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The
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JOHN: This week there is no lack of any thing to talk about. The question of course – we heard it from the horses mouth this week, the new Fed Chairman Mr. Bernanke – if Greenspeak is GS, then Bernanke speak is – what now? JIM: Bernanke Babble – BB – instead of BS. JOHN: Instead of BS, well, we’ll see if that is really true. One of the guests coming up later in the hour here off air made an interesting comment about the fact that the American public is really being lied to by everybody, and sooner or later this is all going to come out and faith in government is going to deteriorate rather rapidly when it does. But, at least first off, we need to look at what Bernanke babble really meant this week in his clearly spoken misstatements. JIM: Well, the differences I think that when we talk about babble versus BS is: the difference between Greenspan when he was often questioned by the Senators or Congressmen he would go off and you would kind of shake your head, and go, “what did he say.” You know everybody had that sort of rolling eyes, like what’s he talking about. To his credit, Bernanke is very clearly spoken, you don’t have to sit there and interpret and say, “OK, what the heck did he mean,” but he talks about stuff that is really what I call misstatements, in terms of inflation: what’s causing it, what are the risks for inflation, or when we talk about inflation being contained? Well, if it’s really contained, and it’s this low then why are you raising interest rates? And if you’re raising interest rates at the same time why are you flooding the markets with money, and getting rid of M3? We’ll get to that in a moment, but I think what happened this week is whether it was Wall Street or Congress who were looking for the Fed to say, “alright, that’s it, we’re done, the last one in January that was it,” well, clearly that was established this week that we’re not done. And I think the problem that Bernanke had is especially with the speeches that he gave on the helicopter money is he needs to establish now his inflation credentials. So, what it looks like right now is they’re going to raise interest rates a ¼ of a point in March, and perhaps a ¼ point in May. They may even go in June if they can’t get the commodity prices under control. In other words, before they go on pause they’ve got to have gold closer down to $500 an ounce which Frank thinks is a good possibility. And they also have to have oil you know maybe if they got oil down to 55. But it’s going to be hard for the Fed to say, “look we’ve gotten inflation under control now, we can go neutral,” if you’ve got gold at $600 an ounce or more or you have oil prices at $70 a barrel. So, they want to get this out of the way, but he needs to establish some kind of credentials with the marketplace, “Oh yes, he’s an inflation fighter”, which is a misnomer to begin with. The Fed itself – by its very nature – is an inflationary institution. [3:08] JOHN: Right, it is the sole cause of inflation on a monetary basis, as Ron Paul said during the hearings. It was fun to watch Ron Paul swoop in again on the hearings this week, but inflation is primarily a monetary phenomenon, followed by price inflation, and that’s probably the biggest confusion in the American public’s mind right now, which is what prevents you from dealing very clearly with what the issue is. JIM: Yeah, it was amazing to watch Ron Paul, you could just see Bernanke’s face, and I always saw Greenspan whenever Ron Paul comes up, it was kind of that look, ‘oh no, him again’. But one thing that the Fed was talking about, they’re raising rates but at the same time if you listen to the testimony they’re telling the markets that, “hey, don’t worry we’ve got inflation under control.” Bernanke: Inflation as measured by the price index for personal consumption expenditures excluding food and energy is predicted to be about 2% this year, and 1 ¾ % to 2% next year. While considerable uncertainty surrounds any economic forecast extending nearly 2 years, I am comfortable with these projections. There he was talking about this personal consumption inflator being 2%. [He was] very comfortable saying that inflation is going to be 1 ¾ next year, but you notice John, he also said, “excluding food and energy.” JOHN: I’m surprised there isn’t a sort of roll of laughter across the Congressional hearing room when he says that, that’s what amazes me. JIM: But if you listen to some of the other comments coming from the either Congresswomen, or Senators they were talking about, “oh it was getting harder and harder for families to make ends meet.” Yeah, it’s because things are going up like food and energy, and the cost of living. However, I think what the Fed has now, they have to prove, or he has to prove his inflation credibility with the marketplace, but he also runs a risk that if he raises rates too far he runs the risk of busting the property bubble. You’ve got right now an inverted yield curve meaning short term rates are higher than long term rates, and that curve is getting steeper and becoming very unprofitable to lend. In other words, a lot of financial institutions take in money on a short term basis, and they have to pay short term rates which are higher while you have longer term rates or interest rates which are falling. So this inverted yield curve is not very good for the lending market, and you’re starting to see some slowdown. And there’s also some signs John even here in Southern California, and I’ve read elsewhere in the country where the property market is really starting to cool off. You’ve got for example reports from Toll Brothers who said in their first quarter their orders are down 29%, and I’ve seen that from other builders as well. [6:01] JOHN: Well, Jim, the Fed is telling us that inflation is under control but if we look at the M3 money supply: 9.554 trillion, now at 10.28 trillion, if we annualize that percentage, that’s a 9% increase, and that’s until it flies off the map and we can’t measure it anymore. Congressman Ron Paul: And I notice in your report to the Congress, you do report M2, and it went up last year 4%, and M3 was not mentioned other than the fact that it won’t be reported anymore. M3 interestingly enough went up twice as fast. And M3 is going up probably more than 2 times as fast as the GDP, and this is information that I consider important, and I know a lot of other economists consider important, and I find it rather interesting and ironic that one of the reasons that the Federal Reserve has given – of course this was before you were the Chairman – for this change is the fact that it costs money, and it costs too much money. Now, that is really something in this day and age, especially since the Federal Reserve creates their own money, and they’re off budget and they essentially have no oversight, and all of a sudden it costs too much money to give us a little bit of information. That was once again Ron Paul who always makes any Fed Chairman kind of squint when he’s getting ready to ask a question. So, what they’re doing, John, is basically while they’re raising interest rates they’re boosting the money supply and credit in the system. I believe that’s one reason with the M3 figures now growing at a 9% annual rate is one reason they’re getting rid of M3. Give me a break, you’re not going to report it because it costs you money? You print the stuff, it doesn’t cost you anything. I just don’t believe they want the markets or investors to know what they’re doing, and they need to obfuscate the inflation issue which is to keep the financial markets fooled. [7:58] JOHN: Let me ask a question. Are the financial markets really being fooled? Are they swallowing these figures or is more and more people waking up to that? JIM: I think they swallow this stuff. Most people are trained as Keynesians; if you take a look at the CFA program which is a very prestigious program, a lot of analysts on Wall Street are schooled in this whole thing. There are a lot of people today that believe these numbers, and believe the idea that inflation is rising prices, not a rising money supply. I can remember when I wrote the Great Inflation and I won’t mention what major Wall Street house but one of their bond fund managers wrote me a nice email and thanked me for explaining that, because that wasn’t what he was taught in his MBA program. I really believe that the debt markets have bought into this. I am so sick and tired of hearing the core rate – wouldn’t you just love quite honestly to go into a grocery store when grocer rings up your grocery bill and it’s $200 or $250 or whatever it is, and you go, “I’ll take the core rate thank you.” JOHN: And of course most of them would look at you like, “what?” JIM: Yup. Or you go in to see your doctor, or for that matter you pay your taxes to the government, and just say I hedonically adjusted my income based on the core rate. So instead of like reporting 50,000 you hedonically adjust it lower, and so well, “yeah, I really got 50, but when you back out all the hedonics, I really only got 35, so I don’t owe much.” JOHN: You know, people are hedonically indexing their income tax. They call it cheating. We’ll talk more about that coming up shortly. JIM: Getting back to this issue, you hear these things about the Fed being an inflation fighter, but yet they’re boosting the money supply, they’re putting more money and credit in the system. You’ve got debt growing also faster, and I think that’s one of the reasons why they’re going to get rid of M3, they’re going to need to monetize some of this debt because you’ve got the budget deficit which is anywhere from 400 to 700 billion a year depending on what you look at is on budget or off budget. The Iraq war is off budget, and don’t forget they’re fleecing Social Security for about 160 billion. So there’s a lot of things that are in the national debt, or the deficit that don’t get reported. Then you have the trade deficit and current account deficit that’s 800 billion. We need to raise a lot of money and credit to keep this system going, and I think they realize that the day that foreign central banks can supply all this money that day is going to come to an end; they’re just not going to be able to do it. And I think the Fed is going to have to start monetizing. So, they’re going to have to obfuscate inflation. The increase in prices for personal consumption expenditures excluding food and energy at just below 2% remained moderate, and longer term inflation expectations appear to have been contained. So, there you have it, John, he’s talking about inflation is contained, it’s moderate. Do you know anybody you talk to that says, “yeah, yeah inflation is really low, my cost of living is…you know, I can’t believe how much my income is increasing, and I’m able to afford and buy more things today, because we have moderate inflation.” That’s not what I hear from people, and that’s not what you read in the paper. JOHN: Most of the time what I hear from people when I talk to them, and I do that a lot when I go to the store, and just quiz them on these things, and what they are really saying is, “well the government is saying inflation is low, but…” scratch, scratch, scratch, scratch on the head, “Gee, golly willickers, what’s with all these high prices?” That’s it. And they don’t understand that dissonance. They have no clear [way of] framing the issue. JIM: One of the things that I notice since I do the grocery shopping I really saw it last week when I bought a box of Tide – I’m paying the same price but the size of the box is smaller. So you’re seeing very subtle things like that. They want to keep price points the same in the store, so what they’re doing is making the packaging smaller. But getting back what they have here, and what they need to do is they need to obfuscate the inflation issue. So, for example, when you heard in his testimony, what some of the risks to inflation are, they blame it on energy, as if for example OPEC and oil companies are responsible for the inflation problem. Bernanke: We are operating close to the margins of available global supply of oil and natural gas, and as a result prices are likely to stay high, and the risk exists if there are significant disruptions of supply, that we’ll get additional spikes or movement in energy prices. JIM: So once again, John, you have the Fed stating there the risk to inflation isn’t really the Fed’s fault, it’s not the amount of money and credit they’re pumping into the system, or the money supply growing at high single digit rates, and who knows, maybe double digit rates after they stop reporting it. It really is kind of like an OPEC or oil company thing. So once again attention deflects away from the Fed and on to something else. So people start saying, “oh yeah, oil prices are up that’s why we have inflation.” Or those evil oil companies. [13:10] JOHN: Well, in summing up what we think is happening, let’s do an estimate of where we’re headed over the next – what? – one, two, three years – something like that. JIM: Well, I think as a result what you’re seeing is we’re heading into stagflation where you’re going to have anemic economic growth but rising inflation rates. And I think that’s going to probably remain with us for a couple of years before we head into hyperinflation, and especially as we get into peak oil, which I think is somewhere the year around about 2008. JOHN: OK, let’s limit it to a shorter term then – this year, how will it play out? JIM: I still believe that the primary trend that you’re going to see in the US equities markets are stocks are going to be up, the advance in prices will be slow somewhat until the Fed basically changes its policy and goes neutral – although I do expect higher nominal prices in stock. I expect the Dow to hit a record high this year, because they can’t allow all these asset bubbles to deflate; in other words, if real estate is deflating they can’t allow the stock market so what’ll happen is with all that money and credit it’ll find a way through hedge funds or financial firms into the market, so I expect higher stock prices. The timing however is going to depend on what happens to the dollar. I think the dollar’s downturn will be delayed but I think by the third or fourth quarter once the Fed is on hold, you can see the dollar start to fall, and that will help overseas profits of international companies because their international sales translated back into dollars will be worth more. And I think what the market is getting used to here is there’s going to be a longer period than expected on the Fed tightening cycle; that should be positive on the dollar and negative on commodities short term as I mentioned. They need to bring oil prices and energy prices down to a level and then they can say, “OK, we’ve got things under control.” What that means is I think gold is going to correct more, it’s going to reflect the higher cost of money especially as we go to a 5% federal funds rate, and especially after the recent run up which has almost gone parabolic, some of the froth needs to be cleaned out of this bull market in gold before the next up leg begins. I also think that you’re going to see the global yield curve start to flatten and invert mode, and not just here in the US but you’ll see it elsewhere, in Europe eventually, and perhaps Japan. So, that’s where we’re going in the short term. [15:39] JOHN: Well, if we go back to what we said earlier, Jim, as compared to Chairman Greenspan, you at least understood what it was he was saying, but nevertheless at the same time you’ve got all of these misstatements in here, so it looks like we’re going to have to address further along the model of getting a Bernanke Babble dictionary.
JOHN: Well, Jim, there’s an interesting quote in the February 20th edition of Fortune Magazine, by Carol J. Loomis. She says, “it is the instinct of wish of most businesses people that General Motors not go bankrupt, the company remains so central to the economy, so sprawling in its reach that going into chapter 11 would be ominous almost beyond contemplation, and yet the evidence points with increasing certitude to bankruptcy.” That’s a real mouthful. JIM: And it’s also the front cover of Fortune Magazine. If you look at the signs they’re there. There’s growing evidence that as you get beyond 2006, there’s a very distinct possibility of Ford and GM, especially GM, going bankrupt. And that thesis by the way – as Loomis points out in her article – is increasingly being supported by the bond rating agencies. I mean, if you look at just the last 10 years alone, debt – and this is the reported on balance sheet debt at GM, not the off balance sheet – but on balance sheet debt at GM has gone from 36.7 billion to 234 billion at the end of 2005. What makes that number rather striking is they have 234 billion in debt, and less than 13 billion in equity. Just pencil that number and talk about the leverage. In the last 5 years for example debt to total assets has gone from 51% to 59%; equity as a percent of total assets has gone from 6% to 3 1/2 %, and just to give you an example in the last 5 years, if you’re analyzing a company for safety, total debt to total assets in 2001, total debt to total assets was 51%, it’s now over 59%; total debt to EBITDA – that’s earnings before interest, taxes and depreciation – total debt has gone from about 11% to EBITDA to almost 58%. I mentioned earlier common equity as a percentage of total assets has gone from 6% down to little over 3%; total debt as a percent of total capital has gone from 89% to 94%. I talked about their debt going from 36.7 billion; Interest coverage has gone from 3 times interest, and that was in 2001, to a negative 4 times; so, they’re not even earning what they have to pay out in interest. And here’s another thing too as an investor. In 1991, GM’s book value per share was somewhere around $42.89; 15 years later, at the end of 2005, GMs book value is $42.80. So in 15 years as a shareholder of GM, book value has basically gone nowhere. Last year the company lost $8.6 billion; almost as much as the total equity of the company. And the other thing that I think is rather telling is their product mix is really out of sync with the times. You know we’re looking at $3 gasoline, by the end of this decade we could be looking at $10 gasoline, I know that’s going to send some people out of their chairs, but I think by the end of this year you could very well see $4 to $5; certainly a possibility of $10. And the product line that people are going to be looking for are the hybrids, the efficient diesels, the smaller size cars, because if your gas prices go up, 10, 15 bucks a week, that starts to hurt a lot of people’s budgets. And we’ll get into our third segment why that’s becoming more important. So they’ve got a product line that’s out of line with the times. And one of the things that Loomis says in her article in Fortune is the car company as a business is doing poorly, and GM is really two companies: it’s a car company, and in many ways, it’s an insurance company because it’s surrounded by all these obligations that it owes to its workers, that are beyond the company’s ability to pay. They have high pension and medical costs, they’ve laid off workers, John, who get paid for not working; they’ve got 5200 workers and as Loomis points out who are costing the company $100,000 a year and they’re basically not working. And they cut their dividend in half recently, but even if they were to eliminate it entirely that still wouldn’t even cover one-fifth of their health care cost. So, here’s the telling thing, if you look at GM, it is basically a company now owned by the unions: GM pension has $100 billion in assets; the company has also set aside 19 billion for healthcare benefits so the employees have a $119 billion versus shareholder equity which is not worth more than 12.7 billion. [23:06] JOHN: Well, it would seem that if we keep down this road it isn’t going to make any difference what pensions there are out there, the pensions are going to evaporate. And also it would seem like unions are headed for a showdown at the OK Corral, in that there will come a time based on a lot of things that we’ve talked about here on the show they’re not going to be able to afford to strike. JIM: They’re not going to be able to afford to strike because I think the American public would get upset if we turned to the taxpayers and say, “bail us out.” We want all these goodies and we don’t want to sacrifice. The problem is GM and Ford, they can’t design cars that Americans want to own. They’re clueless in working with their suppliers, and you have this miasmic management culture. I shuddered at the January auto show when I saw GM executives come out and talk about their new gas guzzler SUV lineup – just the wrong kind of line up for the times. And the other thing that really doesn’t make sense, if you take a look at GM and Ford, they’ve got so many brands does it really make sense for a GM for example to have Chevy, Pontiac, Buick, Cadillac, Saab, GMC, and Hummer. Look at Ford: Ford Mercury, Lincoln, Mazda, Jaguar, Volvo, Aston Martin. JOHN: Well, each of those is a fiefdom though inside GM. JIM: Yeah. You compare that to let’s say Toyota. You have Toyota, then you have their upper end luxury model called the Lexis. You have the same thing going on with Infiniti and Nissan. Even the German manufacturers, you just don’t see 7 or 8 different car brands. And what is amazing is you can see, for example, Toyota is competing with GM and Ford on US ground; Toyota, Honda have plants here in the US that operate at lower cost structure, operate more efficiently, are much more flexible. So you have foreign car manufacturers that have opened up plants in the United States that are beating GM and Ford at their own game on American soil. [25:12] JOHN: Well, obviously the culture hasn’t figured out to a large degree that the jig is up as far as what’s happening. But talk about the concept of downsizing that would be one reasonable thing you could do, or is the answer to be found in offshoring the manufacture of automobiles – move it outside of the US – which of course doesn’t do the unions any good, by the way. JIM: I really think that’s not the solution now with peak oil. I want to contrast for example GM and Ford, to another venerable American institution and company, called Caterpillar Tractor. If you look at Caterpillar Tractor their profits last year were up 40% to 2.9 billion on an increase of revenues of 20%. This year you could see revenues grow to almost 40 billion, and contrast to Ford and GM they haven’t been laying off; their workforce is up 23%, to 85,000. And in contrast to Ford and GM shares, Caterpillar Tractor shares have tripled in the last 3 years. And to understand what Caterpillar did that makes them a success today is they had the exact same problems as GM and Ford are facing with the unions, high costs, they couldn’t compete. If you go back to the early 80s for example Caterpillar was being hurt by inroads being made by Japanese firms, especially Komatsu who was coming in with tractors and heavy equipment, and it reached a crisis in 1984, Caterpillar was losing roughly about a million dollars a day. And what management finally decided to do is say, “OK, we’ve got a problem here, we’ve got to face this issue, if we keep operating like we are right now, we’re going to go out of business. Or, what are our options, do we move everything offshore as was the new incoming trend in the 80s, or do we keep our base here in the US, and take a look at what it is that we do and become more competitive?” Well, what they did is they decided, “no, we’re going to stay in the US, we’re going to keep our base here.” And so what they did is they began building new plants in non-union regions of the Southern United States. So, they built smaller plants; they built about 20 of them in the 80s; they were more specialized plants; they had lower wages; and these plants made the components that fed into the larger assembly plants that were unionized. At first the United Auto Workers objected, basically they said, “no, we’re not going to put up with this.” But what happened is that Caterpillar management dug in; they had seven years of labor unrest in the late 80s and early 90s; 2 strikes – during those strikes salaried managers came in and started doing a lot of the work; they had temporary employees that did the work. And what Caterpillar made the decision to do is, “no, we’re going to preserve our manufacturing base.” So by 1998 they finally reached an agreement with the United Auto Workers that said we better negotiate or we’re not going to have a job here. So what they did is they put a cap on retirement health care costs; and they also got the right to maintain a 15% flexible workforce of temps; recently they transferred some of those healthcare costs to the workers; and today only about one half of Caterpillar Tractor’s employees are unionized. They also beefed up their distribution network. And more importantly – this is how real wealth is created – they invested 1.8 billion in a new modern manufacturing operations; they modernized their factories with new robots, automatic tools; they quadrupled capacity and they only doubled their workforce. So, they became more productive; they made things cheaper; they modernized. And they literally obliterated the management hierarchy: they made more of these product lines into independent units that were responsible. And they’ve got competition coming in from the Chinese but they’ve co-opted the Chinese. So, here you’ve gotten in contrast to GM whose shares hit a high of $94, in the Spring of 2000, and today it’s roughly $22.50. GM shares are down 76%. Caterpillar, on the other hand, has gone from a split basis of $14.91 in Spring of 2000, to $72. So, they’re up 383%. And so here’s a big name manufacturing company making big name manufacturing equipment; they’ve got modern factories, they updated their distribution system; they brought their costs down; they modernized; they increased productivity 4 fold – and they’re competing. And not only that, they’ve got pricing power; there’s a wait to get a lot of their equipment and especially they’re in the right place at the right time with the product in mining and also energy; they’ve just got the right stuff. But here they’re proving that look, the only solution isn’t to go offshore and move manufacturing offshore to try to contain costs. And once again you get back to these problems if you compare GM to let’s say Toyota, Toyota’s designing cars that Americans want to own. They know how to work with suppliers and maintain good relationships; their management culture is more flexible; they’ve trimmed their product line - you don’t see Toyota with 5,6,7 different car companies, you see them with 2 basically. And so, until you deal with those issues, but I’ll tell you as I’ve gone through all the debt issues – debt to asset, debt to capital, interest coverage – I think Carol Loomis is right the company is headed for bankruptcy. [31:10] JOHN: Why is it, Jim, that unions don’t seem to perceive where they’re going, and that the good times aren’t going to roll anymore? Is there a sort of cultural myopia there as well? JIM: Yes, and then they also are very heavily in the political process, so basically they think they can keep the same game going. It doesn’t work when GM lays people off, you’ve got what, 5200 employees you’ve laid off, and you’re paying them with health care costs, and benefits costs cost a hundred grand a year. You can’t operate a company like that. And you can’t force people to buy cars they don’t want to buy. And certainly with oil prices at $60 a barrel, and gasoline prices approaching $3, I’m not sure buying a Hummer that gets 8 miles a gallon is the right product line. People are looking for more fuel efficient cars, and I think as gas prices or oil prices head to $100 a barrel and eventually $200 a barrel, selling big trucks and SUVs is the wrong product line. [32:12] JOHN: Yeah, and I remember John Kenneth Galbraith one time saying when he was talking about fiefdoms and families back through the Middle Ages, he said, “they will resist yielding even a slight part of their prerogatives, and in actuality risk losing it all,” just by doing that, by not being able to see the handwriting on the wall. I thought that was a profound insight on his part. JIM: Well, the handwriting’s on the wall, I mean all you have to do is look at GM and Ford’s balance sheet, look at a 10, 15 year trend, and then also look at the last 5 years, it’s quite honestly frightening.
JOHN: There seems to be an awful lot in motion right now, and we really have to ask ourselves is this business as usual in the economy, or is it really something different this time? We notice that gold has been going up with the dollar; long term interest rates are down while the Fed is raising short term rates up; inflation is on the rise while interest rates down; dollar’s up – largest trade deficit on record; energy prices up a whopping 200%. But the economy is still growing. And the Fed was flooding the system with money while it was still raising interest rates: if we go back to 2005 we find that the M3 is up on a spread from 9.465 to 10.2. In the fourth quarter alone it went up $227 billion; that’s a 9% increase just in Q4. So, reading all of these tea leaves, what are we really looking at here? JIM: I think what we’re doing, John, is it’s remarkable, this is almost deja-vu, we’re going back to the Arthur Burns’ Feds, in contrast to the Fed in the 60s, which refused to basically monetize and inflate Johnson’s Great Society, and Vietnam war program, when Martin was replaced with Burns – Arthur Burns. Burns basically to get Nixon elected flooded the markets with money, and every Fed Chairman up till Volcker did the same thing. And so we’re back to that Arthur Burns type Fed under Greenspan where any time you had a crisis in the economy, or in the international markets the Fed’s first response beginning right after actually Greenspan came on the job – his first crisis within months on the job was the October stock market crash in 1987. And his response was to come in and massive amounts of liquidity injections, and that has been the typical response. And it’s just like every time there’s a problem in the economy, any time there’s a problem with a hedge fund, any time there’s a problem in the financial markets, and anyway the standard response: more money is needed. And it’s almost to the point where we do not want to have any recessions; we don’t want to have any cleansing process that cleans up matters and allows the economy to rejuvenate itself. Instead we basically inject more amounts of money. So, what is upon us, if you boil it down is we are now in the age of inflation: the budget deficit numbers this year – official budget deficit numbers are projected to be $415 billion, but that doesn’t include appropriations for Iraq; it doesn’t include the 160 billion that they’re taking out of the social security trust funds. We’ll have a trade deficit this year which is going to be over $800 billion; we’ve got 60 to 70 trillion unfunded entitlement liabilities. Those entitlement liabilities by the way are going up: if you look at the President’s budget for the following year, 2007 budget, you’ve got entitlement spending going up at almost close to 8%, and you can’t touch that stuff. And just about another year or two, you’ve got the first batch of baby boomers heading into the retirement system, and do you think the politicians are going to sit there, and say, “I’m sorry you’ve paid 350,000 in Social Security taxes but you don’t get it.” No, they’re not going to do that. So, no wonder the Fed’s getting rid of M3. We are now in the age of inflation. JOHN: You know, back in the 70s the keepers of the door were sort of the bond market, but they don’t seem to be the vigilantes of today. So, what has changed between the 70s and the 90s? JIM: Number one, I think the bond market in a lot of institutions has been snookered by the inflation data: they actually believe the numbers that come out. And also, I think there’s a misnomer as to what causes inflation. They think it’s rising prices, so if for example due to productivity if the price of a computer goes down they call that deflation; if you have more manufacturers making iPods, or whatever gadget whether it’s plasma TVs or LCD TVs, and the price comes down they call that deflation. They don’t realize inflation is what is reflected in the bond markets. Low interest rates today at 4 ½ % percent on a 30 year bond, that’s an inflationary symptom of too much money going into the bond market. Rising real estate prices of double digits a year over the last 4 or 5 years, that’s a bull market in real estate, they don’t see that as inflationary. If rising stock prices in the 90s where you saw companies selling at 600, 800, 1200 times earnings, sometimes you couldn’t even measure it because the company had no earnings, that was a bull market. And then the other thing too is I think the financial community has been bought by the enticements of the carry trade; that’s one thing by the way that’s not working right now with the US, you have to go outside the US and borrow money to use the carry trade. You either sell gold short because gold lease rates are incredibly cheap, or you go to a foreign country. But bond investors can leverage to the hilt today, and make a small spread, and arb that with leverage and turn – as John Meriwether said at Long Term Capital Management –nickels into fortunes. And so, I think the bond market is no longer a vigilante as it once was. The other thing too is you’ve got a lot of money that’s coming into our financial markets through foreign central banks who are printing a ton of money as well. The money supply is growing at double digit rates in Europe; it’s growing at double digit rates in China and Japan. So you’ve got all this excess money, and this excess money which is trillions of dollars going into the financial system when you have more money chasing fewer goods, the price of those goods goes up, as the price of a bond goes up, the yield goes down. So that’s one thing that’s happened right now, and I would say if you were a bond investor you own what we call a certificate of confiscation. [39:23] JOHN: What are the consequences of all of this changeover anyway? JIM: Think about it. The way we understate inflation, for example, think of union contracts, think of cost of living raises at most corporations which are based on the CPI; think if you’re a landlord and the rents are tied to CPI; all of this is being understated. [39:46] JOHN: Yeah, Jim, I remember before we got on the air here today you were talking about a friend of yours who got – what was it? – a 3 ½ % pay raise. And you always point out that you can’t just go to your boss and say, “excuse me, but you’re going to pay me x amount this year to keep up with the inflation rate.” First of all, the boss doesn’t believe that there is that much inflation because the government’s telling him that there isn’t, but even beside that, when we factor everything in how did that raise really turn out? Let’s run through the math on it. JIM: Well, a good friend of mine works for a major financial institution here in California. At the end of the year he was telling me about how he got his annual pay increase which was basically at the rate of inflation. And so he got a 3 ½ % pay raise. Well, let’s take a look at that 3 ½ % pay raise. Well, the first thing that comes out of it is 7.65% Social Security tax; in California, if you have income of $50,000 you hit the 9.3% top tax rate – well, actually the top tax rate is 10.3 now – but yeah, 9.3% in state taxes; and then he’s in a 25% Federal tax bracket. So, 42% of his pay raise went to Social Security taxes, the State of California, and the Federal government in the form of income taxes. So, on that 3 ½ % pay increase all he got to keep was 2% after taxes, and he said, “this is a joke.” He said, “a 2% increase, my food’s up, my car insurance just went up, I have to pay for part of my medical premiums that went up, the deductible is up, my grocery bills are up,” he just went on and on, and he said the net difference was taxes and inflation were eating into his style of living. And it was interesting in the testimony this week with Bernanke how some of the Congresswomen and Congressmen were complaining that American families are having a harder time making it, but you know they don’t hit on the problem which is taxes and inflation. [41:53] JOHN: Yeah, I’ve even been listening to a lot of left wing talk radio, right now, and what you hear them saying is that isn’t this crazy we have these tax cuts, and usually they’ll tack on the words ‘for the rich’, and we need to raise taxes because we have a war, if we have to rebuild New Orleans, and we have to do all of these things, and in reality it hasn’t dawned on these people again the game is over as well. JIM: Yeah, I mean who’s going to pay for the $200 billion to rebuild New Orleans, or well, we’ve spent 400 billion on Iraq; our military budget is going to be what 4 almost half a trillion dollars this year; our entitlements for social security, and Medicare are approaching close to a trillion dollars. Somehow, they just think well just raise taxes on somebody that makes money. I mean, at what point do you get where the government takes two-thirds of what you make, or three quarters of what you make. I’ve read – I’m trying to think maybe it was Michael Moore’s book – where he was talking about you need to raise income taxes and take 75%. It’s amazing, and Moore invests in tax shelters and things like that. All these people that talk about taxing do all kinds of things to shelter taxes for their own income, but you’re right, John, you know, raise taxes. Well, I hate to tell everybody but there are a lot more people making less than 50,000 than there are people in this country making 500,000. So when you raise taxes you’ve got to get the broader spectrum of people because that’s the majority of tax payers in this country. [43:31] JOHN: I was talking to some friends of ours who own a medium size business in your fair state, and he said he and his wife sat down and figure out everything they’re paying in either taxes or fees, in other words he said, “I don’t care what we call it. It’s money going to the government.” Or something, right? And they figured it around 52% net of everything they make is going out in taxes, right now. JIM: In some states it’s even higher. In fact, in our next segment, we’re going to talk about that, but the real problem as my friend was talking about is we’ve come full circle to when I got in the business in the late 70s, of taxes and inflation. And the result of that is we’re going back to a stag-inflationary economy, and that has all kinds of implications in terms of lifestyle and investment strategies. [44:24] JOHN: If you really look at it, it seems like we’re going back to a 70s environment and for investors what is going to work in that environment, because that’s obviously the objective of the program here? JIM: Well, if you take a look at what worked in the 70s, and what’s worked in this inflationary cycle that we’ve seen again not only in the late 90s, but especially in this new century is tangible assets. Take a look at oil stocks and mineral stocks, gold stocks, commodities, tangible type assets because the value of money is depreciating globally. And it’s not just the dollar, all currencies, which are no longer backed by gold are all depreciating against the dollar. One thing that you’re seeing and this just proves it: gold was up against the South African rand by 31% last year, it was up 26% against the Australian dollar; it was up 14% against the Canadian dollar; it was up 36% against the euro; up 35% against the yen; and up 32% against the British pound. So, currencies are depreciating. The other thing too is you want to start buying companies that that have pricing power - the ability to raise prices. In fact going back to my Caterpillar story, one of the reasons their profits were up 54%, they were able to pass on prices. There’s a big demand for their products right now. You also want to buy companies that consistently not only have the ability to raise prices but they also have the ability or their business model or product or service allows them to grow – so they’re increasing revenues, which means increasing profits, and ultimately increasing dividends. So, you also need to look at that and buy companies that are competitive. [46:06] JOHN: Well, there’s always the question we get from listeners, and that is what does the little guy do, because that’s as you mentioned the majority of the people out there. JIM: Well, a lot of the things that we talk on this show, maybe you can’t go into the futures market, you don’t have that kind of money, but you know, last week we had Ross Hanson on, if you can afford it you can buy 50 silver rounds, or 50 ounces of silver by just buying these 1 oz silver coins. Or if you don’t have enough money to buy 50 oz of silver you go into your coin shop and maybe you buy one or two ounces. But you start. If you want to be in the areas that we think are going to do well, whether it’s alternative energy, energy or gold, or things like that, there are exchange traded funds so you can buy those for as little as a thousand dollars, sometimes less, depending on which brokerage firm that you’re with. So, you can do a lot of the things that we talk about here on this show. [46:57] JOHN: OK, that’s the little guy, the big guys, the same thing? JIM: The big guys the same thing. You do it yourself, or you hire a money manager that has that similar philosophy, you’re doing basically the same thing. What’s working right now: tangible assets, hard assets, commodities, companies that have pricing power like Caterpillar, that are tied to the commodity industry; companies that have consumer franchise that can raise prices, increase revenues, which means increased profits and dividends. And overall you want to make sure you’re buying companies that are competitive. You don’t want to get yourself locked into a situation like GM, or Ford, where basically they’re non-competitive; and they’re really not doing anything or making anything for their shareholders. And that’s what you’ve really got to be careful here, because you’ve seen GM stock is up over 20% some but in the meantime they’re losing billions of dollars, and the fundamentals of the company are deteriorating by the month. [47:57] JOHN: I must admit when you said what do we do, danged if I know. I expected you to say that. JIM: No, we’ve got a plan. We’ve got a plan. JOHN: It feels great when a plan comes together doesn’t it? JOHN: Welcome back to the next section here of the Big Picture. We are going to look at the coming tax revolt. There are obviously States that are favorable to businesses or to retirees that’s the important thing where people’s money can go further, that’s why for example we even have American colonies growing up in Mexico right now, because their dollar goes further against the peso. But we’re going to see a much bigger tax revolt when it comes to the point of dealing with the increasing burden in some particular types of States, as a matter of fact, does it match the red and the blue states that we all talk about, or is there a different type of distribution, Jim? JIM: No, it’s basically the high tax states are the blue states, the red states are the lower tax states. But you know what’s interesting, John, as I was watching the hearings this week with Bernanke on both days, was the number of people that were calling for a higher taxes. And I’m always amazed by that, as if somehow that the American public has this unlimited bucket of money that they can just dip into. But if we look at all the taxes that people are subject to today: the top tax rate which is due to expire here in the next couple of years but currently it’s 35% on the Federal bracket; then you have a 7.65% Social Security tax rate roughly on the first 90 thousand plus in income. And if you’re self-employed double that to 15.3, then if your income exceeds over that 90 thousand threshold then you’re subject to additional Medicare tax of 1.45%; if you are an employee and double that 2.9% if you’re self-employed. Here in California the top tax rate is now 10.3%. Then we have like for example here in San Diego County the sales tax is 7 ¾ %, and then the property tax goes from anywhere from 1.5 to 1.85, depending on where you live and whether they have such things as metal roof bonds which is basically where they make the developers pay for the improvements. The developers raise the money through municipal bonds, and an additional percentage is taxed on to the property tax. So, I mean that’s a lot of taxes. [50:53] JOHN: Yeah, I notice you left out there if you go to your telephone bills – long distance bills – a huge amount of fees that were snuck in there; taxes at the gas pump, in addition to sales tax; and by the time you’re done it’s tax upon tax, sometimes. JIM: Oh, here in California we charge sales tax on state tax on gasoline. So, we have these initiatives because California is so crowded to spend money on improving roads and freeways, which they’re supposed to be doing from the money they get from gasoline which they really don’t do. And then they had these initiatives, they got them passed, people said, “gosh, traffic’s a nightmare here.” And then there’s a little fine print that says, “Oh, but if we’re running a deficit we can put the money over into the general fund.” Well, now they’ve got a new scheme afloat here where they’re going to try to – they’re running these commercials about you know, “hey we can solve this and really build the freeway and get rid of the traffic problems here in California,” which just depending on where you live you can spend an hour just in a traffic jam trying to get home and that’s a short distance – but what they’re really talking about is another tax hike. And so what we’ve got here, John, is you’ve got these large welfare redistribution states – many of the blue states on both coasts – and there’s an article in Barron’s this week and it was called Revolution on Wheels, and they were talking about quietly and very subtly individuals, families, private businesses are moving out of high tax states like California, and New York, and they’re moving to places like Florida, Nevada, and Texas. And just to give you an idea, between 2000 and 2004, high income paying individuals totaling almost 1.3 million people moved out of high tax states, and they moved to states that don’t have income taxes. I had a friend recently just moved to Florida when they raised income taxes here in California the last year, 10.3, he said, “that’s it, I’m out. I’m gone.” And what was the first thing Tiger Woods did when he signed all his contracts is he moved out of California and domiciled and bought a home in Florida. [53:00] JOHN: Yeah, Rush Limbaugh too. JIM: Yep, people are just saying enough is enough. And it’s not just Florida, Nevada, and Texas that are experiencing this influx of people escaping high tax states. You’ve got other states that are recipients as well: New Hampshire, South Dakota, Tennessee, Wyoming. There’s a stealth migration that’s going on in this country, John, which I think is going to increase and get even larger. Wealthy individuals are upset at higher income taxes and right now at least currently in the United States they have the freedom to move and they’re just saying, “you know what, we’re not going to pay this.” A lot of people are upset because New York and New Jersey are increasing estate taxes as well as income taxes. And here’s the real problem that you’re going to have, right now with Bush’s tax cuts, here are the tax brackets: we have a 10% tax rate on people of lower income; we have a 15% tax rate; a 25% tax rate and that gets most middle class people in that range; then we have a 28, a 33 and a 35. If they do not extend the President’s tax cuts people of lesser income will lose out on the 10% tax rate, that will go away, we’ll have a 15% tax rate; people in the 15% and 25% tax brackets will go back up to the 28% tax bracket; then we get a 31% bracket; then a 36% tax bracket; and a 39.6% tax bracket comes back into play. So, a lot of middle class people and people of lesser income are going to get hurt with this, because right now the 3 tax brackets that affect most middle class, and lower income individuals are that 10% tax bracket, the 15 and 25, and we will lose that 10%, and the lowest bracket will be 15; we’ll lose the 25, it will go up to the 28. So, the other thing too concerns estate taxes after 2010. Right now, you can exempt $2 million of your estate from taxes because we’ve had horrific inflation. If they don’t extend it, or do something about it, it reverts back to the old tax rates of 55% and the exemption goes from currently 2 million, it will go back down to 675,000. Everyone time you turn on one of the media talk shows and you get the lefties and they’re all talking about we need to increase taxes on the rich, we need more taxes as of over 51% tax rate isn’t high enough. And people are sensing this and so what they’re doing is to counteract that is they’re moving to low tax states. There’re seven states in the country right now that have no income tax: they are Alaska; Florida; Nevada; South Dakota; Texas; Washington; and Wyoming. And then we have 2 states that don’t tax income but they tax interest and dividends, and that would be Tennessee and New Hampshire. [56:15] JOHN: You know what I’m really expecting and I know you and I have talked about this before. I am really waiting that as soon as these blue states discover that people are leaving – this exodus – they will come up with what I’m terming an exit tax, because everybody has to file a final return in the state that you left, right? A partial year tax. JIM: Oh, they’re already looking into it. My accountant told me in California most people don’t realize, California had this onerous tax, it was almost criminal, that let’s say John that you worked here in California for 25, 30 years – let’s say you worked for General Dynamics – and you decide “OK, real estate prices are real expensive here, I’m going to go someplace where it’s cheaper to live,” and you decide to move to Florida. Well, up and till about 4 or 5 years ago, California would say to you, “No, it doesn’t hold, you earned that money in California so your pension when you retire, we tax it.” California used to tax people that retired and moved to other states until they finally lost out in the Supreme Court. So, you’re absolutely right, I happen to know California is looking into that because they’re dismayed when they raised taxes and all of a sudden businesses just say, “ you know, to heck with it.” I had a friend last year, when they raised taxes to 10.3%, he said, “that’s it, I’m gone.” He’s in Florida now. John, you were telling me about this friend of yours who has a business in Northern California and they’re looking at all the fees and assessments and they’re paying over a 50% tax, they’re thinking – what? – closing down their business and moving. JOHN: Yeah, that’s already in the works. It’s amazing how that lesson – wasn’t it the world bank that did the study and I think that they show that as you increase the tax rate up to 10% there’s a direct correlation – increase the tax rate and you get an increase in revenues – as you cross over somewhere between 9 and 11%, I’ll say 10%, as you cross over the 10% you begin to see a decline in revenues and it continues in this downward spiral because of those 3 things we’ve always talked about in the case of abusive taxation: fraud, flight and fight. Those three things. JIM: Well, it’s amazing and there’s a lot of pressure in Washington, because the government is spending so much money in inflating that they’re going to let the tax breaks expire which will be another hit on the economy; and so the top tax rate will go back up to around 40%; you add 7.65 for Social Security on to the 40%; add another 1.45% Medicare tax on to that; and if you’re self-employed it’s 15.3%, and 2.9 Medicare tax; add the 10.3% state tax here in California – California sales taxes are as high as many states that have no income taxes but make their revenues through sales tax. You’ve got property taxes that are closer to 2%, so people are just saying, “you know, this is insane, this is nuts.” And not only on top of that the quality of government service what you get for your money has gone down the drain.[59:22] JOHN: Plus if you notice by the way every time you go to do anything you’re fee’ed now, every single thing that you’re required to do, your license or permit for there’s a big fee attached, and those have gone up substantially. And so the question is well, why do I have to pay a fee for this, what am I paying my taxes for? JIM: You know we’ve noticed this because our Broker-Dealer – and I have clients in various states that a lot of the states we have to pay a fee to be registered in every state each year, and those fees keep raising – I think it was the State of Tennessee that in addition to having fees for a Broker-Dealer, fees for being a Registered Investment Advisor, fees for being a Registered Rep, they added a professional privilege tax on top of that. So,.. JOHN: you could call it a professional penalty tax. JIM: Yeah. So, it is just amazing. They don’t call it tax but I think you were recalling you had a town hall meeting and the government was talking about adding, you know, increasing fees, “well, it isn’t really taxes.” And some guy yelled out the back of the room, what did he say, “what’s the diff?” JOHN: “What’s the diff!? We still have to pay it.” People aren’t that stupid, you know. JIM: Well, I would say the next big movement you’re going to see, and especially too I think you’re going to see this with aging baby boomers who are living in these high tax States where you generally have more inflation, and especially in the large crowded metropolitan blue areas of the country: Southern California, where your starter home starts at $750,000, before saying, “you know what, this house that I have 2500-3000 sq ft is now worth over a million dollars, I can sell that house and go some place in the Midwest and buy a house for 200,000, pay cash for it.” I’ve got one client right now that he’s getting ready to retire at the end of this year, and his house, he had a nice house, it’s a little over 4,000 sq ft but the house is worth 2 ½ million dollars now, and of course the property taxes have gone up. He’s looking at going to Nevada, and he says, “you know, I can go there and start drawing on my pension” – in this case it’ll be an IRA that he’ll owe his pension into – “and pay no income tax and buy a nice house with 400 thousand dollars, and I’m going to have excess money.” So, I’m starting to see it more and more. In fact, even with clients that I have in high tax States around the country that are getting ready to retire, we’re getting more and more of these kind of questions, saying, “you know what, my real estate, my home has just gone bonkers. It has gone through the roof. My taxes are going up, I’m getting ready to retire. I want to go someplace where it doesn’t cost me $2 ½ million dollars to buy a nice house. Maybe I can buy something in Florida for 250-300,000 and pay no state income tax. As you know what, my pension and my retirement income is going to go a longer way towards retirement.” JOHN: Yeah. I still think there’re going to be exit taxes. They’re going to sock it to you. It’ll be a penalty – how dare you leave the state type of an issue. But you’re right. Certain parts of the country are being kept afloat by influx from tax abuse states – let’s call it that way where the taxes are abusive. JIM: Yeah. You’re going to see a big thing. If they start doing these exit taxes you’re going to see that go to the courts and be increasingly challenged but I think you’ve got almost a 2 year, 3 year window period here to make your move, depending on where you’re at, because I know California is looking at that because their attitude is, “you live here, your income belongs to us.” I mean, they look at it, that if you’re a business you’re a tax cow, and we raise you to produce taxes for the State. And that’s the attitude that they have, it’s very anti-business, and it’s just like “look, we need money” and we’re getting very, very, very radical in this State and there’s no conception of reality, what it costs to run a business, and what they’re doing to businesses, and then they get angry or surprised when businesses leave the State. Their first reaction is how can we penalize these people for doing that, so… JOHN: Or better, they actually say, “let’s do a study to determine why people are leaving the State.” JIM: Yeah, I remember when they did that in 1991, I was doing television news at that time, and when I saw that the Comptroller of the State saying, “I don’t need to spend this money, I can tell you why they’re leaving the State.” and I was floored. But they wanted to do a blue ribbon commission because we had like in San Diego we had our largest employer General Dynamics that just got fed up, and just pulled out, went to Tucson, they left the State. JOHN: Alright. We usually do emails at this point before we go into Other Voices, but there was so much we got to, what we’re going to do is take both the voice mails and the emails, roll them forward to next week, and we’ll address them then. We need to hear our guests from Other Voices.
JIM: Well, everybody got a glimpse of the new Fed Chairman this week, testifying before Congress as a tough inflation fighter. It looks like the Fed may be raising interest rates a couple more times, but what’s going on with the real economy: the money supply. What is the Fed really doing? And here to talk about that is John Williams, he writes the newsletter Shadow Government Statistics at shadowstats.com. John, last November everybody got somewhat of a shock it came on kinda like a late Thursday night that the Fed was going to drop reporting M3, beginning in March. If we take a look at M3, over the last 12 months, it’s gone from 9 ½ trillion to almost 10.3 trillion; they may be talking tough but they’re sure pumping a lot of money. JOHN WILLIAMS: That they are. And it wasn’t just late on a Thursday night which is when they normally release the money supply numbers, but it was on a holiday weekend; the bond market was closed the next day. So it was timed in the way that you’ve seen prior announcements in the past where there could be a negative market reaction. It was done very carefully so as to have as minimal an impact with as few people hopefully watching the announcement as possible. But M3 is the broadest measure of the money supply as it’s been published for some years; it’s used by our trading partners around the world; it’s used by the Bank for International Settlements as a way of assessing monetary policies in the major countries such as the United States, European Union and such. M3 as a predictor of economic activity is better than the narrower measures. M3 encompasses the money supply M1 which is largely checking accounts and such money, and M2 which gets more into the time deposits; M3 has large time deposits in it, it has repos, it has eurodollars, it has institutional money market funds. It represents order of magnitude, 35% to 40% of the total money supply, and to say that this is meaningless is absurd. I don’t know how you can hope to predict economic activity without looking at M3. I’m an econometrician and economist by trade, and I’ve used a number of indicators in terms of trying to predict economic activity in terms of trying to predict inflation, and one of the better indicators of economic activity is the M3 money supply measure. If you look at year to year change in M3, when that goes below the rate of inflation as happened earlier this year, you always have a recession. And if you have an annual contraction in the broad money supply you’ll see an annual contraction in economic activity. And you started to see the economy slow, but the Fed has really been pumping up the money supply as fast as it can, and unfortunately, from the standpoint of the economy, it doesn’t necessarily work in reverse. It’s the old proverbial pushing on the string: the Fed can pump in a lot of excess money but the economy does not necessarily follow. What will often follow when you see a lot of excess money growth is inflation. And what we’re seeing right now was that year to year change in the M3 which disappears this next month, is accelerating. It’s up about 8% right now on a year over year basis, where M2 the next broadest measure is showing growth in the 4 to 4 ½ % range. It tells you very different stories. M3 is sending out signals: “hey watch out, we’re getting up to levels that suggest some increased monetary inflation.” And I’ve got to believe that’s one reason we’re seeing the Fed trying to cut it out, they just don’t want to show what’s happening there. The excuse, “oh it’s too expensive to put together,” they gather these numbers anyway. They’re still going to publish some of the numbers way after the fact. It’s used by the rest of the world, and it’s also used by many people in the economics community. And the only rationale that I can come up with for its termination is someone doesn’t want the broad public to see what’s happening to the broad money supply growth. JIM: Well, you know, the problem with this is when you look at the inflation numbers which you document are artificially manipulated through hedonics, substitution, geometric weighting, and all kinds of different gambits that they use to change the numbers. I think the number that you’re tracking shows the inflation rate to be about 4% higher than reported inflation. But one thing that you always knew, when you looked at the money supply figures – I’m looking at a chart of M3 going back to January of the year 2001, we’ve gone from almost 7.2 trillion to almost 10.3 trillion, so the money supply in the last 5 years has grown by almost 3.1 trillion dollars: that’s a lot of money! JOHN WILLIAMS: It sure is. JIM: That explains why people are seeing real estate prices go into a bubble, why housing prices have been going up double digits, it’s also why you see a lot of that liquidity spill over into the financial markets. I have this belief and I don’t know if you would buy this scenario: it seems like Bernanke has a credibility factor with the helicopter reputation. So, he comes in, he tightens maybe in March, he tightens maybe in May, so he can show he’s tough, in the meantime beginning in March when we get done reporting M3, he begins to goose the money supply even while he’s tightening, raising the interest rate, he’s really loosening, because that’s what I think he’s going to do. In the meantime, after that, the money supply continues to grow; you won’t see inflation officially reported; we’ll get these stupid numbers like the core rate that is irrelevant to anybody; but yet we’ll start seeing the cost of everything around us go up. I think that when they come out of this rate raising cycle unlike the past they’re going to see price increases. JOHN WILLIAMS: Jim, I think your analysis is right on the mark. That’s exactly what they have been doing, they’ve been raising the rates, they’ve been goosing the money supply. They’ve been trying to put out the image yes we’re inflation fighters but indeed Mr. Bernanke has something of an inflationist image to overcome. A year or two down the road, I don’t think there’s any question of his overcoming that image, I think that’s going to be well engrained in the public and the financial markets minds that he’s, yup, he’s an inflationist. We’re indeed going to see this, and what I look to have happen not too far down the road is have a circumstance where we see some liquidation of the US dollar by foreign central banks in particular. They’re big holders of US Treasury securities, they’re either going to stop buying or in the worst case actually start to liquidate their holdings, that’s going to leave an extraordinary amount of debt for the US markets to absorb, and what I think Mr. Bernanke is going to do is he’s going to go in there and absorb that debt. He’s going to monetize it, which again will be very inflationary and we’ll be able to see some signs that this is happening, but you’re not going to see the full effect as you would have if they were continuing to report M3. [1:12:04] JIM: And that’s the thing that surprises me about this bond market. We have an inverted yield curve right now, and I’m really surprised, John, that institutions have jumped all over this 30 year bond. Given the money supply figures which are growing at high single digits, given the fact that we’re not going to report it, and given the fact that the trade deficit keeps getting bigger and bigger to the point where I don’t think that foreign central banks can finance it completely, why the bond market been so complacent in all of this? And to me, if I was a bond investor, if I was Bill Gross at Pimco, and I’m seeing the money supply figures look the way they do today, and then I see that the Fed is not going to report it, would you be buying the idea, that well guess it’s too expensive to maintain, as if the Fed couldn’t print money to pay for the bill? JOHN WILLIAMS: I sure wouldn’t, and I wouldn’t be buying the long bond. I’d be as short as possible if I had to buy Treasuries. And this is the only rationale I can give you and I don’t know if it makes much sense is that you’ve had some pretty strong political pressure on our trading partners to keep providing the system with liquidity. You may have some domestic buyers who have reasons for wanting to buy a 30 year bond where they can offset it against other obligations, and help price them out. They used to do that – life insurers for example, but if you ever had a good bet as to what’s going to happen here, that you’re going to have higher inflation as the average person is going to experience it: yes, that’s an extraordinarily good bet. And historically the long term interest rates have tended to follow the common experience, not so much what the government tries to put out or tries to sell. What’s been helping to depress the long term yields has been this foreign buying, and again when that reverses – I can’t give you the precise timing on it but I’d be very surprised if it’s more than a year off, maybe six months, could be 3 months, could be next week – when that happens you’re going to see a sharp spike in interest rates, much more in line with the current inflation reality, and what’s going to be an increasing and rising inflation rate going into the future. [1:14:15] JIM: You know, John, one of the things, and this is you document a lot of this, you keep track of the CPI the way it was before they manipulated it, but when we look at all the government numbers we get today – whether it’s the CPI, the GDP numbers, the productivity numbers, the unemployment numbers – I mean they’re all jerry-rigged statistically. I was even surprised to find out that they’re doing this with oil inventories. That they are done with computer models where most people think, “Oh, they report these inventory numbers,” somebody goes out with a dipstick each week, dips it in a well, says, “OK, this is how much gas or oil that we have.” That’s not the case, it’s all being done, massaged, it used to be that you looked to economic data to tell you, OK where’s the economy going, where’s the inflation rate going, so that you could plan your portfolios accordingly. It seems to me we now live in an Orwellian economic world where who knows what these numbers mean? JOHN WILLIAMS: Well, it’s a situation where the politicians with a certain line that they want to sell have full control of the reporting system, and there’s been a lot of changes that have been made: mostly methodological, overall the inflation as you mentioned is underreported in the 3 to 4% range; unemployment right now against the way it was reported say coming out of the great depression or at least was measured at the time is being underreported by about 7%. The government reports puts out a couple of different measures of the unemployment rate, and they show with their broadest measure, unemployment’s up around 9%. There’s another 3% there, that the changes made during the Clinton Administration knocked off. So, you’re up around 12% on the unemployment rate. GDP growth is overstated by about 3% so that in terms of this last GDP report, it showed 1.1% growth in the economy, that in reality was a contraction. But in terms of the way the government reports it, it still was an unusually good report in terms of quality. I mean, forgetting the biases, it was about how you would’ve expected them to report it given the economy actually contracting. So that I do think as you go along here, there are better measures than the government puts out: corporate profits; government tax receipts; the internal revenue service numbers on people’s income. All the better quality numbers will show you that indeed you have a recession, and what people are already beginning to see is it’s an inflationary recession. And that’s the worst of all worlds for the financial markets, at least the traditional financial markets. [1:16:56] JIM: You know what surprises me I think what you’ve got you’ll see you’ll turn on the television, you’ll have the anchors talking about the lowest unemployment rates, inflation is low if we take the core rate, yet you know when you see these Congressional investigations, and you see the Congressmen quiz the Fed Chairman, they talk about people are having a harder time making it, you know, it’s got more expensive, so they’re talking about all the ancillary effects of inflation without admitting it. JOHN WILLIAMS: Yes. And eventually it gets to a point, I don’t have much of an opinion – much of a positive opinion – towards the politicians and Washington. I could come up with some real nasty descriptions, but I think many of your listeners could do just as well. The point is that the system is corrupt, it’s not unusual for a political system to be corrupt, and often the people put up with it so long as they’re doing well. You look back in the days of Bill Clinton, maybe he’s doing some things that we don’t like, but the guys a scoundrel, and “gee, I’m feeling good so I really don’t care too much.” What will happen here and again this is going to be happening sooner than many people might expect is that as the reporting methodology continues to move so far away from reality that the voters are going to be feeling just completely disconnected from what’s happening in Washington. And if there is one factor that people will vote it’s their pocket-books. And at some point there’s going to be a fair amount of economic pain unfortunately, and it’s at that point that you may start to see some changes in the political system, even something evolving in the way of a third party. I can’t tell you what’s going to happen there, but it’s a type of environment where a third party would do well, and people say, “let’s get rid of the scoundrels in Washington,” and maybe under those circumstances there’s some hope of seeing an improvement in the system, because part of the recoil from all the problems will be we’ve got to have honest reporting, and let’s take away all these fudged numbers; let’s get an honest Fed Chairman, on down the line, and you know, the system eventually does tend to be self-righting. [1:18:58] JIM: John, a final question, you are covering the old CPI the way we used to measure it before we started manipulating it, and it shows a wide disparity between what’s reported and what actually most people are experiencing on a day to day basis. Have you thought of covering M3 and putting that together? JOHN WILLIAMS: Yes I have. We’re looking at it. I still think there’s a chance they may be forced to reconsider and continue publishing M3, but it doesn’t look too promising at this point if they don’t, we’re sure going to be given the best estimate that we can on it. You know one thing in terms of the inflation, and this is true with a lot of the reporting is that when it gets misreported as it’s being reported, the effects are cumulative. And if you go back to when the shifts were made in methodology to understate inflation, and keep in mind that the rationale that was behind this in many instances was let’s reduce the amount of cost of living adjustments that are made to social security payments and such. The effect of all of these cumulative changes going back to the 1980s – a little further back than when I was last talking to you about this – if the CPI was being reported today the same way that it was when Jimmy Carter was President, Social Security checks would be about 70% higher. That’s how much the understatement and its cumulative effect has had on the Social Security payments, and it’s how far away from reality that the average guy in the street is seeing between what the government’s reporting and what he’s seeing come out of his own pocket-book. It’s why people say, “Gee, you know, I’m supposedly keeping up with inflation, but I can’t make ends meet.” It’s terrible. [1:20:37] JIM: Well, John, tell people about your website, and your newsletter – what you do. You cover the government statistics, you’ve been doing it for well more that 20 years now. Tell people about it as we close. JOHN WILLIAMS: The newsletter is called Shadow Government Statistics. The website is www.shadowstats.com, and we have available on the website a lot of background material on the manipulations to the various government series ranging from employment, to the CPI, to the GDP, and the terrible things that are being done with the deficit reporting and what the government has been reporting in its GAAP statements that show something ten times worse than is commonly reported. We also have a number of the older newsletters available. Anyone who wants to go through our website will get a pretty good idea of what’s going on and we’re always happy to pick up new subscribers to the current newsletter if anyone has an interest. [1:21:34] JIM: Alright, John, well the name of the website is shadowstats.com. John, as always it’s a pleasure to have you on the program. All the best, Sir. JOHN WILLIAMS: Thank you, Jim, I appreciate your having me on.
JIM: well, everybody gets upset when the price of gasoline goes up at the pump but gasoline prices may be going up this Summer, and may have nothing to do with the oil companies or the world oil situation. Joining me is Neville Henry, he’s a contributing editor to World Energy and World Energy Monthly. Neville, a couple of things going into effect this year that affects gasoline and diesel: the sulfur content and gasoline has been changed I think as of January; and beginning I think either in May or June the sulfur content in diesel fuel will be changed. And that’s going to have an impact on the cost people pay at the pumps. NEVILLE HENRY: Yes, that’s correct. The recent changes in the EPA regulations which come into effect over the next 12 months or so, but beginning as you said in the next part of the year, have increased particularly the controls on emissions: reducing the sulfur content from 90 to 30 parts per million (ppm) in gasoline; and from 500 all the way down to 15 ppm in diesel. Obviously the requirements at the refineries to produce these forms of gasoline and diesel will increase the prices to the consumer. JIM: And any idea what kind of costs that could be. I mean when you take sulfur down from 500, down to 15 that takes a lot of retooling at a refinery, and don’t you have problems when you distribute that fuel through the pipeline system. You have to cleanse the pipeline because you can’t mix the fuels together and contaminate them. NEVILLE Yes, there’s a considerable impact at the refinery level. Obviously they’ve got to change and retool considerably: scrubbers have to be put in to reduce those down as you pointed out the fuel as you move them down the pipeline will intermix and basically they’ve got to be flushed and cleaned, and all of those add the cost of fuel to the consumer. JIM: I want to turn on another topic, the government reported last week I think it’s 24% of our Gulf oil production still remains offline, and Neville, we’re only what? 2 or 3 months away from the next hurricane season. NEVILLE: The impact I think of the hurricanes in the Gulf have been considerable, and longer term than maybe a lot of people expect. Interestingly enough, before Katrina, I think it was Ivan, we probably forgot one of those earlier hurricanes in the season, and the impact on a barrel of oil was as much as $5 at that time. That ripple effect went around the world, so countries like Surinam or countries in Africa that really don’t have any large oil and gas reserves were impacted dramatically as a result of a storm in the Gulf of Mexico. So, the impact of Katrina came on top of that and companies had platforms knocked basically to the sea floor, and to recover that, and to rebuild that infrastructure to get it back online will take considerably more time than a few months. Some companies are doing it faster than others: the company Anglo-Swiss for example was able to capture very quickly an old platform and refurbish it or in the process of refurbishing it they had that platform back on location within a month or so. So companies have reacted within their abilities, some a little faster than others, but the impact longer term I think on the US continues to put pressure on prices. Our economy is still growing, and therefore the energy demand is still increasing and the 4% - approximately 4% - difference between the supply, and what consumers want every year, will continue to put upward pressure on prices too. [1:25:34] JIM: Well, in the State of the Union, the President talked about this country was addicted to oil, but yet if you look at our sources of energy, Neville we’re still mainly a fossil fuel oriented society. Alternative fuels whether it’s wind, nuclear, solar are a minor portion supplying our energy needs. So it looks like in the near future what are the chances that we’re going to have to go after supply? But right now, it’s very difficult as you know for many companies to go after supply because so much of it has been taken offline. NEVILLE: Yes, and you know it’s an interesting question, I think the sentiment is correct regarding ridding ourselves, everybody would like to be a little leaner. The trouble is that the reality is to take ourselves off fossil fuels in the next 5 or 10 years is not reasonable, even over the next 50 years is probably not reasonable. A whole series of factors come into that replacement. Currently the US could bring in LNG from overseas and have quite a significant impact on the supply from countries like Australia where LNG is being produced in a responsible and safe manner for probably 20 years, going into China and Japan. So, there is the capacity to bring that in. Unfortunately, here, the challenges of bringing it into states like California, there’s still a strong lobby that prevents that LNG from being landed that would help that supply issue. On the other side of it the nuclear and coal elements are areas that are still fought against and we’ll have a lot of trouble coming up with replacing fossil fuels and will have their own environmental challenges, so as I see it the demand for fossil fuels will be very strong over the next 30 years or more. [1:27:25] JIM: Doesn’t it strike you as somewhat strange though, I mean, if you look at other countries that did not have the oil endowment that the US had, you’re seeing wind power develop, you’re seeing solar, you’re seeing alternative forms of energy being brought on, they have also a rail system and transportation system that’s more efficient, you can move more goods at a lower cost of energy on a railroad than you can, you know, a semi truck on a freeway. If we get into an energy crunch and it seems like we’ve got capacity constraints worldwide, what does the US do? Because right now, we have natural gas power plants that we’re building in California, but we won’t allow LNG terminals; Canadian natural gas production is in decline. So what does the US do? NEVILLE: Well, you know, many of these other countries have a different pricing policy in their fuel. If I talk to you about $5 gas at the pumps people would probably have a heart attack or close to it, at this point. But in reality in Europe that is the sort of level per gallon that they would be paying, and this has obviously encouraged the development of alternatives. As the price goes up for consumers then alternatives will be looked at in a much more serious way. In many respects the US over the last 20 years has had, because of its efficiencies and low tax structures and other factors have had a low gas price, and you talk to anybody a 50% increase in your gas price in 12 months is a significant hit in the pocket book. And I think from the US consumer point of view it’s what are we willing to pay for? Are we willing to pay for all the clean air and emissions; are we willing to pay for the safety requirements; are we willing to put money in so we would see alternatives developed? I think it is a real issue and a debate for the US, and a debate that’s probably isn’t taking place at the moment. JIM: You know the only problem that I see though is whenever you have a spike in prices when you have a supply shortfall, as we did after Katrina and Rita hit, the only thing that we’re able to do is bash the oil companies. It seems like Neville, we get stuck on this stupid thing and bash the oil companies rather than saying what can we do to increase the supply, what can we do in forms of alternative energy because it is – as you’re right – when a gallon of gasoline goes from 2 to 3, or from 3 to 4, or from 4 to 5, you know that’s where you get conservation measures, and that’s where you get alternative forms of fuel. So, if the government comes in and tries to artificially suppress that in anyway, and do anything to discourage production as for example the British government did with increasing taxes on North Sea oil, and guess what? – production fell even further. NEVILLE: Yes, and you see some of the issues in Louisiana in the last few days, the government of Louisiana talking about additional royalties as well. Yes, I think the idea over a month or so ago when the prices were up and the oil companies were called to Capitol Hill, and chastised, I think the idea that they were taking all this stuff and putting it in their vaults for all the high prices that they were getting at the pumps I think was a very mistaken view. And the reality is that in our efforts to replace or reduce our dependence on hydrocarbons it will take higher prices, and you know I was listening to a number of people talking and the environmental there was an environmental group talking about the oil companies and the high gas prices that were being paid at the pump, but from my side that is something that would encourage less use of hydrocarbons, and the shift to the alternatives. So, there is a price which we as a group of consumers will have to accept if we’re going to make that shift. [1:31:18] JIM: Why don’t you tell our listeners what World Energy is, what do you guys do? NEVILLE: Well, personally I’m a explorer who’s been in the oil and gas business around the world for some 30 years. Under World Energy - World Energy is what I would regard as the leading energy publication in the business. It really covers all aspects of the business, from not only from the hydrocarbon sector but also from the alternatives, from solar, from hydrogen fuel cells, so all of them are represented. World Energy I think is attempting to give a broader picture of the energy business. You know there are executives in this business that are all sorts of personalities, and all sorts o |
