach records (there’s more than a 2.3 trillion naked short position in Treasuries); existing home sales decline by 4.6 percent; bogus risk models need to be eliminated from business schools says Nassim Taleb, author of the Black Swan; zero interest rate world looms as King (that’s the head of the Bank of England central bank) and Trichet race to salvage economies. And John, we're not even talking about the geopolitical storms. [6:40]

JOHN: Well, I remember what Matt Simmons said here on the program quite some time back when we asked him what would happen if you were elected president, what would your first act be? And he said, I’d go into the Oval Office, close the door, sit down and cry because I know what’s coming. And you’re right, what President Obama is going to be faced with are things which are largely out of his control to start with. So this is going to be a major challenge.

JIM: Yeah, and one of the things that we've been saying on the program, good thing that this guy is a young guy, 47, and has a lot of energy. I’m not sure how well McCain, given his age, could have handled the kind of crises that this new president-elect is going to face. In fact, we have a saying here, he’s going to raise his hand and swear on the Bible, and if I was the chief justice, what I would do is I would put a fireman’s hat on him because he’s immediately going to be facing all kinds of financial crises that he is going to get right into. And it’s amazing, John, he barely had time to give his victory speech and already he is being challenged by the Russians who plan to install missiles. In fact, the head of Poland’s government said, “Boy, do we need a missile shield now because of what the Russians are going to plan on doing!”

Stratfor did a piece in terms of what Obama faces in Iraq; if he does pull out what he could be facing is an Iranian showdown sooner than he thinks because there would be a power vacuum in Iran; the Iranians would definitely move in, the Syrians and possibly the Russians. And as Joe Biden said in the election campaign, this president is going to face a geopolitical storm within his first 60 to 90 days in office. He hasn’t even assumed office and he’s already got the Russians on the move, so it’s going to be rather interesting in terms of what he’s going to be able to do given the constraints of the worst financial crisis and the biggest deficits; they’re talking about budget deficits next year that are going to be over a trillion, or close to a trillion dollars and we haven't even got to new economic stimulus programs. This is another Bloomberg story – Pelosi is calling for tax cuts and stimulus program in the neighborhood of 300 billion and Obama isn't even in office yet. [9:05]

JOHN: So our perfect financial storm – well, actually the ‘perfect storm,’ this crisis window is 1) very unstable geopolitical situation; 2) the economic crisis, which you call the perfect financial storm; 3) the perfect energy crisis which is growing now between now and 2012; and then 4), the longer term things, which are all of the entitlement programs which even before everything we've gone through now were a crisis in and of themselves that Congress had been putting off and putting off and putting off. So that’s all of these trends are all convergent, starting or evolving inside this window that we're looking at. So his tasks are going to be cut out for him.

JIM: And the amazing thing about this and we still don’t know this about the man, is will he govern wisely or will he govern ideologically. And one of the problems is if he governs ideologically, and goes with a lot of the things that he says he wanted to do, John, he could become the Democratic version of Herbert Hoover, just as I believe George Bush has become the Republican version of Jimmy Carter. And that’s going to be the key. And remember when Clinton first took office is in the first two years he was very unpopular because he had all of the left side of the party pulling on him, saying, Look, we got you elected, you need to promise. And he went off in this weird direction and John, you remember how unpopular he was and he implemented a program and he lost Congress to the Republicans in 1994. So, you know, I’ve heard different versions about Rahm Emanuel that he may protect Obama from the left part of his party because there’s been a lot of promises. In fact, on Moveon.org, they said, Look, we raised 88 million for your campaign, you better deliver. So he’s going to have a lot of challenges from the left side.

But one of the things that he faces is a recession – probably one of the worst recessions we've had since the Great Depression; he’s got two wars; he’s got a record budget deficits, over a trillion dollars; he’s got the looming Social Security and Medicare crisis and it’s absolutely amazing to see, once again, he’s going to find once he gets in office, he’s going to be constrained just by the very situation that he’s walking into. And we have a chart, by the way, that we're going to put on the website for the radio program is that you now have more record people in the country that are no longer paying federal income taxes, and contrary to popular opinion with the Bush tax cut, you can see on this chart how the Bush tax cuts took more people off the Federal income tax payroll, so you had over 30 percent if Obama was to implement his plans, you would have 44 percent of the country not paying income taxes. By the way, this goes with McCain too. The McCain plan would have left 43 percent of the country not paying income taxes. And so one of the things that I think that he’s going to have to deal with is just how much he’s going to find himself handcuffed by the very situation that he inherits and walks into. [12:33]

JOHN: Well, I guess we are entering a period of what I have begun to call, Jim, the ‘great reneging’ in which expectations have to be lowered from what he promised during the election campaign because given where we are, those can’t be fulfilled. And my real question now is: how much of that can be fulfilled given where we are? My analogy I guess would be it’s like trying to get a brand new aircraft out onto the runway. Well, it’s not quite finished but we’ll get it on the runway, we’ll get it up in the air but right after that you run out of fuel and crash and burn. And again, these are circumstances that are not directly within his control; these are external issues now crushing in on us, or issues which have rolled forward from previous administrations and Congress and just been dumped on this generation.

PRESIDENT-ELECT OBAMA: The road ahead will be long. Our climb will be steep. We may not get their in one year or even in one term. But America, I have never been more hopeful than I am tonight, that we will get there. I promise you: we, as a people, will get there.

We said that the second part of this crisis window was going to be the peak oil issues, and again, we should reiterate to people who may not have heard all of the programs in the past, peak oil is not an issue of necessarily how much oil is out there; it is a flow issue because of the 1) decline in oil fields, 2) the decline in the infrastructure and 3) the increase of demand worldwide. So it’s a flow issue through a bottleneck period until either a) alternatives can be created, or b) more oil can be brought online (hopefully, it’s actually all of the above.) This is going to face President Obama more than the other, Jim, and unlike the Federal Reserve – as you've said before on the program – you can’t print barrels of oil; this is a problem of physics not of finance.

JIM: Yeah, and the other thing that – and we're going to get to some of the priorities because during this broadcast, President-elect Obama just gave his first press conference and we're going to play some clips from that for our listeners that will sort of get to the point that we're going to end this segment of the Big Picture. But the one good thing that the new guy always has is you can always blame the crisis that you have on the old guy. I mean you could probably do that for about six months and just say, Hey, look, I walked into – I inherited a recession, I inherited unemployment, I inherited these wars, I inherited these financial crises. So everybody is pretty much going to give the new guy a honeymoon period and say, Okay, yeah, everybody recognizes that these problems existed at the time that you walked into that Oval Office. But the key is, what are you going to do to arrest these problems and get us back on the road to recovery. And I think it’s going to be a very difficult one because of the magnitude of the crisis that this new president faces.

On the economic front, this is probably the worst financial crisis that we’ve faced since the Great Depression; credit costs have been escalating now. The good news is the credit market seems to be unlocking. It was frozen up. You've got 3-month LIBOR rates have fallen to less than 2.3 percent, the TED spread is back below 2 percent, it was as high as 4.6 percent. But on this day that you and are talking, already, this is just off Bloomberg, House Speaker Nancy Pelosi will seek to add a tax cut to an economic stimulus measure Congress will consider early next year. Now, in Obama’s press conference he said he would like to see that happen earlier because already we're jumping up to 6 ½ percent on the unemployment rate, the higher the unemployment rate goes, the worse it even makes the housing crisis because those who were maybe making their house payments now have lost their jobs so they get into trouble. In terms of tax cuts, if they want to see that happen, details would have to be worked out with the President-elect. Democrats are considering two stimulus measures, one during a so-called lame-duck session this month, and another one after Obama and a larger Democratic majority in the House and Senate take office in January. Previously, Democrats have said stimulus measures would focus on expanding public works projects and aiding states.

And here’s another headline; I’m predicting that you’re going to see over and over again, is a bailout for the states. You already have two governors – Schwarzenegger in California which just announced a plan to raise sales taxes by 1 ½ percent, so in California you can see sales taxes as high as 10 ¼ percent, to overcome a 24 billion dollar budget deficit; it’s getting bigger by the day – much bigger than what they thought less than two months ago. There’s going to be an extension of unemployment benefits, and then they’re talking about direct tax cuts – meaning a stimulus package – a rebate so to speak, very similar to what they did earlier in the year where you give tax rebates even to people who don’t pay taxes; a lump sum check sent to taxpayers before the end of the year, and some kind of other measures that they’re talking about. The US Chamber of Commerce – I’m reading this from a press release – gave a list of 13 recommendations including tax breaks to help retail businesses with losses; repeal of a 3 percent withholding tax on government payments, such as those made to defense contractors. And the other thing that they’re talking about is some kind of stimulus program – infrastructure program – probably very similar to the NRA that was put into place with the Roosevelt New Deal. So look for something like that and then of course, probably some kind of tax measures; whether he goes the full course, I don’t know – hopefully his advisors would advise against that at a time where companies are laying off workers. If you raise taxes, you’re going to see the unemployment rate – it’s already projected, it’s 6 ½ percent as of October and before this plays out they’re talking about before recovery may be as soon as the beginning of July of next year. In other words, this recession is going to be a longer recession. Average recessions are about 9 months, longer recessions like we had in 81 are 16 months, the one we had in 74 was 16 months, and this is looking every bit as though it could go 16 months if not longer. So when you’re in that kind of situation, the last thing that you want to do – and this is why I said, will he govern wisely or will Obama govern according to ideology; and if he implements the full course of his tax cuts, then we go right back into – we won’t even get to recovery, we could be into a depression. I think this guy is obviously smarter than that.

But I mean if you look at the economic statistics, this stimulus program better be more than just handing out fish; it better be creating new fishing industry because if you just hand out fish, once you've eaten the fish, you've got to replace that fish. I mean, I don’t care if you look at any kind of economic statistic, the unemployment numbers that came out on Friday, the ISM report that came out this week, retail sales, factory activity, auto sales – I just think that this is going to be one heck of a recession and let’s hope that he puts together a team and has the smarts not to turn a recession into a depression. [20:20]

JOHN: If we look at the overall situation as we move through this crisis window, one, it really didn’t start with Barack Obama; two, it may not be totally in his control. He’s going to be very constrained as to what he can do here because of all the pressures and I’m not sure even as the new administration will be focused on the economic issues, it’s really focusing on the emergency storm that’s coming. But in reality, he’s going to have set reasonable objectives. Things that can be achieved, which means resetting expectations, or what we're calling the great reneging: You have to be able to tell people, Well, sorry, it’s really not going to come through the way you thought it was.

JIM: And the other thing, and once again, there’s sort of this personality cult around him and I really think and you’ve seen it in the speech he gave (his victory speech) and you also heard it on this Friday, he’s already sort of lowering those expectations, basically pointing out to the crisis that he is inheriting. Now, to his credit, he has demonstrated very superior skills as a politician. I mean one of the things about the McCain campaign is it never got a coherent message across and so he’s got the political skills and like I said, any administration, the good thing about it is everybody knows the US economy is in a recession, we're in a bear market, we're in a credit crisis, we've got two wars going on, so the nice thing about the new administration is saying Look, I inherited this, and you get to blame it on the previous administration; and like I said, that’s probably going to be the three-to-six month honeymoon period. So he has that time to set the stage, a brief period of goodwill and allowance, and then I think after six months, I think the examinations are going to be harsher, they’re going to be more critical and maybe even unrealistic. And so in terms of priorities, let’s go to those clips from his first press conference that he gave on Friday where he said, This is going to be the top goal of my administration, the day that I walk in to that Oval Office:

We discussed in the earlier meetings several of the most immediate challenges facing our economy and key priorities on which to focus on in the days and weeks ahead. First of all, we need a rescue plan for the middle class that invests in immediate efforts to create jobs and provide relief to families that are watching their paycheck shrink and their life savings disappear. A particularly urgent priority is a further extension of unemployment insurance benefits for workers who cannot find work in the increasingly weak economy. A fiscal stimulus plan that will jump start economic growth is long overdue. I’ve talked about throughout the last few months of the campaign; we should get it done. Second, we have to address the spreading impact of the financial crisis on the other sectors of our economy; small businesses that are struggling to meet their payrolls and finance their holiday inventories and state and municipals governments facing devastating budget cuts and tax increases. We must also remember the financial crisis is increasingly global, and requires a global response. [23:28]

JOHN: There you heard President-elect Obama from his press conference which ran yesterday on Friday. Notice that healthcare got a brief mention, but that may have to go on hold given everything else that is happening. Energy and defense are two areas that didn’t get directly addressed, but ironically, they are directly related to each other because energy represents security policy as well.

JIM: And I think that any administration that assumes power, a lot of times they may have an agenda; okay, these are things we talked about in the campaign, these are our priorities. I think the number one priority he’s going to have to focus on (which he mentioned in his press conference on Friday) is the economy. But like any administration, all of a sudden you get those black swans, those rogue events that suddenly change the shape of your presidency and a good example was George Bush came into office in 2001, focusing on the economy, saying that we were in a recession, he started focusing on that with tax cuts, stimulus programs – we had tax rebates just like we did this year, but then, his presidency changes with the events of 9/11. You know, those are the black swans, the rogue events that suddenly can reshape a presidency and the president can find himself in a totally different situation than he had planned on and all of a sudden, now you have multiple fires going. You have an economic crisis that you’re dealing, and now you have a geopolitical crisis; and believe me, we're going to see something happen geopolitically in the first three months of his office because our enemies and those who want to test a new president know that America is bogged down right now with probably its worst financial crisis since the Great Depression. And so this is probably a good time if you want to probe, if you want to take advantage and move politically, this is the time you do it. [25:25]

I think the critical tone that has to be struck by all of us involved right now is the American people need help; this economy is in bad shape, and we have just completed one of the longest election cycles in recorded history. Now’s a good time for us to set politics aside for a while and think practically about what will actually work to move the economy forward, and it’s in that spirit that I’ll have the conversation with the president.

JOHN: There was President-elect Obama on Friday saying we've got to stay away from the partisan politics, and if he does that in avoiding the extremes who are all expecting payback right now, on what I would call the hard, hard-left, which if you recall, Jim, was president Clinton’s mistake because it affected immediately the short term elections (which are two years out or actually 724 days from today). And the second thing is, unlike the Clinton administration, much more so, his success or failure becomes our pain or our gain, so it will be felt directly now by the public rather than something which is just a news story that people look at in the evening and go, Okay, well, I don’t understand what that’s all about, but yeah, okay, fine. This will be directly felt by the American public in an ongoing way for at least the next five or six years, whatever happens here.

You’re listening to the Financial Sense Newshour at www.financialsense.com. More to come, looking at what the future holds, given where we're going into this perfect storm. We’ll find out.

Other Voices: Jason Pearce, Pearce Financial, LLC.

JIM:Well, a lot of you have been talking to us about the disparity between the price of silver in the physical market and the scarcity of trying to get it in the coin market. Many places, like eBay, you can see premiums as high as 100 percent, and a lot of the coins dealers are charging tremendous premiums. And of course, one of the values we see here is just go and get it directly, buy it from the COMEX. Joining us on the program is Jason Pearce from Pearce Financial, they are a commodity broker. And Jason, before we get into the particulars of how to do this, let’s talk about contract sizes on the COMEX for silver, gold and platinum. In other words, what’s a regular contract for silver, what’s a regular contract for gold, and what are mini contracts and what are the difference between them? So if you could give us a little time and explanation, it would help.

JASON: Well, certainly. First of all, when you’re trading at the COMEX, the standard size for a silver contract is 5,000 oz. At today’s current value of close to about $10.05 for the December contract delivery, you’re talking about a $50,000 value contract. Over in the gold, real easy to remember; it’s just a 100 oz of gold. Today’s value it’s about a $73,000 contract because gold closed just above 730. And finally we have the platinum contract. Not nearly as liquid as gold and silver, a lot of people tend to forget about platinum out there. It’s trading around 844 an ounce, and with the platinum, you’re buying half the sizes you would in gold; it’s a 50 ounce contract, so it’s about a $42,000 contract right now. And also, when you’re trading on the futures, until you actually take delivery it’s a highly leveraged market where you only have to put down a fraction of the actual value of the contract. For instance, in gold right now, over at COMEX, they’re only going to require a deposit of about $7400 to control that contract, which is really only about 10% of the value so it does give you a lot of leverage out there. [29:46]

JIM: Jason, can you explain the difference between let’s say a full contract and a mini contract. And what are the differences between them?

JASON: Well, certainly. In the gold and the silver, we do have mini contracts available to trade. We don’t have them in the platinum, but in the gold contracts, it’s about one third of the regular contract where you’re controlling 33.2 ounces. Over in the silver, they’re one-fifth of the size, so you’re going to control a thousand ounces of silver and as you would expect, the margin on there reflects that; it’s going to be a third of the size and one-fifth of the size. Also, we are looking at different exchanges there; the COMEX gold and silver is not the same place that you’re going to trade the mini contracts. That’s going to be traded over the New York Stock Exchange which owns the Euronext which is also part of the London International Financial Futures Exchange; and that actually happened, it used to be traded on the Chicago Board of Trade, what is also known as the CME Group and that was bought out. So until about two months ago, the rights for the mini gold and silver was sold to the New York Stock Exchange Life Group, so it’s all traded at New York at this point. [30:54]

JIM: And let’s talk about delivery. It’s my understanding you can take delivery on the COMEX, but on the minis you don’t take delivery; is that correct?

JASON: On the minis they’re telling us they prefer cash settlement. It makes it very difficult on the minis. I haven't had any experience with somebody actually trying to take delivery of it, so they want to run more of a cash settled type deal out there. Now, on the larger ones, they do make the deliveries. And the irony here is you always hear the horror stories that somebody had a brother-in-law who forgot to get out of a contract of a futures soybean contract and ended up with 5,000 bushels of soybeans dumped on his front lawn. Obviously that’s just a myth; it’s not nearly that easy. So there is a process that you go through in order to take the delivery and it’s not really as complicated as most would think. [31:44]

JIM: All right, let’s go back to the silver because one thing that intrigues me is the December short positions, which are what, roughly 245,000 ounces. It’s amazing to see how these guys are going to have to settle with that. But let’s say I wanted to buy just one contract. I wanted to buy one contract, 5,000 ounces; I’ve got the 50,000 bucks and let’s say I have an account with you, the 50,000 is in there; I tell you to go out in the market and buy the December contract and I plan on taking delivery. Take me through the mechanics of how this trade would work out if I instruct you that my intentions are that I do want to take delivery.

JASON: What you would do is first of all when you open your commodity account, you would make sure that first of all that you would have the margin to initiate the position, but since your intent is to make delivery you also want to make sure you have before the first notice day, the full value of the contract. So what you would do is you would say, Gee, I want to take delivery of a 5,000 ounce silver contract, it’s trading at 10 bucks so we know that’s 50,000 dollars worth. We would buy the contract right there and that locks in your price; you’ve already made a contract, a legal commitment to buy that silver futures. Now, for instance, with this December contract, you’re then going to come into what’s called the first notice day; and that first notice day is typically the last trading day prior to the month of delivery. So, in other words, the last trading day of November which is the 28th of November for this year is going to be the first notice day for the December contracts. Now what’s going to happen is when first notice day comes up, from that point onward then the exchange will dole out the different delivery notices and when your number has come up and they’re going to say, where, Continue to deliver against your contract that you purchased? Then we would instruct them that, yes, we do intend to take the delivery. What you would do is then make sure you have the wired funds in your account available so that they can debit it right away and then they’re going to issue a delivery notice. They’re going to process that. And it’s an interesting thing. What can happen is two things; either 1) you can just have a warehouse receipt in your commodities account that shows that you do indeed own those 5,000 ounces of silver and you just hold it just like you would hold a T bill in your securities account or something; it shows up on your statement and that’s no problem. Now, if you want to go that one extra step and actually have those silver bars so you can stick them in your safe or under your bed or whatever, there’s a little bit more of a process involved. What would happen is we would then have the clearing firm contact the vault designated by the exchange where they actually hold the bars – the physical gold and silver. And they have designated warehouses all within a 150 mile radius of New York city; and what they’ll do at that point is put you in contact with the vault that’s holding that particular purchase, your 5,000 ounces of silver in this case, and they would arrange a meeting between the two of you so you can actually work out the delivery because then what would happen at that point is you would need to arrange the transportation, you know, the carrier like a Brink’s truck or whatever, to pick the gold up and take it off the premises to whatever destination you have in mind that you want the gold or silver delivered to. [35:14]

JIM: Now, the only problem with silver, 5,000 ounces, that’s going to weigh a few pounds. Can you have anything like a Federal Express, a DHL or any of those kind of carriers pick it up and deliver it or do you have to get a Brink’s or somebody else?

JASON: Well, the exchange does have designated carriers. They want to make sure you’ve got basically an armored car out there, so they are going to require that you use one of their recommended carriers on there.

JIM: Okay. But let’s take an example, let’s say I live in Alaska – we’ll just make this a little absurd – I live in Alaska and I want to take delivery of a contract, 5,000 ounces. Okay. Brink’s picks it up, but then how do they get it to me in Alaska?

JASON: I guess it’s going to be a long drive as far as I can tell, because what Brink’s is going to do is pick that up and bring it to your destination. That’s going to be a private contract or agreement between you and Brink’s on where they drop it off because, I don’t know, maybe you want to meet them just around the corner, round the block and have them load it to your SUV; or maybe you want to pay for the long haul all the way to the next bank even all the way to some point in Alaska, but that’s going to be something that each individual has to work out with Brinks. Because once you have taken it off the premises of the vault, everybody pretty much steps back and says, You know, this is out of our hands at this point. So then it becomes just basically a question of your contract between you and your carriers, such as Brink’s. [36:41]

JIM: Do they have, let’s say, trucking systems that or anything even close to like a UPS, or anybody, that does this kind of thing?

JASON: As far as I know, they have not given us any green light to say anything other than their recommended carriers out there. So I’m not really sure if they do. So far, it sounds as if they don’t.

JIM: Because let’s say that for example, if you wanted to put them on a truck and get them to Alaska, or maybe even a plane, the advantage that you have of in terms of trying to find a price of silver at close to what the spot market is, compared to the premiums in the coin market, could that advantage disappear?

JASON: It could, depending on what they’re going to bill you at. Not only that, I would assume that in turn you’re also going to be looking at fuel costs involved. So you’ve got that transportation, which perhaps that might explain a little bit of the disparity between the current physical where everybody is buying gold coins just outright down at their gold coin dealer, but that could be another disparity which could be as simple as it sounds, just something that’s been overlooked by several people. A lot of people thinking that you can’t really take delivery of this stuff and that it’s all cash settled. But that would be one that’s based on not only your transportation costs and your contract of shipping with the company, but I think fuel costs could be an issue there as well. So maybe what an investor might want to explore is if they did take that out of the vaults and they wanted to hold that on the premises in Alaska, perhaps what they want to do is look at the costs of having Brink’s deliver it to an airport and then having that shipped on the airplane or some other method up there. [38:24]

JIM: What about if I say I want to take delivery but I want to leave it at the COMEX, what happens then? What is it going to cost me if I just leave it there?

JASON: That is really simple. As a matter of fact I thin they want to encourage that which is why they make it so easy. Once you've paid for the full amount, the face value of the contract and they make delivery issue on you, you’re going to show that delivery receipt, it’s actually going to turn into a receipt which shows that you do indeed own that physical gold and silver and then it’s just a nominal fee of a few dollars, maybe five or six dollars on a monthly basis for storage charges, security, the assayers, whatever, adds up at the end of the month; but it tends to be just a very nominal fee of a few dollars per contract. So it’s probably a great place – again, that’s going to depend on your faith in the vaults and the security there, but if you’re fine having it (it’s something that’s well guarded like Fort Knox), then that’s probably one of your best bets, one of your best ways to go is to just hold the receipt to show you do own the physical gold. [39:29]

JIM: And then the other thing too, I wonder if you might address this issues. Let’s take the Alaska story. I want to take delivery but I’m going to ship it to Alaska; and the other story that I’m just going to leave it there. If you take it out of the warehouse and then let’s say I contact you, I buy my one contract of silver, I take delivery in Alaska; but now the price of silver goes up to 20, 25 dollars, now I decide, you know what, I think I’m going to take profit; I’m up 15 dollars an ounce, I bought it at 10, I can get 25; Doesn’t that create a problem? Do you have to have it re-assayed? What happens then?

JASON: That’s a very good point. You really do. That’s one other advantage to leaving it in the vault and having the certificate because you could just sell that and deliver it against the futures, whereas if you’ve taken it out and you’re up in Alaska enjoying your 150 percent gain on your investment, it’s really not nearly as easy because now to get that reintroduced to the exchange you do have to have it re-assayed and various fees involved, which from my understanding, I don’t know the exact dollar, it can be a time-consuming and expensive process. As one person at the vault explained to me, he said, you know, basically if you want to take your gold and silver out of here, it’s like buying a brand new car and driving it off the lot. Once you've driven this thing off the lot, you've now just cost yourself something because it’s going to be quite a process to get it back on. It goes through a lot of checks, which is all of course for your safety to make sure that the bars that are already on deposit that you’re buying are the real deal and they’ve tested everything. But for somebody to reintroduce it to the vault, it’s quite a lengthy process. So, again, another alternative is if you did have all your bars of gold or silver shipped up to Alaska, one way you could lock it in before you got that process is for every 5,000 ounces of silver that you want to take profits on, you could sell it forward on a futures contract and lock that price in while you’re processing those bars to get them reintroduced on the exchange. If you’re familiar with the hedging process, if silver went up another buck and you’re losing that money on the silver futures contract, you’re making that on the cash, so basically all you've done there is lock in the price. Now, it could also happen that perhaps silver drops five or six bucks while they’re holding the hedge and at the end of the day you thought, well, you know what, I would be willing to buy silver back here and you would just simply cover your futures contract and cash the profit out and still be holding your physicals. [42:09]

JIM: All right. Well, listen Jason, it seems to me that maybe the best thing to do was just to buy it, take delivery and just keep it there, that way if the price does run up and you want to sell it, you can do it. That’s because, I think, you know, this gets back to if you take delivery and you took it personally, then what you might have a problem is the old kings and emperors used to do, they called it clipping so they want to make sure the bars that come back in the warehouse were the same assayed bars that went out of the warehouse. If people want to get in touch with you, Jason, you guys deal in commodity contracts, how could they do so?

JASON: They could simply call us if they like. Our number here is (800) 800-1399. They could also email us; our email address is info@pearcefinancial.com. Or they could also log onto our site at www.pearcefinancial.com.

JIM: All right, Jason. One more time if you would.

JASON: Sure, the 800-number here is (800) 800-1399; our email address is info@pearcefinancial.com and our website is www.pearcefinancial.com. [43:24]

JIM: All right, Jason, well, listen, I want to thank you for joining us on Other Voices this week, and I’d like to talk to you once again on this market, especially on the silver market and the oil markets as we get into winter and the expiring December contracts. Next month should be interesting. Thanks for joining us on the program.

JASON: My pleasure, Jim.

Recession, Recovery, Depression

JOHN: This segment of the Big Picture; three subjects under conversation which are really three-in-one in a flow: recession, recovery and/or depression. The question is how far down the recession is going to go. So what are the stats showing us right now, Jim?

JIM: You know, if you look at all the key indicators, whether you’re looking at the ISM Report which measures both the manufacturing side of the economy and the service side, the ISM Manufacturing Report dropped into 38, clearly indicating we're in a recession. And now that the election is over, I wouldn't be surprised if the NBER (National Bureau of Economic Research) pronounces that we're in a recession and that it began several quarters ago. And if you look at the Chicago Fed which measures nearly 85 statistics on the economy, key things like unemployment, sales, industrial production, any time it’s been -0.7 – we're well below that now; the Cleveland Fed coincident indicator which looks at the economy’s same four key measures in 50 states – everything says we're in a recession. Now here’s the key though. This will give you a clue in terms of where we're going as a government and as a country. If you look at GDP, it’s made up of four components. There’s personal consumption. And probably for the last three decades, personal consumption has gone from nearly 60 percent of GDP to 70 percent of GDP as consumers went on a debt and spending splurge; and the consumer-based economy is now contracting and they’re not going to bring that back despite whatever they do. Another key component of our economy is fixed investment. That’s probably the most important thing because that’s probably what really creates jobs, expands the wealth of a country, and that has sort of been in a narrow trading range even in this decade. The third component is exports and recently that was the one good news part of the economy; our exports, especially before the dollar took off as the dollar and the yen carry trade reversed (that’s what’s behind the dollar’s recent strength, it has nothing to do with what’s going on in our economy). So exports are the third component. And the fourth component of the economy is government spending.

So you've got a consumer who is contracting because number one, he is losing his job, 2) he is being squeezed by taxes and inflation and he’s up to his eyeballs in debt. So you’re going to have to counteract that. Now, if we do this well and we create policies that spur investment – and I do think that one of the good news about peak oil is you’re going to see reverse globalization. The jobs are going to have to start coming back. That’s because the age where you could buy your raw materials from Latin America, ship them to Asia, let’s say Korea and Taiwan where you subassemble various parts; then it would be shipped on to let’s say China, where it was put together, assembled and then put on a boat to Long Beach and from Long Beach either on a train or truck to Chicago or New York. That’s not going to work. So if you’re an international company, either US or a foreign company and you have 30 to 40 percent of your sales in the United States, you better have a US factory. So the jobs and the factories can come back home. And so investment spending is going to have to replace – and that could be a positive thing – instead of consumption, because no country can build wealth through borrowing and consuming. You’ve got to create something, you have to produce something.

And then the other component that’s going to expand in a way you've never seen before is government spending. We're going to hyperinflate, and we’ll get to that when we get to the Dinner at Zimbabwe segment of the show. So the four components of GDP are going to change; consumption is going to go down, we’re going to have to increase investment and government spending, and you know, there’s been a number of issues, there was a recent editorial in Fortune magazine written by a Columbian professor who said that the Reagan revolution failed, that the age of laissez-faire government is over, the age of a people-planned government is on the way. The problem with that is that we never had free markets, the government has intervened in this market. And the root cause of the mess that we're in right now was created by government and its policies. You mentioned in the last segment when we talked about the Community Reinvestment Act where loans were made to people that really couldn't afford to make those mortgage payments.

And the other chief culprit behind all of this has been Federal Reserve policies, beginning with Alan Greenspan, Mr. Bubbles himself. Any crisis that we faced, rather than let the crisis heal itself, rather than let all the malinvestments that were created, the imbalances that were created through funny money and money printing, what would happen – whether it was the 87 stock market crash, the 1990 S&L crisis, the 91 recession, the 94 Peso crisis, Asia crisis, Russia/Long Term Capital Management, Y2K, 2001, 9/11 – every crisis was met with more money printing. And what it does is it creates all these distortions in the economy, all of these imbalances as we’re seeing now in housing and then what happens is rather than let the problem heal itself, they come back and ask for one more power. Just look at the powers that the Federal Reserve has taken on itself since this crisis unfolded last summer. And then also, take a look at the amount of money creation that the Fed has taken and created. I mean the Fed’s balance sheet has expanded by 185 billion dollars just in the latest week; we're now over two trillion and as we’ll get to in the next segment, we’re going to 3 trillion by the end of the year. So this wasn’t a failure of capitalism, this was a failure of government itself. But in any kind of crisis, the government – the people that created the mess – ask for more powers to get you out of the mess. Once again, the root cause of this whole problem is the Federal Reserve. [51:10]

JOHN: There is a touch of irony in all of this because if you recall back in 1929 we dumped into the recession starting with a Republican administration that really pushed us into a Democratic administration and that made it even deeper. In this case we may almost be doing the reverse as we start into this, but we’ll have to see whether or not it winds up there, but eventually as we know all fiat money systems collapse. They actually drive themselves into the state of collapse faster and faster as they go along. What is it going to look like when we come out of the back side of this because if we look at the quantity of money that is being created right now, this rivals – how far back are we going to have to go back? What? The [18th] Century?

JIM: Yeah, you’re probably going to have to go back to [18th] Century France to find anything of this magnitude. [52:05]

JOHN: I don’t think people even see this happening. The public does not understand this right now. So what are we headed towards as we're doing this. At some point it has to blow. There’s already talk about an international global bank. Newsweek ran an article on this, and that would only logically seem to follow some kind of international global currency, wouldn't it? That’s not unreasonable.

JIM: Yeah, they’re talking about a global central bank, a global currency. But you know, you can’t do that all at once, it comes in stages. But I would say that the next thing coming up is a dollar devaluation. So you really don’t know – when you come out of these great inflations, if you take a look at what happened in France that eventually led to the French Revolution and then the Napoleonic wars; if you take a look at Germany, it led to a great inflation and then eventually Adolf Hitler. If you take a look at what happened into the revolutions in Argentina and it’s amazing what has happened to Argentina, which was once the most prosperous nations in the world, which was ruined by Peron and now you've got the Kirchners in there, both her husband was a president and now she’s president following the same policies. And so you really don’t know. Whether you get a new economic revolution like Ron Paul – and I’d highly recommend people pick up a copy of Ron Paul’s The Revolution. So that’s one outcome where you basically have a positive outcome where fiat money systems are discredited and you go back to a constitutional gold-backed type of currency – that would be the most optimistic outcome. The second would be some kind of disintegration of the Republic, similar to maybe the Dark Ages, you end up in a dictatorship. And newsletter writer, Richard Maybury has kind of addressed these. He gives them different names. He calls sort of the Ron Paul solution the Gladstone solution – Gladstone being a British prime minister who reduced taxes, slashed government and created much of the prosperity of Britain’s 19th Century; or, the Castro solution which is basically sort of a dictatorship; or the Somalia model which is a disintegration and the Dark Ages. I mean we simply don’t know at this point, but it depends on the kind of leadership and it depends on just a whole myriad number of factors of how this plays out. But we're heading for a hyperinflation which is our next topic. [54:38]

JOHN: And how long is it going to take to get there as we move into this?

JIM: You know, you’re probably going to see events start to unfold rapidly. They’re already talking about a 300 billion stimulus program, and I think it’s going to be much greater. You've got the automobile companies that will not survive without the government bailout. After the automobile companies, I would say, and you heard it in Obama’s speech on Friday, talking about some kind of a relief to the states. That’s the big headline because the states are going to be piling up standing in line at the government trough. And then also the airlines. So we're going to be bailing out the auto industry, we’re going to be bailing out the airline industry and we’re going to be bailing out particularly the most populous states with the most electoral votes: New York, California and several other states. So we're going to be getting – so all of that’s going to cost money and where is it going to come from? And the problem is we’ll get into the next topic the twin deficits – both our trade deficit (current account deficit) and the budget deficit are going to be simply too large to be financed and especially if the Fed starts going to quantitative easing, then what you’re going to see it will have to be monetized. It’s the only way out right now – the budgets are just simply too big for a country the size of the United States to finance with the world’s savings. It just can’t be done. [56:00]

JOHN: All right, sounds like interesting times. We’ll be back with the Financial Sense Newshour, talking next about Dinner in Zimbabwe. Www.financialsense.com.

Part 2

Dinner in Zimbabwe

[sound of restaurant chatter]

JOHN: Well, Jim, I really appreciate your taking me to dinner. This is really nice, you know.

JIM: And John, think nothing of it. After all, you're picking up the tab.

JOHN: I'm not sure why we had to come to Zimbabwe to do this. Wait a minute. Here is the check. Merci, Monsieur. It's a nice French restaurant here. You're not going to believe this, but the bill is the same as that luxury yacht you always wanted to buy. Why is that? I don't understand this. Who has got this much money?

JIM: Okay. It's on the internet. I'll see if we can post a link. This is at the Victoria Falls Hotel. This was a dinner -- now, brace yourself, folks -- one bottle of mineral water, 95 billion 635 million. Okay. That was the mineral water. One dinner cost 956,350,000,000. Total tab for food and beverage, 1,243,255,000,000. And that's dinner in Zimbabwe.

JOHN: How long has it been ramping up? I mean obviously Robert Mugabe has been trampling on Zimbabwe now for 20 years. I forget when he first came into office. And despite the fact, by the way, that there was a promise of oversight on the part of the United States and Great Britain, which teaches us something about long term political promises that are made, but all of that aside, how long has it be ramping up into this hyperinflation they are undergoing?

JIM: Almost the beginning of this decade. I'm looking at some pictures here and we'll see if we can post this link on the web. Here are three eggs and the cost of three eggs, 100 billion dollars. How about that? Here is a 100 billion dollar note. Here is a 500 million dollar note. Maybe that buys you one egg. 250 million dollar note. And of course there are pictures of guys with, well, not quite wheelbarrows. In fact, John, if you look at some of these pictures, here is a guy with a whole stack of money that's probably about a foot and a half high and that's equal to a 100 dollar US bill, so a mountain of cash is only worth $100. So it just goes to show what happens when governments hyperinflate when they create money out of thin air which is what we're doing right now. [2:41]

JOHN: I remember a little ways back, Jim, as commodity prices began to drop, we began getting a lot of emails from people saying, Why don't you guys just admit you were wrong, you said it was going to be inflation and it's turned out to be deflation. And I thought to myself, how long has it been since people have been listening to the show? They do not understand the definition of inflation or deflation. They were looking at it as price inflation rather than a genuine definition of what inflation and deflation are. So let us go back and define some of these terms once again

JIM: Well, first of all, I have two dictionaries in my office. The old dictionary defines inflation the way the Austrians and the monetarists do, and I'm going to read the definition of inflation.

Inflating, or being inflating, an increase in the amount of money and credit in relation to the supply of goods and services. An increase in the general price level resulting from an increase of money and credit.

Notice what they said. An increase in prices resulting from an increase of money and credit. Now, you go to a newer dictionary, and this is the new Webster’s newly revised edition. You take inflation and if I look at the definition of inflation: A boom inflationary pattern or trend or cycle which moves towards higher price levels or structures. [4:11]

JOHN: So it's been modified to match the Keynesian definition, which is what causes all of the confusion

JIM: Yeah. And so what you find today when you look at inflation, and I just had this argument with an individual in my office this week, and you've got three camps out there. You have the Keynesians that define inflation in terms of its symptoms. Inflation is rising prices. Deflation is falling prices. These are both symptoms. Then we have the Austrian and the monetarist school which basically talks about inflation being an increase in the money supply, deflation a decrease in the money supply. And then the worse group is what I call the confusionists. They are involved in both sides. If the monetary base is expanding, then they'll move to following prices. If the monetary base isn't expanding as much, then they'll talk about deflation. So this camp moves back and forth between of two of them and they're one of the worst.

And so we have a world today, John, that we have what we call good and bad inflation, and good and bad deflation. Let me define good inflation. And good inflation is, you know, from the Jens O. Parsson's book, the rise of money creates booming asset markets, so good inflation is a bull market and stocks or real estate. Bad inflation is an increase in commodity prices. Likewise, good deflation is falling goods prices; and bad deflation is falling asset prices. And it just goes to show how confused we are on this whole issue. And the real root cause of the asset bubbles that we saw in the 90s with stocks, the asset bubbles that we're seeing in this decade with real estate and now with bonds was a result of an increase in the monetary base and increase in the money supply. And if you look at the graph we're going to put the Fed's hockey stick back on the website accompanying this show with some links because it's growing – I've never quite seen anything like it, at least in my 30 year history in the business and just to give you an idea of where we're going, the Fed's balance sheet increased by 185 billion, and the Fed's Dallas president, which is a gentleman by the name of Fisher said that the Fed's balance sheet will end up at 3 trillion by the end of the year. So between the month of November and the month of December, the Fed's balance sheet will increase by another 50 percent, or one trillion dollars. It will be at 3 trillion dollars and we're estimating that it could be at 5 trillion dollars by the end of the year.

And if you look at the G-3 central banks –these are the largest central banks in the world, the US, the ECB and the bank of Japan – that balance sheet is now over 5.5 trillion dollars. So it's not just the US. It's global. And if you look at the budget and the trade deficits in the United States over the next 12 to 1 months, we're still looking at a 7 to 800 billion dollar trade deficit and we're looking at a budget deficit that's going to be over a trillion. They are saying a trillion now, I think it will be bigger because so many of the things on the budget are off balance sheet. In other words, the war in Iraq, off balance sheet; the repair of this financial crisis, off balance sheet; the repair of Louisiana and a lot of the states of hurricanes, that's off balance sheet. So we're just talking about the official budget deficit, the debt in the last 12 months of the United States has increased by 1.2 trillion dollars, which takes into effect on and off balance sheet debt.

And I think the new buzz word you're going to start hearing from the Fed is going to be quantitative easing where the Fed starts buying more government bonds to keep the interest rate down to a low level, something that they did between 1942 during the war period. [8:31]

JOHN: That's a good point. How long before this is felt in price inflation before it flows into the general economy and people begin to say, Oh my gosh, look at what's happening to XYZ, whatever it happens to be.

JIM: You know, usually it takes probably a six month lag period before you start to see the full effects of inflation in the economy. Right now, the Fed is creating enough money to overcome debt deflation. That's the first target of the Fed's inflation policies. Then at the same time, with the government stimulus program that they are talking about, they are going to have to finance that as well and monetize that as well, and that will be going into the economy and then once monetization gets into full swing, that's when you're going to see the full effects of what you're going to see in terms of the inflationary effects. But, folks, inflation is a monetary event. It is the creation and expansion of money that creates inflation. It is a contraction of the amount of money that creates deflation.

In fact, I'm rereading Ben Bernanke's papers and the Dallas Fed papers going back to 1999, and also 2004, which we’ll probably be talking about on next week's program, because a lot of the program that's you're seeing implemented by the Fed, the targeting of assets, the buying of assets, taking equity positions in the companies that Treasury is doing right now through the TARP program, a lot of these programs were identified in earlier Fed papers when they talked about getting to zero percent interest rates and the federal funds rate is at 1% now, and we're definitely going to be going to much, much greater programs in the months ahead. [10:15]

JOHN: I don't think people really understand as we go week to week here, and I know you did a chart we're going to talk about here for your client meeting last weekend, but I don't think people understand as we go from week to week and everybody has got the handout now for a bailout. The auto industry is coming up real shortly here. That's going to happen. As you mentioned, a number of states who have been fiscally irresponsible through the years are going to pony up to the bar and ask for something. I don't think people have any idea how flabbergastatively large, you like that? I like that. Flabbergastatively large this whole thing really is.

JIM: No. If you just take a look at the capital infusions, the asset purchases and the liquidity provisions, we're almost up to two trillion just in that alone, and I imagine that figure is going to go up when you start looking at bailouts for the automobile companies, bailouts for the states (that's another big headline that's coming up and Obama addressed that in his speech on Friday) And then on top of that, you're looking at maybe even the airlines. On top of the capital infusions, remember, the Fed has pumped about $600 billion or more into the commercial paper markets, they’ve pumped another $600 billion into money funds because there was a run in the month of October on money market funds; half a trillion dollars flew out of money market funds. Well, what do money market funds own? They own bank CDs, bank notes, commercial paper, some asset security paper, auction rate facilities and you know, if people withdraw, they've got to sell. And rather than break the buck, the Fed stepped up to the plate with about 600 billion dollars. And in addition to that, there is 1.4 trillion of guarantees to commercial banks. There is unlimited guarantees on bank deposits, already Sheila Bair has asked for an additional 50 billion to renegotiate mortgages. FDIC is going to need about 200 billion, so John, don't even think in billions anymore, start thinking in multiple trillions. [12:22]

JOHN: A lot of times when we start into inflationary situations, Jim, there are things that can be used to offset the consequences of what inflation does, but then there is a phenomenon that comes in that a lot of people don't understand. I use the analogy of treating it like water or electricity in what is called the velocity of money speeds up as the money becomes more and more worthless and then that has a propensity for accelerating the disaster that's on rushing, so it starts slowly and then begins to ramp up in the speed with which it attacks the economy.

JIM: Sure. And the one thing that you're seeing right now offsetting the Fed's inflationary effects has been a drop in velocity, and if you think about it, this is usually the first stage of inflation. Normally, the first stage of inflation is the central bank responding to a financial or an economic crisis. And what do people do, John, when you're seeing the headlines that you're seeing today – job lay offs, you're seeing contraction in the economy? The first response is one of fear. And when fear takes over, people start hoarding on the cash. They start saying, Oh my goodness, I could get laid off, I may lose my job; they are talking about a recession, people get frightened, they start holding on the cash and that reduces money velocity. They stop spending, the economy contracts. By the same token, you're seeing it on an even larger macro scale done by the banks themselves; and if you look at the amount of money held at the Fed, it's close to 200 billion, and this is excess reserves at the bank. And those excess reserves held at the Federal Reserve which are now earning interest, that's the bank's version of money in the mattress. So right now, banks are sort of reluctant to lend because of the shock of the asset losses and the same thing that's happening to the consumer. They are seeing the stock market drop, they are seeing the economy drop, they are hearing all of this bad economic news. The first response is to hoard cash. So in the first phase of an inflation, you have money velocity that dropped and that offsets the increase in the supply of money. Money is being hoarded. It's sort of a large macro offset as a result of this deleveraging. But these deposits at the Fed –

Now what's going to come, you saw this early on in the Bush administration with the tax rebate checks. I call them helicopter drops. You saw that this year with the stimulus package passed in February, and right now, I'm looking at a Bloomberg story with Pelosi about tax rebates, so the second helicopter drop is coming in the form of tax rebates they want to get into consumer hands and you may get multiple helicopter drops. You may get one towards the end of the year and you may even get one in the beginning of next year. Another way that they can start doing this is through quantitative easing and also watch to see what they do in the mortgage program where you could have the government go in, make low interest rate loans, buy down mortgages and get the money flowing in the credit markets back into mortgages. So look for those things to happen. Those are the kind of helicopter drop things that start happening and we're going to see that maybe as soon as the next 30 days if Pelosi has her way, she's talking about maybe 150 billion to 200 billion before the end of the year; and then they're talking about even a bigger helicopter drop coming in the beginning when Obama assumes the presidency in January. [15:59]

JOHN: But all of this just keeps piling up the indebtedness and drives us toward that currency collapse you were talking about

JIM: Exactly. And one of the things that you have with inflation is you have all of these depositories of inflation, and we've done programs on this in the past when money dies, and that is the money wealth. And money wealth is debt instruments. These are bonds, these are mortgages, these are annuities, they are fixed income type of vehicles; and the one thing that John Maynard Keynes always talked about, the money wealth is the area that the government sacks, that's were you profit the most in inflation. It is the main target and look at all of this talk about deflation and low interest rates and people are talking about inflation because at first the money wealth is duped by these policies and they continue – look at all of the money that's gone into fixed income, look at all of the money that's gone into guaranteed bank deposits, look at all of the money that's gone into Treasuries and that's what government wants because that's going to be the main area that they are going to pillage because that's what inflation does is it destroys the money wealth and Keynes talked about it, that should be the first primary target of a government in an inflationary policy of reflation is to target the money wealth. And remember, for all of you deflationists, you can't have an increasing bond market without an increase in the money supply because it is the increase in the money supply that finances that. So all of this money wealth that we've been talking about, credit instruments – bonds, cash, annuities, fixed contracts, mortgages –must be destroyed and the best way is going to be through hyperinflation.

The other thing if you look at this, if you look at two of the most famous investors in the world, Warren Buffett has been called the stock king, the world's richest man and probably the most astute investor of the last century; and Bill Gross, who has been called the bond king. Now, when the stock king and the bond kings are telling you the same thing, Bill Gross in his newsletter to clients in June talked about they were moving away from treasuries because of negative bond yields and if you were going to be in treasuries, about the only place to be is in TIPS which are somewhat inflation protected. He talked about moving to commodity-based assets, foreign equities, assets in foreign currencies and especially in the BRIC countries. Warren Buffet in his op-ed page in the New York Times is talking about he's 100 percent buying stocks and he's all out of his US government bond holdings because of inflation is the future trend. And when you take a look at these two investors and they are saying the very same thing, investors should be wise to take note because they know what's coming, they know a Zimbabwe or something close to hyperinflation is heading in our direction and especially when you talk about the magnitude of dollars that we're talking about creating in central banks, not just our Federal Reserve but central banks around the globe. [19:18]

JOHN: And that ties into the velocity of money you were talking about earlier because money has two purposes, of course as a medium of exchange, but also a store of value. And once the public perceives that the currency is not a safe store of value, yes, they have to use it for exchange, but no they are not going to hang on to it, they get rid of it as soon as possible and convert whatever they have to some other storage medium until such time they need to cash it back into the currency they use in exchange again.

JIM: And that's when the velocity. See, money has two purposes, one a medium of exchange and two, a of store value.

JOHN: Right

JIM: And what you've looked at over the last couple of years and especially something that's accelerated since the orchestrated attempt to bring gold prices down this summer has been gold has separated and has now become the store of value. That's why it's getting harder and harder to get globally, not just here in the United States. The very delays and the premiums that are being charged in order to get your hands on silver and gold are going to get even larger; it's going to get even scarcer and harder to get and it's not just here in the United States, you're seeing it globally in the US and in Europe, in Dubai, Mumbai, you’re seeing it in Asia, Australia, Latin America. This is a global phenomenon. [20:40]

JOHN: What we seem to be approaching is John Maynard Keynes’ old expression, when someone asked him years and years and years ago, Professor Keynes, doesn't this finally come to a point where everything collapses? And his response was reported to have been well, in the end we're all dead anyway, meaning things have to die out. We are rapidly approaching that point. We're not talking many, many years out now like maybe we would have been 20 years ago or something like that, which means if there has to be a new currency, probably global in nature, even Newsweek had an op-ed piece on it calling for – I don't know if it was Newsweek. Maybe I'm wrong about that but there were a couple of calls for them. Asia Times had one, and looking for a new currency, that means they are probably going to have to base it on something because at that point, I don't think the world is going to take a fiat currency in the short run. (Although the currencies always seem to devolve into that because governments can't keep their hands off of it.)

JIM: It starts as soon as next week. You've got the G-7 meeting in Washington, you've got France's president Sarkozy talking about a new Bretton Woods II System. I think what is coming, John, is going to be dollar devaluation and the stage is being set for that dollar devaluation. And then I think what you're going to see is maybe not a global currency at once but as some have already suggested in Foreign Affairs is regional currency blocks. You already have it in the Euro, the United States could be moving towards a North American currency, the amigo. Asia could be moving towards a currency, the miso and then eventually, we get the globo. So a lot of Os, euro, amigo, miso and globo. [22:20]

JOHN: Oh so. The new international currency is going to be the oh so. I think that one of the candidate names was the Phoenix, as I recall, for that. But yeah, you're right. I thought we were going to skip the North American currency at one point. I think things were going to fall apart, but that remains to be seen.

JIM: Yeah. There was a lot of focus and attention on it, by remember, new currency regimes result when old ones fail and collapse, and so the currency crisis comes first before you get these currencies and the new currency regime is always suggested as a means of solving the problem. So first the crisis and then the currency in that order, so you're going to see a series of currency crises, that's coming; and when it happens, John, it's going to come like a thief in the night. It will happen overnight, you'll wake up one morning as people did, I can remember this very vividly. It was either 1973, or maybe it was 84, that Mexico – we had a lot of people when I first moved to San Diego, you had a lot of people here, a lot of seniors that were putting money in Mexican CDs and Mexican banks because the interest rates were 25 and 30%. Now forget the fact that we were paying 15% on government bonds, why get 15 when you could get 30. And then I remember there was a crisis in Mexico and on a Saturday the president of Mexico said, “No, we believe in the peso” and on Monday they devalued it by 50 percent. So if you had a 100 thousand dollar CD in a Mexican bank, the very next day if you tried to bring it home, you lost $50,000 or half of your investment; and if you have your money in dollars, if they devalue the currency, you can lose half of your purchasing power overnight, so the important thing to remember is central banks are creators of inflation. Their job is to manage inflation, but all fiat currencies all fail. [24:19]

JOHN: Let me ask a question here, Jim, remember this pattern we've been going through? Even now, you can see the run up to this where ‘No, we don't have any problem’ or the case of Mexico's president ‘no problem’ and then all of a sudden, ‘Well, you know that problem we had, well, we fixed it,’ but in case of when the currency finally dies, it seems like the goal of denial right down to the last minute is to keep people from stampeding out of the dying currency before the switch can be made.

JIM: Sure, and a lot of it is done with misinformation, so all of this talk about deflation at a time when you're seeing monetary creation as we have never seen before in history, you'd have it probably go back 300 years to find anything close to what is going on today. And you're seeing all of the signs of this, John. In fact, in Marc Faber's recent newsletter, he quotes from one of my favorite books on inflation is Bresciani-Turroni’s book, The Economics of Inflation. And some of the visible signs are concentration of wealth because wealthy people can invest in an inflationary period and profit from it, where if you're just an ordinary Joe and you're living paycheck to paycheck, you can't go into your boss and say, Look, inflation is running at probably 10 percent after taxes, I need a 15% pay raise. That just doesn't happen, so workers get further behind and it's usually the middle class. The scriptures say, The poor we'll always have with us. But you know, one of the things about inflations is that they wipe out the middle class.

A second thing you're seeing visible signs of this hyperinflation, in addition to the concentration of wealth, speculation is preferred over production and savings. In other words, businesses start speculating and if you take a look at the S&P 500 companies, the number of companies that have achieved higher amounts of their corporate earnings have come through speculation in derivatives. Also the savings rate. Another thing that happens and you're going to see this is during these periods of monetary inflation, not only do you see a concentration of wealth, but you see a consolidation of business. Look at the merger activity in the 90s and in this decade and now look at the merger activity that you're seeing in the financial industry. You see these huge concentrations of wealth and what we're about ready to recognize, and what's going to take place here when this unfolds and the crisis unfolds is probably going to be the greatest wealth transfer in the history of the world that's about ready to take place and fixed income and middle class investors are going to get wiped out if they don't protect themselves. So that's why I go back to the bond king and the stock king. Bill Gross manages the largest bond fund in the world and when the guy that manages bonds says that he's getting out of bonds or moving towards tangible type assets, and if you look at Buffett when he sold all of his US government bonds and he's moving into stocks, that should be a big warning sign that what these guys are doing. And the thing that happens is when this ends, you emerge out of this and you're going to have two classes of people. You're going to have wealthy and you’re going to have the poor. And John, this is what leads to revolutions and all great inflations end up this way; if you take a look at Argentina, if you take a look at Germany, if you take a look at Russia, if you take a look at all of these places; Argentina’s confiscation of pensions and we don't have the time to cover in this show, but there is a talk about doing the very same thing here. The GRA, the Government Retirement Account, doing away with 401(k) programs and replacing it with a fixed income investment with the government 5% of your paycheck, the government will pay you 3% and what they'll do is just simply spend the money like they do with Social Security because we know there is no Social Security trust fund and they'll issue zero coupon bonds in their place. So the most important thing you need to do is defend yourself and hold on and don't get shaken out during these corrections. [28:26]

JOHN: How are you going to deal with that at the 401(k)? You know it's ironic, you hate being right but you were talking about this, I think as early as five years ago and we said it will be called the Retirement Security Act of 2010, and you're right; all it is is “trust us, these times are insecure, you can't be trusted yourself to manage it, give your money to us and we'll keep it for you.” In reality, they'll keep it, spend it, leave an IOU and it may or may not ever get paid.

JIM: Well, shall I say history repeats itself, maybe not in the same way, but it always, as Mark Twain says, may not repeat but it rhymes. And look for what's going on in Argentina, and next week, John, if we have time, we're going to continue on with this because I'm rereading Bernanke's and the Dallas Fed papers in terms of getting to zero interest rates and we'll post the link to those in next week's show if we have the time; and we're also going to be discussing the recent investigation by Congress into establishing a new government retirement account. In other words, they would take away that liberty and force workers to contribute into this retirement account. It may be their next source of revenue. [29:34]

JOHN: As they thrash around keeping the beast alive. We'll be back in a second. You're at www.financialsense.com, keep your head above water.

More Than the Greatest Debt song by David Farant

Mission Impossible

JOHN: World events are always sort of interesting, Jim, and how most people don't see things coming. Remember if we jumped ourselves back six months and I were to tell you that Russia would go into Georgia and deal with them there, changing the face of how Russia is dealing with the world not to mention energy blackmail; two back to back hurricanes out there; an IEA depletion report in August, which had a 4.5% rate which in October jumped to 9.1%, first of all people would have said I was crazy if I had just told them some of this stuff, but then that oil would be dropping to 61 dollars a barrel. At that point, they would have hauled me off to Happy Acres, I think.

JIM: You know, the remarkable thing we're seeing today, John, is very similar to the events of 1997 and 1998 that led to a 50% drop in the price of oil because if you recall back then, we were dealing with the Asian crisis and everybody said because of the Asian crisis, you know, a lot of the emerging economies were going through probably the most severe recession they had ever gone through, and this was going to create less demand for energy. And then the following year we had the Long Term Capital Management and then the Russian debt default, and what happened is oil prices went from 20 dollars to 10 dollars because there was going to be all of this surplus oil because of demand destruction. Does that sound familiar? [32:51]

JOHN: Yeah. I mean it's what you typically hear.

JIM: Yeah. It's exactly what you're hearing today and the problem is if there is real demand destruction – Now, back then, the Asian economies and respectively China weren't as big and large as they are today and the problem was is there was supposed to be this hypothetical excess inventory that nobody ended up ever finding, but it was what dominated the trading pits and it was what dominated – in fact, John, you remember the front cover ‘awash in oil’ by the Economist in 1999 which said that the modern new economic paradigm, the new technology economy would consume less energy, energy would become less important and so is there was going to be all of this demand destruction, there would be less demand for oil. This was what gripped the trading pits and trading markets and we drove the price down to $10 a barrel, which was a major mistake because the oil companies thought, Oh my goodness, we're headed for lower and lower oil prices, and all of a sudden we started converting to these big massive gas guzzlers and SUVs because it was thought, just like the front cover of the Economist in 1999 that we would be dealing with lower and lower oil prices. (The Economist even though oil was at 10 dollars, they were predicting oil was going to go to $5 a barrel.) [34:50]

JOHN: You know, the term you hear out there all of the time right now is a constant mantra of demand destruction which is allegedly due to the recession that we're pouring into, and as a result the prices of oil are coming down, you're seeing less demand and inventories are going up. But what they are really not saying is that gasoline inventories are the lowest they've been in how long a period of time anyway?

JIM: You would probably have to go back two decades to find gasoline inventories this low. You know, everybody focuses on, on a weekly basis, oh my goodness, it was up this week and then they drag the price of oil, next week it's down but people forget about that. And the more important thing, John, is because we have seen double digit inflation in the energy sector and even in the mining sector that has averaged over 20% a year, the marginal cost of production for a barrel of oil is somewhere between 70 and $75. The marginal cost of a barrel of oil in the tar sands is between 85 and $100. So as a result of this huge drop off, drillers are pulling their rigs even though we don't have enough rigs. Drilling rigs in Saudi Arabia have gone up three fold; in addition to not only having a difficulty in terms of operating at these prices because oil and natural gas are a depleting asset, you've got a lot of off-shore platforms that are saying, “You know what, we're not going to bring this stuff on-line, it's stupid because we're meeting wells and offshore wells deplete much faster and we're going to do this at a loss, we're not going to do that.” So in addition to that, a lot of the smaller drillers, these independents that go into these small areas that are too small for the big oil companies to even venture into, they are having trouble getting access to credit, so now you're starting to see a lot of, even with the bigger oil companies, a lot of mega projects are going to get pushed back. And if you throw in a windfall profits tax, you're going to see a lot of these mega projects not even come on stream. They are going to say, you know what, at the cost of taxation, the cost of even building it out in terms of capital cost is not worth it, we're just not going to do it.

So the only thing that can solve this problem temporarily, John, is for the world to go into a global depression, equivalent to what we saw in the 30s and although I do think Chinese economic growth is going to modify (you may see Chinese economic growth next year only be 5 or 6 percent instead of the 11 or 12 percent that they got when the world was going full steam because there is roughly about two to three percent of Chinese economic growth comes from exports so that 11 to 12 percent figure that we saw at the beginning of this year, back that off and we may see only five or six percent economic growth in China), but barring a depression in China and India, there is just no way to offset that. And so the central banks right now as we discussed in the last topic are deflating. The purpose of that is to reinflate, restart economic growth. China is doing it, Australia is doing it, New Zealand is doing it, Europe is doing it, Canada is doing it, England is doing it, the United States is doing it. All of the central banks are inflating at the same time with the objective of raising economic growth. So at some point, you throw trillions upon trillions upon trillions of dollars at a problem, you're eventually going to get an economic jump start eventually; and what will happen at the time these economies start to jump, we'll have some of the same problems that we had this past summer where the economic stimulus checks hit the consumer but the price of gasoline went from $3 to almost $5 and so any stimulus that you got from the government rebate checks was being more than offset by what you were seeing in food prices and gasoline prices.

And the other thing that you can see, Fox News carried a story about this on one of their news segments and they were talking about people, oh, goodness, gas is below $3 again, one guy, they were showing this guy filling his SUV, we can get back on the road again and people are going back, John, like we're going back to the way it was, which is probably the worse thing we can do. And automobile manufacturers here locally are trying just to get rid of these big gas guzzling SUVs. People think, hey, we're going to lower gas prices and this is just an aberration in price, so what's happening is with the incentives, they are buying these big gas SUVs. [39:28]

JOHN: So if we do look back to 1997, 98, even I think the economist argument back in 99, they've been projecting all of this demand destruction but it simply isn't is there or if it is there, it's not quite at anywhere near the levels that they were predicting and what classically happens, personally in the area of energy right now, the world is grossly under-estimating the demand growth for energy. There are a lot of countries, it's interesting to hear people in the United States say we've got to go back and be more like a third world country or this or that. Well, the other countries that are trying to climb up disagree with that. They are not trying to go back. They are trying to get up here. So you have this double thing going on, but that's really the competition that’s kicking in right now.

JIM: Sure. And once you sell a Chinese an automobile he's not – remember, in much of the developing world and this was something that was very clear in the midterm report that came out from the IEA, if you look at OPEC, OPEC is consuming more of what it produces, which means it has less to export. If you look at the Soviet Union, it is consuming more of what it exports and its demand is growing. If you look at the Latin American countries where it's subsidized, those countries that produce oil are consuming more of what they produced. And so if you look at OPEC, Latin America, Russia, Asia and India, these countries are expanding, so that if you take the world's demand for energy collectively, yes, it has receded in the United States, it has receded in Europe, but if you add the world collectively together, it is still growing. And that's what these pundits still don't get, John. They haven't got this from the first time oil began to rise off 10 dollars a barrel back in 1998, which was the bottom of the bear market in oil and it went up 14 fold from there, they missed the entire 14-fold increase. One prominent money manager regretted in looking at the last six, seven years this was a very well known money manager that said we missed the entire natural resource thing, but you know what, I think we're safe to say that we can stay away from it for another couple of years. He's going to miss it again. That's what we don't clearly understand is the demand side, you have to look beyond the developed world. In fact, the IEA has clearly stated that: All of the marginal increase for the demand for energy is going to come from the developing world. The developing world is the economic story. That's the marginal increase story that we're going to see for the next two decades and you've got to think outside of the box, think outside of your country, if you live in the developed world, it's the developing word is the real story here. [42:24]

JOHN: We were talking about some of this when you came back from ASPO, if you remember because as world demand is going up, the supply growth is simply not going to keep par with it. That's all there is to it. It's not going to happen. But translating that into public consciousness of the lady or gentleman who is pulling into the gas station to tank up, that's another step. There is no comprehension of that at this stage. Very few people seem to know exactly what's headed in this direction.

JIM: Yeah. If you look at conventional oil, it peaked in 2005 at little over 74 ½ million barrels. John, at end of 2007 conventional oil production had dropped to 73 million barrels a day; it's dropped further since then because we know, for example, Mexico's field, and the decline rate which we're going to get to, but here's where we're going to make up the difference because people are saying, “Gosh, if oil has peaked, how come I can still get it? I may not like the higher price...” Well, we're getting roughly about eight to nine million barrels a day from natural gas liquids, we're getting about two million barrels a day from refinery gains and we're getting about a million barrels a day from biofuels. So if you add that together, that's where you get the difference of 11 million barrels between what we produce conventionally and then what we're getting from alternative fuels. All you hear, almost ad nauseam when you turn on the cable channels, is demand destruction, demand destruction. Well, you know, they are only looking at one side of the equation. They are not looking at the other side which is supply. And what I found alarming and I remember reading this in the month of August, if I learned anything, John, we're not taking August off anymore because it was probably one of the most intense – it wasn't a vacation because I mean we were –

[44:16]

JOHN: We kept running back in. Yeah.

JIM: Yeah. I mean I was up to two more. I've never done so much reading. I literally came back from our beach condo back with two mail carriers of stuff, but I remember going through the IEA midterm report and it came out in August and they said, you know, we're studying the world's oil fields and you know what, last year we said the world depletion rate was about 4%. That was the figure that CERA was going with. Well, we're raising that to 5.1 percent, and in a 1% increase in depletion was quite significant and then I remember going to ASPO in September where Matt Simmons was talking about a conference that Simmons & Company had in Scotland with the oil service industry, and there was a poll around the room and he asked individuals, and you know, you're talking about people from Schlumberger, Baker-Hughes, all of the big oil service companies and they said the real depletion rate is closer to 8%. John, I was absolutely floored last Friday when the IEA released their preliminary report now that they've studied 250 of the world's largest oil fields and the depletion rate was 9.1%. It's actually worse than expected. And they said what that translates into without further investment we need to find 6.7 – almost 6 ¾ million barrels a day just to stay even. Now, if you go through the IEA report, they said, Look, we're going to have to spend (and mainly the developing world because that's where most of this marginal demand is coming from) – the developing world is going to have to spend 360 billion dollars every single year for the next two decades. And if they do that, they can get the depletion rate from 9.1 down to 6.4%. Now, if you take the higher figure of 74 million – it’s actually 73 now – that means we need to find roughly five million barrels a day to handle existing depletion, and that's assuming we're making this 360 billion dollar a year investment, and probably a million to million and a half barrels a day to handle future economic growth. We need to be finding the 6 ½ million barrels a day whether we spend the money or we don't spend the money. And all future demand, as I mentioned, is coming from the developing world and they are going to have to make a big involvement. And John, let's go to that press conference that a reporter had with the individual from the IEA. Let's play that right now and let our listeners hear because I don't want them to get comfortable with oil prices where they are right now. [47:06]

JOHN: Right. This is an interview from the Financial Times online.

Welcome back to the Financial Times. Oil prices are going to bounce back as the world economy recovers over the medium term at least, back to over $100 a barrel on average between now and 2015 and up to $200 a barrel by 2030. Well, two FT reporters got hold of the reports of these forecasts from the International Energy Agency, Javier Blas and Carola Hoyos. Carola, first of all, the thrust of this today is that there is going to be a supply shortage and that's based on a lack of investment. Why is that?

CAROLA: In a way we're running to stand-still. The older fields that we're relying on are declining each year and declining relatively steeply. This report says that naturally they decline at a rate of about 9%; that means you have to throw a lot of investment at them to make sure they level off or get a bit more crude for a longer time. That's not coming at $60 a barrel; to invest in very expensive fields like the Canada oil sand doesn't necessarily make sense in the short term. And national oil companies who have the cheaper fields to invest, countries that are now saying Look, we need the money to plug our budget rather than giving you the money to invest in the oil fields.

FT: How much did the IEA say is needed annually in order to build up production again?

CAROLA: It's a big number, 350 billion dollars a year.

FT: That is a big number. Is it going to happen?

CAROLA: It's doubtful.

FT: Okay. Javier Blas. Quite a gloomy report in many ways. Has it had any impact on prices this morning?

JAVIER: It's not meant to have an impact on today's prices because the oil market is focused on a more gloomy situation; that's the global economy going into recession. But it's a good signal to the market to know where things could move as soon as the economy recovers.

FT: What would be the impacts of 200 dollars a barrel. Surely that would have quite a dampening effect on the economy?

JAVIER: Indeed. The report says that consuming countries, so the US, Europe, Japan, China will devote about five percent of the GDP, five to seven percent of GDP to pay for oil.

FT: A huge chunk.

JAVIER: That's a huge chunk and we had devote that amount to oil only in the second oil crisis in the early 80s, so it's also warning that we could have a problem again when oil prices recover.

FT: And for producing countries, $200 a barrel would be a significant increase in their income as well.

JAVIER: It's a dream. For producing countries, a dream. The report forecast that OPEC would move from today's 700 billion dollar to two trillion dollars, two trillion dollars in 2030. So for the OPEC countries it's going to be a lot of economic power and also a lot of power for the national oil companies.

FT: Okay thank you very much indeed, both of you. There is a significant bit of analysis of this on www.ft.com.

[50:01]

JIM: That IEA report that they are referring to, John, that's going to be released on November 22nd. I think it's 1200 euros for the report and we're going to get a copy of it and we're going to have in the month of December an oil roundtable with Dr. Robert Hirsch (he was the gentleman who did the original study on peak oil for the government, we had him on earlier in the year in a roundtable) along with Matt Simmons and hopefully Jeff Rubin. So we're going to have once the report’s out, I've had time to divest it and all of us have had time to digest it, we're going to have an oil roundtable in the first week of December. [50:41]

JOHN: So Jim if we're going to have to makeup this difference in oil, how much are we going to have to make up on a daily basis and what is this deficit in oil on a daily basis going to look like by the time we get to the end of our crisis window at around 2013?

JIM: Well, if you look at the depletion rate and actually, I've got more updated figures on conventional oil production. It's really 73 million barrels a day, so if we take 73 million barrels and we take that times 9.1%, which is the current depletion rate, John, that means we have to find 6,640,000 barrels a day. That's just to stay running in place. But you also have to add on top of that anywhere from 1 to 1 ½ million barrels for increase in economic growth because China's economy even if it slows down to 5 or 6% or India's economy slows down to 3 or 4%, it's still growing and that's half the world's population, so you're talking about numbers between let's just say that the – that's the 9% depletion rate, the 9.1. Now let's suppose that the emerging markets invest this 360 billion dollars a year in new investment, you could get the depletion rate down to 6.4%. That's not going to happen, so I think a probably better number to use is going to be the depletion number that came out of the Simmons International oil conference which is 8%, and that 8% figure is going to get you roughly about 6 million barrels a day. So what is more important is remember, this depletion rate takes place every day every year, it doesn't go away, it gets worse. So to put this into perspective, by the time we get to the end of our crisis window around 2012, 2013, at the old depletion rate of 4% and that's the number CERA uses, you need to find 25 new million barrels a day of production from new fields. At a 6% depletion rate, let's say the world did take it seriously and invested this 360 billion dollars a year in energy, you need to still find 32 million barrels a day and if you get to the 8% figure, it's 38 million barrels and if you get to let's say the 9% figure and let's say we do nothing, then you're going to have to find over 40 million barrels; in other words, we're going to have to replace more than 60% of our current production with new oil fields and the trouble is most of this oil – nearly half of it – comes from 116 oil fields that are on average about 45 years old. And so if you look at the discoveries and there is a direct link between discoveries and oil production in the future, oil discoveries have just been minimal in this decade and the average production out of these fields is roughly about 150,000 barrels a day. You know what? That's why I'm calling this Mission Impossible; just flatly, we're not going to get it.

I mean we're getting the eight million barrels from gas liquids, we're getting two million barrels a day from refinery gains. Maybe we might get one or two million barrels from biofuels, but we're going to have to start converting our transportation fleet, we're going to have to electrify it and the problems don't end with just finding oil. If you look at the energy infrastructure, it's old. It's decaying. It made of steel, steel rusts. A lot of these oil platforms in the Gulf of Mexico are 25 years old. They need to be replaced. You've got underwater teams doing repair work and not only in the Gulf of Mexico but the North Sea, so the problem is this isn't going to go away; and people that say, well, they are just looking at price and they are talking about demand destruction, John, we're making the very same mistake that we made in 97 and 98 that culminated with the front cover of the Economist saying ‘gushing in oil’ and they were predicting when oil was at 10 dollars a barrel, it was going to 5 dollars a barrel and you've got the same pundits out there making these very same predictions. And the only reason we're at 61 dollars a barrel has nothing to do with demand destruction. It has to do with a lot of deleveraging that came from commodity index funds, that came from hedge funds, that came from pension funds and that's the only reason we're down here and just as quickly as we have gone down here, we can just as quickly make our way back, so that's why, as my mother-in-law used to say, this too shall pass. [55:35]

JOHN: It seems like the whole thing is a race against the clock. In other words, President-elect Obama would like to bring alternatives on, and we're both fans of alternative energy, but there is a time factor in that. Five, ten, fifteen years to get those not only commercially viable but actually the infrastructure put in place, so we're chasing the clock on all of this.

JIM: And that's why if you thought of ‘getting a fuel efficient car, but gosh, the automobile companies are making me a terrific bargain on getting an SUV,’ think again. The time to get your fuel-efficient car is now. The time to think about locating closer to work, you know, the one hour commute in each direction is not going to work as we head into the next decade. So we may be in a soft period here with the deleveraging and the psychology of the market that has a lot to do with demand destruction. You know what? They are collectively as a globe, there isn't demand destruction. We're still consuming more oil this year than we consumed last year. And last year we consumed more oil than the year before, and next year, we're going to consume more oil than we did this year, so the thing that you want to do is take those steps to prepare now. [56:50]

JOHN: Given the fact that we are headed in this direction, basically we understand that from a personal preparation standpoint what we need to do. Now there is an investment standpoint. What will energy stocks be doing in the future?

JIM: You know what? You're going to have to look at your energy portfolio. Definitely want to be in the oil service area because we're going to need that to get that extra oil that's going to give us a bridge until we find out whatever replaces fossil fuels. You're also going to want to own oil companies that have the capability to grow their reserves, that's very important. Just like in any bull market, investors are going to pay a higher premium, a higher PE ratio to own stocks that can grow their production and grow their reserves and then also you're going to want to own companies that have their reserves and production in politically stable parts of the world because its world is becoming increasingly more and more unstable. [57:45]

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

Part 3

Meet the Henrys: High earners not yet rich

JOHN:Part of British history which I’m going through right now, move all the way from Henry II to Henry VIII, on through the Stuarts. Everybody knows about Henry II usually – Becket – Thomas a Becket. Henry VIII – all of his wives and Thomas More. Famous periods of British history. Now you've got some Henrys here. Meet the Henrys. This is a new term, Jim, so now you have me mystified.

JIM: Okay. It’s an acronym. Henry stands for “High Earners, Not Rich Yet,” and these are the folks who make 250,000 plus and get taxed to high heaven. This is on the front cover of the recent issue of Fortune magazine. This is the November 10th issue and it starts with the headline, “Who pays for the bailout? You do.” And it’s by Shawn Tully, and Joan Caplin. You heard in the debate, the couples that make this kind of income – if in other words, you’re below 250,000, if you’re above 250,000 you’re going to have to pay higher taxes. And what’s really amazing about this is as the article goes through – and let me see here, they’ve got one, two…five different couples that they have – and let me see – the first couple, he’s a financial advisor, and his wife is a freelance photographer; their combined income is 375,000, they live in Peoria, Illinois and this title here, he says, “ ‘I try to save 25 to 35 percent of my income every year, says Bill. I’m a financial advisor so I practice what I preach.’ At that rate, he’s among a few people in his income bracket heading for an affluent retirement. He lives frugally, buys cars on eBay and shops for discount air fares online. ‘When I was young, I thought the well-to-do in Peoria had perfect lives. Now I know they’re just hard-working people supporting their family.’”

I’m not going to go through each one of these couples. One is a couple – they make 350,000. He’s a pediatrician, she’s a dentist. Another couple is a CEO of a maintenance company, and a chemical engineer. Another couple – a senior manager at a telecom company, and then an attorney. A biomedical engineer and the manager of a state agency – the combined income is 275,000. So, John, if you think of those kinds of income, you would think, “Wow, these guys are rich.” There are about 5 million American households that earn between 250,000 and 500,000 dollar a year. And John, any idea of how much of the nation’s income taxes these two groups pay? [2:56]

JOHN: I would guess it’s somewhere between the 70 and 80 percentile. Would that be a fair guess?

JIM: Well, let me see. This according to Fortune – those individuals that are in the 50 to 100 thousand income bracket pay 18 percent of the country’s income taxes; if you’re between 100 and 200 – and see this is what we don’t know where the next president-elect is going because the figures range from 250 in the campaign to 220 – but if you’re in the 100 to 200 thousand income, you pay 20 percent of the nation’s income taxes. Now, let’s get to the Henrys. This bracket that earns between 200,000 and 500,000; they pay 17 percent of the country’s income taxes. And what is amazing about this group – now, John, when you think about rich people, what do you think of?

[3:54]

JOHN: When I think of rich people, I think of one million, two million, three – a year income, that type of thing, because I soberly know that inflation is chewing everybody’s heels. It may be rich people 20 years ago who might have been [earning] 100,000 or 500,000, something like that, but that’s not true anymore.

JIM: No, and I mean when you think of really rich people today, you think of people that fly in private jets, luxury vacations in Europe, heated garages with Bentleys and Porsches and lots of jewelry. So, you know, very ostentation sort of lifestyles; sort of the Lifestyles of the Rich and Famous if you used to watch – I can’t think of the [name]

JOHN: Lifestyles of the Rich and Famous. That’s what it was called.

JIM: Thank you, John. See, the brain’s going.

JOHN: What would he do without me?

JIM: Yeah, but Robin Leach. That’s who I was trying to think of. And you think of these kind of – you know, these mansions, these chateaus, the yachts, the private jets. And when you talk about the Henrys – high earners not yet rich – and as Fortune goes on: The reason the Henrys are strapped (now, you would think somebody making between 250 and the kind of incomes we are talking about for a lifestyle is too full): they already face large and rising tax burdens, both federal, state and property taxes; and plus, a lot of these couples, even though they might have mortgage payments, state tax deductions, are being hit with AMT (the alternative minimum tax). As one individual said, Taxes are by far my biggest expense. And this was the financial advisor – the Kwon family. The second biggest expense for the Henrys is they invest heavily in a distinct set of high grade staples that in effect really defines who they are. At the top of the list is they invest in their kids, saving for a private college education, paying for daycare (because they’re both two-earner couples) which is a must, and because mom and dad are working the other kind of things that they invest in are their kids (dance lessons, tennis, gymnastics). So the first thing that comes out of their paycheck – and their largest expense, over a third of their income – goes in the form of taxes. So right out the door, the combination of federal, state, Social Security taxes and you’re talking about – especially remember, both earners are paying Social Security tax. It used to be in the 80s if you both worked you would pay – especially if you ran your own business, you would only have to pay one Social Security tax. But today, both earners pay the Social Security tax. And the Henrys, as Fortune interviewed these families, indulge in virtually none of the toys that brand families as rich. As this one individual said, ‘I eat at fast food and I take my kids to soccer.’ A 300,000 paycheck goes a lot of further in Peoria or Wichita than it does in Manhattan or San Francisco or Los Angeles.

And there was one couple here that made 400,000 dollars in California and between kids, saving for college – Now here’s one that’ll throw you for a loop. John, you have a son who’s going through college; I know when I put myself through college I was fortunate, I went to junior college my first two years – and listen to this – I paid 45 dollars a semester for tuition (plus my books). And so 45 dollars a semester I got my two-year degree for 180 dollars. And then I went on to Arizona State where I paid 300 dollars a semester. So the next two years of my education – plus I went to summer school – it cost me roughly about 1500 dollars to finish my undergraduate degree. And think goodness I had two scholarships to graduate school, so graduate school didn’t cost me anything. But John, one of the big concerns about these families; you know, they’re well educated, they’re professionals from dentists to doctors to attorneys – what we consider high-income earners, highly professional people, big educations – one couple was talking about, one of their biggest goals and they thought they would never do it – one couple, they met, got married, went to Duke University and by the year 2020 and 2023, when their children hope to be going to Duke, it’s going to cost a half a million dollars to put a child through Duke University. It’s costing close to 50,000 a year now, and almost five years it’s over 200,000; and with the way education inflation is going up, and especially as states are under pressure right now, they’re raising tuition even mid year. You have, what, one son in college right now? [09:08]

JOHN: Yeah, he’s the last one that’s in college. The other two are out.

JIM: Okay. So your son goes to a state school, right?

JOHN: Right. Washington State University.

JIM: And he did the same thing that I did. Didn’t he go to a junior college?

JOHN: He went to a junior college. As a matter of fact, he’s still doing some of his gen-ed requirement back at the junior college during the summer time because he doesn't want it to get in the way of his major, plus it’s a lot cheaper to do the credits at a junior college.

JIM: So you take a look at this expense, a college education, I just couldn't imagine what it’s going to cost to go to Harvard or Stanford 10, 12 years from now.

JOHN: You know, there’s an interesting chart that Investors Business Daily published about the percentage of people paying no income tax. And what it says here is “more people paying nothing.” “The share of American’s who pay no federal income tax at all has risen steadily during president Bush’s year in office, despite false claims that Bush gave tax cuts to the rich and little or nothing to everybody else.” If you look at the number of people percentage wise paying nothing into the income tax system, it was pretty steady during the Clinton era – although it rose from 1990, remember the tax hike that happened in there – that went up from about 21 percent to about 24 ½ percent; you get to 1993, tax hike. Then it leveled off, dropped a bit during the 1997 tax cut, but generally stayed in the 25 percent range. Now, from the 2001 tax cut, upward, the number of people percentage wise in the country – workers – paying no tax jumped from 25 to 33 percent; and after the 2003 tax cut, went from about 33 percent and has gone to about 35 percent. So we had a substantial jump in the number of people not paying, and so it’s proceeding upwards. We are actually coming to the point right now where we are about 45 percent of people who pay nothing into the system. [11:05]

JIM: And that’s one of the problems if you take a look at either McCain’s plan – and this is by the way, Investors Business Daily both looked at McCain and Obama. Obama would raise the number of people paying no taxes to 44 percent, and McCain would have raised it to 43 percent. That’s why during the campaign, a lot of criticisms there were really weren’t too many differences between McCain and Obama, other than the fact that McCain wanted to lower the corporate tax rate. So if you take a look at nearly 45 – let’s just round it off to 44 percent, 43 percent; whatever number you want to stick with – you’re talking about almost half the country that doesn't pay income taxes. That really skews the election process because now you have a lot of people involved in the election process that pay no income taxes. Now, I want to clarify. Income taxes and Social Security taxes are two different things; when we say income taxes, this is the tax you pay on your income above what you already pay in Social Security tax. Everybody, if you have a job, you pay Social Security tax. But we are talking about income tax – the biggest source of revenue for the government and that’s going to come increasingly from only 56 percent of the population. So half of the population is going to be asked to pay the taxes for the entire population. [12:33]

JOHN: Then you come into a situation where people demand more and more and more and so one part of the population is literally beating the other half of the population to death.

JIM: Sure, because we want more benefits, we want more goodies and we don’t want to pay for them; we want you to pay for them. And let me just go back here to that graph in terms of income taxes. So we already said the Henrys, or that group, pay roughly 17 percent of the nation’s taxes. Now, those who make half a million to 1 ½ million – and by the way, the Henrys only represent 2.3 percent of all taxpayers – and those making 100 to 200 represent roughly 9 percent of all taxpayers. Now, those that make half a million to 1 ½ represent only half a percent of the nation’s population. Those making 1 ½ million to 5 million only represent one-tenth of one percent of the nation’s population, and they pay 10 percent of the taxes; and let me see, the guys – I forgot to mention, the people who are making half a million to 1 ½ million, they represent a half a percent of the population, they pay 14 percent of all the taxes. And those of the nation that make 5 million and higher are only 0.03 of the nation’s population and they paid 13 percent. So if you add it all up, from 100,000 to over 5 million – let me see, we have 17, 27, 37 – we have 47, 51, 61, 75 percent of the nation’s taxes are paid by people earning 100,000 and up. So you've got roughly right now, about 35 percent of the country doesn't pay taxes, and that figure can go up to 44 percent. And that is a gross distortion. And like I said, these people – and it’s a great article because it’ll give you an idea who these people are; and you may agree and say, “Hey, these people don’t deserve to send their kids to good colleges” and they don’t deserve to live in the suburbs, but you know what, you’d be surprised, John, 300,000, 250,000 dollars in America’s big tax states (like a California or a New York or a Massachusetts) the cost of living and the taxes these people pay, that doesn't put you on Easy Street, and it certainly doesn't put you in a lifestyle you think of in the Rich and Famous. The lifestyle of the rich and famous are really that three one-hundredths of a percent; the people who are making 5 million and higher. These are the people who fly in private jets, these are the people that can afford to have the yachts and live a lifestyle that we think of as basically rich today. A rather interesting article, I thought in terms of defining this group. There are about 5 million people in this group and this is who we're going to ask to pay for all of these expenditures. And like I said, as we did in the first hour, in Obama Nation, I think the President-elect is going to find himself constrained because there is no way you’re going to pay for a new healthcare system, a new bailout – all the bailouts that we’re going to have – and you’re going to ask these 5 percent of these families to pay all these taxes and pay for all these programs, which is why eventually we're going to go to monetization.

In addition to that, these people are also being hit with something called the alternative minimum tax where basically it’s the government’s way of basically taking a look at if you have for example state taxes as a deduction, charitable contributions as a deduction or interest expense, they phase part of those out so you can pay higher taxes; and especially those that even have tax-free bonds. So it’s amazing when you look at all of these figures and add them all up and take a look at it, and you’re talking about a very, very small percentage of this nation’s population. And you’re going to get all this money to pay for all these trillion dollars of spending programs? There’s no way. It’s just mathematically, it’s impossible. So that’s why monetization is the route and printing money is the route that we're going to go down because there’s just no way to pay for these bailouts and these bailouts are going to get bigger. The stimulus programs are going to get bigger and the spending programs of all sorts are going to get bigger; and not to mention the existing growth of the entitlement programs, especially Medicare and Social Security and retirement programs. So that’s why I think we are on the road to dinner at Zimbabwe. [17:32]

JOHN: That’s why of course inflation then becomes a tax which affects everybody and most adversely, the poor and the lower classes. It comes right around to bite. So everything they’re promising they’re not going to do, they wind up doing by monetizing, the tax comes down on the people who can least afford to pay it.

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

What the Next Bull Market Will Look Like

JOHN: Since we now know that we are committed on this course of hyperinflation, every time the Fed in the past has been goosing with large amounts of inflation, you wind up getting a bubble and/or a bull market in something. In the 70s it was natural resources, in the 90s it was the tech stock boom – it was basically in stocks all over, but the technology bubble – in the 2000s we saw the real estate boom in the early part of this decade, and of course in bonds. Now that we’re pouring trillions and trillions…and trillions of dollars into this system now, we've got to see some kind of a bull market somewhere, so where is all that money going to run and what’s the next bull market?

JIM: You know, there’s been a number of stories. Bloomberg just did a rather extensive piece called ‘Obama may inherit a bull market,’ after a 6 trillion dollar loss that we've seen in our markets this year, and also with the trillions of dollars that the Fed is creating. Also, Bank Credit Analyst have said they’re still not giving up on the Debt Supercycle, and you know, we're getting down to a number of things; last week they issued a special report, ‘Fed now monetizing’ and that’s sort of the last bullet is monetization. The Fed has been trying to avoid it with asset swaps, but the commitments that are going to be coming from trillion dollar budget deficits – we may even get to trillon dollar trade deficit, who knows, because we don’t make a lot of this stuff here. And depending on the size of the stimulus, buy if you throw trillions and trillions and trillions of dollars at something, you’re going to get a bubble somewhere because that money is going to go somewhere. Eventually it’s not just going to stay at the Fed as banks are currently doing, or staying in somebody’s mattress.

And the next bubble in my belief is going to be in natural resources and emerging markets because emerging markets that’s going to be the area of the world that will have the fastest economic growth and the fastest growing population. And there’s a direct link to that; we’ve got declining populations in terms of birth rates in the West. And then the other thing is in any kind of bull market, Jeff Christian talked about this, we never saw the big surpluses built up. Now, economic growth is slowing down, we've had some deleveraging and that has a lot more to do with where you’re seeing prices right now. And so, if Obama plays his cards right, he could as Bloomberg talked about, inherit a bull market and he will get the credit. Just as whoever is in office when the event occurs, if you’re in office – you know, in fairness to Bush, he inherited a recession but the media didn’t want to tell it that way; Obama is inheriting a recession. Because the media is pro-Obama they are talking about a recession. We are in a recession. So whoever is in office when a recession takes place, they get blamed for it. Whoever brings you out of a recession gets the credit for it. And likewise, with bull and bear markets, even though the technology market burst in the last year of the Clinton administration, he never got tagged with it. But Bush got tagged with this one and rightly so, I think the big selloff and especially the big fiasco – you know, I think historians will look back at this what the government did with Lehman Brothers and what it triggered is one of the great mistakes. But nonetheless, whether you look at the bear markets that happened in 74, we had another bear market in 79, 81, we had a mini one in 91, they are followed by double digits gains and sometimes, depending on the severity of the market, substantial gains in the following year. So if he plays his cards right, doesn't get too extreme in burdening the economy, he could get away with being the beneficiary of a great bull market. [22:27]

JOHN: Okay, well, assuming that we are in a recession right now, and that it would take something like that to at least give the appearance of popping out of the recession, how long is the recession going to last, and of course that’s assuming it doesn't get side-tracked by some of the other things in the crisis window we've been hearing about?

JIM: Normal recessions probably have a nine month duration, but then we get the doozies, John, and the doozies can last anywhere from 16 to 18 months, and this is going to be a doozy. This is probably one of the worst recessions that we've seen since 1981, so let’s assume it lasts about 16 months, this should take us probably into summer of next year. In other words, by the time we get into the third quarter beginning in July of next year, we could begin to see some improvement in the economic numbers. Now, given that the markets are a discounting mechanism, somewhere between now and maybe February, March, depending on what Obama does in his first 100 days in office, the market will already start discounting a recovery; and so given the fact that the recession may last until July of next year, we could see this market start to really turn. And certainly there are a lot of values out there today that we haven't seen in terms of – I mean you take a look at the Dogs of the Dow. I mean you just take the dividend yields on some of these Dow stocks; now, you've got to be careful because some of these stocks have dividend yields that aren’t going to be safe (in other words, they’re going to end up cutting – and GM has lost so much money it no longer has a dividend yield because they cut it), so you've got to be real careful with some of these dividend yields that they aren’t way out of proportion and especially if the company is losing money. But the one thing you have is dividend yields you not only get between 4 and 7 percent in some stocks that have good cash flows and good businesses, and you look it, even some of the drug stocks, you can look at some of the energy stocks, you can look at some of the utility stocks, even the water utilities, so a lot of the dividend yields have come up substantially and a lot of fund managers –you know, you don’t get paid money to sit in cash – are starting to put that to work, and especially some well known value managers are doing that right now. [24:52]

JOHN: Well, Tim Wood was saying earlier in the program, he was talking about taking out, what, 75 percent of the gain in the Dow and some of the other technicians are talking about testing the low, so how is this going to factor in here?

JIM: There’s a lot of people who are looking at the lows that were set in the last bear market if you’re looking at the S&P, 768; there are a lot of people saying we can take that out. Some are even saying that we could get down to lower levels on weekly charts where we get to the 600, the 650 level; and on the Dow, you’re talking about 7200 level. But when all of the technicians are moving to one side of the boat, sometimes that doesn't happen. And judging by the fact that the Fed’s going to create another trillion dollars of liquidity – remember, they just created 1.3 trillon dollars of liquidity here in about 7 weeks, and they’re going to create another 800 billion of liquidity in the market – and that’s money printing – another 800 billion here by the end of the year. When you’re talking about the trillions and trillions and trillon of dollars that this government is going to create, so you either have two scenarios here you believe in. One, the end of the world comes to its end and it’s Armageddon. And if you’re in that camp I guess, well, maybe the best advice we could give you is build a bomb shelter, get plenty of food guns and join a militia group. On the other hand, if it goes in the opposite direction, when you hyperinflate then what happens is you get nominal increases in the value of the stock market and this could be the buying opportunity of a lifetime, especially if you look at some of the depressed resource stocks, that’s what some people – and a lot of very astute people, people like Warren Buffett, people like Bill Gross – there are a lot of very astute investors that have stood the test of time that are in the market. Buffett’s op-ed piece from a couple of weeks ago in the New York Times.

So it’s going to be one of those two. When you throw this kind of money, either this will fail and we get Armageddon and the world comes to an end, or it could be the buying opportunity of a lifetime. [27:09]

JOHN: Well, Jim, you’re just at your 30th anniversary anyway of being in this business, I’m sure you've seen some of these Armageddon scenarios in the past. Some of them were sort of there; look at 87. What do you see now?

JIM: You know, it’s amazing, if I take a look this January when my 30th anniversary in the business, and John, I started out in this business with the Iranian hostage situation, the 79 recession and gosh, in 1979, the inflation rate was heading towards double digits, interest rates were heading towards 18 and 20 percent, Volcker had just taken over at the Fed, he was raising interest rates to levels we had never seen before. And if I just look at, gosh, 30 years in this business, Iranian hostage crisis, the 79 and 81 recessions, the summer of 1982 and the Latin American debt crisis, that was why Volcker cut interest rates in August of 82 because these countries (we had recycled a lot of these petrodollars from the rise in oil during the 70s) were in danger of defaulting; the Plaza Accord in 1985 when the G-7 got together to devalue the dollar; the 87 stock market crash. (And folks, believe it or not, what we did in 87 took us almost a month to do in October because everybody remembers the 23 percent plunge in the S&P in October, that Black Monday as everybody called it; what people forget is the previous Friday, the S&P was down 10 percent and the previous Thursday the S&P was down 5 percent. So we had a 5 percent decline on Thursday, a 10 percent decline on Friday and a 23 percent decline on Monday. So the 87 stock market crash.) Then we had another stock market crash in 1989. I remember it because it occurred on my birthday. Then we had the Savings & Loan crisis, the 91 recession, the first Gulf war, then of course, now we get into the 90s, the Peso crisis, Orange County bankruptcy and derivative crisis in 94, the Asian crisis, Long Term Capital Management, Russia, Y2K, the tech bubble burst in this decade, the 2001 recession, we had accounting scandals, the events of 9/11, the investment banking research scandals, the second Gulf war, the mutual fund scandals, the housing bust, the resource selloff and of course financial bankruptcies. [29:38]

JOHN: A lot of times we've said here on the program that when the Fed raises – when we go through a rate-raising cycle, the Fed keeps raising these because they don’t have any real indicators, it’s not like a gauge or something, you know, [to show] when they’ve done enough. So they basically raise the rates until something breaks. And then something breaks and it’s either going to be in the markets or the economy and sometimes it’s both. This time we got both.

JIM: Yeah. I mean I’ve got a chart that I use in my client presentation, it is Fed rate hikes going back to the 60s and the 70s, we had the Penn Central bankruptcy, 1974 the Franklin National Bank bankruptcy, in 92 we had Latin American debt and farm belt defaults, 83 and 84 we got Penn Central, Continental Illinois, Drysdale Securities, we had the crashes of 89, we had the junk bond crisis (if investors today remember back that far – Michael Milken scandal, the junk bond crisis with Drexel Burnham Lambert) Of course, we had the Gulf war and just a whole slew of crises. Actually, ever since Greenspan took over and cranked up the printing presses, I mean just one series after another. Almost if you look back at this, in terms of a timeline, almost every two to three years, these crises have evolved. But you know, the amazing thing is when I began my investment career, and where we are today, the market went up 27-fold despite all those different crises. And so, put enough money in something and that’s what Warren Buffett put in his op-ed piece, you know, you take a look at some of these big blue chip companies that we have in America today, companies that have been around a long time, and he said, as he quotes the famous Wayne Gretzky story, You know what, I skate to where the puck is going to be rather than where it has been. And he said a lot of these companies, sure, are going to have their earnings hiccups, but three years from now, five years from now, 10 years from now, these companies will be earning more money.

So, two scenarios to look at; either the Armageddon scenario, in which case you go and get yourself a bomb shelter, get plenty of food and shotgun shells; or another bull market. And once again, you throw enough money – if Obama plays it well, he could be the beneficiary of another bull market. I think when it is a bull market, and all of this inflation kicks in, it’ll be a nominal increase in values because hyperinflation or inflation will be eroding the nominal increase. And so that’s what I think you have to put that in perspective, and then when we awake to that moment when peak oil, and especially when we get into the next decade where this crisis really begins to unfold as we talked about in Mission Impossible, there’s just no way we're going to be able to replace a 9.1 percent depletion rate; so depending on how fast we can move on alternatives, conservation, a number of other things will determine what degree of crisis this turns out into in the next decade. [32:46]

JOHN: Once all of this does flow into a bull market, there are going to be certain things that will obviously do well, other things that won’t do well depending on how the market is moving. What do you think those categories are going to be? What will be in them?

JIM: I’m sure you can see a bounce in some of the financial system, you've certainly seen that with the little games that the government has played since July; but these financial companies are going to be deleveraging over the next two to three years and they’re going to be raising a lot of capital, the business models that made these companies profitable during this financial expansion in the economy are no longer working, and there’s going to be a lot of dilution that is coming. Just look at the capital raises.

I have a little screen here – let me just call it up on the Bloomberg. Right now, worldwide, we've had about, let’s just round it off to 690 billion in losses worldwide and had 712 billion in capital raises. So that’s an awful, awful lot of equity dilution, which means there are more shares outstanding, so even when they return to profitability after they get through this loss phase, the profits are going to be divided over a lot more shares. So I think the areas I would watch out for and I would be leery of are financials, telecoms; another area that I think you’re going to see is this new area of frugality, and that’s something that we've been talking about on the show here for quite some time – the death of consumption. And so consumer discretionary stocks, or related to consumer discretionary spending, is an area I would want to avoid. In fact, I would probably be short that sector. Areas that I think are going to do well is still going to be technology, energy, agriculture, precious metals, and a lot of these companies – especially those that are self-financed, have cash flow, are least vulnerable to the credit crunch. So they have financing power, but also I think pricing power. I think energy has that, I think consumer staples have that, I think healthcare has it.

And another area that I will probably turn more bullish on is infrastructure because remember when we talked about the four components of the economy, we had government spending, we had consumer spending, we had fixed investment and we had exports. Well, if consumer spending contracts, government spending increases and it’s going to go towards infrastructure spending and that means industrials. So industrials I think are another area that are going to do well with the infrastructure and the stimulus program that they’re already talking about. Pelosi is talking about getting a bill here started before the end of the year, and another major infrastructure spending bill that will come in probably the first three months of the Obama administration. They’re ready to go and a lot of that is going to be stimulus spending on infrastructure; we heard from Obama on Friday in his first press release as president-elect, he’s going to emphasize that in his economic package, and so I think that’s going to benefit industrial stocks. So I think areas that don’t have pricing power, have vast needs for credit and won’t be able to roll over are going to see – and that’s in the consumer discretionary, and I don’t think the government gives a darn whether a department store or some retail clothing chain goes out of business. So you just take a look at the cutbacks; Circuit City cutting back 150 stores, contracting. So you’re going to see much more of that. And I would definitely be avoiding commercial mall, real estate REITS because they’re going to be losing a lot of tenants because the spillover effect that’s going to be coming from consumer discretionary spending. [36:33]

JOHN: We have run out of time for today. We have quite a backlog of Q-Lines and we elected not to do them today. We're going to try to do a large number of them next week, but so much has happened here over the last couple of weeks we felt it was really important to address those things on the program today. So looking forward to next week’s program, what are we having on, especially in the way of guests?

JIM: Well, coming up next week, my guest is going to be Mark Taylor, he’s written a new book called Confidence Games. The week after that, Daniel Amerman; we’re going to talk about credit default swaps, inflation and deflation. And of course, Thanksgiving we will have our annual gold show. It’s going to be a different show this year, so stay tuned. And then of course, we've talked about in the first week of December, I’m going to have Matt Simmons and Robert Hirsch on an energy roundtable. We're going to try to get Jeff Rubin so we can have a threesome like we did earlier in the year, and we're going to talk about the IEA report that will be coming out just before Thanksgiving about the world’s depletion rate, now over 9.1 percent. And that is alarming. And we’ll get their outtake on that. Then Terry Burnham has written a book called Mean Markets and Lizard Brains. And then we will have one final show – actually, two final shows where we’ll kind of wrap-up, take a look at the year just past, some of the big stories and we’ll take our annual break for the Christmas holiday.

Well, on behalf of John Loeffler and myself, I want to thank you for joining us here on the Financial Sense Newshour. I want to say a special thanks to Eric King for sitting in for us. We got quite an exciting time. We got my last son married. My youngest son married on a Saturday and the following day we became grandparents with our first granddaughter. So it was –

JOHN: Quite a weekend, quite a weekend.

JIM: Yeah, quite a weekend. We were just sitting around. We knew that my daughter-in-law was due within a week or so, and you know, it was funny because she was at my son’s wedding and her water broke. It’s like, ‘oh my goodness.’ But she wanted to be there. And they had her at the hospital and then it was, “No, she’s okay. The contractions aren’t close enough.” And then the next thing, we were sitting on the back porch enjoying a nice glass of wine, and celebrating, hey, this is finally behind us, and my son gives us a call and he goes, Get to the hospital as quick as you can.

JOHN: It sounds the stuff of which movies are made.

JIM: Yes. But anyway, I want to extend my thanks to Eric for sitting in and giving me two weeks off to spend time with family and also with clients and also all of the guests that Eric had on the show. A special thanks to him for doing that for us. And meanwhile, we've run out of time. So on behalf of John Loeffler and myself, we hope you have a pleasant weekend.