The
BIG Picture Transcript
November 3,
2007
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Part 2
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Part
1
$125 Oil: Further Evidence of Peaking
The Land of Oz
Q-Calls
Part 2
What Were They Thinking?
$1,000 Gold and The Junior Bonanza
Q-Calls
$125
Oil: Further Evidence of Peaking
JOHN: Well, Jim, there are weeks and then there are weeks. I mean, some weeks you get on the air and go: “I don't know, what do you want to talk about?”
“I don't know. What do you want to talk about?”
“Well, I asked you first. What do you want to talk about?”
This week it’s: “Do we have to talk about all of this stuff here?”
JIM: Yeah. It's just the opposite of what we were seeing in the summer, John, which was the slow news day – until we got to about August when this whole mess began to unwind.
But, yeah, you're right, some days you kind of look like, “Well, what are we going to talk about? There is nothing there.” But lots of stuff this week. [0:46]
JOHN: We have oil prices are crowding...Well, they are over 90 and I think they are going to keep crowding 100 very shortly. You try to tell these people but they don't listen to you. We've been saying this for a year that all of a sudden everybody is going to be talking about oil. Everybody is acutely focused on the oil markets. People are wondering why oil prices are this high. And if we flip on the tube, the common explanation is that this is a hedge fund or hot money or the ever popular speculators driving up prices. But I guess we don't agree with that. There are some fundamental reasons why prices are this high and they are basically fundamental and actually geological to start with.
JIM: Well, if you listen to this program, we've been talking about higher prices way back to January. And John, you remember, the first couple of weeks of the year oil dropped from 70 down to 50, and they had warm weather in New York and they were talking about oil going to 30 or 40. And we said we're likely to see 80 more than we were to see oil at 30 or 40; even though the experts were telling us $40 oil. And the reason they were doing that is the US economy was slowing – and remember, the GDP numbers that we got in January where we were under 1% US economic growth. But you know, if you don't understand the peak oil concept then none of this seems to make sense. [2:15]
JOHN: Well, I would think that it would all boil down to basically demand and supply issues. That would be my thought on it.
JIM: You're right on the money there because the rate of growth in oil demand over the last couple of years, it doesn't matter who you're looking at whether you're looking at OPEC's numbers or the IEA. If you look at OPEC, they are saying in the last two years oil demand globally has grown about 1.3 to 1.5 million barrels a day. The IEA estimates are a little bit higher. They range anywhere from 1.2 to 2.1 million barrels a day. So here is the interesting thing. Despite the fact that we have seen higher oil prices over the last three years, demand has grown instead of weakened. And John, you remember, gosh, we've been covering this and talking about it for six years. You remember when oil moved from 20 to 30 and then there was, like, “boy, if we hit 40, that's it, the economy is toast.” Then it was 50, then it was 60, then it was 70. And you remember the demand destruction, so-called, event after Katrina and Rita when oil hit 70. And here on this Friday, we're looking at $95.53. So you take a look at these higher prices, demand did not weaken. Instead it grew.
In addition, world economic growth has been running around 5% a year. So economic growth is driving demand despite higher nominal prices. And another factor is there isn't sufficient production capacity in the oil market. If you go back a couple of decades ago, OPEC's spare capacity was 10 million barrels a day. Now that capacity has shrunk to 2 million barrels a day and most of that 2 million barrels is in Saudi Arabia. So there is no magic switch that we can flip on which is going to flood the markets with more oil and bring prices down like, let's say, OPEC was able to do two decades ago when world daily consumption was in the neighborhood of 60 million barrels a day versus 85 million barrels a day. [4:29]
JOHN: You know, this is an important point to make, Jim, because a lot of the discussion about peak oil centers around how much oil is actually in the ground. You hear if we can just open up Alaska we'd be gushing in oil and there wouldn't be any problems. But in reality what we're looking at here is there is it’s not just the quantity of oil, say for example, tomorrow the Gulf of Mexico were to turn into a giant vat of oil. It would probably have little bearing on anything. We couldn't produce it that fast. That's an important concept. One is the amount of oil there. The second is the amount of oil that we can process. This week www.secureenergy.org had posted on its website a new article, on November 1st a new version of Oil Shock Wave, Oil Crisis Executive Simulation which was conducted in Washington DC. And we're going to run a couple of clips from their website that are very pertinent to what we're saying right now:
It only requires a relatively small amount of oil to be taken out of the system to have huge economic and security implications and I think that's the message.
JIM: What he's talking about, here, John, he's making the point that there isn't any slack in the system. Whether you get a weather-related event such as the hurricane that's growing in the Atlantic right now, a geopolitical event or an economic shock, it will only cause prices to spike because there isn't any spare capacity. And as you were mentioning, even if they were to make a giant oil discovery, let's say they found another North Sea or a North Slope, it may be 10 years before that oil is brought on stream. Like the oil discovery that they made in the Gulf of Mexico last year, the Jack discovery, the oil is so deep they don't even have the technology yet to extract it. And even if they develop it, we may be looking 10 years from now. The problem is we have a problem right now and there is no available surplus and so what we're doing is we're digging into inventories. [6:30]
JOHN: Why do you think the prices are where they are right now? Is there a possibility that these things could correct rather sharply.
JIM: Well, you know, there was a bit of a correction, I think it was on Tuesday where I think Goldman Sachs came out and said, “Oil has had a nice run up, we recommend people sell.” And the price of oil dropped $3. And guess what? The next day it was right back up and now we're at a new record high. Sure, I mean they can come in with derivatives and move the price lower, but I just don't think so. Even if you take a look at what happened with the Goldman recommendation to sell, it went right back up.
So the problem is we're entering into the colder weather months of the year where demand picks up in the fourth quarter. Demand is expected to rise to 87.1 million barrels a day according to the IEA and OPEC. That's up by one-and-a-half million barrels a day from the third quarter. The problem we have here is non-OPEC countries are supposed to produce roughly about 56 million barrels and OPEC is supposed to produce 31 million barrels. The big problem is supply is short by almost 300 to 500,000 barrels a day. So the markets are going to face a shortage, which means that shortage is going to have to be made up from existing oil stocks, which is what you're starting to see right now. The drawdown in stocks is leading to the higher prices. The more that our stockpiles are drawn down – and that's reported – the higher prices are going to spike. [9:41]
JOHN: Isn't it true there are also problems in the entire energy system because there are bottlenecks everywhere that plague the system; say, for example, lack of supply to actual shortages of excess refinery capacity. It's the whole system from start to go.
JIM: Sure. That's another issue because in the US, we don't have enough refinery capacity (we haven't built a refinery since the 1970s) and we now find ourselves in a bad position where we have to import gasoline, diesel, jet fuel. And the other thing, our refineries are so old that they are starting to break down more often; there is more downtime from maintenance. The system is worn out and it's breaking down. Many of these refineries are 50 to 70 years old. And on another level, the level of oil stocks are down considerably. In fact, in the US, we're down around 76 million barrels from where we were last year at this time in the US. European stock piles are down roughly about 18 million barrels. As stock piles are drawn down, prices are heading higher. [9:20]
JOHN: So if supplies are tight and we have very little spare capacity, then I would think at this point we would have to start worrying about geopolitical tensions because I'm sure most of the governments and energy agencies in these various countries are aware of this. And it seems like any kind of a geopolitical event, such as Turkey going into Iraq, all of this is going to threaten the supply and that would spike up prices very rapidly.
JIM: Sure, because traders know that supply is very tight right now. Inventories are falling. So any time there is a geopolitical event or concerns in the Middle East, they have a greater intensity and significance – whether it's Turkey moving into Iraq as you mentioned, Iran threatening Israel, or rebels shutting down production in Nigeria. It doesn't matter what it is. There is just no slack. So the problem is the US and the West are very vulnerable to another oil shock, which I believe is coming. Energy security dominates foreign affairs today. Any time the G-7 get together it's at the top of the agenda. And unfortunately in the US, we don't have an energy policy. The President proposed one several years ago but it was inadequate. And Congress – take a look at what they’re doing, they are focusing on carbon trading credits this week. So Congress is focused on global warming, which is three to four decades out there versus peak oil, which is on our door step. [10:51]
JOHN: Let's go back to Oil Shock 2007. This is addressing the whole lack of an energy policy:
I don't think there is a foreign policy or national security solution for our energy predicament. It distorts our foreign policy, it distorts our national security. By the end of the day it's going to be the conversation you just ask for about really energy policy that is going to have to be the focus. If we succeed there, it will to some extent liberate our foreign policy and our national security from many of the challenges I believe we now face. And if we don't succeed in coming up with a better energy policy, we will continue to be twisted around this reality that, as you said before, relatively small developments over there have enormous developments here economically. [11:37]
JIM: You know, that clip just absolutely amazes me because it's an issue we've been covering here on the show numerous times over the last several years. And we've got only one option available to us, which is a military one, because we're totally unprepared for an oil crisis. If somebody cuts off our oil, whether it's a Chavez or a Middle Eastern country, then the only option left is war. [12:05]
JOHN: You would have thought that after the last crisis which we went through in the 70s – at least for those of us who have the courage to admit that we lived through it, because we're that old – you'd think we would have prepared or done something about it. But after we went through the crisis everything just slid back to business as usual and no one seemed to be concerned about the whole thing. Participants in this strategy discussion which went on in Secure Oil sums it up very, very well.
I have worked in Washington for six presidents over the last 40 years. And I would tell you that in my perception, other than the Cold War, long range planning in the American government tends to be about a week from today.
JOHN: I mean it is so true.
JIM: You remember all of the out cry after Katrina and Rita, what did we do after that? About the only thing we've come up with is corn-based ethanol. [13:01]
JOHN: But that's what tends to be the rule in Washington. Until reality sets in, politicians don't panic and then they panic because that's what's on their constituents’ minds and then they move back to whatever their agendas and programs are. Very little is ever done proactively.
JIM: The tragedy here is that as oil prices head over $100 we're going to pay a terrible price for being unprepared. Because what do we do when we get $120 oil, or as this panel in Washington this week talked about $160 oil in terms of a crisis? That is usually, as you pointed out, what happens. We need some kind of crisis to occur before the politicians and the country usually wakes up to our vulnerability. John, play that clip, where the one expert warns us of this crisis really unfolding as the prices of oil head even higher.
As we look at the consequences of $120 oil or more a barrel and gasoline at $5 a gallon, that the American people are going to pay a terrible price, at least in the short term for not having had a strategy. [14:11]
JOHN: You know it's really revealing this week. There was a White House press briefing on the economy after the GDP numbers came out this week, one of the questions came up was as follows:
How do you think the economy is going to be able to stand the pressure of these increasing oil prices that we're hearing so much about this week?
Ans.: The way I think of it is we have already felt the pressures of the oil prices. They are reflected in the current numbers. That is we can always say: But for growing oil prices, what would our growth rate have been? And it probably would have been higher. The point is the American economy is resilient and it's able to shrug off higher oil prices, primarily through gains and productivity growth and through expansions into other sectors. So, for example, the service sector is not quite as sensitive to oil prices as is construction and manufacturing. We have a very strong service sector. The service sector continues to grow. And that's one way that the economy adapted to it. But there are a variety of ways even within manufacturing and construction. We simply see the high productivity growth offsets the cost of oil prices. If we have lower oil prices, things would probably have grown even faster. [15:24]
JOHN: You know what amazes me is all of that happy talk we see coming out of everything right now because the prices head up and we're being told they are going to come back down; Wall Street is talking about why prices are going to be doing that. They've been saying that for years now as each time it goes up to a new spike and a new high saying this is an unsustainable level blah blah blah, and then Washington follows in that train. Let's face it, Washington is oblivious to it.
I even saw some conservative think tanks. I was reading this last week they are buying some of these GDP numbers and everything else. They all just swallow the numbers and say, “see, isn't it wonderful,” and everything goes on and on. But the obvious is getting to be stronger and stronger here, but it gets very little mention even on the presidential debate. You look at the issues – and I watched the democratic debate this week and the Republican debates last week; the issues they are talking about are not these issues which are going to be the issues. And we're only 300 and some odd days out from the next election.
JIM: There isn’t a week that goes by where there isn't more evidence that peak oil is at our front door. On Thursday, Exxon Mobil announced their third quarter earnings. They were down due to decline in the refinery and chemical margins, but the company's oil and gas production business dropped 3%. I think the number was like 6.3 billion. But it was due to a 2% drop in production.
And there was another study that was released this week and it was done of 21 E&P (Exploration and Production) companies in the US. And here is what I found remarkable. What the study revealed, John, was very disturbing. It's been clear for probably many years that conventional production of oil and gas in North America has been declining. And here is the key thing. Since 1996, the average proven booked reserve additions per well – and I want to emphasize that, per well drilled – have been in serial decline while the well count required to maintain volume has risen. The result is that the amount of capital employed by the industry has begun to inflate rapidly and that's driving cost and price up. It’s the same trend we're seeing in Canada where reserves were flat for about 20 years and then they went into decline in 2000. [17:43]
JOHN: Well, overall, what is this basically telling us now as far as what the future is going to hold?
JIM: If you translate that study, it's telling us that there is a downward trend in proven reserves added per well despite the rapid rise in prices. In other words, rig count has been growing since 2003 and it's been steadily growing every year. Yet despite more rigs and drilling operations the operators are finding fewer reserves. In the past, John, when the rig count went up, reserves per well would also increase, but this is no longer the case. Even though higher prices are spurring more investment by the industry, which results in the industry doing more drilling and hopefully finding more reserves, it isn't happening. [18:34]
JOHN: Overall, if you look at it, this is not a very good picture. What is the bottom line for this whole thing/
JIM: You know, if you translate the bottom line, the industry is spending more, drilling more, but finding less. Only 5 out of the 21 companies studied actually were increasing their reserves per well found. This is a remarkable figure. Whether you're looking at production declines in the big companies or even the smaller companies that are increasing their reserves they are having to spend more money, drill more; and yet what they are doing is finding smaller and smaller oil deposits which means they are getting less bang for the buck. [19:15]
JOHN: Any other evidence or factors out there?
JIM: We touched on this, oh gosh, it must have been a month ago in a previous show. But revenues for the oil industry in 2006 were up roughly about 20 percent. But lifting costs or the cost to get it out of the ground and produced were up by 31%. And exploration costs, which means the cost of going out and finding it were up 26%. This is one reason why oil prices are going to continue to go up, John, because the cost of finding it, the cost of getting it out of the ground and getting it to the consumer are going up at rates 31%, 26%. There is no way you're going to produce at lower prices when your costs are going up to that magnitude.
On top of that, government's take in the energy business is also going up. Tax receipts from all taxes rose 12%, consuming almost 50% of all pre-tax profits. If you look at it from the perspective of the industry, last year, the industry spent $401 billion more than it took in in cash flow and yet reserves were only up about 2%. And on top of that, if they went on an acquisition binge, which is one of the ways the large companies are replacing their reserves, the acquisition cost for proven and unproven reserves increased by a remarkable 85%; or 139 billion. Companies are paying $11.42 per barrel of oil equivalent. So companies are struggling to replace reserves while at the same time they are finding it more difficult to control their cost. [20:55]
JOHN: Yeah. We've been talking for a long time about the perfect financial storm, and it would seem like a big factor is going to be the perfect energy storm. And that actually may be driving the perfect geopolitical storm given the way things are turning in the Middle East right now.
JIM: All three of those are interrelated because peak oil is going to affect all of us that live on this planet. With oil prices heading towards $100 a barrel and then beyond, shortages and price spikes are sparking economic and social tensions from Beijing to Tehran. For example, China announced this week they were increasing gasoline prices 10% on domestic gasoline and diesel prices. And what they are doing is in effect reducing state subsidies. People don't understand that in countries like China and the Middle East the government subsidizes energy; and they keep those prices way below market so that encourages greater consumption but it's causing problems. Shortages of diesel fuel are being reported in regions throughout all of China and that's forcing truckers in the transportation system to line up supplies. So you're going to see more of this as prices go up; and greater and greater demand is being placed on a system that is having major difficulties in supplying and meeting that demand. [22:20]
JOHN: And we should emphasize once again, now, there is still plenty of oil left in the ground. In other words, that isn't over with yet, but there is a problem. The problem is who has it and how do we get to at it? Nearly 85% of the oil that's out there lies either in an OPEC country or in the former Soviet Union somewhere in the ‘Stans or elsewhere. The easy oil worldwide is for the most part gone. And I think that's what most people don't realize. A lot of this argument has been about “if we just open up this area or did this or that, we'd be awash in oil again; and this could go on for hundreds and hundreds of years.” You hear this over and over again. But as you mention, oil companies are spending a fortune now to find more oil and gas. At the same time they are being threatened with more taxation because they are evil and greedy. But they aren't getting much bang for their buck anymore.
JIM: That's why we've been in energy for six years now, John. I've been writing about it. We've been talking about it. When I wrote my Perfect Storm back in 2000, 2001, I said if you wanted to be in four areas over the next decade and beyond to make money, I said precious metals would be number one, energy would be number two, water would be number three and food would be number four. And just look at commodity prices: Oil prices are at over 90 – almost $96 a barrel; we've got gold over $800 an ounce; we've got record prices for agricultural commodities; and water is becoming a scarcity.
And so that's why when you listen to this program, and any time we get a pull back in energy as we did earlier in the summer or earlier in the year in January, we tell people, “look, we're holding on and if you do get a pull back, buy more or add to your positions.”
It's another reason why we've been investing in alternatives because, John, at $100 oil and as we go over $100 oil heading towards 150 and eventually 200 and I think in a crisis we could be over 200 easily, a lot of these alternative are going to become economic. It's one of the reasons why you're seeing a lot of people, the technology billionaires or tycoons are moving into this area of alternatives because they get the energy picture. We're going to have to solve it. I think people are becoming more aware as you mentioned, the easy oil is gone; we're not finding it, we're not replacing, companies are struggling to keep up with production and demand keeps growing and it's insatiable. We're going to have to come up with solutions somewhere and it’s technology in some form that is going to be that solution. And I think the high tech venture capitalists are moving in this area and that's why we see this as a very promising area. [25:04]
JOHN: We've noticed too that over the last, what, six months to a year now, more and more people who come to as clients now are really sort of hot to be in energy. They are concerned about this because they seem to understand this as well.
JIM: Well, we made a strategic decision this week and we are opening up a new account and it's going to be strictly an energy portfolio. It's going to be for high net worth individuals and it's only going to be focused, John, in energy. That's all the portfolio is going to do. We're going to be buying energy infrastructure; we're going to be buying energy producers; we're going to be buying companies that are involved in energy bottlenecks; and we're going to be buying alternative energy.
But we've been talking and writing about this for six years and I take a look at performance figures – you take a look at the S&P 500 sectors, this year, there are ten sectors in the S&P. What stands out, right at the very top of the list, is the energy sector which was up 26%. You take a look at last year's top performing sector, it was energy. You take a look at 2005, energy was in the top one or two sectors. So John, it's every single year. And each year you and I go on the air and we're talking about higher oil prices.
We just had our client-only meeting on October 20th and every year I get before my clients and we're talking about higher oil prices. This year, here you and I are talking on this Friday and we're looking at oil prices close to $96 a barrel. So eventually we're probably going to end up having portfolios in certain sectors, whether it's going to be food, water. We already have a gold portfolio. Now we've started an energy portfolio because, John, think of what is going to happen when prices move north of a hundred dollars a barrel. The demand for energy, the demand for energy alternatives, the demand to fix energy bottle necks – this is going to be a boom industry.
And it's interesting. It's corroborated by, if you look at regional economics, if you go to Texas, the Texas economy is booming. Why? Number one, they never went through the big housing bubble like the rest of the country, but the reason it's booming is because of energy. And so I just think energy has been performing and delivering double digit returns every single year and I see that going forward. [27:27]
JOHN: What about the concept of diversifying? It would seem here you're sort of focused on one sector. There has got to be some risks entailed.
JIM: Well, sure. If you're focused in one sector and you had, for example, a pull back as we did at the beginning of the year when energy prices dropped down and we had that first market correction in February, they went down. And then we also had, if you take a look at the middle of July, the energy sector peaked and then we had a steep selloff in the major oil indexes. So yes, you have these corrections and especially today when there is a lot of money floating around.
But, you know, if you understand the fundamentals and take a look at where energy demand and supply is going, you don't worry about that as much. What you do is you ride out the downturns because just as the energy sector bottomed in the middle of August, what’s happened is it’s just been on a tear since then. So you're right though, by focusing on only one area...but it's not just one area, it's not just oil and gas. It's going to be alternatives; and it's also going to be energy infrastructure. [28:31]
[The Long Johns - The Last Laugh video ]
[03:07 in video]
JOHN: This summer there have been actual causes behind the volatility in the market specifically, and especially in America, granting vast numbers of mortgages to people who can't afford them, on properties which are diminishing in value
GEORGE PARR - BANKER: This is the so-called prime situation, yes.
JOHN: How does that work in fact?
GEORGE: Well, imagine if you can, an unemployed black man sitting on a crumbling porch somewhere in Alabama in his string vest. And a chap comes along and says, “would you like to buy this house before it falls down, and why don't you let me lend you the money.”
JOHN: And is this chap who says this, is he a banker?
GEORGE: No. No. No. He's a mortgage salesman. His income depends entirely on the number of mortgages that he can arrange.
JOHN: So his judgment to arrange mortgages is completely objective.
GEORGE: Completely objective. Yes. Absolutely.
JOHN: And what happens next?
GEORGE: Well, then this debt, this mortgage, is taken – bought by a bank – and packaged together on Wall Street with a lot of other similar debts. Without going into much detail about what is actually–
JOHN: Without going into any detail.
GEORGE: No, it’s far too boring.
And so this is put into a package of debt, and then moved on to Wall Street and this is – it’s extraordinary what happens – and then somehow this package of dodgy debts stops being a package of dodgy debts and starts being what we call a Structured Investment Vehicle.
JOHN: An SIV.
GEORGE: An SIV. Exactly.
JOHN: I see. And then someone like you comes along and – and buys it.
GEORGE: I buy it. Yes. And then I will ring up someone in Tokyo and say, “Look, I've got this package, do you want to buy it?” And they say what is it. I say I haven't got the faintest idea. And they say, “how much do you want for it?” And I say, $100 million and then they say, “fine, that's it.” And that's the market.
JOHN: Presumably this package, I mean that kind of thing can happen several times to the same package?
GEORGE: Possibly. Yes.
JOHN: And every time it does, of course, then you, or someone like you, will get a fee and a mark up, and so on...
GEORGE: And a profit. Yes. Well, you can’t expect us to do it for nothing. It's hard work.
JOHN: In view of the fact that in these packages is a lot of dodgy debt, what is it about it that attracts the financial risk takers?
GEORGE: Well, because these hedge funds as they’re called, which specialize in these debts, they all have very good names.
JOHN: You mean they are responsible companies.
GEORGE: No, no. It has nothing to do with their reputation. They have actually very, very good names. The names they think up are very good. I'll give you an example. There is a very well known American Wall Street firm called Bear Stearns who have two of these hedge funds which specialize in these mortgage debts. And they lost so much money – well, lost so much of its value – that Bear Stearns announced they would have to put in $3.2 billion into one of the funds to try and keep it afloat.
JOHN: 3.2 billion!
GEORGE: 3.2 billion. Yes. Yes. And even then they said the investors couldn't get anything out of it and they were going to let the other fund go. But one of these funds was called High Grade Structured Credit Strategies Fund and the other was called the High Grade Structured Credit Enhanced Leverage Fund. Well, that sounds very good.
JOHN: It sounds very trust worthy.
GEORGE: This is the magic of the market. What started off as lending a few thousand to an unemployed black man in a string vest has become a high grade structured credit enhanced leverage fund.
JOHN: I like the sound of it. It is good. It sounds very trust worthy. I mean, it’s got good words in it. It’s got words like High?
GEORGE: High is good. Better than low anyway.
JOHN: It is. Absolutely.
GEORGE: Yes. And structured is another good word.
JOHN: Very good. Enhanced.
GEORGE: I love enhanced. I'd buy anything if it said enhanced.
JOHN: Absolutely. Yes.
GEORGE: It might have been different if it had said The Unemployed Black Man In His String Vest Fund, but...
JOHN: Yes. Because alarm bells might sound...
But despite these very plausible names, surely the reality is that the people that lent all of this money have been incredibly stupid.
GEORGE: Oh, no. No. The reality is that what was stupid is at some point somebody asked how much money these houses are actually worth.
If they hadn't bothered to ask that question then everything would have gone on as perfectly normal. But unfortunately they did.
JOHN: I see. But now people are saying the crisis is likely to turn into financial melt down. I mean can that be avoided?
GEORGE: It can be avoided provided that governments and central banks give us the financial speculators back the amount of money that we’ve lost.
JOHN: But isn't that rewarding greed and stupidity?
GEORGE: No. No. It's rewarding what the Prime Minister Gordon Brown called the ingenuity of the markets. We don't want – we don't want this money to spend on ourselves. We want this money just to go into the market so we can carry on borrowing and lending money as if nothing happened without thinking too much about it.
JOHN: But if the worse came to the worse and you didn't get this money, what then?
GEORGE: Well, then there would be another market crash and then I would say to you what do people like me always say that it's not us that will suffer, it's your pension fund.
JOHN: Thank you very much. George Parr.
GEORGE: A pleasure.
JOHN: Those are the voices of the Two Johns – a comedy team from the United Kingdom – on ITV just very, very recently after the subprime debacle moved up.
You know, people have asked us before here on the program, Jim, for a definition of derivatives. All right? And even experts find it hard to give one. It reminds me of Jimmy Carter’s description of what causes inflation: Many strange and mysterious things interacting in strange and mysterious ways. And they go, “Oh! this guy is the president?”
But this team has really expressed it exquisitely well. And they got right down to the point – which was exactly what Dr. Bob McHugh said in the first hour – which is that where this is crashing down is on the little guy and the middle class. That's who is going to absorb all of this where the people who made the loans and took the risk are going to be bailed out. And surprise, surprise, if you listen to this week's economic reports, why, “everything is coming up roses for the US economy! Economic growth is running strong at 4% and economy is creating a lot of jobs.” Why isn't the market buying into the story, by the way? [36:05]
JIM: One simple reason, John, it's fiction.
JOHN: Something worthy of Ayn Rand; right? Who is John Galt?
JIM: Well, let's start with the GDP numbers because that's the number that surprised everybody this week. The economy had been expanding since the slow down at Q1. And you remember, John, in the first quarter where economic growth got down to less than 1% and it was clear to a lot of people the economy was slowing down on the verge of going into a recession. Well, the Q1 numbers, the economy was growing at 0.6%. Then we go to Q2 where the economy jumps to a growth rate of 3.82 and then the numbers they reported on this Wednesday in the third quarter, the economy grew at an annual rate of 3.9%. So the economy, if you follow the government's reported numbers has been accelerating.
So despite all of the mortgage problems, the derivatives, the housing industry sectors, the problems in the auto industry, the economy is on an accelerating growth path. Now, on its surface it sounds like economic growth is accelerating. But here is the catch. The GDP price deflator – and we start out with nominal dollars in GDP which is just the gross dollars of goods and services produced. But to get at a real GDP number we have to subtract inflation; that's called the GDP price deflator. They take the nominal GDP, subtract out real inflation to get to real GDP.
Well, in the first quarter of this year, the GDP price deflator was at 4.33% and that was in the first quarter. In the second quarter, the GDP price deflator drops to 2.63; and then in this third quarter, the GDP price deflator drops to .75%. To put that in perspective, the price deflator for the third quarter is the lowest it's been since Eisenhower was president. John, plain and simple, these are fictional numbers. There isn't any sign that economic growth is accelerating in this country as would be in interpreted if you looked at these anybody's just on the surface. [38:26]
JOHN: What is the purpose of the deflator anyway? I mean we talk about the books being cooked all of the time and it's very hard sometimes for people not directly involved in the process to understand what they are supposed to be doing here. What is the theory and the for-public-consumption theory behind this?
JIM: It's supposed to get at what rate the economy is really growing. Let's say that in the year 2006, the economy and this is just for illustration's sake, let's say the economy produced 1000 widgets at a cost of $5. Now, let's suppose in this year the economy only produced 1000 widgets but the price of those widgets went up from $5 to $6. So instead of having a GDP of 5,000, our GDP this year a thousand widgets times $6 would be 6000.
So on the surface it would sound like, would you, GDP grew from 5000 to 6000. The only problem is that 1000 increase in GDP was all inflation. It was from price increases. So what they do, the purpose of the GDP deflator is to take the goods and services, back out the inflationary component to get at real goods and services produced.
And basically, what they've been doing, and how they've arrived at these strong growth rates is they keep lowering the inflation numbers or what they deflate the GDP numbers by. We've gone from, let's say, 4 ¼% inflation in the first quarter to three quarters of 1% inflation. Does anybody really believe that inflation has fallen by 82% over the last six months?
You know, it gets even worse if you look at the individual GDP components. Consumption is in a down trend. It was growing at 3.9% in the fourth quarter of 06. It's now down to 2.99%, but it did rise slightly in the third quarter. Other components – and this is even more important for the economy – fixed investment both residential and non-residential investment is declining. Government spending came down in the third quarter. The only thing that was really up was exports and a slight increase in consumption, but even consumption has been trending down on average since last year. [40:59]
JOHN: So the way we get to these strong economic numbers is by a process of declining inflation. But oil is at $95, gold is over $810, do they really think people are going to buy this for much longer?
JIM: Take a look at what you have here though. Look at TV, pick a paper. I forget who it was, John who said if you tell a lie often enough and a big enough lie, people end up believing it. However, there is just too much evidence to the contrary. I mentioned that investment trends in the economy have been falling. The growth in real spending by the corporate sector peaked two years ago in the first quarter of 2005. In fact, corporate profits have been driven mainly through financial engineering and overseas profits. That's what has been driving profits over the last two years. But here's the catch. Overseas profits do not support domestic spending on plant and equipment here in the US, so earnings are going to be declining, I think, over the next two quarters and maybe even more. So a slow down in corporate profits which is more likely – we're already seeing that in this quarter – argues against any major spending on investment here. [42:09]
JOHN: Well, there is a slew of economic reports out this week that actually ran contrary to the strong GDP numbers.
JIM: Sure, you had a number of numbers come out this week and these were industry reports the Chicago Purchasing Managers Report fell from 54.2 in September, John to 49.7 in October. And a reading below 50 would indicate a recession. So it's at recession levels. There was a sharp drop in production which fell off the cliff last month. You've got to remember part of that was reflected by the automobile strikes in the month of September. But bringing that back however on Thursday, Chrysler announced 12,000 job cuts. The New York NAPM number is still looking weak. We also got this week the ISM Manufacturing Report which fell from 52 in September to roughly below 51 in October – so that continues to go down. So manufacturing is on the verge of stalling.
We saw reports of personal income and spending is in a down trend. So everywhere you look, you see anecdotal evidence of an economy that is stalling and may well be heading towards a recession. I'm not sure at this point, John, if we can withstand anymore shock waves; whether it's a 25 dollar spike in the price of oil, some kind of geological event, weather-related event, or geopolitical event – the economy is too weak. It's been in a down trend, it's getting weaker. [43:39]
JOHN: Well, then explain today's strong job numbers if that's the case.
JIM: Well, that's another piece of fiction, the job numbers. The headline number was the economy created 166[,000] hypothetical jobs. So on the surface that sort of surprised everybody because it came in stronger and people were saying, “See, we've got strong economic numbers on Wednesday, and this just corroborates the strong economic numbers, the economy is creating a lot of jobs.”
But here's the problem, the birth-death model accounted for 103,000 of the 166,000 jobs and then we had seasonal factors which were altered again. In fact, if the seasonal numbers were handled consistently, the October number would have been 123,000 according to John Williams at Shadow Stats. So making the birth-death accounting for roughly 84% of the job numbers, the statistically sounder household survey, which is the number of people employed show that employment fell by 250,000 jobs for the month of October. [44:44]
JOHN: So then you don't buy into the numbers, what does that mean where we're heading?
JIM: Because Q4 is usually a stronger quarter for consumption, also a little investment, you have inventory builds because of the retailing season in the fourth quarter, I think we make it to the rest of the year without an official recession. However, I think next year in the first half it's looking rather iffy. But right now, we can pretend things are strong. If you listen to the numbers this week, there is no inflation. In fact it's going down, if you just ignore $95 oil or $96 oil, $800 gold. And right now gold and oil, if you look at what's happening with gold stocks, oil stocks are starting to separate from the rest of the markets. And I think they are marching to the music of their own tune as they break out trends from the rest of the market.
JOHN: What we're going to do right now here on the program is do what we customarily do – plan to take over the world. And failing that, it's time to go to the Q-Lines. Have you ever seen Pinky and the Brain? That was one of my favorite cartoon series, Jim
JIM: Pinky and the brain?
JOHN: You never heard about that, huh?
JIM: No.
JOHN: I'll have to steer you to that.
JIM: I was a Flintstones and the Jetsons.
JOHN: No. No. Pinky and the Brain is five times above that. All right. Here we go. Our call in line is 800-794-6480. That is toll free from the US and Canada. It does work from the rest of the world – you should know that by now if you listen to the program – but you have to pay for it from anywhere other than the US and Canada. And some people call in and think that the calls are queuing for the show they are listening to. The Q-line is open 24 hours a day, but we only download it once a week when we get ready for the show and we answer all of the questions.
I should remind you that radio show content is for informational and educational purposes only. You should not consider this as a solicitation or offer to purchase or sell securities. And our responses to your inquiries are based on the personal opinions of James Puplava. We cannot take into account your suitability, your objectives, your risk tolerance because we really don't know that much about you because you're not a client. Financial Sense Newshour is not liable to anyone as a result for financial losses that result from investing in anything that we profile here on the program.
The other thing is by the way, when you call into the program, please make sure that you keep your call brief. People have gotten into the habit of phoning in master’s theses again and we just can't use those on the air. But we will pass them on to your board so about when it comes time to defend your thesis, they'll at least have the material.
JIM: I have to laugh. I'm trying to think of the guy, but I think he called, wasn't it, John, like three or four times.
JOHN: The recording machine would time out and then he would call back and continue where he'd left off.
JIM: Yeah. I mean it was, like, 15 minutes or –
JOHN: Something like that.
JIM: Yeah. I mean when you go that long, I've lost track of stuff, so really, it makes it much easier for us if you just get right to the point. Tell us where you are from because we always like to know who is listening to the program and from where and just get right to the point. And it makes at least my job much easier.
JOHN: Edward is in Palm Beach, Florida.
My name is Edward. I'm calling from ground zero in the housing bust in Palm Beach County, Florida. Got a question about my folks, my parents. They have about $700,000 in retirement savings. Most of it is going to be invested in dividend producing income abroad. I'm curious whether or not it would be prudent to take approximately 5% of this and invest it in gold producing juniors. Again that's only about 5%. So let me know what you think. Thanks a lot.
JIM: Edward, given your parent's age and retirement, I think having a 5% in the gold area would be prudent. I just wouldn't be in juniors because they tend to be more volatile. Granted, you're going to have a lot more upside with juniors than you would let's say with majors, but I'd probably stick to the larger type companies. They tend to be the go-to stocks in any correction. And you get less of a pull back in those areas versus a junior. I just think that to take your parents out of savings and put them into a junior producer that could drop 30, 40%, I think that might be too much volatility for them. [49:14]
Hi Jim, this is Joe from Newport Beach, California. I have a question regarding hedging. I hear Southwest with their hedging program is paying $40 a barrel and I was wondering if you were a small business that depends on oil price for the bulk of your cost what's the best way to hedge against the higher oil prices for a small business owner. I appreciate your answer.
JIM: Joe, there are a couple of ways. You could go into the futures market and hedge on energy prices, or you can make some investments in energy stocks. For example, Newmont mining to give you an example hedged it's rising energy costs by investing in Canadian oil sands stock and made quite a bit of money. [50:00]
Hi, Jim and John , this is Ed calling from Toronto. I've got a couple of questions this week, one in terms of GoldMoney.com, you have talked about that organization several times. James Turk has been on several times. One question I had is if you became a customer of www.Goldmoney.com, is it possible to take physical delivery of your gold and silver bullion. And if you do, how is that done, how are shipping charges done or do you have to go to their facility? Is that possible, how does it work? Second question was what's your prospect for the price of uranium? Thanks.
JIM: You know, Ed, you can take physical delivery if you have a GoldMoney account. I think you would have to contact them and make arrangements where you would like to take physical delivery. So I think you can get that information from the website or talk to them directly. But I do know that's possible because I've talked to them about that before.
In terms of prospects of uranium, we're looking at spot prices roughly around $84. I think they are going to go well over 100 again, maybe as high as 125, 150. [51:04]
Hello, this is John from Seattle. Regardig Gary Dorsch from last week where if the US keeps lowering short term interest rates and the Europeans keep raising theirs, what happens to the US economy and dollar? Thank you. Love the program.
JIM: John, if the Fed keeps lowering and the European central banks keeps raising that means the euro will move up against the dollar, the dollar will depreciate. I think if you see the Euro at a buck fifty, they are going to start crying uncle over there because they are very, very dependent on exports. That's the strongest part of their economy, although Germany's economy is somewhat of an exception now. But they have new legislation that they are trying to introduce in Germany that would reverse the gains made over the last couple of years. So the net and short of it is once you see the Euro over a buck fifty, I think you're going to see a cry by European politicians to devalue their currency. In fact, Sarkozy in France has already hinted at that: If we inflate our mess overseas, then they would have to respond, which is what I think will happen eventually. [52:11]
Hey, Jim, this is Jim from Tampa. I was referring back to your question as to who it was that was specifically on your show that relayed a story about Paul and Greenspan not changing a word about his report. That would be Lawrence Parks from www.fame.org. He was one of your guests and he has your interview on his website. And if you could get him back on the show, that would be great, but otherwise go to www.fame.org there should be a link there to it. Thanks. Love your show.
JIM: Jim, thanks for pointing that out. That's right. It's been a couple of years since we've interviewed Larry Parks. Maybe we'll have to get him back on the program because certainly monetary depreciation is something that he talks about. [52:53]
Hey, Jim and John , this is Brett from Santa Barbara, California. And I was thinking about diversifying away from the US and I wanted to transfer my brokerage account to Canada and set up a bank account as well. And I didn't know who go with. I know the Royal Bank of Canada is very big there as well. Do you have any suggestions on who to go through if that is possible to actually transfer brokerage account or set up a bank account being a US citizen. Any direction would be very helpful. Thanks a lot.
JIM: Brett, there are a number of large Canadian brokerage firms, from Canaccord to BMO Nesbitt Burns, RBC, TD Securities. There are about five or six top big ones. Gotta remember, as you diversify out of the US, just think of the year 2010 when all three currencies – the loonie, the peso and the dollar – become one. Just keep that in mind three years from now, they are going to try to merge the three currencies into one currency. [53:44]
Jim, it’s David here calling from Canada. I’ve been a long time listener. Great show. I want to explain briefly why gold is a screaming buy for Canadians. The high dollar causes stress in Canada's manufacturing heartland. Our products are now more expensive. Manufacturing will contract, government tax revenue will decrease along with job losses. Taxes will increase, further shrinking business. The deteriorating government balance sheet will weaken the dollar. Attempts to lower interest rates to stem the rise in the dollar will be met by inflation. Gold Positive. 80 percent of our products are sold to the US. As the US drives into recession, our dollar will be under more pressure because the government balance sheet will further deteriorate and as revenues shrink. Also, oil and gas is used to give Canada a high dollar, but mining and oil and gas extraction only accounts for 3.65% of the total GDP according to Canada. I say gold is a screaming buy for Canadians right now as our M3 money supply is around 16%. We will suffer high inflation and our dollar will weaken eventually, so right now, gold is on sale for Canadians. Thank you.
JIM: Boy, you've got a good hand on the pulse there, David. [55:12]
This is Bert in Yuma. Investing in junior mining companies – by the time the company gets to the feasibility stage, a large part of the move is already behind it. Could you explain to me the significance of a scoping study and prefeasibility study in terms of determining whether or not we have something that's going to actually turn into a mine as opposed to just ounces in the ground. Thank you.
JIM: Bert, what they are trying to do with a prefeasibility study is take a look at the economics of the ore. And remember, when you go through a prefeasibility study when you take a look at how it's going to be mined, the cost of mining, you usually have a geology model, a handle on metallurgy, then you're actually going to take a look at the economics. So given the ore grades and how you're going to mine it, what you're trying to do with a prefeasibility study is say, “Hey, if we turn this into a mine, are we going to make money?” And it's very, very important that a company do this because they are going to have to get financing. Let's say they are going to put either a leach pad in, or it’s going to be underground mining, they are going to process it through a mill, those are huge capital costs that can run hundreds of millions of dollars. And they are going to have to get financing for that. And no bank would give financing or it would be very hard to go out and get a stock issue unless there was a feasibility study done on the project, which really measures the economics of the ounces in the ground.
JOHN: Welcome back to the Big Picture and the Financial Sense Newshour at www.financialsense.com.
You know, Jim Rogers was quoted as saying that Ben Bernanke is a nut and that interest rates cuts by the central banks are harming the economy by fueling inflation. He was interviewed on Friday. And in addition to saying that Ben Bernanke is a nut, he's saying the dollar is collapsing, commodities are through the roof and all of these people are leading us into terrible problems. It seems like they are interested in protecting their friends in the banking system rather than protecting the little guy. The little guy is going to wind up paying for it shortly here
JIM: Well, you know, John, I think what they are trying to do is just forestall the day of reckoning. I know a lot of people are saying, “Look, you shouldn't be lowering interest rates. You ought to be raising interest rates.” But, you know, let's deal with the facts as they are today. We have inflation in the system. We have an economic and political system that believes in intervention. We subscribe to Keynesian economics and the problem that you have, let's say you did raise interest rates, the system would collapse, the malinvestments in the economy would be cleansed, businesses would go into bankruptcy and it might take three, four years, maybe five years to thoroughly cleanse the system. And then if they came up with a gold-backed currency, the government balanced its books, we got out of our foreign entanglements. All of these are great things if they were to unfold that way.
But I can tell you, if they collapse the financial system right now and they put the economy into a great depression, this isn't the same country that went through the Great Depression in the 30s and fought World War Two. Morally, spiritually, economically, this isn't the same country. We're no longer sufficient in manufacturing; we’re no longer sufficient in capital; we’re no longer self-sufficient in energy. You know, and on top of that, we've been raised in a society that says you can have anything you want and there are no rights or wrongs. Everything is a gray. So it's a different kind of society today. So, you know, Rogers is right that by lowering interest rates he is going to create inflation. But remember, for politicians inflating their way out of a mess is better than going through the severe economic hangover there would be if we got off the credit and the printing money drug. And so that's one of the problems that I have in this situation here, which is I don't know what kind of country this would be if we were to go into a financial collapse at this point. [3:03]
JOHN: That's something that a lot of people reckon with in a whole different area. I was talking to a retired Marine colonel the other day. I said, “Do you realize how badly the military have been downsized in this country since the beginning of the Clinton Administration.” Do we realize that the manufacturing has gone offshore. Remember during World War Two, how is it we were able to get spooled up so fast between Pearl Harbor in 1941 and by the time we were really rolling in 1943. That was because we had the infrastructure then, Jim. We had the factories. It was just a matter of retooling the factories over a period of time to be able to produce the war materiel. We don't have that now anymore. We don't have the financial strength. We don't have the military issues that we have. But most people don't know that. They are simply looking at the surface and that's what all of the politicians are dealing with right now.
JIM: Sure. You mentioned that the manufacturing has moved offshore. John, it's not just that manufacturing has moved offshore. In this country we have allowed our infrastructure to go into decay. The civil engineers do a study every couple of years on the shape and condition of America's infrastructure and we got a D rating. I don't care if you're looking at airports, if you're looking at our rail system, our barge system, roads, bridges. There is probably not a month that goes by that you're not seeing some kind of problem. They just had the study that they haven't fully released that NASA got a hold of on the near collisions in the air and on the ground with our airliners. And they are trying to keep that quiet because of how risky it is – although BusinessWeek alluded to it in their issue they did in September called The Summer From Hell talking about the airline industry. So you're right, we don't have the infrastructure.
We don't have the savings. You know, most people in this country don't have savings. We don't have the endurance or the capacity to endure hardship as we did, let's say, 50, 60 years ago. The character of the country has changed greatly over the last half century. There just isn't a lot of that character that we had in this country, which is what made us great. We were hard working. We were savers. We were very industrious. You know, today, it's like, how can I scam the system, game the system? We've become more of a welfare society, an entitlement society; and these are the kinds of thing that do not do well in an economic downturn. So I think that's why the politicians are afraid of that and that's why no politician other than Ron Paul is addressing these very same issues that we've been talking about here: what would be necessary to right the system?
We're not ready for that and it's usually – it's a crisis that prepares you for it. But you don't know how you come out on the other side of the crisis. Do we emerge as a republic or do we come out as a dictatorship? I'm reading right now a 600 page biography on Julius Caesar by a gentleman by the name of Goldsworthy. It’s a great, great biography and he's trying to answer one of the questions: Did the public come to an end in Rome on its own, or was it strictly done by Julius Caesar or did Caesar really just hasten the process? And so we started out as a republic and you can see what happened to this country in terms of government involvement, government intervention, the debasement of the currency that came out of the Great Depression. John, I don't know what kind of country we would emerge out of this. Would we be a republic? I don't think so. [6:44]
JOHN: It's interesting to see the number of liberals and conservatives coming together on this issue. It's beginning to dawn on more and more people who are really facing a constitutional crisis here across the board. That by the way, both Republicans and Democrats have created for us over the last 40 years, each of them choosing to end run the Constitution when it suited their own political needs.
JIM: You just did a recent interview with, I think it was Judge Napolitano who has got a new book out that basically says, “we are stripping away the Constitution and the Bill of Rights, left and right, and nobody seems to be noticing.” [7:18]
JOHN: Yeah. I would take umbrage with the concept that nobody – there's a core of people that notices, but he's right. And he's pointing out how we’re doing this on both the left and right. The three things that have contributed the most to it: The first thing was the war on drugs where we began to enable the seizure of property with easy moves.
JIM: You're talking about like RICO.
JOHN: Yeah. Like Rico, with forfeiture of property that's done in a civil process by accusing the property of committing the crime. The second thing with the environmental laws which allow the debasement of people's property, the seizure of property, inordinate levels of fines, the destruction of the value of the property simply by yelling “save the planet.”
The third area that came in, of course, is the war in terror now in which we are talking about torture and the Bush Administration is trying to claim it's not torture. But right after 9/11, sure enough one of these trial balloons got floated out from one of these think tanks which you know darn well was government prompted like, “ What do you think about torture to keep America safe?” and everything. And the first time I heard that like two or three days after 9/11, I thought where did that come from? And along with the direction of Habeas Corpus, or as Judge Napolitano calls it the corpse of Habeas, and a whole series of other rights under the Fifth Amendment to the Constitution.
And at the very same time that liberals say for example are complaining about the Bush Administration violations, they are doing their best they can in Congress to pass more and more egregious violations of the second amendment. So both parties are contributing to this simultaneously. And fortunately there is a core recognition – this is a passionate subject of mine – because a free society is essential to a decent economy and vice versa. And a core of people from both sides are saying, wait a minute, we're blowing out the whole foundations here and if we don't stop it we're going to wind up where your worst fear is. [8:54]
JIM: I guess where I'm coming back and taking issue with you, you said the majority of people. Now, you talk about a core, John. But where is that core visible? You don't see it in the media. You don't see it in newspapers. You don't see it in companies and corporations. The whole political system is geared around all of this using-Washington-to-advance-your-own-agenda or benefits for either yourself, your constituency or your industry. [9:23]
JOHN: And one of the other problems that you have is the fact that a lot of people in either party see the problem as being the other party. So for example, the Democrats will see the problem as being George Bush, Dick Cheney. You know, “darn Cheney, darn Rumsfeld, darn Bush.” Whereas on the other side everyone saw it as “darn Clinton, darn for, darn Hillary in the 90s.” Whereas both groups have very successfully done little end runs around the Constitution and pushed us further and further, closer to this edge. And they've got to get out of that and realize that, no, the whole issue is the Constitution says “shall not be infringed” for a whole bunch of things, and everyone is end running it. Especially an activist judiciary. That's another area where basically you have judges making law instead of interpreting law and they are really having to torture the English language to do it. So that's why we're in danger because we keep treating the Constitution as, to quote Al Gore here, a living, breathing document rather than an absolute limit on government power, which is what the Founding Fathers intended it as.
Well, I'm going to get down off my high horse. The reason I think I get so impassioned about this is because it's been a hard sell to both conservatives and liberals for me over the past 20 years to say neither of you can keep trampling on the Constitution without something radically going wrong in the near future. You can't do this.
But anyway, let's get back to Jim Rogers and he was saying that basically the dollar’s collapsing based on what the activities of the Fed are. But in reality, if we zoom out and go to a global perspective, you have to realize that all of the central banks are inflating all around the globe and that's putting their economies into the very same type of jeopardy. So the analogy is all of these ships are on the same ocean, they are all sinking. Some are just closer to the waterline than others. [11:10]
JIM: The problem I have with only looking at the US is central banks around the globe, and you know, if you are listening to this program, we often mention this I have a screen on the Bloomberg that tracks year-over-year money supply growth in countries. Just listen to these figures and I'm going to get to this as we end this session and bring this to what's this mean for the economy and inflation rates. But Russian money supply grew by 44%; India, 21%; China, 18%; Australia, 18%; Denmark, 15%; Brazil, 15%; Mexico, 15%; the UK 14%,; Korea, 10%; the OCD countries total M3, 8 ½%; Canada 8%; and the US, it's running about 15%. So, you know, you look at all of those kind of inflation money supply growth rates and it's not surprising that you're seeing housing rise around the globe; agricultural commodity prices rise around the globe, economies heating up. And what's funny, John, is governments are getting wise to the kind of playing fast with the numbers just like we do. You know, you hear concepts in Japan, core inflation or core inflation in the country. So everybody is kind of picking up upon it, “hey, we’re inflating, but, you know, the core rate is down.” [12:30]
JOHN: As if that affects anybody. So in reality basically everybody is printing money. But what about the notion that the Fed’s on pause now, that they are – I have to put on a long face to do this – that they are very concerned about inflation?
JIM: Well, if you take a look at statements accompanying the September FOMC meeting and the October FOMC meeting, what they basically did is flip-flop. In September they cut 50 basis points and they said core inflation had improved. This month, they cut 25 basis points or they cut 25 basis points in October and now they are concerned about an upward pressure on inflation. So in September they were concerned about economic growth. In October, they said economic growth was solid and that financial strains had eased so there is this renewed inflation pressure in food and energy and deflation accelerating in housing, which is intensifying.
JOHN: Why the flip-flop anyway?
JIM: Well, we talk about what we call the open mouth committee. I think they are trying to manage expectations on inflation because, let's face it, you know, you look at the CRB Index breaking out to new ground. You've got oil prices at $96, even though the politicians ignore that figure. We've got gold breaking out over 800 on Friday, silver at 14.60, heating oil is rising. We've got corn close to $4, we've got nickel breaking out, we've got soy beans prices rising, cotton is moving up, you've got weak prices at almost $8.
I mean, if you look at the CRB Raw Industrial Index, John, it's rising to a new record level. So I think what they are trying to do is the Fed is playing a high wire act. They are trying to maintain a balance between a falling dollar and a falling economy. They cut interest rates and slash them. You notice that the Fed isn't doing what it was able to do in 2001 where Greenspan just took the federal funds rate from 6% down to 1% and did it almost in a 12 month period. I mean he just slashed and slashed. The Fed is in a bind this time because as we mentioned what's different this time is prices are rising, inflation has spilled over into the real economy. So what they do is they got to play both sides of the fence. They've got to sort of play to the slowing economy, which I think they are really worried about, and especially what's going to happen to the American consumer. On the other hand, they've got to play to the inflation hawks as they inflate. So you get the token one dissenting vote on the Fed concerned about lower interest rates and that kind of plays okay. You've got a couple of guys on the Fed that are concerned about inflation. So that's what they are doing. They are playing a high we're act between a slowing economy, a falling economy and a falling dollar. [15:26]
JOHN: But what they are trying to convince us of is they are not worried about $100 oil or $800 gold. This doesn't mean anything.
JIM: Sure. I think they are worried more about what's going to happen to the American consumer who may be going on strike here in the fourth quarter because I believe you're going to see it unfold in this year's holiday sales. And I’m just talking to merchants and about the only way they are going to move merchandise out the door is to start sales early, so you'll be seeing sales before Thanksgiving. So what they are going to do is try to – what the Fed is going to try to do is both look hawkish and dovish at the same time. And you'll have one day of Fed governor making a speech and he's concerned about inflation, then you send out another Fed governor the next day and he's concerned about a drop in the economy.
So whatever your listening to, whatever you're following, if you're worried about a slowing economy you've got a Fed governor talking about that. If you're worried about inflation, you've got a Fed governor talking about that. And so what they are going to do is try to play both sides. They know they've got major credit problems that are only going to get worse. I mean just look at what some of the brokerage firms and some of the big banks were talking about. I mean you had a story coming out this week about Citigroup. Their losses are so big and these banks are taking so much debt on to their balance sheet, stuff that was supposed to be securitized and passed on to somebody else now is going on the their own balance sheet. That's only going to get worse here, John, in the next six months. So as the Fed injects huge reserves into the banking system...there was one day this week they injected $41 billion to keep the system liquid. So they are playing to concerns over inflation.
What this is it is really a high stakes public market perception. I call it a confidence game and right now, we may be experiencing some seizures in the banking system. We've seen a contraction in M1 while M2 is expanding. You know, if you take a look at the 13 week rate of change for M2, it's up 6%; while the 13 week rate of change for M1 is down about 0.8%. So it's just remarkable. And you know, the phenomenal thing is if you look at what's going on in the real estate market, and remember, we have foreclosures increased significantly. What does that mean? That means the people that loaned them money – your bank, financial institutions, a savings and loan – that means they are taking losses. And those loans aren't good, they are not getting the interest payments. And also if they are going to have to turn around and sell the property, they are probably going to have to sell it for less than what the mortgage is because remember, a lot of these loans were taken with no money down.
I mean let me just go through some numbers that will kind of just give you a clue of where this is going. This is a year-over-year change in property foreclosures. In Arizona they are up 202% year over year. Arkansas up 254%, Connecticut up 921%, Delaware 389%, Florida up 131%, Iowa up 180%, Maryland up 491%, Massachusetts up over 1100%; Minnesota 125%; Nevada, 212%; Ohio 136%; Vermont 400%; Virginia 516%; Wisconsin, 155%; Georgia, 85%; Michigan, 79%; New Jersey, 57%; New York, 67%; North Carolina, 99%; North Dakota 86%; Tennessee, 57%. John, that's a lot of foreclosures.
This is probably the worse real estate recession where you actually see houses decline because it's worse this time is the mania or the run up was worse. In other words we saw greater housing appreciation. We saw loose lending standards; I mean no-doc loans, no money down loans, you name it. And any credible lending practice was thrown out the window because banks didn't have to stick the stuff on their balance sheet. They would simply just make the loan and basically just sell it to somebody else and hope that everything worked out okay. [19:40]
JOHN: So Houston we've got a problem. But if we get back to the concept of global money printing, let’s put that in a substance somebody can understand.
JIM: Well, you know, my son is coming out with an article on Market Wrap and we were talking about money supply growth, CPI, so he was doing some research. And if you take a look at the money supply growth and then take a look at the CPI in the countries, now remember CPI numbers are fudged, not only in the United States, but elsewhere. So you've got in the G-7 countries, you've got money supply growth of 6 ½% and you've got a CPI roughly of 2%. In the Pacific Rim, you have almost 17% money supply growth and you have CPI of over 5. Other countries outside of the main area: 21% money supply growth, 7% inflation. And then the Americas, 21% money supply growth, 7 ½% inflation. In Europe – and this is distorted by some of the eastern block nations – you have almost 25% money supply growth and almost 8% inflation. And you can't print that kind of money and not have it show up. And he did a regression diagram between inflation rates and money supply and there is a clear correlation between higher inflation rates and higher money supply.
JOHN: I think some examples would be pretty good right here.
JIM: Let's go to G-7 countries. The highest money supply growth is in the UK. This is official. It's 13 ½%, CPI is 2%; in the US M2 is 6.3% and we've got CPI of 2.8. Remember, a lot of these numbers are doctored.
If we go to Europe, we have, for example, 6 ½% money supply growth. In Greece we've got a 3% inflation rate; in Slovenia you've got 6% money supply growth, 5% inflation; Hungary 9% money supply growth, 6 ½% inflation rate; Netherlands 9% money supply growth, 2% inflation; Czech Republic, 11% money supply, 3% inflation rate; Estonia – and this is where we get these higher money supply figures on the eastern block – 18% money supply growth, 7% inflation; Latvia 23% money supply, 11% inflation; Lithuania 25% money supply, 7% inflation; Russia 44% money supply, almost 10% inflation; 48% money supply growth in the Ukraine, 15% inflation.
And then if we go down to South America: Mexico, 15% money supply, 4% inflation; Costa Rica 18% money supply growth, 10% inflation; Argentina 23% money supply, 9% inflation; Venezuela our friend Hugo 38% money supply growth, 17% inflation.
So there is a clear correlation here between money supply growth and what is happening to the CPI. And John, it is universal. You look all around the globe and that's because we're on a fiat system. [22:55]
JOHN: What is it going to mean globally? We always keep talking about what is going on here in the United States, but on a global scale, are we going to see the same things replicated in other countries or what?
JIM: Sure. You're seeing real estate inflation in Europe, you've seen it in Latin America, you're seeing it in Asia. You're seeing rising food and energy prices here. You're seeing it in Europe, you're seeing it in Asia where the government is already starting to crack down and they've had riots in China; you're seeing it in Latin America. The stuff that's going on in Latin America with some of these countries like Chavez what's happening to the Venezuelan people is just incredible. You can't have a 40% money supply and then have your productive capacities be declining and you're not going to see inflation. You know, they are running into hyperinflation in Venezuela, which is why the people are upset and starting to riot and protest and those people are being crushed by the Chavez government. But that's what happens in an inflation. [23:56]
JOHN: Yeah. We had a few emails over the months when we began to talk about, if you remember, Chavez as being a dictator and a number of people said “you're ruining your credibility because Chavez was duly elected.” And of course we always pointed out that Adolf Hitler was also duly elected. But if you take a look at what he's been doing over the last couple of months as a matter of fact, first of all, he's been trying to change the Constitution taking over control of the radio and TV stations, insisting the private schools teach his curriculum, which is basically a socialist-type of curriculum. He's doing everything that every dictator before him ever did after he came to power. And many dictators rose to power by means of a legitimate process. So the fact that he was elected doesn't mean anything if the government he finally leaves behind is one that is totally corrupted.
So I guess if we were to summarize all of this up anyway give some of the economic instability, I hear is: all currencies are depreciating this means all currencies are losing value, therefore your faith is still in the ultimate currency which is gold or silver or I guess some of the other precious metals too platinum, palladium.