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The BIG Picture Transcript
April 5, 2008
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  Part 1
  Bubble Troubles or Bubbling Opportunities
  When Money Matters
  Part 2
  The Creamy Filling
  Planning for Retirement - Part 2
  Part 3
  Q-Calls

 Part 1

 Bubble Troubles or Bubbling Opportunities

JOHN:  Well, now we need to ask a summarily important question:  When is a bubble not a bubble?  After all, we're living in a rather interesting age when we look at the area of the markets and commodities and the metals.  Over the past x number of years – that will just sort of bracket it very concretely there, but you can put down x number of years -- oil has gone from 20 to $100 a barrel, gold started around 250 and has zinged up to 1,000.  Copper went from 60 cents to $4.  And every time one of these things makes a move, Jim, somebody is yelling that it's a bubble, but don't put any faith in it because the bubble will self-correct and the markets will go back to normal, or something like that.  So the real question is:  Is this really bubble trouble, or is this really bubbling opportunity?  That's going to be the first topic we cover, so lay your thesis out here. 

JIM:  Well, there are two aspects to understand about commodities, John, and one thing that has perplexed economists and analysts with the US economy –the world's largest economy – going into a recession, meaning that we're going to be consuming less whether it's copper or base materials or energy.  Because obviously with the economy slowing down and especially in the construction area, which has driven the recovery since the last recession, it's like, how can commodity prices be this high?  And I think in order to understand that, you have to look at commodities and separate two aspects to it.  There is the cyclical aspect of commodities meaning the business cycle and the economy itself, so it's true that when the economy slows down, like it is in the United States, then you would see less demand for commodities.  There would be less demand for energy.  But that's the cyclical aspect. 

The other side of the economy equation is what I call the structural aspect of commodities and that is the supply nature, the imbalances that we have between demand and supply.  And here is what is interesting about this whole argument.  Despite the fact that the price of commodities have gone up in the case of energy five-fold, almost 7, 8-fold in terms of price of commodities, we have not seen a supply response.  And that's what makes this aspect of the commodities market very interesting because we've seen supply disruptions, whether it's power outages in South Africa, if it's attacks on oil platforms in the Niger Delta, if it's the breakdown or shutdown of refineries here in the United States or elsewhere.  And some people are looking at this and saying how long can this go on; how long can prices keep rising before it has some impact on the price either on the demand side or on the supply side?  And the problem that we're seeing in industrial economies like, let's say, China and India, demand keeps going up relentlessly. 

And John, the problem is we're looking at this subject from the view point of being an American.  If you look at the price of oil going up, let's say, five-fold from 20 to, let's say, over $100 a barrel on this Friday morning that you and I are having this discussion, West Texas Intermediate Crude is at 105.48, so it's at almost 105.50.  But if you look at oil prices denominated in euro, in euros, the price has gone from 16, 17 euros to 68 euros, so the price impact in euros has been less because the euro has gone up against the dollar.  And also in many Asian countries where you've seen the price of the Japanese currency go up against the dollar, you've seen the prices of the Chinese yuan go up against the dollar, the impact has been less because their currencies have been going up against the price of the dollar.  But there is two aspects here to this argument.  One is structural, which gets down to the levels of supply and demand and the other is cyclical.

JOHN:  We have a situation now where we have seen an increase of prices on the market, and of course everyone is complaining about it, that's one of the big topics here in Congress this week, but in times past, a lot of times, the supply would rise to meet the demand.  Why has that not happened now?  What's different in the world market? 

JIM:  If you were to summarize it, John, part of it has been policy-driven investment constraints, and what I mean by that:  Governments stopping supply coming on-line; and whether it's here in the United States or it's overseas in OPEC countries or national oil companies in terms of their production.  I mean Venezuelan production is down, Mexico's production is down and production within OPEC itself has hardly gone up. 

And then also you have geopolitical instability, so the problem is, and especially with governments – and I want to point to our government here, John – you cannot drill for oil.  We know for example there are 30 to 40 billion barrels of oil off the coast of California.  We know there is a lot more oil in the Gulf of Mexico.  We know there is a lot more oil off the coast of Florida, but our governments do not want to allow access.  We also know there are large areas in the United States that contain deposits of natural gas and oil.  We know there is a large amount of oil in Alaska, but our governments do not want to allow the oil companies access to this energy.  And yet, John, the problem that our politicians don't understand is 95% of our transportation system runs on liquid fuels.  And the only response that we have allowed, which is almost a non-response, has been ethanol.  Ethanol is less efficient.  It takes almost as much energy to produce ethanol as it does to get the benefit of it.  And at the same time, in terms of having access to oil, natural gas, coal, uranium, we're not talking about it.  And this week they dragged the oil executives on Capitol Hill.  And John, let's go to that clip in terms of the Congresswoman from California, Hilda Solis about, “we don't want to talk about drilling, we don't want to talk about having access to these fuels, but yet we want cheap energy.”  Let's go to that clip.  [07:10]

SOLIS:  And the suggestions that I don't want to hear are that we're going to keep drilling where we already know folks in our district, particularly California, do not want to allow for more drilling along our coast and opening up old refineries like in the city of Whittier –Nixon country it used to be known as – where we have some oil fields owned by, I think, Chevron.  [07:29]

JOHN:  In other words, we have a crisis going on here, but we don't want you to do this, we don't want you to do – we don't want you to do the other thing here, but we still want to drive all of these cars in California.  What do you say? 

JIM:  In California, we're doing nothing in terms of mass transit to alleviate the traffic jams or to prepare for higher oil prices.  And we know, John, for example, we have some refineries.  And because we have these bottlenecks, remember, the US refines about 17 ½ million barrels a day whereas we consume close to 21 million barrels a day of oil products, and what we can't refine in this country, we have to go elsewhere in the open markets –whether it's diesel fuel, whether it's jet fuel, whether it's gasoline; and we import about 4 million barrels a day of refined products, and yet we do have some old refineries and they want to stop them.  They do not want to build them nor do they want to activate some of the older refineries..  And congressman Solis from California exemplifies what I call the NIMBY, the BANANA people, the CAVE people.  We have all of these acronyms, CAVE (Citizens Against Virtually Everything), BANANA  (Build Absolutely Nothing Any Time Near Anybody), and of course NIMBY (not in my backyard.)  We've got two states that are going to the Supreme Court and the Supreme Court has validated that one state can block access to energy even though it may impact another state. 

So we still have, for example, the eastern coast that is trying to stop the building of refineries, the building of windmills, the building of LNG plants.  In fact, there were a number of spokesmen representing these Northern states that are going to Canada and saying, you build it.  [9:25]

JOHN:  But theoretically, the reason for why they don't want to build these are for environmental reasons, but that means they don't have any problem off loading environmental hazard to Mexico or Canada, for example. 

JIM:  The policy is we do not want to build it here in the arrogance of “you build it in your backyard and then we'll import it from you.”  And that's not going to work when you think about the stupidity of this, the US is transferring half a trillion dollars of this nation's wealth regarding energy each year to other countries.  I mean that is a policy that is not sustainable.  So that's why we get back to these bottlenecks and these policy constraints.  They are policy-driven investment constraints which are hindering the long term supply growth against a backdrop of what we've seen is stronger trend demand growth coming from especially the BRIC countries.  So the combination is creating this structural backdrop and is creating these, what I call this paradox of rising commodity prices in the midst of an economic slow down; and that's why it has puzzled people that we've seen higher prices that have diverged from economic fundamentals of underlying physical commodity demand in the markets.  And that's why, John, this structural component is dominating the cyclical component of commodities.  And we've seen this over the last, what, seven or eight years now, so what we believe in is you're going to see further price increases in the oil and gas, the metals and the agricultural sector.  [11:08]

And unfortunately, we've seen decades of poor returns in oil, gas and metals, in the mining industry –or what we call the ‘old economy’ – in the last bear market; and what has happened, it is starving the commodity industries of the capital they needed to expand capacity.  I mean who wanted to build a new mine, a new refinery or go look for this stuff in the 80s and 90s when the rate of return was higher in other industries.

JOHN:  You know, if you listen to what was going on in the testimony this week, and I will say when the Congress critters started their opening statements, the executives from the oil company looked like somebody was about to be skewered, you know, but there is a major disconnect in the understanding of exactly what was going on in the world market. 

If you look at the fact of, okay, we have higher oil prices and everyone likes to tout all of these record profits, but the record profits, I think, are more key to volume.  In reality, the profit margin of the oil companies still remains between 8 ½ and 9 ½%.  The cost of producing things has been rising steadily that they have to pay as well in order to do that.  So in reality, everything is floating upward, and they are not exempt either.  [12:23]

JIM:  No.  In fact, there was a great article in the Wall Street Journal this week about one of Norway's richest men.  The guy is worth about 7 billion.  He owns a fleet of oil tankers, and he dominates through his company called Frontline.  But he also owns a drill ship company called Seadrill.  And John, there are only about 39 of these deep water rigs in the world.  And his company, Seadrill, owns four of them with eight more under construction.  But the article in the Wall Street Journal talks about Mr. Fredriksen who was in Houston talking to the big oil companies about leasing out some of these drill ships or drill rigs that he has, and any idea what he's getting for day rates on this? 

JOHN:  Not a clue, Jim. 

JIM:  $600,000 a day.  And some of these oil company executives were balking, but you know what, they had to comply because there is only 39 of these rigs in the world and there is great demand for them from not only big oil companies but also from national oil companies.  And so this gets back to one of the reasons.  Whether it's the cost of steel, the cost of personnel that, yes, the price of energy has gone up, but energy inflation in the sector itself has been going up between 30 and 35 percent a year.  And that's something that these Congress people are totally clueless.  And the fact that these Western companies only produce about 15% of the world's oil. 

And yet, John, what we want to do is we want to deny access to these people, which leaves us with our only choice if we don't want to build an LNG terminal, we do not want to build a nuclear power plant, we do not want to build wind turbines in the ocean, we do not want to build clean coal plants.  And then by the same token, it's like this congressman Solis, we're not interested in this, but we want cheap energy.  It’s like we're entitled to it, but, you know, what is the policy?  That's why we talked about this crisis window, John, and watching our Congress people, the US is the least prepared to meet this crisis that's going to come.  And the unfortunate thing, the only solution that is going to be recommended here is pain to consumers.  In other words, the price of energy is going to have to go up to such a level and become so much more acute before policy makers – in other words, people start complaining to their congressmen, “I don't want to hear about you bashing the oil company, all I know is my utility bill has gone up, the price of energy at the pump has gone up to 5 and $6 a gallon and everything from the cost of food and everything else has gone up to such a level that:  Do something about it!”  But right now, they don't want to do anything about it.  [15:20]

JOHN:  Maybe we need to listen to an exchange this week between Senator Edward Markey who is a Democrat from Massachusetts and Steven Simmons who is Senior Vice President of Exxon and then you and I can comment on this. 

MARKEY:  Poorest 20% of America, it's now 10% of their income going to paying their gasoline bill.  So as these consumers are at the pump being tipped upside down and having money shaken out of their pocket, your message to them is that you can't do anything for them.  That you're about to begin a partnership to think about what you're going to do about a renewable energy agenda, and that's not going to send any message that we're going to put pressure on OPEC, that we're about to change business in our country. 

SIMMONS:  Well, if we're going to have the kind of impact that you and I want longer term, it's going to take breakthroughs and that's what we're trying to do there.  That does not say that we can't do something to try to address the price at the pump today.  About 80% of that price or 70% of that price is crude oil.  What can we do there?  One thing, we can moderate demand in terms of the transportation sector.

MARKEY:  But you can't have it both ways, Mr. Simmons.  You can't on the one hand be nickel and diming renewables at Exxon Mobil and at the same time be recording $40 billion worth of profits and simultaneously fighting our efforts to move over the billions of dollars into the research and renewables, which this country needs to break its dependence on imported oil.  You cannot do that, Mr. Simmons.  Exxon should make a commitment that they are going to put 10% of their profits into renewables so that America has a comprehensive strategy to fight that dependence upon imported oil.  Are you willing to make that kind of commitment? 

SIMMONS:  Mr. Chairman, we continue to look at that area.  If we identify an area where we think it can have the impact that you're alluding to, we will do that.  But we've studied all forms, even anticipating some improvements.  And the current technologies just do not have an impact of any kind of appreciable impact on this challenge that we're trying to meet. 

MARKEY:  Mr. Simmons, that is just going to be a continuation of a policy of tax breaks for the oil companies and tough breaks for our consumers at the pump, and that just doesn't work.  OPEC has us over a barrel, and you're saying you're going to study the issue for another 10 years, and with all due respect to Stanford, you have competitors here on this panel who are already investing in multi-billion dollar strategies in alternative energy.  And I just think that it's time to move to this new agenda for the sake of our country and for the consuming public that really does feel as they have been short changed.  [18:22]

JOHN:  Oh, Jim, they are talking here about the fact that we need to get moving with all of these alternatives, but if you heard Simmons, he was trying to say there was nothing out there yet to fix it to.  You know, you heard that, and they are all saying “well, we just have to do this”…yada, yada, yada, along what we heard earlier from congressman Hilda Solis that “well, we don't care what your problem is, you're not going to do this, this and that, what would you like to do” – that type of thing.

JIM:  Yeah.  I mean, John, let's go back to Solis again because what they don't understand –and it's a point that we made on this program – it is a liquid fuel problem.  You put jet fuel in an airplane, you put diesel fuel on a ship or a railroad.  That's what they burn on or trucks that transport, or gasoline.  These are liquid fuels and about the only thing that we have come up with, which is one of the worse solutions,  I mean if I was president, the first thing I would do is get rid of ethanol tomorrow.  I would go to something like switch grass or cellulosic ethanol, something that does not drive up the price of foods. 

And John, we've been talking about energy here.  And I want to move on the some of the other commodities here in just a minute, but part of the problem that we have is these policy constraints on the free flow of capital, labor and technology are substantially constraining supply growth regardless of the price or the expected return.  I mean a large part of the cost over runs that we're seeing are due to increased taxes by sovereign entities.  And you never notice that.  Even in that exchange there between congressman Markey, they never make reference to how much money the US government itself makes on energy.  In other words, the US government makes more money on the production of energy than the people that go out and explore for it, the people that find it, the people that refine it, the people that transport it and the people that eventually sell it.  So there is never a reference to that in terms of well, this is how much we're making; like, for example, in the State of California, as the price of gasoline goes up, the State of California makes more money through its sales tax in addition to their regular tax that goes into the cost of a gallon of gasoline.  So when you buy gasoline here in California, the government of California and government of the United States makes more money on the sale of that gallon of gasoline than the oil companies or people involved in the energy industry.  [21:01]

JOHN:  That fact never tends to come out, so if everyone is screaming about the price at the pump, well, government, cut back your taxes.  You're never going to hear that one.  That is not going to be heard.

JIM:  No.  And we've been talking about energy, here, but, John, we can talk about base metals, the warehouse supply of copper is down to about two weeks in the world.  And so we have not seen the supply of copper come onstream.  I mean, we've seen over the last couple of weeks the president of Freeport copper has been on some of the cable financial shows and they are saying how is the business doing; he said business is going great – “everything that we can produce we can sell and we still need access to produce even more.”  But that's even more difficult because places where copper is, some of the largest copper deposits in areas where copper is located is owned by national oil companies. 

And John, we're looking at a situation here, when it comes to the agricultural commodities where we're looking at food shortages and these price hikes are global.  For example, farmers in Argentina have just called off a 16 day strike against higher taxes on grain exports because the governments are saying, “look, we don't want you to export more because we don't have enough to feed our people.”  In the Asia-Pacific region, biofuels are not only hurting poor consumers in Asia by driving up crop prices, they are also failing to help farmers who have not been able to adapt their production to cash in on the boom.  If you go to Australia, global wheat stocks are at their lowest level since 1979 as an Australian drought is one of the reasons why.  In China, China said this week, it will pay farmers more for rice and wheat trying to raise output and cool surging inflation that threatens to fuel unrest ahead of the Beijing Olympics.  In Egypt, Egypt has banned rice exports from the months of April until October to ensure availability of the grain at affordable prices as an alternative food to wheat products.  In the Philippines, higher rice prices have sparked protests.  In Russia, Russian consumer prices probably rose between one, one-and-a-half percent in the month of March from the previous month driven by food costs.  Accelerating inflation is starting to hit the grains and food supplies.  We've seen it in America.  We've seen it with higher ground beef prices, milk prices, chicken prices, apples, tomatoes, lettuce, coffee, orange juice.  In Vietnam, a rise in rice as Vietnamese exports and farmers stockpile in expectation of higher prices in the months ahead. 

So John, it doesn't matter if we're talking about oil, natural gas, agricultural products, base metals – and that is something that everybody does not understand in this whole scenario is that governments are denying access.  And until the price rises at such a level that you start getting riots, you start getting protests, government is going to do nothing about it, just as congressman Solis said.  You know what?  I don't want to hear about drilling.  I don't want to hear about having access to energy because we're not going to allow it.   [24:24]

JOHN:  You know, Jim, as you're talking like that, all I can think of as I was watching the hearing this week, if you remember the Howard Hughes movie with Leonardo DiCaprio and when Hughes was called up before Congress, he just climbed up all over them and threw it back.  And I thought, I'm surprised these guys went in looking like sheep with their tail between their legs rather than going in with some of this back energy and saying, well – and at some point it did come out, people were saying, “you don't have a comprehensive energy policy, guys, and until you do, we're going to be stuck in this.” 

Unfortunately, though, if you look at it even on the evening media, we don't have a realization of that in the discussion of what's going on out there.  So you're right about your ‘pain’ thesis. 

JIM:  Yeah.  Because what you have is you have these sound bites, clean fuels, nobody ever takes it down and breaks it down to its essential components:  “Wait a minute.  You're talking about clean fuels, wind solar.  Okay.  How is that going to help get a jet in the air?  How is that going to help power a train to transport goods from Long Beach to New York?  How is that going to help a semi truck and how is that going to help me in gasoline?”  And even when it come to windmills, John, they are trying to block building wind turbines where they are most efficient offshore.  They are talking about we don't want clean coal.  We don't want nuclear.  We want natural gas, but we don't want you to drill for natural gas, nor do we want to hear about building LNG terminals, which is the fight between, I think, New Jersey and Rhode Island.  [25:54]

JOHN:  You could say, let me give you an example, a legitimate answer to what you just asked.  If you went to a European railroad model where, for example, you had electric railways, remember the old pantographs and a lot of places in the world they still work.  You could gradually switch over your rails.  You'd have to put a lot of infrastructure, overhead wires and everything to make that work, but then you would need the generating plants to generate the energy to drive the trains.  Planes, I can't foresee any extension cords dangling off aircraft in the near future, so imagine the tangle of about 4000 aircraft every day.  But it would work with trains.  You could conceivably make the argument.  But, and this is what some of the things that came out in the hearings, this is not going to happen overnight.  This is a radical quantum leap, is what they were saying in the technology.  So in the short term, you're right, we are stuck with liquid fuel. 

JIM:  Yeah.  We're stuck with liquid fuel, and even if we make the gradual transition to what I call electric or plug-in hybrids, which is what Toyota is working on right now, you know what?  If everybody is plugging in their car at night, I mean that's going to be more demand for power.  What are you doing to build more power plants?  We're doing very little.  So I mean these people are talking out of both sides of their mouth, and that's why I think the higher prices...I have seen reports coming out that I think, John, by 2010 between 2010 and 2012 you're going to see $200 oil.  So what are they going to do when oil is 7 and $8 at the pump and your utility bill doubles and triples?  I mean that is something that these guys aren't prepared and nobody takes a look at.  If I were an oil company executive, I would take a gallon of gasoline and I would break it down into its components, this is how much it cost to find it and this is how much profit for the people that find it make, this is what it costs to refine it, this is the profit of the refiners, this is what it costs to transport it, this is the profit of the transporters and this is what it costs for the people that sell you, let's say, the gas station.  This is their profit. 

And remember, the interview we did last year with the gal that wrote the book Oil on the Brain where she said one of the reasons why you see these fast food marts at gas stations, they make more money on Pepsi and chips and selling corn nuts than they do or a gallon of gasoline.  Then what I would do in my presentation to Congress, I'd say, now this is how much you make, Congressman.  This is how much the government makes.  If you want to relieve pressure, relieve taxes.  And what are you going to do to either 1) build power plants or come up with a system that if we're going to go to some kind of technology on the transport system that you're going to allow for is that energy to be provided because you're sure stopping us from providing it or getting it or bringing down the cost.  [28:55]

JOHN:  Okay, well, so far we've been looking at the US situation on the domestic side here.  And what becomes clear out of this is that we do not have a substantive energy policy.  You have different competing interests pulling back and forward and right now not everyone is pulling in the same direction.  So as we come into this energy crisis or this time of roughness, I guess, is the easy way to say it, we are probably the one country that is the least prepared for what is heading in our direction.  A lot of this has to do with policy constraints, like I said, no direct real honest energy policy that's going to work.  It's all based on competing ideologies.  But what about constraints imposed by some of the oil companies themselves, in various sizes as well; is there anything we should look at in that area in all honesty?

JIM:  One of the problems or a good example of this, John, is Mexico.  I mean our two largest areas of imports of energy into this country come from Canada and from Mexico.  And Mexico's largest oil field, in fact, the second largest oil field in the world has been Cantarell; and Cantarell's production, John, is down around roughly 40% since peaking in 2005.  For example, last year production at Cantarell fell 18% and PEMEX has very little petroleum lined up to replace it.  And the problem is the Mexican government relies on income from PEMEX to fund its spending.  PEMEX funds about roughly 40% of Mexico's government spending.  And only rising oil prices have prevented Mexico from falling into a budget crisis, which would ruin its three-year record of balanced budgets, stable exchanges, interest rates and stock market performance that rose four fold in the last five years.  So current projections, and this is coming from Mexico's own energy industry, if they do not do something to turn this around, Mexico may find itself in a position where it has to import light crude for its refineries by 2011. 

And one of the problems is the current president is now dealing with this issue and they want to open it up.  In other words, they know there are large deposits in the Gulf of Mexico, but you have to spend the money.  And the problem that Mexico has is it does not have control over PEMEX's 110,000 union workers and some of them who get paid not to work.  And it's suffering from too little investment, high taxes and laws that forbid competition, corruption and corroding and exploding pipelines.  It almost resembles what Brazil's largest oil company, Petroleo of Brazil, looked like a couple of decades ago until it was reformed and now it's one of the fastest growing large oil companies in the world.  And so you do have leadership within Mexico that is talking about that “we need to do something here or this country is going to be in big problems because we're going to have declining revenues, we're going to have declining energy and we're going to have to turn from being an exporter to an importer.  and yet, we know there are large deposits right off our shores,”  just as there are large deposits right off the coast of California.  And there is a movement a foot to maybe turn PEMEX into a model just like Brazil.  Brazil's oil company has a market cap today of almost a quarter a trillion dollars and will probably double and triple its production.  So once again, these are political constraints that are keeping the supply factors from coming online and supplying more of what it needs, whether it's agricultural products, whether it's copper or whether it's base metals or whether its natural gas.  So that's one of the issues.

You know, as we sum this up, John, is we have constraints here that have been put in place by government that is preventing, and this is the structural side of the commodity equation, which people aren't taking into account.  They are looking at the commodity side from a cyclical perspective and they are saying, “well, the economies are slowing down, there should be less demand, why isn't the price coming down?”  [33:22]

JOHN:  Okay.  Well, what we're hearing is that money pouring into the sector by speculators and other such investors is what's creating this bubble.  Is that substantive, or is it being driven by anything else? 

JIM:  Well, you know, money is going to gravitate towards where it can earn a higher return, but if you take a look at in the world today there is probably about 40,000 mutual funds, there are fewer than about 500 in the resource sector.  And yes, you've seen money move into the area, but it's moving there as a result of several factors.  One, it's moving because you're looking at the paper markets or the financial markets.  We've seen a pull back in stock this is year as a result of the credit crisis and the United States and around the globe.  I mean even though we've seen a nice rally, in this week, you're talking about double digit losses for most of the world's markets, the European markets are down double digits, the Asian markets are down double digits.  We've seen huge write downs and losses in the credit markets where a lot of people are saying, “you know what, we don't trust a lot of this Triple-A paper out there.  It's turning out not to be Triple-A rated.”  And even Triple-A rated paper like Fannie and Freddie, has turned out to be non-liquid, which gets back to the Bear Stearns crisis. 

So investors are looking at saying the currencies of the world are being debased.  They are depreciating.  We are looking at financial markets that are becoming more risky and people are saying, “what can I do to hedge against these risks of financial turmoil of inflation and depreciating currency.”  So money is moving into the sector by the very nature of what is going on in other sectors of the market, the credit markets, the stock markets, the currency markets.  So it's become sort of a hedge, and it's no different than, for example, when money began to move back into the stock market in the late 80s as the returns from commodities began to decline, as the inflation rates began to come down, money moved into the sector, especially institutions. I mean I can remember in the 80s when you picked up a copy of the Wall Street Journal and the mutual funds section represented one quarter of a page and now it's three or four pages if you take a look at the number of funds; and we're just talking about the US alone.  So the argument that money is coming into the sector represents a bubble, I think, is nonsense.  [35:52]

JOHN:  If you had to summarize the whole situation here, we'd say, first of all, if you look worldwide whether it's food or energy, we have a -- especially in the area of energy -- growing demand all around and the supply at the same time either due to geological reasons, some infrastructure or especially political problems around the world have resulted in no increase in production.  So you have increase in demand, no increase in production.  That means that this is basically not a bubble.  If it's not a bubble, then we are going to see higher prices simply because of the fact that -- well, that's just the nature of supply and demand, and so people will see higher prices in their grocery bills, their energy bills, especially their utility bills.  When they feel a lot of pain, and this is going to take quite a bit right now to get the politicians to stop posturing and to start doing something comprehensive.  Right now, it's fun to point fingers in all different directions, but the bottom line is we still don't have a comprehensive energy policy that's going to work.

JIM:  Absolutely.  And until you get rid of this nonsense like the congressman from California that says “I don't want to hear about refineries, I don't want to hear about drilling for oil,”  you know, John, it's almost like they think, well, just come up with something magically, technologically that will solve this problem.  And we're not living in an age, given our industrial structure in the world that is industrializing, where when the world was using whale oil to light up a home, we discovered kerosene and we discovered rock oil.  We have nothing out there.  And this is what one of the executives were saying at the energy company, “find a technology that can do something that will replace all of this and we will invest and supply the energy to it.”  About the only thing that we have going for us right now is research at the automobile companies to go to plug-in hybrids.  If we convert our transportation fleet, let's say cars to plug-in hybrids (because I don't think that's going to work for diesel tricks or for trains) imagine the amount of power plants that are going to have to come onstream to power when your car is sitting in the garage at night recharging.  And if we don't want to build nuclear, we don't want to build clean coal and we don't want to build wind, about the only thing we're going to do is solar, and that's not going to do it.  So until we get this crisis that we're talking about and the pain gets so bad and the shortages, only then I think is this issue going to even attempt to be resolved. But unfortunately, until that time, we're going to see much, much higher prices.  That's why we're anticipating not only $125 oil this year, especially in the second half of the year and maybe even higher if we get some kind of crisis or unexpected event, but John, in that window period that we're talking about from 2009 to 2012, I expect to see $200 oil price – and that may yet be conservative.  [38:56]

JOHN:  I guess we'll have to refer to ourselves as Pain Central here.  You're listening to the Financial Sense Newshour at www.financialsense.com.  Remember, we feel your pain all of the time. 

 FSN Humor

I'm Stanley Congressman.  I've got a great country.  I shell out more than $400 billion a year in defense spending.  Like my entitlements?  Some of them are new.  I never vote for a balanced budget.  I outspend all my colleagues.  I even give aid to foreign countries.  And how do I do it, I'm in deficit up to my eyeballs.  I can barely pay the interest charges.  Chairman Bernanke, please help me. 

Need a smart way to help finance your national debt, come to spendingspree.gov and get inflation aid from Bernanke's bankers.  Remember, when congressmen compete, you lose; at spendingspree.gov.   [39:59]

 When Money Matters

JOHN:  You know, Jim, in the first part of the Big Picture today, we were talking about pain that people feel.  That's where my heart always breaks because people who are well off typically have enough buffer underneath.  You know the upper middle class, I guess what we would call rich people, or well off people have buffers, so the prices go up, yeah, moan, groan, but you're not in desperate straits.  The people who are middle class on down really get impacted directly by taxes, by inflation and rising commodity prices.  These things impact them directly.  They don't have any clearance underneath, so when it goes up, something else has to go in their lives, whatever it is and sometimes there is nothing left to go depending on what your financial situation is.  And right now, people are perplexed.  They go to the grocery store, they go to the gas pump, they see the prices going up, they know that even service things are going up in terms of health care, etc, but they don't understand why.  In all honesty because of all of the off-loading that's being done – in the last segment we were talking about coming up with some kind of a comprehensive energy policy – by government, that actually clouds the issue.  And if you have a cloudy issue, then people don't know where to point the finger to say “fix it” at this stage of the game.  And meanwhile, they just know things are deteriorating. 

JIM:  We've often talked here about the root cause of inflation, which is a monetary root, and that is an increase in the supply of money and credit in the financial system, and we often talk about money supply growth rates, all around the world which are the highest that I have seen in 30 years in this business.  And the result of that is when you print more money, and remember, when this money was printed, there was no wealth creation behind it.  There was no productive capacity that was added.  There was no savings that came about from an increase in the production of goods.  You just printed a bunch of money and there was more money around chasing fewer goods, so the prices of those goods go up. 

And there has been a significant sea change, especially in the Greenspan Fed, and also in the Federal Reserve under Ben Bernanke that harkens back to the inflation problems that we saw in Germany in the 1920s.  And the head of the German Treasury was a gentleman by the name of Helferich, and he made the decision to take the Reichsmark off gold backing in order to finance World War I. So rather than with taxes or the issuing of bonds, the German government would finance the war through the printing of money.  And there was an intellectual argument that was made at the time by the head of the Reichsbank and the head of the German Treasury, Helferich, which they refused to admit that there was a relation of cause and effect between the increase in the quantity of paper money and the depreciation of the Reichsmark.  And Helferich made the argument, “well, it's our balance of payment problem.  We're importing more stuff than we are exporting and it's this imbalance that is creating the depreciation of the Reichsmark.” 

In much the way, John, you have seen Federal Reserve officials and Treasury officials dismiss the value of the dollar going down.  We've actually heard in testimony Ben Bernanke saying, “well, you know, if the things that you buy in this country are in dollars, this really doesn’t affect us as much.”  What he is basically saying, “look, unless you travel overseas you're really into the going to be impacted by the dollar's depreciation.”  But if we look at what has happened since Greenspan embarked in the last crisis in lowering interest rates and expanding the supply of money, the dollar on a world basis against a basket of currencies peaked out at roughly almost 121 on the dollar index in July of 2001.  Today that index is at roughly 72.  So we've seen 121, which was the value of the currency back in December of 2001, and today it's 72.  So we've seen a 40% depreciation in the value of the US dollar against other currencies.  And they are saying that this doesn't matter anymore. 

In fact, carrying this a step further, there has been some intellectual arguments that have been made by various individuals within the Federal Reserve, and the main argument is that we have abandoned the quantity theory of money.  In fact, the Fed even made an argument that, look, it doesn't make sense to keep track of M3 –high-powered money – because it's not important to us. And the Federal Reserve now has taken to this concept of inflationary expectations, so we can print –as this argument goes – and expand the supply of money and credit.  And it's going ballistic with all of these Fed injections that we've seen.  We can expand that supply of money in unlimited quantities as long as inflation expectations are well anchored.  And you hear this in Fed policy statements, you see it in testimony before congressmen that inflationary expectations are well anchored:  “Hey, we're printing enough money, but right now, we've got most people fooled because inflation expectations are actually lower when you go further out.”  [46:05]

JOHN:  You know what we were saying earlier about the whole issue of government clouding the issue, so to speak, and this would include the Fed, we keep hearing talk about deflation, things referring to a commodity bubble and it's almost like they are trying to predetermine where the outcome of these things are going to be.  They are going to talk inflation down, they are going to talk prices down.  But this is more of that clouding the issue about what's really happening. 

JIM:  Yeah.  What they are trying to do is influence perceptions in public psychology, so you'll here that for example, if you get a big jump in CPI or the price of energy goes up or food prices are going up or other things, they will say, well, you know, two Fed governors voted against lowering interest rates.  They are concerned about inflation.  And that was supposed to be, okay, if it does rise, they'll take care of it.  But they are trying to use the psychological – it's almost like propaganda.  It's like,
”look, I know your food prices are going up, your energy costs are going up, your cost of living is going up, but these are really one off events and the core rate of inflation remains low and inflation expectations are well anchored, so the inflation that you're experiencing really isn't there.”  And it's confusing people.  It's like: “I can't figure this out.  The government tells me core rate is down, the CPI is only going up at two or three...”  It's actually 4% right now, but people in real life are experiencing cost increases that are much, much greater than that. 

But even then, John, with the CPI that we report –as Bill Fleckenstein talked about in his interview on Greenspan – is they are using hedonic adjustments and substitution to change the headline CPI numbers.  So even though they've risen substantially in reality, they are much, much higher than that, and that's what most people are experiencing.  Yet in this political campaign, what people are asking for and what Wall Street is asking for is more government spending and more money printing – not realizing that this is in effect leading to the higher prices that we are experiencing on a day-to-day basis.  [48:18]

JOHN:  This almost sounds like Orwell's 1984 in newspeak.  It's really creates a horrible amount of cognitive dissonance in the public because basically they'll say, if you back out these prices, then the real inflation rate is this rate over here.  Well, yeah, but when mom goes to the store to buy something, the prices are up, you know; and they don't really care what your indexes say.  They just know things are getting harder and harder, but this creates dissonance because they are going, “well, wait a minute, why is the government saying everything is okay, but I know it isn't okay, so something is wrong here.” 

JIM:  Yeah.  The first sign that we are heading for these higher inflation rates is when they get rid of the indexes or providing the information that tracks them like M3 and when you see Fed officials talk about abandoning the quantity of money, the monetarist line, and you hear them talking more about psychological indexes:  “Well, as long as people think inflation is going to be low and stay low, then you really don't have to worry about this.”  That's the first clue that we're heading for higher inflation rates.  And I think so often is the issue of inflation and deflation gets confused by if real estate prices are falling, that's not deflation; falling asset markets or a falling stock market is not deflation.  It is what is happening with money and credit, and that's why you've had the Fed injecting money in the banking system, the Fed is taking back securities, they are talking about lowering the capital standards for Fannie and Freddie, so Fannie and Freddie can go out and buy about 2 to 300 billion in mortgages. 

You have a bill that's being worked on in Congress now with bipartisan support that will be some kind of mortgage rescue package.  And remember, how do bubbles correct themselves?  They correct themselves by prices falling to levels where the excess inventory can be cleared out.  In other words, prices fall to such a low level that finally you bring in more buyers.  You make it more affordable.  And one of the problems we have right now with this real estate bubble is the price of real estate rose to levels that it became unaffordable.  So how do you make it more affordable?  You allow the prices to fall.  But that's exactly what Congress is working on is they are working on a bill to keep prices from falling; and listen to the testimony all of this week, it was about we've got to stop real estate prices from coming down.  [50:53]

JOHN:  But in the long run, there is a real world out there, and there really is such a thing as gravity, isn't there? 

JIM:  Yeah.  One of the problems we got into is as the price of real estate rose as money and credit expanded, the price of real estate rose to such high levels, the only way that people can afford to buy the homes at higher prices was to go to these exotic type mortgages – no-money-down mortgages with adjustable rates that were at such artificially low levels, that would be the only way these buyers were able to qualify.  Now that interest rates are still high, but they are still low by historical standards, something has got to give.  If interest rates go up, then to be able to get into a house, the price has got to come down, just as interest rates come down, the price of real estate goes up.  So there is an adjustment process here and the government is coming in and trying to attempt that adjustment process from taking place.  And this is why we're going to, I think, move more into that crisis window because the government at every level is interfering in the marketplace.  [52:01]

JOHN:  But there is gravity and gravity takes over sooner or later.  You know, an airplane runs out of fuel, gravity takes over, doesn't it?  And that’s what we're going to see happening ultimately.

JIM:  Yeah.  But more importantly, what we want to emphasize here is the inflation that we're heading for, the inflation that people are experiencing, that inflation is only going to get worse because, John, everybody wants a bailout.  Nobody wants pain.  Wall Street wants a bail out, so it doesn't have to have losses.  Homeowners and people want bailouts so they don't have to experience looses.  And look in this political campaign.  Every speech these candidates are making, John, there is a new agency and now they want a poverty czar.  They want a slush fund to bail out homeowners.  You have to ask yourself, where is this money going to come from?  We don't have the money.  You and I were talking about that this morning about all of this talk about we're the wealthiest country.  We're not a wealthy country anymore.  Any country that has to borrow 3 to 3 ½ billion dollars a day from overseas investors or governments to pay for its trade deficit, that is not a wealthy country.  That is a debtor country.  [53:13]

JOHN:  Well, right now, you can see why, especially in a politically charged year like the year we're in right now, we have all of these proposals for bailouts and new programs that we know we can't afford.  We can't even afford the ones we've already made promises on that are coming right now.  But all of that aside, when we put these into effect because there is intense political pressure to do that, when you put them into effect, then they have further consequences which are usually negative.  In other words, like the definition of a crash, we talk about a crash from a pilot’s perspective:  A landing is a crash you can walk away from; as opposed to an uncontrolled crash where a lot of people get hurt and that's where we're heading right now. 

JIM:  It's amazing to see this happen, but what's that comment that the ‘people always vote for the politicians that will do the most harm.’  [54:04]

JOHN:  That will harm them the most.  That will promise them Heaven and in reality deliver hell when everything is over with.

JIM:  Yeah.  Because essentially what they are saying is we can give you a free lunch and that's what we always see in these political campaigns.  John, I forget, who was it, it was one of the think tanks where just keeping track of all of these new spending proposals and programs, they are talking about trillions, literally trillions of dollars of new spending programs.  And John, this is a country that's running 4 or $500 billion worth of budget deficits; and then on an unfunded basis meaning the accruals that are mounting in the system for unfunded Medicare and social security liabilities add up to a trillion dollar deficit.  So this absolute insanity that I have not seen before and yet, you don't see any rational discussion of this in the political debate for this year's election.  Nobody is asking:  This is a new program, where is the money going to come to pay for that, where is the money going to come to pay for this new program?  Because, John, you're talking about programs –not a hundred different new programs [but] new government bureaucracies, new government agencies, all of this kind of spending, somebody is going to have to pay for it.  And if you can't raise it through taxes...you can literally get rid of the US military, just cut out the military budget and raise taxes.  Let's just say if you make 100,000, anything over that, we're going to take 100 percent, you still wouldn't have enough money to pay for Social Security and Medicare.  [55:39]

JOHN:  But that's one of the arguments we're hearing right now, though, if we weren't engaged in this very expensive war over in Iraq, the implication is we would have enough money to pay for this, but we're in trouble no matter how you look at it.

JIM:  And we need to be putting aside 50 to 70 billion a month to pay for these unfunded liabilities of $54 trillion; and that's the elephant in the room nobody is talking about that in this political campaign.  [56:04]

JOHN:  And as you mentioned before, Jim, I really believe that for the most part until people really feel a lot of pain as a result of some of these policies they are not going to talk about it because it's politically incorrect.  How do you fess up to the fact that say for example, the Social Security money has been spent, ain't there, ain't going to be there and we don't have enough revenue to make up for it, so we'll see.  You're listening to the Financial Sense Newshour.  We are at – you should know this by now – www.financialsense.com.

 Part 2

 The Creamy Filling

JOHN:  Well, every time we get to this part of the program, I have overwhelming temptation to abandon my addiction to Chips Ahoy and move over to Oreo cookies because we've been talking for some time about a creamy filling and we're now in Q2, Jim.  I mean here we are.  It's April, so we've left the first three months of the year behind.  Still some pretty bad news out here.  You can hear it in the talky channels and what's going on on C-Span.  Do we have creamy filling filling up our horizon now, or do we have to revise the predictions you've been making since the beginning of the year?  And assuming we're on track – well, answer that question and then we'll turn to question number two about what we should do then. 

JIM:  Okay.  I still think we're on track for the creamy filling, John.  I think the next part of the bailout package, Congress is back in session this week, which is always dangerous because they are working on a new bail out program working with lenders, riding down mortgages, forgiving mortgages, Fannie and Freddie coming in and buying a lot more of these distressed mortgages, lowering their capital requirements and the government getting behind a lot of these issues that we've seen here in the credit and the banking system. 

And so once that gets stabilized and people say:  “Okay.  We're getting close to the worse that we've seen.”  And I think it was the month of March was its peak for mortgage resets for this year, so we're going to start to see gradually those mortgage resets decline.  I think we're heading into that creamy filling.  In fact, we've seen, this is a rather good week for the market, the market holding up to its gains for the week, the Dow which has been down over 10% for the year ,is now down a little over 4 ½; the S&P which had been down 12 and 13% is down, cut its losses in half.  The NASDAQ, I think the NASDAQ loss has gone up, like, 16, 17%, they are down about 10.  And even overseas in the European markets, they rallied along with ours this week, the same thing we're seeing in the Asian markets.  [2:11]

JOHN:  Yeah, but we look at the volatility that’s out there and some of the companies are banging into new lows on the bottom, but you still think that despite that we’re smoothing out at this point.  You know, you take a look at the…there are a  number of issues, the peak in new lows on the stock exchange was in January; with each sell down that we’ve seen in the market the number of new lows being registered are less; and also, you’ve got to remember that huge volatility is more often associated with market bottoms than it is at market tops.  At market tops things are complacent, the market keeps going up, so we’re seeing a lot of the evidence that given what we’re seeing in the market now, things are starting to turn around and be positive.  And so now it’s just…I mean you’ve got to remember what is it?  Next month the first payments on the helicopter drop on the stimulus package that Congress passed in the month of February will start hitting. 

So if you’re a family, let’s say you have three kids in your family and you qualify, that’s going to be a $2100 check in the mail; for most married couples, 1200 bucks; 600 for a husband and wife; $300 for each kid – that’s going to start kicking in.  And they’re working on this bailout package which they’re working around the clock.  It’s going to be bipartisan so they’re working on that.  And then, once they get this bailout package look for also another stimulus package maybe on infrastructure spending, who knows, a new highway bill, a new airport bill, a new something.  And so you throw enough money, and you consider 400 billion coming from the Fed, 120 billion coming from tax and probably another 300 billion coming from Fannie and Freddie; by the time we’re done, you’re talking about almost a trillion dollars of stimulus.   You throw enough money you’re eventually going to inflate your way out of it, and that’s what I think the stock market is starting to sense.  In fact, if you look at even the dismal earnings that we saw in the fourth quarter, back out the financial sector which was experiencing huge writedowns, most sectors within the S&P were reporting growth in earnings.  And I would expect that to follow through as we get into the first quarter; most of the damage so far has been primarily within the financial economy, the financial sector within the stock market.  [4:47]

JOHN:  So we can pretty well expect by election time then that people will be pronouncing the crisis over, things back to normal.

JIM:  Sure, because we can see once this stimulus package kicks that spending will play itself out over the second and third quarter; you’ll start seeing some improvement in the economic numbers, you will be seeing the anchors on cable channels going bonkers (“see here it is, it’s over, the economy is now on the mend, the economic numbers will improve as the stimulus package kicks in”).  And remember, as the dollar continues to fall one of the aspects for the dollar is the one strong sector within the economy has been our exports.  So I expect that to continue.  So we’re going to get a brief respite from a lot of the bad news.  I mean is there anything on the financial front that has not been discounted by the market yet that we don’t know about.  And that’s the question:  Is there something that we haven’t seen yet and the only sector that would be a surprise there would be on the derivative front.  But normally these prices peak out with the – you know, usually have a large casualty,  large investment firm, large bank or something that goes under at the sort of trough in the crisis and that’s where I think we are right now.  I think we’re getting towards that creamy filling.  John, let’s put it this way, the Fed will inject enough money and the government will inject enough money and if you keep doing as much as what our government or our Federal Reserve is talking about doing, eventually there is so much liquidity thrown at a problem that you create the genesis for the next problem or the next bubble.   [6:38]

JOHN:  Well, given that we seem to be sliding into the creamy filling area, where should an investor be putting his or her money right now.  Obviously, things are always changing so you have to keep watching this, but right now where would you be investing?

JIM:  There are a number of things that I think are looking rather attractive.  Number one, the large cap stocks have an advantage in this market over small cap stocks for two reasons:  1) large cap stocks are generally stronger financially, they have plenty of cash, they have access to credit so they can finance their business, that’s number one, versus let’s say a small cap company that may have a tough time getting financing.  A second aspect that the large cap stocks have is they tend to be primarily multinational companies which get a good majority of their sales from  overseas and that’s where the economies in the globe are growing the fastest.  And so that I think gives them a leg up.  And then a third aspect of that is because they are international and get a large portion of their sales overseas you also have the advantage of their getting paid in strong currencies that are going up against the dollar and that’s factoring into their profits.  So I would definitely say the large cap growth stocks are going to be at an advantage in this next up-cycle I see coming into the market.  And then other factors are going to be sectors where you can maintain profit margins where profit margins are going to be growing and there are definitely four or five sectors that are very strong in that segment.  [8:08]

JOHN:  So if we were going to look at areas where profit margins would expand or at least maintain themselves where they’re at, where would we look at, what sector?

JIM:  A couple of sectors – energy definitely is going to be at the top of the list and the energy companies are reasonably, gosh, in fact incredibly priced.  Energy would be one sector.  Agriculture would be another sector.  I mean a good example is on the day that we are talking is a company by the name of Mosaic reported its profits and they were up nearly 1000%.    They make fertilizer and the farmers can’t get enough of it to increase their crop yields.  So the agriculture sector, energy.  I think also the base metal producers; I think technology is another sector.  I think the health care and consumer staples are going to be another area.  And then I think industrial stocks because we’ve talked about the infrastructure boom that we see taking place as a result of decaying infrastructure within the United States and Western countries and building infrastructure in the developing countries.  [9:15]

JOHN:  If we talk about those areas, can you break that ultimately into a bit more detail. 

JIM:  If you take a look at a couple of things that are going to go on, and is going on globally, and that is, if you take a look at what is going on in the commodity complex and the industrial complex, companies that can help unlock the supply bottleneck are going to win while those that are encumbered by bottlenecks of supplies will lose.  And specifically, you know, sectors like the mining and machinery companies, engineering and construction companies – some of these companies have sold out; their demand backlogs go out two or three years.  Also if you talk about improving food diets, as more and more countries around the world adopt western type diets, you’re seeing increases in various diseases associated with Western diets; an increase in diabetes, heart disease and obesity around the globe.  And so winners are going to include companies in those relevant disease categories.  And another factor I think is going to happen:  As we see inflation go up, and taxes go up on individuals that’s going to squeeze, and so I think you’re going to see a lot more people trading down, a lot more people staying at home and that means they’re going to be eliminating more discretionary spending.  Food will garner a larger portion of the wallet, along with energy.  And you will see the concept of nesting, more stay at home, eat at home and things such as entertainment at home is going to become more important and I think these companies are going to do well.  So this is going to be a long term trend. 

And companies that are in the area of industrial, companies that can make money extracting, shipping, or refining commodities.  And this includes the sector of engineering and construction, mining equipment, agricultural machinery, things like railroads and bulk shippers which would enable producers to ship their goods across country.  It’s more fuel efficient and cheaper to put one of these containers on a railroad from Long Beach to New York than it is to put it on a truck.   I also think companies with significant businesses in these emerging countries that are benefiting from higher commodity prices and then also I think the railroads are going to be a beneficiary.  These are some broader themes, so I do expect the stock market to head back up, I do expect if they keep the stimulus going we could indeed possibly even see, especially if the news gets better over the next couple of months, that we’re going to see a new record in the stock market.  There are trillions of dollars that are waiting on the sidelines that have been sitting idly and they’re in money market funds that are getting interest rates that are half a percent; and then also there is a tremendous amount of short positions that are in the market right now that if this stock market starts to head up, these short positions are going to be unwound.  Add that to money coming off the sidelines and saying, “Phew, we got by that crisis,” and everything is coming you hunky-dory again, so it’s time to come off the sidelines.  So there are a number of factors that could drive these stock prices to levels that could lead us to new records.  The amount of cash and the amount of short covering that exists in the market today.  [13:00]

JOHN:  Given that the fact that we seem to be holding to the creamy filling theory, obviously there is always the little wildcard coming out of left field or somewhere, is there anything that could move you off this base?

JIM:  You know, sure.  I mean there could be a giant hedge fund out there that is so large, connected to the investment banks and you know, it’s that rogue wave or that black swan out there that we can’t see.  And certainly with over 500 trillion in derivatives in terms of notional value there is always that possibility.  There’s also the possibility that terrorism, because people think terrorism has gone away.  It hasn’t.  There are people out there that are plotting.  I mean you follow this as well.

JOHN:  And right now in the Middle East if you watched, despite the fact that we hear a lot of talk about the peace process we are really moving towards a very slowly a war footing again.  You can see this happening, right, as we watch it. 

JIM:  Yeah, and there’s also the idea that depending on the outcome of the election that the US will pull out of the Middle East, and so you’ve got all kinds of actors that are rearming and hope to take advantage of that.  So we could actually see depending on the political outcome a war break out in the Middle East.  [14:13]

JOHN:  So basically the Oreo theory is still on track for what?  Second or third quarters?  When do you expect it to unravel?

JIM:  You know, I expect towards the end of the year.  With as much stimulus that the government is now using and as much stimulus and printing by the Fed that I expect higher interest rates and inflation to start rearing up.  In other words,  inflation rates will start to rise and along with that will be interest rates but that could come towards the end of the year.  [14:41]

JOHN:  It’s going to be interesting because by one of those quirks of nature I guess, that’s going to be after the US election.  So whoever will have been elected will be elected by then and facing this. 

JIM:  Oh, absolutely.  And that’s why the powers that be – and this gets both parties because remember the entire House of Representatives is up for reelection.  Whether you’re a Democrat or a Republican.  And that’s why you’re seeing such cooperation on these stimulus and bailout programs because these guys have got to face the voters in the fall, and they don’t want to face angry voters.   [15:15]

JOHN:  Financial Sense Newshour – you’re listing to the Big Picture right now.  Don’t forget, coming up shortly we’ll be getting to the Q-Lines.  This is www.financialsense.com.

FSN Humor – Hedono Tax

Brrr-race yourself, income tax season is upon us again.

You know, it’s bad enough having to pay this outrageous tax, but do we have to go through so much pain just to fill out the forms – there are hundreds of them. And even if you do use one of those tax computing programs, that still doesn’t improve your bottom line: you still have to pay the tax. But now there’s Hedono Tax, a computer program that recalculates your income tax using the government’s own bogus hedonic indexing.

First, input all your W2s, 1099s and reporting forms. Oh my gosh, look at the tax you owe. But wait! Don’t panic. Now just click the Hedono Tax Button and watch tax magic happen right before your eyes using our patented Ponzi process algorithm, hedono tax indexes your tax information based on current government nonsense, it divides the amount you reported by the current GDP, adding back in the cost of fuel and food and reindexing for a COLA adjustment reduced exponentially by a differential of a the reported inflation rate versus the real rate multiplied by the percentage of increase in the M3 money supply, as offset by a standard deviation in the M1 and M2 money supplies, with a deduction for the cost of lunch at the Fed’s Open Market Committee meetings.

Couldn’t follow that, huh?

Good!

The IRS can’t either. And the Hedono Tax calculation is buried in thousands of pages of IRS forms, leaving a cloudy paper trail not even an IRS auditor can follow. It’s audit proof. It even randomly changes your tax payer ID number. Now look! You don’t owe any tax. Hedono Tax is only sold in Bogotá, Colombia, and can be ordered online. Hedono Tax is an income tax supporting program and tax evasion scheme. It’s not fun, it’s not even legal, but it gets the job done. [17:16]

 Planning for Retirement - Part 2

JOHN:  We now continue with the subject we began last week planning for retirement.  This is a four part series.  Today we are in Part 2.  We would recommend that you go back and listen to last week’s Big Picture if you want to catch up on what we did early on in the program. 

Life expectancy is becoming longer and longer, but the guarantee of government provision and other issues, especially if inflation is chewing up your pension as you watch it, you have to make all sorts of new adjustments.  Retirement for our generation, Jim, the baby-boom generation and the Gen-Xers following behind us is not going to be anywhere like it was for the World War II crowd.  So we need to look at that.  What are life expectancies right now.  What can we seriously anticipate.

JIM:  The latest actuarial studies, a male aged 65 today has a 50 percent chance of living to age 85 and 25% chance of living to age 92.  A woman on the other hand, a woman aged 65 has a 50 percent chance of living to 88 and a 25% chance of living to 94.  So between a male and a female there’s about a three year age difference in terms of longevity.  And you contrast that when they first passed Social Security, a male was expected to retire at age 62 and die at age 65; basically collect three years of Social Security.  Well, what we’ve seen with medical technology, the advancements in drugs and other technology, people are living longer, people are trying to take care of themselves today through exercise and diet.  And so there is a chance that people in retirement can live for a longer period of time, so you’ve got to be very careful in terms of having so much of your income on a fixed basis because of inflation you may be living off that income and your needs for that income may last for a longer period of time than what you originally anticipated. 

And last week, we talked about the budget.  We talked about breaking the budget between fixed and variable expenses.  And then we talked about expenses subject to inflation, expenses that weren’t subject to inflation and a lot of people are looking at changing their retirement dates. 

In fact, it was amazing, there was an article in the Wall Street Journal this week, and it was on the front page and it said, “Americans are delaying retirement as housing and stocks swoon.”  And they give the example, of about four or five couples, one guy was an executive for IBM and he was looking at his 401(k) program and also looking at selling his house, downsizing his house, taking the proceeds, getting a cheaper home to live in, taking some of the excess paying his house and then also where his retirement plan.  Well, guess what?  At the end of the year it was a bad year for him last year, this year he was down 20% on his portfolio; the proceeds from the house – they had to drop the value of their house a lot more than they were anticipating.  So you’ve got millions of retirement age Americans who are stung by this recent economic pall who are suddenly having to reassess their plans with many forced to quickly change course. 

So in case of this IBM executive, this guy is postponing retirement.  They talk about another couple that had several million dollars, they did all this retirement studies, location, budgets and rates of return, and then were horrified as the stock market turmoil began last August and the credit cycle began, they were seeing losses in their bond funds, their stock funds and so they went to cash and then Bernanke began slashing interest rates furiously and now their cash is returning about a half a percent.  Two million dollars at a half a percent doesn’t produce a lot of money.  Think about that!   That’s only $10,000 income on $2 million.  So even staying in cash is making them nervous.  [21:41]

JOHN:  So if we’re facing this situation, how do we do this now.  Maybe the core issue you’ve just brought up here, Jim, is the fact that uncertainty is the name of the game here.  Where I remember my folks were able to retire, and my father did, he retired early in his 50s and was able to carry a military pension with him, another pension, Social Security ultimately in another few years, and everything was fairly stable.  He set my mother up well and that carried her through the rest of her life.  And she didn’t have to do much to worry about.  But that’s changing; isn’t it?

JIM:  Oh, absolutely.  And this bring up, since we’re talking about budgeting, two very, very important aspects to add to the retirement equation: 1) one obviously is we’re talking about downsizing, so you don’t need – as this couple in the Wall Street Journal, they didn’t need the big house anymore.  But also, I think in addition to downsizing, you have to add in relocation.  That’s why you’re seeing a lot more retirees moving to states –whether it’s Tennessee, whether it’s Nevada, whether it’s Washington, whether it’s Texas or Florida – where there are no state income taxes and you don’t have this huge welfare mentality or bureaucracy that you have to pay for all these welfare programs that just drive up the state’s budget into deficit where the state has to increase taxes. 

Here in California the top tax rate is 10.3%, and you reach the 9.3% tax rate at income a little over 50,000.  And California doesn’t give you a break on capital gains and pension deductions in the way that you get on your federal taxes.  So, I mean, think if you’re paying 9.3% of your income in state taxes, you move to a state like Nevada, Washington, Tennessee, Texas or Florida, you just eliminated your state tax bill.  And the other thing that you’ll find in a lot of these low tax states is it’s not just the fact that you don’t pay any income taxes, but the rest of the taxes tend to be less too.  The real estate taxes are not as high as they are, for example, in states like California; or even the sales taxes are less.  So these states are dependent on other things such as tourism or industry like mining or gambling, which in Nevada helped pay for most of the state’s expenses.  So relocation is a very important aspect.  Relocating to a place where number one you don’t pay state taxes, and also relocating to an area, a smaller town where your money for housing, because remember housing is a big part of the budget, where your money for housing is going to be so far less than what you’re paying in living in the big city on the east or the west coast.  [24:34]

JOHN:  Living in another country, especially for people who don’t have too much of a difficulty say with language or culture, is becoming more and more popular.  I have two families that we know directly who have purchased property and are moving to Panama – at least part time or full time.  So that is becoming viable and there are other expats.  I’m finding there is a large community of them in say for example Thailand, and other parts of Latin America as a matter fact, because there is also a large American community in – I think it’s in Guadalajara in Mexico.  There are different communities there. 

JIM:  Oh yeah, Mexico has a big US retirement population, you’re seeing it in Panama.  One of the individuals who works in our office has a place in Uruguay, a place on the beach for $30,000.  You know, that’s incredible – $30,000!  That doesn’t even buy you a storage facility in California.  

Relocating to other areas of the world where your money goes so much farther and especially if a lot of your income is fixed, what are you going to do with inflationary costs?  One aspect you have to consider in retirement planning is you look at that budget – and I can’t emphasize enough of putting together a retirement budget.  Until you look at your expenses, what they’re going to be, what’s going to be fixed, what is variable, what new expenses will you have incurred, what expenses will go up more now that you’re retired than when you were working.  And then breaking that out to the amount of your budget that is going to be subject to inflation and the amount that isn’t going to be subject to inflation.  And then when you get a firm grasp on that, it’s then taking a look at all right, how can I get my costs down.  In other words,  if you don’t have enough income to pay for your budget then how can you bring your cost of living down.  And it’s definitely you’ve got to look at relocation, whether it’s within the United States or outside the United States; locating to states where the cost of living is much cheaper.  In fact, the top retirement areas – the top ten cities for retirement –  have that feature:  low taxes, low cost of living, low housing and then also access to medical facilities, cultural facilities like a university.  So that is an aspect that you have to factor in on the budget side in terms of keeping your costs down.  [27:04]

JOHN:  Obviously, relocation would be really good about bringing down your costs, and that’s really valid, especially say for example you could work from where you are.  Say you work on the internet, or something, as long as you’ve got a decent internet connection and a good phone connection you’re okay.  I’m trying to visualize whether or not Walmart could put greeters in every aisle instead of just in the front door.  You know, “hello, Sir, welcome to the toiletries aisle.  We hope it is a pleasant experience.”

JIM:  Welcome to produce; yeah, right.

JOHN:  “Did you need the laxative, Sir, or the…”  that type of thing.  But working is probably going to be part of future life,  it’s just not going to be retirement per se.  And to be honest with you, I couldn’t visualize myself sitting around playing golf every day.  I would be nervous if I weren’t around the radio. 

JIM:  It’s absolutely fascinating.  I was going to retire back in 2001 and John, I quickly realized that I would go nuts and secondly, I love this business.  I love reading, learning and in fact, we take a month of in the summer and even if I go saying, I mean I love to sail, that’s one of my favorite passions in life is sailing, but after sailing seven days in a row, John, I got bored.  I mean, so you have the chance to do something that maybe there was part of your life that you worked in a different field but you always had in the back of your mind, “boy, there was something I wish I could do.”  Maybe it’s community work, it has something to do with a hobby.  I had a client who worked for a large publishing company, when he retired he ended up becoming a tour guide at the Hearst castle and just loved what he was doing, and just loved all the aspects to the castle that went into it. 

I had a history professor who conducts tour guides for one of the travel companies.  So if you’re going to Europe, you’re going to Italy, there’re all kinds of things that you can do that can supplement your income and also they found that people that are active, that are doing something productive in retirement tend to live longer too.  So it’s also part of keeping young in retirement.  Work is definitely something that you need to consider; some kind of part time supplemental work that you could do to supplement your budget; maybe only work a couple of days a week. 

I have a doctor that’s going to retire, loves medicine, doesn’t want the stress, doesn’t want to be on call, but there is a clinic that he’s going to go and provide services for and work a couple of days a week.  So it allows him to keep up with the practice of medicine, and a couple of days a week is going to provide enough income that is going to pay for all the kinds of hobbies that he likes, which are photography and travel.  [29:51]

JOHN:  A friend of mine is a dentist and he did the same thing.  He retired and then went to work giving dental services to people who may be could just afford state services or something along that line, to people who could not normally afford them.  So there was purpose in his life but no long term commitment. 

JIM:  And he still has plenty of time to take off.  So part of this is going to be good too, because I mean if you take a look at the natural resource sector, one of the problems that the resource sector faces today, John, is a lack of personnel.  I mean, nobody wanted to become a geologist and so maybe people stay on in their field longer because they’re experienced and the wisdom that they have over their working career versus let’s say, somebody just coming green out of college.  One of the problems that a  lot of the technology sector and some companies are claiming we don’t have enough educated people in our workforce which is why we’ve been hiring foreign workers.  And so there’s plenty of – or maybe it’s an issue you didn’t have time during your working career, raising kids to go back to school to get knowledge on something that you wanted to do, or maybe you had an interest in doing.  So these are the things that you can consider or think about as a means of supplementing your income and also reducing your costs.  And I think these are two factors – relocation and part time work to supplement retirement – I think these two factors are going to have to be added back into the equation for retirement planning, in addition to postponing the date of retirement.  [31:31]

JOHN:  Well, we were planning to look at investments from a retirement standpoint next week, but since we’re tying in budgetary issues right now, could that be factored in here, just in brief, because like I said, we’re going to hit that a little harder next week, Jim. 

JIM:  I think probably one of the biggest factors that we have seen is a lot of individuals have