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The
BIG Picture Transcript
[Bye Bye Miss American Pie] JOHN: Boy, does that go back a long time Jim. American Pie goes right back into the early 70s as a matter of fact, and right now as people go through what is called a paradigm change. In history most people have never recognized they are right in the middle of something. Most people see it in retrospect looking back, such as when the Baroque period ended, and the era of classic music began. Right now in this country we are in major paradigm changes, we are in paradigm changes in terms of world view changes in collision; we are going through economic paradigm changes; we are going through paradigm changes in the nature of our government. And we are not going back, and that’s an important point to recognize. You know, Mark Twain said history doesn’t repeat itself but it does rhyme. So things seem to come back at us over and over again. JIM: You know, John, you’re absolutely right. One of the things that we try to do as human beings if you’re trying to take a look at and guess at where the economy is going, where the market is going, or for example where world events are going. We always tend to look back at the past, because the past is our benchmark, and when you look back in history we ask what happened in similar circumstances, what events and what conclusions can we draw from the past that would apply to the present. And the one thing that stands out if you take a look at where we are today is perhaps we’re not repeating a cycle that is very similar to the 60s and 70s, but on many planes we are very close to it. For example, if we look at the late 60s and 70s we had the guns and butter program with LBJ, today with George W. we have guns and butter again. We have entitlements on the rise. We have drug prescription benefit programs. We have the war in Iraq – very similar in nature. Like the 60s and 70s we were involved in the Vietnam war, and like we are today we’re involved in the Iraq war. And just as we were building bases and moving troops one of the things –no matter what we do in Iraq – we are building bases throughout that country and that and that sort of speaks to a permanence or a presence that we’re going to be there for a while. If we take a look at Middle East tensions back in the 60s and 70s, the Yom Kippur war, the tensions with Egypt and Syria against Israel – today it’s Iran and Syria. And towards the middle of the 70s a new economic term was coined ‘stagflation’: rising inflation, anemic economic growth. Likewise, in a similar vein, we had a very embattled and unpopular president, President Nixon. And today we have an embattled and unpopular president – Bush’s public approval is in the low 30s. And also you have the potential for impeachment – we’ll get into that in just a moment. We also have political and labor unrest. You can see not only here in the increase in the number of protests. There is a definite mood of unrest in the country, you can pick it up in art and entertainment, the rise of horror films that are becoming more popular; the protest films – we had Fahrenheit 9/11, now we have Aaron Russo’s prescient film America: From Freedom to Fascism. So we’re seeing this rise of political unrest, it’s very similar, and it’s not just here in the United States – just look what’s happened in France over the last 12 months. We also have in monetary policy the abandonment of monetary aggregates. The Fed says it no longer looks at them; we’re no longer reporting M3; we’ve had a redefinition of inflation in terms of not the rising supply of money which is the root cause of inflation, but it’s rising prices. And we also even have a bit of government credibility, the government’s credibility in terms of the war on terror; the Fed’s credibility in terms of its fight of inflation. So a lot of throwbacks to the 60s and 70s, and as Mark Twain stated, perhaps it’s not repeating in the exact same fashion, but certainly there are a lot of parallels and similarities between the era that we’re in now and the era that we were coming out of in the 60s and 70s. [5:29] JOHN: Yes, maybe one of the things here is the fact that the costs of that era however have still not to a large degree been paid. They have been rolled forward. That is one of the things that is not cyclical, it continues to mount, and that results in the things we’re seeing ib taxes and inflation again. JIM: Yes, obviously taxes and inflation are back on the front page. Taxes are sort of rising. You can see a call for punitive taxes against oil companies. With rising budget deficits there’s a call for raising income taxes, there’s tax this, tax that. So taxes are back on the agenda. Here in California we passed an income tax increase last year, and once again on the June ballot there’s another initiative to raise income taxes here. And then of course we’re seeing the talk of inflation, and we’re seeing it all around us in our daily living. The other too is like the 70s is we’re obfuscating what is inflation. We get the cost-push concept of inflation: it’s labor unions back in the 70s raising prices –and we’re probably going to get into that this decade as people have a harder and harder time keeping up with the cost of living. But also we’re seeing rising prices and expanding money supply. And right now people are confused, the impression you get when you read a financial publication or turn on a financial news channel you get the impression that inflation is rising prices. They don’t talk about what is the root cause of rising prices. So if you were watching the financial channels or reading the financial press, you’re thinking rising prices in the form of higher energy prices is what’s causing inflation. And so right now I think a lot of people are confused by this inflation issue in terms of they feel it they see it it’s real in their lives – they can’t help but see it whether they go to the gas pump, the grocery store or the department store, it’s all around them. But as to it’s cause people aren’t quite sure, they just know it’s happening right now and we’re keeping them intentionally fooled. [7:45] JOHN: Which of course is part of the political process because otherwise you would have to deal with accountability. Accountability is the big issue as to what is the cause, that also keeps you from correcting the situation as well. You know one of the themes that we have been thumping here on the program over the last few weeks is first of all people need to understand that inflation is primarily and always a monetary phenomenon. It is the result of expanding the money supply, it is not the rise in prices. The rise in prices results from the expansion of the money supply, that is the cause of inflation. And if we look at what’s going on around the world, what do we see in the various central banks. JIM: You often hear me cite the Economist which each week in the back of its publication publishes money supply growth around the world. And as I mentioned you have Australia increasing its money supply over 10%; Canada by almost 12%; Denmark 18%; Japan 6%; the United States, last time we measured it was over 8%; Europe 10%. And there was some talk that there were worries about Japan whose money supply growth has slowed down to only 5%. But there was a very important event this week: the interest rates – the overnight call rates – started to rise in Japan. And on Monday the Bank of Japan pumped a record 1.5 trillion yen into the money market on Monday to curb sharp increases in unsecured overnight call rates. It was the largest bill buying operation for a single day. So once again John I’m not buying the fact that central banks are fighting inflation, or they’re tightening the money supply. When you have single digit money supply growth here in the United States, or double digit money supply growth in Canada, and in Europe and you have the Bank of Japan intervening in their money market to the tune of 1.5 trillion in a single day. That is not a tight money supply, that is expanding the money supply, and one of the reasons we’re coping with inflation. [9:55] JOHN: Ok, but if there is a correlation here between a rising money supply –an expansion of the money supply – and a rise in prices, it would seem like there’s been a real big lag time of over a decade between the increase of the money supply and then the resulting twang in the prices that are out there. Usually it’s like a 12 to 18 month lag all things being equal. So, why the difference this time? JIM: There actually was no lag. As we talk about on the program, inflation has two outlets, one is the financial markets, and that’s what we saw. The outlet for inflation was the financial market in the late 80s and the 90s. The financial markets began to inflate in the middle 80s as thEY tried to bring the dollar down, and also as Volcker began to switch gears somewhat. But it really began to accelerate when Alan Greenspan became Chairman of the Fed in August of 1987. And so the outlet for inflation was the financial markets and that’s what we got: we got double digit gains in the financial markets, and we got a stock market bubble at the end of the decade. The other thing that I think defused the inflation – and here’s something where people get confused – as a result of manufacturing increasing globally, in other words the United States was no longer a manufacturing power house, we were now competing with Latin America, Mexico, and especially in the 90s with the rise of Asia and India. And as you increase manufacturing capacity you bring down the cost of the goods that you produce, because once you increase volume your fixed costs are amortized over a larger number of widgets, so the cost comes down. And so that masked on the surface level what we call general prices. But now it’s gotten to the point where you have India’s economy just reported 1st quarter economic growth of 9.3%; China’s economy is growing at over 9%. So you have the two most populous nations in the world at the fastest growth rates that we have seen. When you have an economy the size of China growing at 9-10% a year, or one the size of India that begins to make a difference – and that’s putting a demand on raw materials. Now inflation is heating up again. But I think also all of the central banks around the globe are inflating simultaneously at high levels of money expansion and credit growth. And so now what you’re seeing is it’s spilling over into the real economy, and that’s what we’re facing on a day to day basis as consumers. JOHN: You know, so we did see but it was just masked as we go. But now if we look at the fact for example these central banks are all inflating, what’s the end game in this whole thing? JIM: Well, the real problem and the reason that they’re doing that is the world’s financial system is in danger of collapse if they stop inflating. Because obviously, the more debt you add into the economic system the more debt you have to keep pumping, otherwise if you have a debt contraction in a fractional reserve system you get deflation. And the reason they’re inflating once again is that fractional reserve banking system where you expand the amount of credit 10 dollars or more for every one dollar that’s created or deposited in the banking system. So there’s a real danger here of deflation through default. In other words if you have a financial crisis people go bankrupt, foreclosures etc, you could get deflation because banks all of a sudden start losing so much money they become more prudent in their lending practices, they raise their cash reserves; or you could have deflation if the public loses trust in the financial system, and begins to withdraw cash, for example, as they did in Argentina. So it’s very, very critical at this point to maintain confidence in the banking system or the financial system implodes just like it did in Argentina, but this time it implodes globally. You have, for example, Chinese banks where you have almost 50% of their loans are technically in default, the government can print money and increase its foreign reserves through exports, but as fast as they’re taking on reserves and inflating the defaults and bankruptcies are running at almost the same run-rate. So it’s like they can’t stop. And the whole problem as you know John when you build a financial system on a house of cards, the system implodes if you don’t it going. It’s like if you don’t keep giving the patient another round of alcohol, eventually he’s going to have a bad hangover. So they try to keep this thing in perpetual motion, and unfortunately the more and more debt we add into the system, the faster we have to run from keeping it from imploding. And as much as central banks fear inflation they fear deflation even more. Japan this week injecting 1 ½ trillion yen in the money market has a great fear, it does not want to go back to 15 years of deflation. The US is adding on so much debt it does not want to go back to the 30s where you have a deflationary depression. So now, with no currency being anchored to gold, and no government having any prohibitions put on it in terms of how much they can inflate, they’re doing exactly what we’re seeing now in the rise of the money supply. Yes, they’re raising interest rates but they’ll never raise interest rates high enough to wring inflation out of the system. In other words from this point forward we’re going to be – well, we have been for the last couple of years – negative real interest rates which are highly inflationary. [16:06] JOHN: Well, obviously we had a significant event in this whole process that you’re describing right now with the appointment of Mr. Paulson as Secretary of the Treasury. And I guess the speculation is whether or not he is being brought into this position to provide confidence in the financial markets given the fact that Bernanke seems to be making some flubs right now. This’ll be sort of a game for two to keep this thing afloat. JIM: Yes, one thing is that Bernanke is more of an academic. Yes, he’s spent a lot of time studying the Great Depression, and his conclusion was if we could have just printed enough money we could have avoided it. But Bernanke does not have the confidence of the financial markets right now at a very critical time. And at the same time he doesn’t have the experience of how the financial markets work. In other words he doesn’t know which levers to pull. And that’s why they’re bringing Paulson in as Mr. Fixit, because Wall Street is well aware of how precarious the financial system is right now, and they don’t want to see this thing fall apart. So you’ve got to bring somebody that’s going to bring more respect, and more command of the financial markets, and so you’ll see Paulson probably working very closely with Bernanke, and Paulson being able to pull the right levers. I don’t think they’re going to be able to solve the problem, but what they might be able to do is manage the problem temporarily for a period of time, and gradually talk the dollar down. Their hope I suspect would be able to avoid an outright crash of the dollar. I think things have gotten so bad that the only thing they’re going to be able to do now is delay it. JOHN: In the last hour you and Frank Barbera and Brian were talking about the fractional reserve system – I don’t think most people really understand how this works. I like to go up to people in my bank and I hold up a $5 bill, and I say what makes this valuable, and you get the typical he he, you know, and the teller doesn’t have a clue of why this piece of paper has any value. So let’s explain this to people. JIM: Well, one of the things we have in this economy is we have a fractional reserve system and it really violates all canon laws throughout history. And it starts with the checking system in this country. When you deposit money at a bank you deposit it to your checking account – and let me just give you an example. Let’s say, John, I’m a banker and you come into my bank and you give me a thousand dollars and you deposit it. You expect to have full use of that you’re depositing it in your checking account because you’re going to be writing checks and you’re going to be paying bills with that. [18:50] JOHN: And it’s called a demand deposit for just that reason: I can demand money from it at any time. JIM: Now, under the old banking system in the Middle Ages and especially throughout the Roman Empire, and for almost several thousand years if you deposited with any kind of financial custodian that custodian was expected to keep 100% of your deposit in reserves, strictly for that very reason – demand. If this was the Middle Ages and I was your banker and you gave me 100 gold coins and you said, “hey, keep that for safe storage,” and I’m going to charge you a fee for that, and that’s how I make my money. I have a vault, maybe I have guards but I keep the money secure so when you demand those 100 gold coins I’ve got them there and I can give them to you. Actually what happened is the bankers figured out is that most of the time most people don’t withdraw what that deposit. So, they began to lend out the money rather than getting all their money from the fees for storage. In fact, John, I don’t know if you can remember back in the 50s and 60s a lot of times in checking accounts you had to pay a small fee for a checking account because the idea was the bank wasn’t making money on those deposits – they were keeping them there so you could write checks. Here’s the problem, on demand deposits most of the time you don’t get any interest because that would imply a loan just as for example a time deposit. You place the money with the bank with the idea that you’re going to be writing checks on them. What banks have found over a period of time is that very few people actually take the cash out. In other words, let’s say you deposit a check for a thousand dollars, and you hit the ATM machine on the weekend for cash to go out and see a movie or something, maybe you only take out 10% of it, so bank reserves are only 10%. The problem that we have with the fractional reserve system is the minute those you deposit those thousand dollars in the bank, the bank can immediately loan out $900. So, if you really think this through, John depositing a thousand dollars and he’s probably going to write checks historically for $900. But how can John write checks for $900 if I took $900 of John’s deposit and loaned it to somebody else on the street? And what happens is most of the time, let’s say John you write checks for $900 to the local merchants in your area, the merchants that you write the checks to may actually have accounts in the same banking system, so the money stays within the same bank and very seldom leaves it. But even if it does leave it, let’s say you did some home repairs and you wrote out a check for $900 to pay the men that worked on your home. The contracting company that worked on your home doesn’t have a checking account at your bank, they have a checking account at another bank. Now, here’s what happens. That deposit –the $900 check that you wrote to this contracting firm – that contracting firm’s bank can take the $900, keep 10% of the $900 in reserve, in this case $90, and loan out $810. So if you look at collectively what happens when you deposit that thousand dollars in the banking system is it increases. If you divide 10% into it, It will increase 10-fold. So for that thousand dollars that you deposited in the banking system the banks within your area collectively will probably make loans equivalent to $9000. In other words, they’ll expand the supply of money 10-fold from the deposit that you initially made. [22:58] JOHN: So this is what you refer to as the multiplier effect then? JIM: To some extent the multiplier effect. The reason you have to have confidence in the system is what happens when you withdraw your thousand dollars? Instead of leaving it inside your checking account you decide you’re going to take a vacation take cash with you, you go to the bank and withdraw a thousand dollars. Now obviously if you’re withdrawing a thousand dollars from the bank the bank has enough customers around that maybe someone else is depositing a thousand dollars. Where they run into problems in a fractional reserve banking system, and where you get the crises the boom and bust cycles that you see is what happens if confidence is lost in the value of the currency? If you see for example the currency start to depreciate and you will say, “I ain’t holding on to my dollars, I’m gonna spend them as fast as I can get them.” Or if you have a major bank failure as we saw in the 70s and 80s Penn Central, Continental Illinois, all of a sudden there’s a panic and people have less faith in the financial system. So the reason they have to keep inflating is today they cannot afford to have a fractional reserve system or a bank run because the party ends. [24:16] JOHN: Yes, basically if everybody shows up at the same time the game of averages is over: they don’t have the money to cover it nor for that matter does the FDIC as a matter of fact though they guarantee you all this insurance. And they’ve been changing that as we’ve gone through the years. First they guaranteed x amount, then they said each deposit is guaranteed up to 100,000, and then they said, no it’s all of your accounts now. So, that’s been changing as we go through the years as well. But if we turn to what you said earlier is once you get on the treadmill you have to run faster and faster. You have to keep inflating in order to keep the game going, but at the same time we’re hearing talk about the Fed fighting inflation but the way to fight inflation of course would be to allow for stabilization or a contraction of the money supply, and the economy just will not absorb that. JIM: Yes, essentially what the Fed is trying to do is perform a balancing act right now. They’re trying to slow down the rate of inflation in the economy and also to slow down the rate of depreciation of the dollar. However, John historically throughout history politicians have always opted for sacrificing the currency. In other words, if the Bush Administration, Congress and the Fed have a choice of letting the currency fall and depreciate and basically destroying the currency, versus destroying the economy they are going to opt for destroying the currency. And if we take a look at what dominates policy today. It’s Keynesianism, which has come back in full force, and Keynesian economic policies favor credit expansion and deficit spending whenever for example there’s a recession in sight – and I predict we’re probably already in one. So the politicians always call and vote for more government spending that promotes more employment and higher income. So we’re unlikely to see the Fed raise interest rates to a level that would call a halt to the currency debasement and credit expansion that would store trust in the dollar the way Paul Volcker did in 1979. I mean you take a look Volcker, he raised his all the way up, and brought interest rates and treasury bonds were paying almost 16%, money market funds almost 18%, the prime lending rate at 21%. We would simply collapse at this point if we tried to do that. So the Fed is unlikely to raise. And I think what we saw this week with the appointment of Paulson is Paulson’s job is to come in to manage the dollars fall, and manage the financial markets, in other words the bond rate, the rate of interest, the financial markets. [27:03] JOHN: Yeah, but no matter how many of these games you play, ultimately you come to a crisis. You run out of the ability to run fast enough to manipulate things fast enough and that brings you to a crisis in whatever currency is involved, and that’s where we’re headed. JIM: Sure, and I predict probably in the next 12-18 months you will hear talk –if not implementation – of wage and price controls to contain the level of inflation. People will be screaming about the price of energy to do something about it. You’re going to see increased regulations, increased restriction and prohibitions against certain actions. And if you violate what the government wants you to do there are going to be penalties. I also believe you’re going to see some form of capital controls, and also if we do run into a crisis in the banking system you will see cash withdraw limitations; the corralito they put in effect in Argentina. Now will it get that bad, maybe they can stretch it out but you are going to see one form or another or several things that I just mentioned: the wage and price controls, the regulations, capital controls, penalties, and also you’re going to see very punitive tax rates eventually imposed. So if we look at the 70s and what we did – remember Jimmy Carter’s wage and price controls at 7%, the windfall profits tax – what we’re looking at John is the 70s but even worse: political tensions between both parties; left and right want to impose more controls. So really what we’re looking at going forward, as Russo was talking about in his film, either fascism or some form of Marxist dictatorship. And you only have to look at what’s going on in Latin America right now, in fact the front cover of the Economist last week The Battle for Latin America’s Soul, and they talk about for example the return of the Peronists, the return of the generalissimo’s in Latin America, and what’s going on there. And we also know of the horrible experience that Latin America was thrown into as a result of those policies in the 70s and 80s. Then eventually the currency collapsed. Meanwhile, what we’re seeing in the news is this constant state of fear: we’ve had mad cow disease; avian flu; now global warming. And at the same time as they’re pushing this state of fear they’re keeping the real issues hidden, and they’re also keeping us entertained. I’m almost reminded of that one line in the move Gladiator where the two senators were talking about how the Emperor really understood the mob. And I think there was a line something like: he keeps them entertained while each day he takes away their freedoms: Senator: Fear and wonder - a powerful combination. Senator 2: You really think that people are going to be seduced by that. Senator: I think he knows what Rome is. Rome is the mob. Conjure magic for them and they will be distracted. Take away their freedom and still they’ll war, the beating heart of Rome is not the marble of the Senate, it’s the sand of the coliseum. He’ll bring them death and they will love him for it. [30:28] JOHN: What has been interesting as we’ve gone back over the last 20 years, actually it’s 30 by now. We’ve been through a whole series of proposed crisis whether it was the population crisis, ALR; global warming is the crisis du jour right now. But the solution to this, Ok, we go to Kyoto, which was proposed by the way before a lot of the evidence was in supporting global warming, so they were already going in with that predetermined outcome the assumption. But Kyoto was an economic treaty, it was not a scientific treaty. It was also badly flawed in that many of the countries that were going to be major producers of CO2 were going to be exempt from the requirements of the Kyoto treaty. It provided for wealth transfer and taxes, those were the two big things. Now all of a sudden this week we heard of a global tax on CO2 on businesses. In other words, Kyoto is pretty much dead it’s not coming back. Countries such as Russia for the most part signed it, not because they believed in it but because they wanted Europe to support their entrance to the World Trade Organization. And they made that pretty clear that they had no intention of implementing that treaty. Russia is trying to put itself back on its feet. And so now we see, well, ok, Kyoto is dead, long live the treaty. And we’re going to see the next method move forward in the area here, and then in addition to that you mentioned earlier you were talking about punitive taxation. Why in a time like this do we see punitive taxation when everybody’s having an awful time trying to get along? Why does it show up at that point? JIM: It shows up because, number one, government needs more control and the way they think is they think statically. If I have one dollar of economic output, and I only get 30% or 35% of it in the form of taxes if I can increase taxes 15% I’ll get more revenue. And what they don’t understand and never have is that when taxes go up to the point where that border on slavery what happens is people take evasive action. We get back to what tax historian Charles Adams in his book, For Good and Evil, talks about tax history gets back to “fight, flight and fraud” when taxes become unjust and punitive which is what we’re seeing right now. And it’s amazing John because as you and I were talking about this very same thing, Friday morning, as we were going over the format for today’s show and topics, and lo and behold right as we’re talking, flashing on CNBC is global warming tax. CNBC: The Government Accountability Office reports that private business efforts to curb global warming are not working. Duke Eenergy and 12 other companies have told Congress that the government need to get involved and possibly even impose a tax on companies based on how much of the greenhouse gas they emit. [33:20] JIM: A global warming tax which was featured during the lunch hour, a whole discussion on imposing a global warming tax. And this is the first thing that they’re going to do as we move more towards global government. First you start with corporate taxes, then you move eventually to individual taxes. And they’re smart enough to know if they were to impose individual taxes everybody and their brother would be screaming. So the way they have to do it is they have to come in through the back door. [33:48] JOHN: So what’s the end game of all of this, Jim, as we move forward? JIM: We’re moving toward global governance, John. One of the things instead of a very powerful Federal Reserve Bank we’re moving more toward a world central bank. We’re also going to be moving more towards a cashless society because one of the problems in a fractional reserve system is when cash is withdrawn. So if we go to a cashless society you don’t have the problem of bank runs because you have cards and digits and everything stays corralled within the system. [34:20] JOHN: But that means then we’ve heard proposals now from the world bank that say Americans are going to have the Amero – one currency for the US, Mexico and Canada. Europe already has the euro. So they’re moving first of all to regional currencies, and then there is even discussion now of an international currency (and it changes names a couple of times, remember the euro was not the first choice for a currency there) but that means they’re ultimately expecting the dollar to tank. I mean the dollar will die as a currency. JIM: Sure, who knows what the acronym will be for an Asian currency, but you’re going to see 3 currency blocks, you already have the euro, and then probably within the next 5 to 6 years you’re going to see the Amero which will be the emergence of US, Mexico and Canada. And then you’re going to have a currency emerge in Asia. So we’ll have 3 currency blocks and it’ll be whether they can then take those 3 currency blocks, and then get everybody to agree to move to a more global governance, a sort of global currency, a global central bank, and move in that direction. But that’s exactly where we’re moving. It’s just a matter of can this be orchestrated or put into place before the institutions are erected. Picture you’ve got on one side this building that is crumbling and that’s the dollar as the world’s reserve currency. On the other hand you have all the workers working furiously to see if they can resurrect a new building to take its place. And that’s really the $64 million question right now. [35:53] JOHN: And the question is can they do it but before the other building comes down. End segment JOHN: Well, there it goes, at least some things do change Jim I don’t know if you remember way back when you couldn’t vote, you could be drafted at age 18, but you couldn’t vote until you were 21 years of age, and that was changed back in the time of the Vietnam war. You cannot help but feel number one we’re repeating a lot of patterns of the past. And number two, that there is a big deal being cooked up as far as Iran and others, especially reading some of the intelligence services. JIM: Sure, I mean if you look at today once again on the forefront: the Middle East is back on the front pages. Well, actually it never left the front pages, but now it’s very prominent there. And we’re almost running into what Professor Samuel Huntington talked about in his book, The Clash of Civilizations. John, this issue is not going away. What we’re seeing right now is a confrontation between the East and West from the riots in France of last year and this year; the assassination of Dutch politicians; in the Middle East there’s probably not a day that goes by that there’s something in the news concerning the Middle East. A good example today the Dow was down 12 points it was up earlier today on the unemployment report but then all of a sudden Iran came out today and said, “Nope, we’re not going to stop our nuclear program and development of that.” And then all of a sudden the market took a dive, in the minute that news hit. So there’s not a day that we’re not seeing the Middle East right at the forefront. At the same time, what I really think is going to be one of the main problems that causes this whole thing to disassemble and that is going to be a conflict over the world’s resources. In other words, I’m a big proponent of peak oil, and we’re running out of cheap available energy and it’s getting scarce. Another issue on the back burner right now but I think it will be on the front pages and that’s the shrinkage of potable, safe, clean water. Water evaporation, and especially where you have large population centers, in the desert the Southwest of the United States. In the Middle East, a lot of the rivers are running dry. And that by the way is going to the topic of my special guest next week When the River’s Run Dry, where we talk about what’s happening to the world’s water supply. Food supplies right now are at their lowest levels we’ve seen globally in decades. And what you have happen when the supply of energy – new energy coming onstream – is not coming onstream fast enough to fuel economic growth and is not coming online fast enough to replace the amount of energy that is depleting. For example, this year the United States will produce less energy than it did last year; the North Sea will produce less energy than it did last year; Alaska’s North Slope will produce less energy; Kuwait’s Burgan field will produce less energy; Venezuela this year will produce less energy. Venezuela right now is having to import 100,000 barrels a day from Russia just to meet its supply commitments without being penalized. Mexico’s Cantarell field this year will produce less energy. 1985 was the last year that we discovered new oil reserves that were equal to what we were consuming. And I’ve heard all the proponents of the theory that there’s 175 billion barrels of reserves in the Canadian tar sands and 2 trillion barrels in the shale in the United States. And just as Matt Simmons said reserves are very misleading because that would imply if we had 2 trillion we could be producing 80 million barrels a day. No. Canada has 175 billion potential reserves in the Canadian oil sands, but does that mean that Canada will producing 20 and 30 million barrels a day – No. Maybe in the next 10 years they double their production to maybe 2 and 3 million barrels a day. But it’s not going to be 10, 20 and 30 because it’s taking more energy to produce each new unit of energy that you find. And that’s where I think there’s going to come a real conflict here that you’re going to see. [40:57] JOHN: You know, Jim, this is nothing new for people who’ve been listening to Financial Sense Newshour because for as long as I can remember since we’ve been doing this show you’ve been talking about this particular area. And that’s where you’ve got your clients invested as a matter of fact, so at least you’re putting – well, you’re putting their money where your mouth is. JIM: Well, and also putting my own money where my mouth is. It’s something I believe rather strongly and it’s working out, but if you think about this we’re not finding new energy. I hear all this talk about a commodity bubble and to imply that we’re in a commodity bubble you would have to have excess supply start to come online. In other words, everybody and his brother gets into the oil business, the food business and the water business. And lo and behold overnight or over a period of years (like we saw the technology glut in the late 90s) all of this new supply comes online as prices are going through the roof. We’re not even there. Try to name me where we’re going to replace all the oil that we’re going to lose this year from production from the Burgan field, the Cantarell field, the United States lower 48, the North Slope, the North Sea, Indonesia, Venezuela – I could go on and on and on. So, no, it’s something I believe in rather strongly. [42:12] JOHN: You know you’ve talked also on the program –not as in depth I would say over the last few years –at the possibility of wage and price controls, currency controls. When you hear the word control you also have to think diminishment of freedom, less opportunities. And you’re beginning see the nexus between political freedom and economic freedom go hand in hand right here. JIM: Yes, we’re not exactly at a crisis point, but gradually since the 70s you can take the Bill of Rights coming under attack – I don’t care if it’s freedom of religion, freedom to bear arms, forfeiture. And you’re more up to date on this, share a couple of thoughts how RICO was developed as a way of taking assets away from criminals. Now it’s being applied against individuals. [42:59] JOHN: It’s called civil forfeiture. It’s nothing new, it goes back quite some distance into our history, but it was resurrected in the early 80s as RICO statutes came in. They began to say: “Well, Ok, we can’t convict these guys of drug running or whatever but we want to be able to easily seize their property and therefore cut off the source of their funding so they can’t defend themselves in court or whatever.’ So that enabled a process called civil forfeiture by charging property with a crime, and then since property has no civil rights making the property owner go and get the property back. Now, we were assured at the time (and every time one of these things come in to do a little end run around the Bill of Rights) because the 4th Amendment guarantees us we shall not be deprived of life, limb or property without serious due process. This reduced the process to just basically the accusation that you had done something. And we were assured, “don’t worry, if you’re not doing anything, you don’t have anything to worry about.” Well, sure enough within a very short amount of time, forfeiture has expanded way beyond that, to the last count I think several hundred statutes. And people every week – innocent owners – lose property and then get involved in this pitch battle in the courts –in a civil action, not in a criminal action – to try to get their property back. That was just one facet of it. Now, that’s been joined with things that we see in the Patriot Act – the same promise remember: “If you aren’t doing anything wrong you have nothing to worry about.” Yeah, but…Look at what the definition of enemy of the state is, or enemy combatant is. And once you set up all of these precedents then the only thing the state has to do to fit future crises –economic or other things – is to change the definition to make sure because the mechanisms are already in place, you just have to change that. And it’s really spooky, and this is not a Left versus Right issue. There are people on the Left and the Right. The one fault the Left makes right now is they blame the Bush Administration but the Clinton Administration was well into that as well, they were well underway, and it is not a Left versus Right issue. And my own prediction, I think you’re going to hear the term economic terrorism be used more and more because remember what you said about fraud, fight or flight, and as people try to save themselves from the abuses of the system they will be branded as unpatriotic. You can hear the language coming right now, you don’t have to use much imagination. And I think you’ll see that term: economic terrorism. [45:20] JIM: Well, certainly we’ve seen at any time that they’re going to raise taxes on somebody, and they’re going to pick their pocket the first thing they have to do is demonize them –whether it’s demonizing the drub companies, demonizing the oil companies, demonizing rich people. They demonize them and they try to drum up public support by saying, “we’re really going to sock it to these people.” But in order to do that you have to discredit them. And one of the most scary things coming into the patriotic act is that anybody can now be labeled an enemy of state, imprisoned without trial and their assets taken away. Now there may be some protests, and maybe you might be able to fight it, but as we come upon harder and harder time, as we get closer to that time, John, you’re absolutely right there will be enemies of state – and that will be defined by the state. [46:12] JOHN: Right, as the state tries to stick it to you. That’s just historically what happens. You can go all the way back to Ancient Rome and find that. This is nothing new, like you say ,history is coming around again, maybe a little different shape, a little different look, it’ll do the same thing. But nevertheless, we have to plug on and keep on with our lives, so what should we do as the multiple days of reckoning as they approach. What will we do? [46:36] JIM: Well, I’m pounding the table now: it wasn’t raining when Noah started building the Ark. And I’m just going to say: it is time now to start building your ark. And I’m going to be pounding the table on that because I think they’re going to be able to postpone the day of reckoning for maybe another day. But the day of reckoning is not far away. Somewhere between 2007 and 2008 the floods will arrive, and I’m just not smart enough to tell you when that day is going to be here. But I do know, as I look around you’re starting to see the barometric temperature start to drop, you’re starting to see some dark clouds on the horizon. When they arrive here, I can’t tell you – I think somewhere within the next 12 to 18 months, but the time to start building is now. [47:23] [music: American Pie] [49:25] JIM: Well, several years ago investors woke up one day to find out that they had bond funds that had invested in derivatives. A lot of these funds blew up at a time that they shouldn’t. And so here we are today in what has been one of the most explosive bull markets that we have seen in literally decades, and yet some funds are loaning out their shares to people they can short the gold market. Joining me on the program is GATA President and head of Le Metropole Café, Bill Murphy. Bill, when I first heard that some of these gold funds were loaning out their shares I just about dropped, because why would you lend out shares of gold companies you owned to somebody else unless they were going to short them. BILL: Well, that’s exactly it, Jim and it fits right in to what GATA’s contentions are about the manipulation of the gold market – that extends to the gold shares. We seen this incredibly peculiar action in the gold shares from time to time, it usually came right before the bombing of the gold market. And here it is now, a very specific example – the Oppenheimer Gold and Special Mineral Fund – can lend out up to 25% of its shares to JP Morgan Chase who just happens to be one of the ringleaders in the gold cartel. It’s black and white, it’s now public record, and we found it. [50:41] JIM: And also we might point out if you look at the Comptroller of the Currency’s report on derivatives, they are one of the largest owners of gold shorts –if you take a look at the percentage of derivatives – they’re right there at the very top. BILL: That’s correct. They’re a monster in that game, and it all fits right in how some of these big banks in New York, these bullion banks – operate to the detriment of the public. [51:06] JIM: You and I know that the inflation rate is running higher than the core rate they blather out on TV, I don’t think anybody in the real would thinks inflation is only 2%. But we’ve had this 2 year rate raising cycle at the same time they were running the printing presses like there would be no more trees left. And then they got rid of M3 which sort of told us where they were going. But in order for them to go on pause, because I think right now the car is on the edge of a precipice, if we call the car the economy, the front two tires are hanging over the canyon. They need to go on pause here pretty soon, or they’re going to drive the car over the cliff. It’s hard to go on pause if you have oil prices at $75, gold at $728, and you’re telling everybody, “we’ve just contained inflation.” So one of my contention is that they were going to have to hammer the gold market, the commodities market, before they were getting ready to go on pause. And that seems to be what they’ve been in the process of doing. BILL: Well, you’ve nailed it because I was told yesterday by another tremendous source that one of the Senators in one of the Western states told him orders came down from Washington for the markets to do just that including not just gold but the other commodities and so on. So that’s exactly correct and that’s exactly what they’re doing. [52:28] JIM: And you know it was interesting too because last Thursday Bernanke in response to one of the Senators from his previous testimony was writing to him in a follow-up question and Bernanke was saying that they felt – or he felt – that the CPI numbers overstated inflation by almost 1%. And the last time they started talking about overstating inflation, as you know Bill they start tinkering and we got new inflation figures and voila – we got a lower inflation rate. So I wouldn’t be surprised whether tinkering with the commodity markets, they’re also going to be tinkering with – who knows? – hedonic adjustments instead of owner’s equivalent rent. Who knows what we’ll get? But it sounds to me like we’re going to get some miracles in the CPI index. BILL: Well, I say they’re going to have to do something. A lot of these numbers are really lousy, they were terrible today, and there’s not as much oomph out there in the economy as they would like with rates doing what they’re doing it’s starting to have an effect, especially with energy prices so high. JIM: You know, one thing that we’ve talked and of course GATA has done a tremendous service by researching the manipulation of the gold market. We have in my opinion no longer what we call free trading markets, when you have a central bank you have intervention in the markets, miracles in the stock market, the currency market – whatever market it is we trade in today. None of these markets operate freely, and that’s why I think we get a lot of anomalies,. And sometimes these anomalies really trip you up – let’s say if you were a technical trader and you were looking at a pattern and saying, “Gee, this should go down,” instead it goes in the opposite direction. But getting back to the gold market, I wonder if you just might give some advice to listeners on the program. As anybody knows when these corrections come in the gold market, they’re sort of gut wrenching, they happen very quick, they can be short brutal and violent in nature. But if you’re long you own your bullion, you sit on it, you own it, you have your shares, you own it, you’re not leveraged – you just ride this out. BILL: I didn’t expect this big a drop because I know how bullish the fundamentals are. I got a call today from one of my sources – a top European bullion banker – who called this correction right says that we’re not going to see these prices that we have today $625 area for years to come – I mean within a few buck up or down now – but I think this is it, pretty much for sure. We had a big wipe out in the COMEX open interest, I’ve never seen anything like this [inaudible] it went down 26,000 contracts yesterday, the shares are held up tremendously the past few days. The HUI is actually up a net 6, even as gold has dropped $25, so it tell me the market is sold out in this area. I think silver is getting ready to take off again. The gold cartel had to get the price down to do some covering. They did. The open interest is at the same price now as when gold was at 445, so I think we’ve seen the downside, and it’s back up now we go. [55:38] JIM: And Bill, one thing that’s been unusual this time is gold has moved its way up into the 700 range. You haven’t seen as much, I don’t think, of the aggressive short-selling. Am I correct in that? BILL: No, just the reverse actually Jim. They’ve been trying to get out. The open interest just never went up, this is why I didn’t think we’d get such a big drop. They’ve managed to pound and pound away and get some longer term speculators out of the market recently. But no, there’s very little new speculative interest in this market ironically enough. It’s why again I didn’t think we’d see such a big sell-off, because again there’s no fluff at all. And they needed to get the price down, and you see they did. [56:16] JIM: And another thing about this too if you look at the fundamentals and of course we’ve all seen the stories about commodities and gold in a bubble. How can you be in a bubble when you’re running a supply deficit? Normally, in a bubble if we take a technology bubble where we had excess broadband, excess fiber cables [but] we don’t have surplus gold today, we don’t have surplus oil. We have just the opposite in terms of fundamentals on the supply side. BILL: Well, again that’s exactly the case, and the fundamental situation for gold and silver is still explosive. The run up to 735 was no fluke. I think we’re going right back up again. I think it’s going to be dramatic, in my opinion. Even I think copper’s an incredible price even with this correction at 3.47. Years ago if you had told me 2.50 copper I would have though you were nuts. So here we are at 3.50, and I think people have been fooled by these base metals because according to my sources the Chinese have tied up a lot of these metals very quietly. People think it’s all excessive hedge fund speculation. And I think a lot of people are being fooled by the Chinese. [57:22] JIM: Well, I can tell you, when you have gold go from 255 to 700 that’s hardly a bubble when you consider then what would you call the Dow going from 780 to 11,700. And certainly in perspective if we take a look at the commodities markets of the 70s, where you had gold go from 35 all the way to 850. So, I’m sure a lot of our listeners have read James Turk’s article in Barron’s this last week where he’s talking about $8,000 gold. BILL: Yeah, at Gold Rush 21 our historic conference which the Russians came to a lot of us felt that price is going to go to between 3,000 and 5,000. And I still do. And as far as a bubble price again you’re right the number two guy at the Russian central bank two years ago Oleg Ornikov [phonetic] cited GATA’s work, and according to the Russians gold should have been between 740 and 760 back then, just to have kept pace with inflation. So we’re far from a bubble. I know the public in America is just not in this gold market yet. [58:26] JIM: No, I think they’re still chasing momentum stocks – Google, watching Cramer – but I can tell you your average guy in the street isn’t going out putting his 401K money into gold funds – even if he could get one, nor is he buying gold stocks. This has largely been contained I think to the gold community itself, but in terms of the broader market John Q Public has no idea. Maybe he heard gold is going up 700 but ask him is he buying gold and I would probably get a resounding no. BILL: You get that from everybody. The interesting thing is no more do they laugh at you if you talk about the gold market, they used to sneer in the gold days, but just as you say if you ask them are you in it. No they’re looking at it. It’ll probably take a price of $1000 to get the US public involved. JIM: You had Gold Rush last year up in the gold valley in Canada, and you published a video of all your speakers and it was very profound, very well done. Why don’t you tell people, if they would like to get a copy of that DVD. BILL: Well, thanks Jim, to me I think it’s historic. Just look at the 2 minute trial at www.goldrush21.com and you can see what it’s all about. But it’s incredible, these speakers that were there – the smartest people I’ve ever met in one group – said what was going to happen to the gold price and why. Andrei Bykov [ph.], an economic consultant to President Putin showed up at our conference, he bypassed the mainstream gold conference in Perth, Australia. At the end of the conference he said, “Bill, this is the finest conference I have ever been to.” Two days later, gold exploded. It was 436 then, it rallied from that point over 300 dollars with the dollar and the price of oil not doing very much. [1:00:15] JIM: Well, once again Bill, give out that website so if people could find out how they can purchase a copy of that DVD. Very informative on some of the best minds in the gold industry in terms of where gold is heading. BILL: It’s www.goldrush21.com. It’s an easy one to remember. JIM: And Bill your website – LeMetropoleCafe – just like it’s spelled. Great website, a lot of free thinkers there, a lot of different ideas and certainly give people a certain perspective than let’s say what you’re going to read on CBS Marketwatch. BILL: Well, thanks Jim, and I appreciate talking to you and you know you’ve been a leader in all this stuff, and you’ve got a great website yourself and I look at it all the time. [1:00:54] JIM: Alright, Bill, as always a pleasure to have you on the program, I hope you’ll come back and talk to us again. BILL: Any time, my pleasure. Say hello to Liz. [1:01:16] JOHN: Well, Jim, you mentioned with Frank and Brian with the last hour I keep going back to American Pie we ended the last segment on and it’s like the dream is over, but we’re going to try to engineer this one more time. Let’s keep the patient alive and make it go, and we’re going to entitle this segment: engineering a recovery. Frame the picture for me, what do the stats look like? JIM: Ok, let’s take a look at the economic stats. And this is just this week the ISM manufacturing index is down from 57.3 to 54.4 – 50 is neutral, below 50 you’re in a recession. Automobile sales are down for like the second and third month; jobless claims are up this week; construction spending is down for the third month – down 1.1%, one of the biggest drops we’ve seen in a long, long time; home sales are down 3.7% in the month of April – third month in a row. Companies are raising prices. Dupont came out on Thursday saying their raw material prices are going up at such a rate that this is the second time in less than a year that they’re going to have to raise prices. And they also reported at the same time that for the 4th quarter and the 1st quarter they failed to cover their cost increases. At the same time, we’ve got mortgage applications have just fallen off a cliff. And then also John at the same time here we get back to that stagflation economy the “prices paid” component in the ISM numbers jumped to 77 which is a 7-month high. So we’ve got the economic statistics which are telling us day by day, week by week, the economy is slowing down. In the meantime, the Fed – if I was to draw a picture for our listeners – the Fed has driven the economic car to the edge of the cliff. The two front tires are hanging over the canyon right now. They need to go on pause because if they can’t cause the car to brake you know they head right into a recession – that’s going to be worse than the recession that we had in 1991, or the recession that we had in 1981. We’ve got $12.7 trillion of debt that we’ve added in the last 5 years. In fact, if we take a look at the 4th quarter of the last year, the annual debt increase was annualized at almost 3.7 trillion. Remember when I said we have to run faster and faster with credit creation to keep the patient alive, we’re almost taking on now almost 4 trillion – I would be surprised if that number isn’t even bigger in the first quarter of this year, especially with the economic spending and the economic growth that we had in the first quarter. So we’re having to run faster and faster. The national debt since Bush came to the presidency, when he took office the national debt was 3.31 trillion. John, two weeks ago the national debt just crossed 8 trillion. We’ve almost added 5 trillion; we’re almost adding a trillion dollars a year in debt. [1:04:22] JOHN: Is it my imagination or is it exponential? It seems to be doing something exponential here. JIM: Oh, it’s exponential. And it’s going to get even more so. JOHN: And no amount of tax is going to bail us out of this one either. JIM: No, the government spending now is so large like I said you could just take everybody in the country and say anything over $100,000 we take 100% of. We do what we did during the Great Depression when Roosevelt raised tax rates on 100,000, the tax rates were 94%. Now, you add state taxes and that pretty much takes 100% of what you made. That was one of the reasons a lot of the big movie stars didn’t make too many pictures because at one point everything you made went into taxes. Now, granted, $100,000 was a lot of money back then. But there’s no amount of taxes they you could come up with that would ever balance this budget. [1:05:17] JOHN: I’m reaching for the Prozac, Jim. Can it get any worse than the picture you’re painting? JIM: Well, take your second one because I’m not done. JOHN: Am I sitting down is the question – yes. JIM: Yes, are you sitting down? Ok. We talked about was the fractional reserve system, but the other thing that is worse this time is the banks have 65% of their portfolio invested in real estate from mortgage backed securities to mortgages. The other thing John is there is less equity cushion today than there was in the recession of 2001, or the 91 recession because of all the creative financing. Here in California, 65% of all loans have been adjustable rate, negative amortization or interest only. So banks don’t have that equity cushion that they had in the past. Consumers are leveraged at an all time record; government is leveraged to the hilt, including municipal governments. About the only person in good shape right now are corporations which are the least leveraged. Although many corporations like GM could find themselves in financial trouble as I get into in the next segment. But here’s the problem the Fed has: the further that they go beyond 5% the greater the risk that we run into a full-fledged financial crisis and recession. Like I mentioned as I painted the picture, they’ve driven the economic car to the edge of the cliff, the front two tires are now hanging over the canyon. It’s just a matter of can they balance and engineer this to the point where they can get the car, tie a rope to it and to a horse, and start pulling the car off the edge of the canyon, and how long can they keep it there? [1:07:24] JOHN: OK, but they obviously will have to engineer a way out of this thing, so if they’re pushing back the storm clouds, pulling the car back from the edge of the cliff how are they going to do this. JIM: Well, let’s take a look at some of the main things weighing on the economy. And this is confirmed by the public opinion polls. Obviously, the war in Iraq: every single day the media gives us all the negatives and that’s weighing on the public. Two, you’ve got gas prices over $3 – I mean everybody is pinching. You look at retail sales this week that were reported a lot of the retailers were reporting higher gas prices are starting to pinch and hurt their business. We’ve got rising interest rates. And remember we’ve got a trillion dollars of adjustable rate mortgages that are due to reset and a lot of these people aren’t going to be able to meet those payments as those mortgages get adjusted upward. We’ve got rising inflation weighing on the market, we’ve got tanking financial markets globally as we’ve seen especially in emerging markets. Emerging markets have fallen off a cliff here in the last month. We’ve got the President’s poll numbers are down. And John, I would predict if all of these conditions: the Iraq war is as bad as it’s reported today we have $3.50 or $4 gas prices, the Fed keeps raising interest rates, inflation continues to escalate and the financial markets are in a free fall – I can tell you the Democrats are going to take control over Congress. And as they have said in their party platform one of their first priorities will be to begin to put together a committee and hearings on the possibility of impeaching the President. [1:08:48] JOHN: Yeah, it’s payback time. JIM: It’s payback time. Second is they’re going to raise taxes. They’re going to repeal the tax cuts and also raise taxes at the same time, and also get into price controls, and taxes on energy. They’re talking about price controls, breaking up the oil companies, putting price controls on energy. You know if you’re the President, sitting in the White House, and you’re looking at all this, or you’re the Republican Party and saying impeachment, tax raises, price controls, obviously what are you going to do to get out of this mess. JOHN: I believe they see this coming, and in seeing it coming there are counter moves they are going to have to be made. Usually it’s a series of strokes prior to elections, within two months say or the month of the election. JIM: Yes, because you don’t want to do it too early because if you do something now people will forget about this come September, October - people will have a short attention span, they’ll be focusing on something different. So, I’m just positing this as a plausible scenario, I’m seeing a lot of things that make me think what’s going to happen. Number one, you develop an exit strategy with Iraq, so for example imagine a peace deal with Iran. We’ve seen in the last 20 days the President of Iran wrote a 16-page letter to President Bush. And then on Thursday you saw Condi Rice gave a press conference, saying for the first time in 26 years the US is willing to sit down with Iran. And of course you hear the blustering. When the President got Iran’s letter, he said, “no way.” You’ve obviously got to play hard ball and act tough. The same thing when we tried to open channels on Thursday, suggesting a meeting with the United States sitting down and talking with Iran. What did you get on Friday, Iran said, “absolutely not, we’re going right ahead.” But what most people don’t realize is John, politically it’s not what is the headline you see in the evening news, it’s what’s being done quietly through the back channels right now. And let’s put it this way, the traffic is increasing tremendously. [1:10:54] JOHN: A rule of thumb in politics is never watch what they say, always watch what they do. And you’re right, people are very busy watching their p’s and they’re not watching where exactly they’re going. JIM: So, throwing this out, if they can defuse tensions between the United States and Iran we can get Iran to cooperate in Iraq because they know they’re behind a lot of the insurgency. And if that accommodation or treaty can be arranged between the two of them, watch what would happen by September or October the US or the President announces a gradual pull out of troops. JOHN: Well, you know one of the things we’ve been talking about too is when you look at the whole total price of oil on the world markets there’s a segment of it which is called the geopolitical premium. Meaning, if everyone is real nervous about what’s going on with Iran, and what could happen there in the Middle East then this of course has the effect of driving the oil price up. Now, obviously the Bush Administration can’t do much in the straight market supply and demand area but it could bring the GNI – the Global Nervousness Index – down and thereby assuage the geopolitical premium part of oil and they would score at the pumps. JIM: Sure, absolutely, because you know the supply and demand factors for the price of oil are somewhere around $50 a barrel; you’ve got another $10 premium because of strong investment demand; and then you have a $10 premium that comes from geopolitical tensions. So, if you can remove part of that geopolitical tension and also part of the investment demand, in other words if oil prices start to drop you’re going to have a lot of people exit and cover their long positions in the market and take profits. So, number one, you can see September, October if this can come about, the price of energy comes down, which means the price of gasoline at the pump comes down, so that helps. That helps lower the inflation rate, that helps to take away some of the pain of higher gas prices, and you can imagine the political windfall of the United States announcing for example its first stage of troop pullback in Iraq. The other hand thing I think they can do –and I think Paulson is going to be good at this – is hammer the commodity markets especially raw materials costs. That brings the CPI down and also enables and gives the Fed the excuse it needs to go on pause. At the same time you bring down long term interest rates as the price of commodities come down, so there’s less of an inflation premium. You can help refinance part of the debt bomb – this trillion dollars of adjustable rate mortgages that comes due in the next 12 months, and then you also place a stabilizer on falling real estate prices. This enables the Fed to go on pause, they can goose the money supply, they can monetize the debt, helping to bring down long term rates. And with all of this going on the stock market heads to a new high. So, John what you have by the November elections: peace with Iran, troop withdrawal from Iraq, the oil premium goes down bringing down gas prices with it. As that happens long term interest rates come down; commodity prices come down – this brings down the CPI. It allows rates to head lower, the Fed goes on pause, the stock market hits a new record. The result: you just checkmated your opposition at election time. [1:14:27] JOHN: Did you ever see one of these machines that throws out the ping-pong ball at one end and all sorts of stuff happens. That’s what it reminded me of. JIM: There seems to be evidence, you know you’re talking about engineering the financial markets but just take a look at the appointments: Bolton as the President’s key adviser from Goldman Sachs; and then this week we just got Paulson from Goldman Sachs at Treasury. Remember, when Clinton brought Rubin in 1994 when his ratings were really down and he had just lost control; he brought in Dick Morris; he brought in a Wall Street team. And there was a very famous point in Bob Woodward’s book The Agenda where they were saying, “how do I get out of this mess?” Bring down interest rates. So if you take a look John at the team: he’s got Paulson and Bolton from Goldman Sachs – similar to what Clinton did with Robert Rubin and Altman; he’s got Tony Snow as Press Secretary. He’s rebuilt the cabinet and this Administration is putting together an offensive football team, and one of the greatest mistakes that’s happened to his opposition over and over again is his enemies have always underestimated him. [1:15:47] JOHN: That is true. JIM: Now, can they orchestrate all of this? I can tell you this they’re going to move every wheel in the markets in Washington to do this because there’s a lot at stake here between two sides. You know you have an analogy that you like to talk about being a pilot, where the plane has gone into a nose-dive and you’ve got both pilots fighting over who’s got control of the yoke. JOHN: Basically everybody in the back is yelling, “pull up, pull up.” It’s a perfectly flyable airplane but in reality what’s happening is the pilots in the front are fighting over control, and so no corrective action takes place. That’s the danger anyway even as you were describing earlier when we were talking about what would happen if we ever had a regime change. Well, everyone’s going to focus on the impeachment issue and that will be news night after night etc, etc, but in reality the real crisis is still confronting us – we need to pull up. And they will not be doing that. JIM: No, and so in terms of is this a new era – our perfect storm – all that this really does is postpone the day of reckoning until probably after the elections – maybe the middle of next year, end of next year or in 2008. It
reminds me of that song of the 70s, it’s like they want to create
the aura or the illusion that we’re going to go back to normal
times. In other words: “Ok, we’re done with the rate raising
cycle things are over, inflation is in check, and the CPI will start
coming down, and the economy will start picking up, interest rates
will come down.” So, a lot of people on Wall Street and a lot of people in the financial press are looking back in history and are saying, “well, this is what happens every time we go through this boom bust cycle, and then we’re going to get back to normal.” They’re going to try to give the illusion that things are all coming back to normal, they’re going to try to engineer it and all they’re going to be able to do is push the clouds back for maybe one more day, and then eventually the clouds return. [1:18:28]
Truth the final frontier, these are the adventures of the economic ship compromise. Its 5 year mission to explore government statistics, to seek out true numbers and reliable data, to boldly go where no Fed chief has gone before. Inflation date 9522.6 – the compromise is dead in space, stopped cold by rhetorical obfuscation in her pursuit of real inflation figures. We’re attempting to get beyond the core inflation data to explore the naked inflationary truth. Kirk: What is it, Scotty? Scotty: Captain, there’s no reason for it but the computer’s fading out. Spock: Fascinating. Kirk: Computer! Request security procedure. Computer: Not to worry, inflation is contained. Dr. McCoy: Jim, Spock, what in the name of insanity is going on? Spock: My readings indicate a contradiction. Computer: You do not have the security clearance to access data you have requested. You can only access the core inflation rate. Scotty: Captain, what’ll we do? Kirk: Start your computations. Spock: Computing now, Captain. Computer: Please do not attempt to access the M3 or your self destruct sequence will commence. Warning! Warning! Warning! You should have contained your activities within the core rate. Self destruct sequence initiated. 3 minutes and counting. Kirk: Scotty, Warp speed in 3 minutes or we’re all dead. Scotty: My engineers are working on it now, Sir. We’ll have it within the hour. Kirk: Stop the computer, destroy it. Scotty: Going down, Captain. Kirk: I’m going to sleep this off. Please let me know if there’s another way we can screw up tonight. Dr. McCoy: I don’t know if you’ve got the whole picture or not but he’s not exactly working on all thrusters. Spock: Humans make illogical decisions. Computer: 3-2-1. [sound of explosion] JOHN: This is the Financial Sense Newshour you’re listening at www. Financialsense.com, that’s like making sense of something. The new programs are posted every Saturday morning at 0700 hours in the morning obviously universal coordinated time. Also known as Greenwich Mean Time. If you’re military it’s Zulu time. And that’s about 3am Eastern time here in North America. Also the call in line – the Q-Line – that we take questions on is open 24 hours a day 7 days a week. Whenever you happen to be listening to the program. If you think of a question you’re welcome to call in at 1-800 794-6480. That is toll free in the US and Canada, if you’re calling from anywhere else it’s not toll free but the number does work, just remember to drop the ‘1’. On to our Other Voices from today, Richard Loomis. [1:22:08] [1:22:20] JIM: Well, on the day we’re talking Exxon-Mobil is holding its annual shareholder meeting with a storm of protesters outside upset over its exiting chairman receiving a compensation package which he took for $100 million. Well, it seems not everyone loves Raymond, and to talk about it, joining me on the program is Richard Loomis from World Energy. Richard, I thought we might just put this pay package in perspective because his retirement package was valued at around 400 million. And let’s talk about his lump sum payment of 100 million. The media’s going with 400, even though what he took from Exxon is 100. Let’s begin with that. RICHARD LOOMIS: Well, I think accuracy is not in the media’s best interest – sensationalism is. I think Exxon stands out there like a shining beacon within the energy industry. It’s very visible so it’s hard for them to get a break. And if you look at Lee Raymond’s career I mean he didn’t do the job pandering to the media. I remember not too long ago he did a talk at IP Week – I think in 2005 and he arrived with some 20 bodyguards, and they still had people out there protesting and asking him to sign the Kyoto Protocol. And of course his comment there was: “Hey, I run Exxon-Mobil, I’m not a country, I’m not authorized to sign the Kyoto Protocol, whether I agree with it or not – that is really not relevant.” He was very, very pragmatic in his approach to the business he was with Exxon for a long time. [1:24:02] JIM: 43 years by the way. RICHARD: Yup, 43 years. And he took it through some difficult times and some good times. He also engineered the largest merger in the oil and gas history. And he steered Exxon-Mobil well. I mean there are those that would argue anyone could have done it. Well, I don’t know of anyone else who built arguably the largest corporation in the world and certainly our most profitable. So, did he surround himself with good people? Sure he did. But he also maintained a very consistent message. JIM: Well, the other thing to his credit Richard, if you go back to 1989 when he took over the reins of Exxon, he has had some of the best returns on equity of any oil company in the world – return on equity, return on capital – consistency. And during probably some of the most difficult times as you can recall back in 98 when oil prices got down to 10. And as he was pointing out to his critics, “nobody called me up and said how can I help,” when oil prices were at $10 a barrel. Here’s a man that manages the largest corporation on the planet, he got a $100 million pay package. And I wonder if we might just contrast that, for example this week Paulson was nominated as Secretary of the Treasury. His pay package last year from Goldman Sachs was 58 million. When Sandy Weil had to resign from Citigroup under a cloud of impropriety his severance package was a billion dollars. When Michael Eisner stepped down from Disney his compensation package was one billion dollars. In fact I can remember in 1998 Eisner’s pay package equaled one-third of Disney’s gross profit. [1:25:53] RICHARD: You didn’t see protesters out in front of Disney when those things happened either. But I mean it gets better, if you look at someone like Henry Mckinnell of Pfizer, coming out with 78 million over 5 years while Pfizer’s shares plunged 35%. I mean we’re in the habit of paying for no success. One of the most recent was Carly Fiorina from HP and her package totaled 43.5 million, and arguably she almost killed the company. So if we’re dealing in those kind of figures, and that’s what we’re paying for those that are not very successful, I can’t see how you can argue with Lee Raymond’s package – you might even say it’s too little. [1:26:35] JIM: Well, given what he’s running there’s a double standard. Nobody protested Sandy Weil’s compensation package under a cloud of impropriety. Nobody questioned Eisner’s billion dollar pay package, nor did anybody question the annual bonuses and pay packages that are handled out routinely on Wall Street every single year; or if you want to look at the entertainment industry what some of those people get paid in compensation packages. So what you have here in my opinion is a double standard. RICHARD: Well, I think and we have to congratulate the Exxon-Mobil board and shareholders of Exxon-Mobil: they haven’t bent to this controversy. It’s done, it’s over, and they’re moving forward. And I think if I look at this and I say, “alright, what did Mr. Raymond not do well.” I mean he really did not come out and pander to the media, and they’re punishing him now, or punishing Exxon-Mobil. I think if I look at this and I say how do you justify complaining about this with the level of value he brought to the shareholder? You really can’t. I mean unless you want to go through every industry and say you’re going to pay an exorbitant and shareholders are not going to put up with it. I think T. Boone Pickens went in for that in the early 90s with shareholder rights, but in this case the shareholder’s are pleased, besides GM, he called global warming bad science. For that he doesn’t deserve his exit package? [1:28:06] JIM: Yeah, it’s really a double standard because Paulson’s going to Treasury, you know they released his compensation package last year and of course a lot of the top heads on Wall Street, you know 50, 60, 75 million is nothing and you’re talking about an annual pay package. Here’s a guy that started out at the bottom worked his way up through the ranks 43 years at a company, through some of the most difficult times. The only thing I’m trying to point here Richard as your article did, it really is a double standard. It’s kind of like it’s Ok for Sandy to make a billion, it’s Ok for Michael Eisner to make a billion but it’s not Ok for Lee Raymond. And it just goes to show and I think this goes back to the muck raking days of Ida Tarbell, the oil industry seems to be everybody’s favorite whipping boy. And this is just another example of that. I want to move onto another subject, and the article Venezuela under Chavez, and a World Energy hosted a piece that was taken from a lot of people that was taken from within the country from the Interior Minister…and why don’t we talk about what’s going on in Venezuela since OPEC is meeting there as we speak. RICHARD: Well, it’s interesting, you have two things happening in Venezuela. One, you have Venezuela by Hugo Chavez. And in Venezuela by Hugo Chavez it really is power for the people, and he’s put together this utopia where the poor are working, and he’s taking care of everyone. And he’s reaching out to his neighbors, and then providing them with low cost energy and encouraging them to I guess resist American capitalism, and to take back their resources as we just saw in Bolivia. And now Ecuador’s following a similar pattern. And so there’s that side of Venezuela, the side that we can see. And of course, Mr. Chavez controls the legislature, the judiciary, the media, the television so he can put out this very nice image. What we did in that editorial is we went and interviewed the individuals who started out on Hugo’s side, so they were on his team. Milos Alkale [ph.] was a career diplomatic, he was Venezuelan Ambassador to the United Nations, he resigned in 2004 that was 2 years ago. We went and interviewed Louis Justi [ph.] who is the last successful president of Pesaveda, and I say successful because he held the job longer than anyone, and turned the national oil company into a real contender globally. And of course we interviewed several others trying to see what insiders would say about what’s happening in Venezuela, and the picture was very, very different from the image that Chavez would like us all to see. And you see production dropping for Pedevesa. And it’s interesting if you take the numbers as reported by the central bank of Venezuela one of two things is happening, either Pedevesa’s production has dropped further than is being reported, or someone’s pocketing the difference because the deposits aren’t there. And I don’t know what that tells us except that you know someone’s not being completely honest with the rest of the world. If you look at the heavy oil I guess they’re coming up in the Orinoco Basin there’s a reason why Hugo Chavez wants to count those reserves. Right now he’s pitted himself in OPEC as we need to cut production, we need to try and keep the price of oil high. He can’t do that unless he commands as great a resource basin as Saudi Arabia. So you have these contentious factions going on within Venezuela, and then contending with the rest of the world, what will Hugo Chavez do next? As I talked to some of the CEOs who operate down there it’s very interesting they’re not given very much of a choice with how to work with Pedevesa – it’s this way or no way. I mean we’ve seen that over and over again. Interestingly enough the only company to really resist Mr. Chavez is Exxon-Mobil again, under the leadership now of Rex Tillerson –then Lee Raymond. And he’s started to do these interviews and this picture starts to unfold of you have this sheen or this veneer projected by the Chavez administration and then this corrosive effect underneath it. He’s already announced that he’ll win the election by 10 million votes – I guess it helps if you own the company that’s preparing the voting machines. I heard a fun statistic they have one gentleman in Venezuela who is apparently 175 years old. And we have an ungodly number of people who are over a hundred years old who have registered to vote – some 49,000. So either something wonderful is happening in the water down there, or we can’t really trust the registration. So what kind of things are going to come out of Venezuela. Here is a person who has put together a media machine, he’s certainly locked down the government, he’s got all the branches, he has his own programs in place, poverty is going up, you know you hear all kinds of numbers from 49 to 57%. The economy is doing Ok because of the high price of oil, but he’s steering those funds into buying favor from other nations. Sometimes it works – I mean he’s not doing as well in Colombia as he was doing before; Peru doesn’t seem very happy with him; Mexico is certainly not pleased. But others are willing to work with him: Argentina, Brazil. These countries don’t see much of a choice: it’s either his way or our way and they’re not very fond of what’s going on in Latin America. And this is not a subject that is going to go away. If Hugo Chavez lives up to his own predictions he’ll be there for another 40 years in Castro like fashion. I think what’s more concerning is his relationship now with Iran, his support of Hamas, his willingness to come toe to toe with the United States on just about any issue – arming his own citizenry to say we will resist any US invasion. The last time I looked I don’t think anyone had any urge to go run through the jungles of Venezuela. [1:34:22] JIM: The one thing that he has had going for him is oil is around $10 to $12 a barrel when he took office so we’ve seen over a 600% increase in the price of oil. That has helped because the statistical figures I’ve seen from the BP annual statistical survey of the oil industry, his production is down somewhere in the area of 40% to 46% since he’s taken over. You know, he’s been fortunate enough because he’s fired basically everyone who ran the oil company and put in his own cronies but while his production has fallen the price of oil has gone up over 600%, and that’s been his saving grace. RICHARD: Well, his call to OPEC is to reduce production which is going to keep the price of oil high. Of the announcements I’ve seen so far OPEC has no intention of cutting back production. The statement from the current Ambassador Bernardo Alvarez that’s also in the publication they’ve put some very aggressive targets of implementing a very aggressive $56 billion business plan to boost production to 5.8 million barrels per day by 2012. That’s highly aggressive – without the expertise as you pointed out he let go of more than half the company, and has put cronies into position who don’t have the experience to make that happen. The last numbers I saw they were reporting they were down to 2.6 billion barrels per day. That would mean he would need a spare capacity of another 2.5 billion. At their peak under Louis Justy they were at 3.2 or 3.3, somewhere in there I can’t recall, and they were doing very, very well. And under an aggressive plan at that time they anticipated being able to increase their production to some 6 billion barrels. But that plan has not been followed, and the idea that you can put a plan in place today to get them to that position is highly unlikely. Particularly when he likes to take the profits he’s receiving and use them to curry favor in other countries: like giving away low cost oil in our own Northeast to poorer neighborhoods; or in trying to elect a more liberal president in Mexico who will help keep their resources privatized. Pushing Morales in Bolivia towards nationalizing his natural gas field could, one, be seen as trying to help Bolivia which is the position he’d like to put it in, but could also be seen as a way to prevent Bolivia from securing its position as the natural gas provider for Argentina, and clearing the way for the pipeline Hugo Chavez would like to build right through the jungle and into Argentina. Is he taking a long term strategy or is he pushing the Bolivarian revolution? I think it’s anyone’s guess. Strategically, his moves to lock down the Venezuelan country have been done very well, so we can’t call him a fool. [1:37:40] JIM: Well, you know the one thing that seems to happen and Richard this reminds me of almost a throwback to the 70s when you had Peron, and what we call the el caudillo take over and run most of the Latin American countries. And it’s interesting Alan Garcia is now being perceived as the front runner in Latin America and he basically ran Peru into the ground in the 80s. Now he’s come back and he’s considered let’s say the moderate compared to Humala, the other guy. So, you’ve got a situation where it almost reminds me we’re going back to the 70s where you have the dictator take over the country, and those policies as you recall, Richard, ran the country into the ground: resource production scarcity, shortages and hyperinflation. It’s interesting that that the Venezuelan currency since Chavez has taken over the country has gone down by almost 300%, and inflation in the country is running now at 17%. RICHARD: Well, you’re correct. I mean in the last editorial that Ramirez the energy Minister wrote for World Energy, he talked about grandiose projections on where Venezuelan production would be. And no one’s called him on it but they’ve had several shortcomings and production falling and it continues. In Peru, you mentioned Garcia, I mean his campaign promises is I will oppose Chavez and that seems to be getting him some ground and he’s hoping that nobody notices that his last run at President didn’t go that well. You’ve got to wonder what’s going on with Latin American politics. Chile still seems healthy but who would be the next one who would begin to nationalize their resources, and think that this is a good idea? I mean it’s anyone’s guess but you’ve got to be looking at the countries they are trying to curry favor with Venezuela, or trying to follow that model. And I think if you look at the success Hugo Chavez would like to project, you know he paints a very pretty picture, Allia [ph.]Rocky Rodriguez who was the head of OPEC for a few years did several editorials for us from that position and then as head of Pedevesa just before Mr. Ramirez took it over, and in those editorials he outlined a strategy of investment. And that strategy was derailed when the Pedevesa employees said hey, we’re not following the strategy we’re going to go on strike.” And then of course since then they’ve not been able to put it back together again. We’ve had reports also of refineries exploding, and other issues that Venezuela doesn’t really want to publicize that would call for even less production and inability to meet these contracts that they’ve put in place. [1:40:41] JIM: Well, it’ll be interesting as inflation continues to heat up into the country the currency continues to go down as well as the country’s production, how long he can hold this together and perhaps that’s one reason why he’s putting together his own private army of 100,000 – I guess what is it, 100,000 AK-47s – and maybe he’s doing exactly what Castro did which is just have your own private police force. RICHARD: Well, he’s creating militias, you’re correct, to secure his position with the military. Then you look at the position, where are they? And one of the problems that they’ve got is that the opposition is stifled by controlling the media, by controlling each of the houses of government, controlling the voting machines, controlling the registration, having a blacklist for anyone who opposes you makes it very difficult to get a real picture. The individuals that talk to us I thought showed real courage in willing to come out and say what’s going on down here, and that’s not the picture that we would typically see. And if I look at the editorials we’ve received from the region they don’t show this either. The editorials we’ve had from Pedevesa and from Petrobras and from Argentina have all been rosy – things look very good down there, come on and invest with us. It makes you wonder doesn’t it.? [1:42:06] JIM: It sure does. Well, Richard, unfortunately we’ve run out of time. I want to thank you for coming today and speaking to us on Other voices. Why don’t you tell people about World Energy, your website, because it’s really one of the most unique newsletters in the energy business. RICHARD: Well, for the last 10 years we have been publishing world Energy Magazine which is a quarterly publication entirely written by the CEOs, Presidents and Chairmen of the industry. Lee Raymond has been one of our authors since 1999. You’ll also see editorials there from the energy minister of Saudi Arabia and from Alatia [ph.]of Qatar, and a gentleman like Mr. Ramirez from Pedevesa – talking about how they see the industry. We have the World Energy Monthly Review which is where we take a look at the topics the corporate executives can’t really address. And that’s where you get these editorials like Not Everyone Loves Raymond and these pieces that we did from the executives in Venezuela themselves. The Monthly Review kind of connects the dots – we try to say if this is what’s happening around the world this is what we need to be aware of and what we need to be looking at. And of course our research comes from our visits with the CEOs as we prepare our quarterly. And then one of our most exciting projects we’re going back out on television with world energy CEO roundtables. I call it world energy television. The next 5, we’re going to turn it into a weekly broadcast, you’ll be able to see those directly over our website also. But the first five on how technology applies in the industry, how do we do this, how do we increase production, how do we work towards energy independence and what technology’s are going to allow us to do that. And as you mentioned it’s all tied together by our website which is the world energy source. And on that website you can read every editorial ever written for the last 10 years by these CEOs. You can also subscribe to the Monthly Review and see our analysis of what’s happening around the world and watch the broadcast. We also have one on one video interviews with CEOs, I think the last time I counted we had some 400 different interviews with everyone from the head of dominion to Schlumberger to Shell Oil, all participating in on-camera dialogues as we like to call them. The world energy source and World Energy are really the voice of the industry in their own words, unedited and unfiltered. [1:44:37] JIM: Well, Richard, once again I want to thank you for joining us on Other Voices. I hope you’ll come back and speak with us once more. RICHARD: I appreciate the time. [Beegees Staying Alive] JOHN: Well, Jim that’s going to become a very, very important skill in the near future staying alive in any environment if the things we’ve been talking about here on the program are actually true – we’re going to have to do it, as we wonder whether or not that car is really going to pitch over the cliff, or not. JIM: Well, you know, one of the positive sides it doesn’t matter what kind of market that you’re dealing with – bear markets, bull markets – there’s always a place that money gravitates. If you’re having a bull market in stocks then you’re having a bear market in commodities that we saw between 1982 and in the year 2000. You have a bear market in stocks between the year 2000 to 2003, it’s been a great time to be picking up commodities. So everyone would like to find a great investment: the next Microsoft, the next Intel, or Google or Starbucks. The problem is what I think people sometimes try to do is looking to get a homerun versus consistent singles, or doubles. And it was amazing, we’re looking at hiring another CFA in our business and I was talking to a gentleman this week, a gentleman who has worked for one of the world’s richest men. I’m talking about a guy who is probably worth 6 or 7 billion dollars, which by today’s standards I guess when you look at Bill Gates or Warren Buffet is nothing, but a very wealthy man. And he worked on his money management team for quite some time. This gentleman was also an analyst for Value Line where he started out his career. He’s a CFA, and we were talking about the investment markets today and we were talking about the styles [of investing]. And one of the comments he made he said almost 60% of the investment style today is momentum investments. Whatever’s going up you latch onto it, fund managers, a lot of individual investors subscribe to the momentum style of investing, which is basically hop on board whatever is moving. Then you’ve got about 20 to 30% of the investors are sort of an amalgam of growth at a reasonable price – GARP as we call it – or some form of value investing. But there’s really only about 10% of investors today who practice what I call true value investing, and we ascribe ourselves to that kind of school. We were talking about it but when you take a look at the value investing style as advocated by Ben Graham and people like Warren Buffet. And Buffet is probably at the top of the game in terms of value type investors, although his philosophy is more Ben Graham and Phil Fisher. And one of the things that Buffet talks about a lot is finding the best companies to own and sticking with simplicity in a way. Many of the best companies that you would like to invest in are right underneath our noses all around us – we’re familiar with it. And one of the axioms Buffet has always talked about in his career and it’s in his annual reports is talking about finding companies that have a competitive advantage in either a product or service, and the durability of that advantage. Not something that’s a flash in the pan, that have a good product for a couple of years and they’re on top of the heap and then somebody invents a new mousetrap and replaces them. What he’s talking about here are businesses that maintain that franchise and they’re able to do that without spending large sums of money or capital to maintain it. One of the problems that Buffet always had with technology is you have the best mousetrap out there but all of a sudden somebody comes along later – a year later – and they invent a new mousetrap and they replace that, and so companies in the technology area have to spend vast sums of money to stay on top of the heap. And even look at Microsoft where you have upstarts such as Google today that are garnering more advertising dollars on the internet. And so you had Microsoft announce that they’re going to increase their internet spending by 2 ½ billion dollars, and of course Microsoft stock tanks. So, even though Microsoft is king of the mountain they could easily get pushed aside by somebody else – I don’t think that’s going to happen but nonetheless that’s what happens in the technology area. Buffet tends to stay away from those kind of things and so do value investors because, number one, vast amounts of money have to be spent in R&D just to maintain that; or you have a commodity type business that has to spend a lot of money just to maintain present profits. So what Buffet looks at is a durable competitive advantage and some of the things that indicate that, and the reason he’s looking at that is number one, he wants predictability of earnings. Earnings power must be consistent. He doesn’t want a company who’s earning are up 20% this year but next year they’re down 30%, and I’ll give an example of this in just a moment, but he also looks at competitive cost factors that are going to support profits. [1:50:42] JOHN: If you were going to try to find one of these companies Jim, what kind of yardstick or benchmark should I be looking for to determine that I’ve actually found it? JIM: Well, there’s a couple of benchmarks that Buffet will look at in addition to really understanding the company’s business model. Two things that I think stand out. One is a superior return on equity which is very indicative of a company that is well run. Either it has a competitive advantage in product or maybe on the other hand a service – and return on equity, one of his benchmarks is 15%. I usually like to see something a little bit higher today because I think the inflation rate are running higher.[1:15:21] JOHN: But, Jim, I think there’s some warnings that should go in here, aren’t there, because companies that have high return on equity also have high debt? JIM: Sure, absolutely, and I’m going to give an example here. The lower your equity base is if you have a good year in earnings the higher your return on equity. And we’ll get to an example that will illustrate this in just a moment. But the second factor is that you test that, in other words return on equity (ROE) if you have high leverage and you have good earnings in one year you can have high ROE. But the second thing that you test that with is high return on capital (ROC). And high ROC means not only the return on your equity but also the return on your debt, and that will usually weed out a lot of the weaker companies and get around this debt issue. And I think another factor, a third factor besides ROE, being number one, ROC being number two. And if you see high returns on equity, and high returns on capital consistently year in and year out that tells you, for example, that you may have found a company that either has a competitive advantage in products or a competitive advantage in services. A third factor is a historical track record, that is consistency of earnings. [1:52:40] JOHN: Jim, it would help right here if you could give us an example of the type of company that you’re talking about. JIM: Well, let’s just take two companies, company A is a company that you suspect has a high ROC, a high ROE and consistent earnings. And their earnings might be in year one $1, the next year $1.16, a year after that $1.28, $1.42, $1.64 etc and at the end of 10 years their earnings have gone from a $1 to $1.60, but what you see is a very consistent earnings trend. In contrast we might have another company that starts out with a big loss in one year. Let’s say they lose $2, the next year that make $0.06, the year after that their earnings go to $0.30, then that go to $0.50 the year after that, then the following year that have a loss of $0.40, the next year that have a loss of $0.60. And what you’re looking at there is probably a cyclical company during an economic upturn, that make a lot of money like the automobile companies but then as the economy slows down they get into losses. So Buffet wants a historical track record and what you look for is predictability so that you have a consistent earnings trend. And then I think another factor that’s very important, and something for investors to look at especially right now with the weakening economy, is low levels of debt. And here I’m going to give an example between two companies, one is GM and one is Wal-Mart. For example if you take a look over the last 10 years, GM’s total profit were $23 ½ billion over a 10 year period. Now GM on the other hand at the end of its fiscal year in 2005 had $255 billion in debt. There is no way that GM is ever going to pay off that debt. In fact, let me give you an example John if we take GM and this is what you can see many times with cyclical companies is they’ll do very well in an economic recovery. For example, if you take 2001, GM made 600 million. The following year in 2002, they made $1.7 billion and then 2003 they almost made $4 billion, their profits started to slow down to $2.8 billion in 2004. So in 4 years they made $9 billion in profit, but last year 2005 GM lost $10.6 billion. So, in one single year their losses were so great they wiped all the profits of the previous 4 or 5 years, and that’s what you can see with these kind of companies and that’s what you don’t want to see. In contrast, for example you take a Wal-Mart. Wal-Mart has total debt of $35 billion last year Wal-Mart made almost $11.3 billion. Wal-Mart, if it wanted to could pay off its debt within 3 years. In fact, in contrast to GM over the last 10 years, Wal-Mart’s profits have been about $68 billion. Even though Wal-Mart debt has increased from $10 billion to $35 billion you’ve also had Wal-Mart sales increase from $100 billion to $300 billion, and their profits go from $3 billion to over $11 billion. And once again they’ve seen their debt increase but it isn’t unmanageable, and more importantly they’ve had consistent earnings growth. By contrast, General Motors debt is getting worse, and they’re destroying shareholder value. If you take a look at shareholder equity at GM last year it was a little over $15 billion – let’s say $15.6 billion – GM owes more to its pension plan with retirement benefits and back pay than shareholder equity. So who owns GM? And that’s another thing that Buffet tends to avoid is unionized companies because this is the problem that you run into, they tend to be very unprofitable as investments. [1:57:04] JOHN: So, don’t invest in them. JIM: Very astute there. JOHN: I was listening, I was listening. JIM: Ok. But another thing too that you want to look at is companies that have the right kind of product and service. And one thing that you’ll see that I think people like Buffet do, is you look at a company that makes a product that people need, that people consume. So if it’s a product that people consume whether it’s See Candies, whether it’s Coca-Cola, or it’s Dairy Queen what you get is repeat purchases. And one of the things that we happen to like right now is products that people need and consume. [1:57:48] JOHN: Jim, is this what you’re always talking about when you’re talking about things like energy, food, healthcare, other staple items that type of thing? JIM: Sure, and of course I’ve written about this in The Next Big Thing, but take a look at energy I don’t think what’s going to happen in the economic you’re going to turn on the lights, you’re going to use your oven to cook dinner. So, you’re going to consume energy in some form; you’re going to put gas in your tank; truckers are going to have to put diesel fuel in their trucks to haul goods across this country as well as railroad cars; airplanes need fuel to fly. These are the things that people need. Another area and we’ll be talking about this next week when I interview Fred Pearce and his new book When The Rivers Run Dry is water. I mean without water farmers can’t grow their crops; without water we would die as human beings. It’s almost more valuable and precious to us than energy right now; and the on the other hand thing is we need clean water and we also need water to keep ourselves clean. So water is something that we consume everyday. Another area that you’re going to see me move into and talk more about is food. Food supply’s globally are down to their lowest levels that we’ve seen in nearly 3 decades. Healthcare as we’ve talked about if your doctor says take this pill because it lowers your blood pressure or take this pill because it keeps your cholesterol count down you’re going to take that pill, you’re not going to say: “Ah, I don’t know, I’m not feeling too good about the economy right now.” You’re going to refill your prescription. Consumer staples. I don’t care if it’s deodorant, to shampoo to toilet paper, these are things that people consume and need on a daily basis. And the other thing that I think is [important are] metal stocks, precious metals and base metals. And once again I go back to the supposition this is not a bubble as many have written about commodities. There aren’t large mines that have been discovered, and large supplies of gold and silver. We’ve been running supply deficits in gold and silver for the last 15 years and had it not been for central bank sales of large amounts of gold, gold would be much, much higher – almost 2 or 3 times higher than where it is today. Base metals would be much higher; silver prices. And the thing about energy despite some softness which I think is ahead for the energy market –which is going to spell an opportunity for many people to get back into this market if they’ve gotten themselves out – is name me the major oil discoveries that are going to come on line. And one of the mistakes I think analysts make all the time is they talk, “Oh this field is coming on line, we’re getting new supplies from this area.” Well the unfortunate thing is it doesn’t take into account all the field that have gone into decline and the word depletion, and we haven’t replaced what we’ve consumed since 1985. And so one of the reasons you’re seeing as we talked about last week why governments around the globe are increasing their strategic stockpiles is because the global capacity, the excess capacity of 6 to 8 million barrels that existed 15 to 20 years ago is gradually disappearing. So we’re down to one, maybe 1 ½ million barrels, maybe 2 million at best, but I really don’t think it’s 2 million. So any time like Friday with geopolitical tensions Iran talking about their nuclear program, one of the other stories that hit the newswires on Friday was Nigerian rebels. On one of the platforms the Nigerians kidnapped a bunch of oil workers and the rebels in that areas said, “we’ve taken Shell offline now, and cut their production and now we’re going after Exxon.” So all of that creates tightness in the market. [2:01:42] But getting back to the investment theme is when you have things that people have and need and part of my perfect storm and my ark scenario is going to be precious metals, it’s going to be food and then it’s going to be energy and water. These are things that people have to have. And quite honestly governments will go to war over these things. The other element I would just put it in terms of reviewing this again where we’re going in terms of what makes a good investment: number one was high ROE; you balance that out to make sure that have a high ROC; a historical consistent track record of earnings; low levels of debt was number 4; number 5 is the right kind of product or service – things that people need; and number 6 is pricing power. Remember, we’re entering an era of inflation, and one of the stories that hit the wires this week was Dupont talking about they are now going to raise prices for the second time in the last 12 months because that were unable to recoup their cost increases in raw materials in the 4th quarter and the 1st quarter of this year. And one of the things they said is this is unsustainable, we can’t operate a business like this if our costs are going up faster than what we can raise prices. Eventually if we continue to do that we go out of business because we start losing money. And then finally I would probably throw in a 7th factor which is a company that can add value through retained earnings and earn more on reinvested profits, because any time a company earns a dollar they have a choice, they can pay out a part of it to shareholders in the form of a dividend, or they can retain it in the business. And if they retain it in the business we go back to number one and number two. What are they earning on equity and what are they earning on capital? Because if they are retaining profits in a business but they have poor returns, and they’re generating cash but they’re not deploying cash, these kinds of companies become take over candidates because they’re misusing shareholder money and misappropriating funds. And companies that have large cash balances and they have an ineffective way of investing in a business they really should be returning it to shareholders. [2:04:06] JOHN: Well, basically what we’ve tried to show today is that in any event as long as you understand what’s happening –I would say that’s the caveat, you really have to understands what’s really going on – you can actually make wise investments and actually profit from that. But it’s also been a lesson here in that there are relationships between politics and the fundamentals of economics and technical analysis. They are all interrelated and a lot of times in emails they will say stick to this, don’t go there, they’re all tangled together you cannot extricate them – they’re all interrelated. JIM: Yes, I mean the fact that the Bush Administration is shaking up his cabinet, he’s bringing in a guy like Bolton, and Paulson from Goldman Sachs on Wall Street – this is politics and it’s going to be implemented in terms of what you’re going to see as economic strategy. And that’s going to affect the markets in terms of what’s going to happen. You can’t separate those and say I’m only looking at this, because if you’re doing that you’re only looking at two legs of the stool. If you’re looking at fundamentals and you’re looking at technicals if you’re not looking at the geopolitical or political aspect of it you’re missing a whole big segment of the big picture. [2:05:15] JOHN: I once had a flight instructor –since you brought up flying a little while ago here on the program – an ex-California highway patrolman, he made an interesting statement to me when he was trying to train me to handle emergencies. He said in any situation the rules don’t necessarily count, do your best to understand what is happening and then take whatever action is appropriate to deal with the situation. And I have found that applies clear across the board. It’s the same situation we’re looking at right now. In any situation in your financial life it’s not a matter of stocks versus commodities, it’s understand what is going on, take a look at the big picture, operate out of the fundamentals and then take whatever action is appropriate at that given instant. And where people get snagged is where they keep trying to stick with orthodoxy – to borrow a religious term – at different points, “well, I’m a gold man,” or “I’m a this man,” well, that’s what they’re doing you can’t operate like that, you have to understand what’s happening and then make whatever moves are appropriate to keep things moving in your financial life. JIM: Absolutely, first of all one of the hardest things any investor can do is control your emotions, and we’re all subject to those things, we can either get overly optimistic or excited or we can get overly pessimistic or very bearish. And it’s very easy to paint yourself into a corner and say, “I’m a bear, this is going to happen, and I’m going to ignore all the news.” I mean one of the things that we’ve seen is geopolitically in the White House the President is putting together a very offensive economic and political team here. [2:07:06] JOHN: It’s a swat team is what it is. JIM: And you just don’t bring in two guys from Goldman Sachs and think there’s not going to be changes that you’re going to see in the market place with an election coming up, and you don’t think the investment environment is going to change. Or when you see for example interest rates tick up in Japan above, what the bank wants it to do, and everybody’s got the assumption that Japan is really going to start ratcheting up interest rates, and lo and behold you have the Bank of Japan intervene to the tune of 1.2 trillion [yen]. There are a lot of things that are being misread right now, John, and it reminds me – going back to your flying analogy – sometimes you’re looking at your gauges and you’re saying what the heck’s going on here, something isn’t feeling right. [2:07:53] JOHN: Well, I would say, Jim, at this stage of the game your philosophy is working out because if we look at all the indicators across the board versus the different accounts and the areas that you’re operating in, so far the results for your clients are rather remarkably above what the standards are out there. And I can say, and I’m one of your clients that consistently over the last – well, we’ve been doing the show for 5 years – you’ve been outperforming the numbers all the time. That’s the proof in the pudding of any theory whatsoever, the proof is in the pudding. If it doesn’t work out there forget it, you can trash it. JIM: You know, I had a mentor several years ago and – I’m not going to mention his name because he wouldn’t want his name mentioned. He comes more from the technical side and I come from the fundamental side and he gave me a book to read on psychology and one of the most important things that I walked away from reading that book was learning to question my biases and my assumptions. And so what we have internally, when we make an investment we have a sheet that lists the funds, it lists the technicals and then it lists the assumptions. Why are we buying this company, what are the assumptions, what do we expect? And if the stock drops or if the stock moves and then if something happens we can always go back to that sheet to test. But one of the things we do and is probably one of the things I kind of enjoy now – originally when we started doing it I didn’t – but in our investment staff meetings as we review the portfolio we bring out the assumptions what we think and everybody in that meeting has a free rein to challenge – and especially challenge me on my assumptions, or challenge me on my thought or challenge me on why I think we ought to buy this stock or why I think we ought to sell this. And that I find John has probably been one of the great breakthroughs in my investment career probably over the last six or seven years, and it has really paid off in terms of the performance because it is very easy. And I’ll give you an example when I wrote the perfect Financial Storm in 2000-2001. It was very difficult to go against the grain, and especially the technology market, and I can tell you as a money manager getting out of tech stocks in December 1999 cost me clients, cost me business. Buying some of the commodity stocks in gold in 2001 and 2002 in terms of what I was writing also cost me some business because people were saying: “What in the heck are you doing buying gold. Or: “what the heck are you doing buying oil, who would buy oil?” Also, after the events of 9/11 watching what transpired in 2002, 2003 with the money supply and what happened to the market and what happened to the economic, the 0% loans, seeing real estate take off instead of going down, consumer debt. Looking at all of that and sitting back and saying wait a minute, The Perfect Storm, what they’re doing is actually postponing this. And that’s why when I did the studies on the great inflation and said something is different here [the way] this is unfolding, and it was that epiphany that also helped accelerate our performance because remember when we wrote the Great Inflation all the attacks that came with like you’re an idiot, and well, look where we are today two years later. So, it is getting rid of your own biases, filtering those biases out, and not letting your emotions and biases get the best of you. Once again I would say, 5 years ago, this is probably one of the biggest breakthroughs that I had coming from the fundamental side on investment performance. [2:12:01] JOHN: You know I have really come to believe what we should do is keep a “nyan, nan na nyah” file because if you notice when people will tell you you’re an idiot, when it pans out two years later they’ll never email you back and say gee golly you were right. We need a “nya, na na nya” file so we remind them two years later remember you told me this, you were wrong. JIM: Yes, and it goes back to as everybody remembers our call for gold top the last two weeks of last year, it’s also coming to the recognition you made a mistake. And that’s also important too, because there’s a couple of things that you can do as a money manager: you can say, you can overlook that and say I’m going to ignore it and then what happens I’ll say I’m going to hold on till I’m eventually proven right; or you could start doing some things and say no, I was wrong on that. And that’s also important too. It’s not just sticking with what you believe and checking in your biases but also admitting to yourself, hey, I’m wrong. [2:13:00] JOHN: Jim, this program has run fairly long today, we are not going to do the Q-Line we’ll roll those over to next week so your calls this week were not in vain, and the same for the emails but there’s a big sea change that has occurred this week. It’s a lot more important than I think some of the main line media have emphasized and we needed to cover that one, so that’s what we’ve done here today. JIM: Yes, so once again we apologize to the Q-Line calls. We’ll try to get to those and make a point of it, and there were so many things happening this week that we just had to get them in and one of the things that I just want to tell people that happens we had two interviews this week and we’re going to have two interviews next week. One of the problems that you have with people in the investment community and authors is sometimes you can get them and you’ve got to get them on their schedules because they’re on speaking tours and especially people on Wall Street. So next week we’re going to have James O’Shaughnessy will be my guest, and we’re going to talk about his new book in terms of figuring out where the market’s going. And also something that I think is going to be very important, I’ll be interviewing Fred Pearce he’s written a book called When the Rivers Run Dry, and it’s talking about the coming crisis in terms of water. So, water and energy to me are two of the foremost areas of crisis prone resources that are existing today. And so we’re going to talk to Fred Pearce. Well, once again, our apologies for going long but there was just so many things happening that we wanted to fit it all into one show, maybe we should call this week the Financial Sense Newsday, John but anyway – yeah, we say this but it just keeps getting longer. [2:14:38] JOHN: But if we ever expanded it to the Financial Sense Newsday it’s going to be the Financial Sense News Year before we get done. We might as well call it the FSN Financial Sense network “24 hours, when it breaks first, right here on FSN.” So, you see we’ve got it all ready to go. JIM: Well hopefully there’s enough out there and unfortunately our author’s and guests in terms of interviews are just stacking up on us, and so when that happens we get a little double time here. In the meantime, on behalf of John Loeffler and myself we’d like to thank you for tuning us in on this extended Financial Sense Newshour and until you and I talk again we hope you have a pleasant weekend. © 2006 James J. Puplava, Financial Sense™ Newshour |
Historical Rhythms
- the Economic Ship Compromise