Financial Sense Newshour   Home |  Broadcast |  Big Picture Archive |  About Us |  Contact Us

The BIG Picture Transcript

  Part 1

 Barron's Forum with:  Thomas G. Donlan, Editorial Page Editor; Randall W. Forsyth, Editor, Barron's Online; and Gene Epstein, Economics Editor

JOHN:  Welcome to the first part of the Big Picture today, and something I always like doing, Eric, is sitting around a fireplace on a winter’s night (especially if the snow is falling outside) and discussing the issues of the day.  You know, if you’re somewhat of a political of economic-driven critter, which in news work we are, that’s exciting to do.  And I think you've got something like that planned here.

ERIC:  You know, John, one of the fun things to do in radio is just to sit around and have a fireside chat with a bunch of guys talking about the issues of the day, which there’s certainly no shortage in today’s crazy markets.  Sitting around our particular fireplace today on the Financial Sense Newshour is Tom Donlan, Editorial Page Editor from Barron’s Magazine; we also have Randall Forsyth, Editor, Barron’s Online; and Gene Epstein, Economics Editor, also from Barron’s.

Gentlemen, thank you for joining us today, I know you’re all busy over at Barron’s and I appreciate your spending time with our listeners to talk about what is happening in the markets and economy today.

Let’s start off with your opinions of how the United States got into this mess we find ourselves in today, with the need for bailouts and money printing by the Fed and the issuance of new debt by the Treasury.

Tom, let’s start with you.  How did we get here?

THOMAS DONLAN:  We got here by having an extraordinary run of good luck.  Some people have called it the Great Moderation, but whatever you like to call it, we came out of the 2000, 2001, 2002 slow period looking really good and people began to believe that it was safe to take on large amounts of leverage; there was no penalty for taking risks.  That proved, as it always has, to be a wrong conclusion, but we took it much farther.  Our banks, investors took it much farther and we took it around the world besides.  That’s how we got started.  How it finishes I can’t be so sure.  [2:00]

RANDALL FORSYTH:  This is Randy.

ERIC:  Absolutely, Randall.  Come up.

RANDALL:  Yeah.  I think luck was only part of it.  I think there was a definite credit bubble.  There was in essence a whole credit structure that was international; we had a sort of symbiotic vendor finance system whereby we could spend beyond our means; we could save less than we invested because the rest of the world, in order to stimulate their growth through exports, were willing to lend us the difference.  The result was unheard of credit expansion in the United States resulting in a huge external imbalance, and as Tom said, we obviously took it to great extremes.  But it was a systemic structural problem and for a long period of time we were lucky enough to be on the right side of it.  Now, that structure is imploding.

GENE EPSTEIN:  I want to second virtually everything my colleagues have said, and also point out that my colleague, Randy, has been ahead of the curve on a lot of this.  I thought the harm to the economy would be far less than it turned out to be and I think Randy was far more alert to the dangers.  I want to go back to an essay that Alan Greenspan wrote when he was 40 years old, which regrettably he didn’t cite in his recent testimony; it was called Gold and Economic Freedom, written when he was age 40 in which he argued the very creation of the central bank creates more problems than it solves, that it creates the atmosphere for excessive risk taking, for the casino economy; and I should add that it also creates an environment in which the fast-buck artist momentum players – the people who are not sufficiently risk adverse – begin to dominate financial institutions and their more conservative counterparts (who would question against excessive risk) get pushed into the background because after all their advice does not yield a lot of profits.

On top of that, the complacency that was created in part by Alan Greenspan and by his successor, that we have this ‘put’ underneath the economy and that you can take excessive risks without fearing the downsides.  So that poisonous environment, which I think is fundamentally the kind of environment that the centrals necessarily create is at the root of it.  I disagree only in a nuanced sense, saying that things could have been managed better.  Indeed, they could have been managed better in hindsight.  However, one way or the other, the very existence of the central bank or the cartelization of banking that creates the leveraged fractional reserve system under which we operate is going to create boom and bust inevitably.   [4:52]

RANDALL:  To Gene, thank you very much.  I have to say that Gene’s influence has led me to a greater appreciation of Austrian economic principles, and besides that, I still keep looking to the international aspect of various pegged exchange rates that did not provide either stability or sufficient flexibility.  It was neither fish nor fowl and it exacerbated the global credit expansion.

ERIC:  I’m going to come back to the Fed, and I’m going to want Tom also to comment when we get there; and Gene, I’m glad you kind of started that.  But let me come back just to a minute to the banking system because the politicians seem to want to say that nobody saw this coming, but there were many sounding the alarm bells; and Gene, you just brought up Randy.  But there were many others.  And this is the question that I have, and I’m asking you to kind of prognosticate a little bit here.  But what will it take, meaning, how many trillions will it take for the US to regain its footing here and stabilize the banking system?  Tom, why don’t you start.

THOMAS:  Well, that’s an imponderable question.  The only possible answer, given the people that we have in charge, is:  as many as necessary.  In the same way I think Randy emphasizes – and I agree with both of them of course, but Randy emphasizes the willingness of people to take risks and to lend without necessarily having a prospect of getting paid back; and I think that that’s the short term, this problem continues. We are dealing now with the same thing that created the crisis. That is, we are protecting our institutions, our banking and our bankers’ customers from the consequences of their actions; and I think that’s very dangerous.  [6:38]

GENE:  Well, I want to concede to Randy on that.  I have to say again it’s imponderable.  And indeed, it is true that however many dollars are necessary – it’s similar to what President Bush said about the hurricane Katrina, “just put it on the plastic;” and they’re putting it on this Fed plastic and they’re not counting what that will do down the road.

RANDALL:  Well, first of all, I definitely agree it will be ‘whatever it takes,’ will be the total amount.  What is not appreciated is however many dollars are thrown at the problem is that it will still take time.  We are still an instant gratification society and we bristle at the idea of having to wait to let this process work out.  I mean already 700 billion has been voted, put into the nation’s banks and other financial assets to shore up the system and you’re already seeing articles, “where is the lending?”  Well, it’s been a couple of weeks.  The main problem with that is there are bad assets; the bad assets have to be liquidated.  You can’t have those bad assets bought by anybody, there is no lending; and you can’t have lending without capital.  But it goes back to – we get in there, the best – what will be the history books is Chuck Prince’s, the former Citigroup CEO, who said in the middle of 07, “as long as the music’s playing we have to dance; and we’re still dancing.”  And this was exactly at the peak.  There is a penalty for prudence in a mania.  So as long as that happens, we will have manias and busts.  And also, there was a presumption that government can fix whatever damage; that was the explicit policy articulated by Alan Greenspan.  “We can’t predict bubbles, but we know how to clean them up.”  We're finding out this is maybe beyond the capabilities of what we can clean up.  In terms of numbers, I am already seeing estimates of Treasury borrowing – not Federal Reserve money printing, but actual Treasury borrowing in the markets – of two trillon dollars in the next year.  [8:42]

THOMAS:  Who do you think is going to provide the cash for that borrowing if not the Fed?

RANDALL:  That is precisely the question.  I do think it’ll be the other dollar holders in the rest of the world who will essentially – right now, this time, Tom, there is a shortage of Treasury securities relative to the demand in the rest of the world.  I think we will satiate that demand and then we’ll see.

THOMAS:  Right.

GENE:  Picking up on Tom’s remark, I guess Randy is open to whether the debt is monetized – and by the way, it’s a very subtle process by which that happens.  But effectively the system is set up so that if the debt doesn't sell, per force, inevitably the Federal Reserve prints money and buys it with printed money.  One way or another, the outcomes are not good.  There will be down the road certainly some heat up of inflation.  Whether it’s going to be huge or not is a little bit harder to predict.  But we are looking at major monetary expansion.  [9:38]

RANDALL:  In the last seven weeks, the Fed’s balance sheet has effectively doubled in size which is a staggering amount from 900 billion to 1.7 trillion.  That is how much the Fed has printed.

THOMAS:  That’s exactly what Milton Friedman would have suggested that they do in 1930, 31, 32 because money was evaporating from the system.  The question is: are we really in that phase or not?  Should we be fighting deflation just because Treasury interest rates are virtually nothing?

RANDALL:  I would say because markets are saying that the demand for dollars exceeds the supply of dollars, the dollar is soaring, commodity prices are falling and gold has also fallen.  I would not take just Milton Friedman’s quantity theory but only when it’s corroborated by the market’s symptoms.  The supply of dollars has exploded, but it has not been sufficient to satiate the demand.  [10:31]

ERIC:  Let me move on to the economy with the three of you.  Again, I’m going to ask you to look forward and kind of give your thoughts here; obviously, you have to somewhat guess or use your models.  But when looking at the economy going forward – and Randall, I’ll start with you, but I’m just curious – how will the US economy fare over the next few years in your opinion?

RANDALL:  I think that again this will be rather long and drawn out – we will be operating well below our potential.  The comparisons with the Great Depression are totally misplaced.  If anything, all policies are directed to preventing a re-run of that; both good and bad – whether money printing, credit creation, but also I think an appreciation of the deleterious effects of protectionism.  But still, you have according to the Austrian precepts, the greater the excesses, the greater the bust and the longer the healing process.  So I would expect a fairly long drawn out –now used to using letters to describe economic cycles and so forth – I do not expect at all a V-shaped recovery or a U.  I think it could be something more along the lines of an L.  We are now feeling a definite fall off in activity, and I think it will remain suppressed for a period of time; and after that point, the problems are healed, then we will set the stage for fairly vigorous growth after a lot of these excesses and malinvestments are cleared away.  Building houses for people who can’t afford them is not a good use of capital, and once capital is redirected to more efficient uses, I think we’ll set ourselves up for a better growth.  But I think that is a 2010, 2011 event.  [12:26]

GENE:  Well, I’d probably disagree with Randy to some degree.  I do agree that we're in for a prolonged period of stagnation.  It will be just for starters and in broad brush strokes, roughly similar although worse than the period of stagnation that resulted from the bubble that caused the recessions of the early 90, 91 and the period of stagnation that resulted in the boom and then bust cycle of 2001 that caused the recession in that year, which took a couple of years to recover from.  I think it’s going to be a kind of saucer-bottomed – to use something other than a letter – a figure, sort of a saucer-bottomed situation and negative three-tenths of a percent growth in GDP in the quarter that just ended.  We're always looking backwards with those numbers indeed.  The third quarter that ended December 30th, we’re looking at negative three-tenths of a percent.  I’m somewhat more sanguine, more optimistic than I believe my colleagues are.  Although I certainly think that when Randy refers to potential economic growth, one working definition would be to ask:  can the economy grow fast enough to utilize all its labor resources?  Certainly not.  Certainly it won’t.  The unemployment rate is going to continue to rise through the end of next year.  [13:42]

ERIC:  Tom?

THOMAS:  I have been more sanguine about the – in current terms and much less optimistic in longer terms.  I think we have some systemic imbalances.  It’s my job to bring up entitlements whenever anything turns to the economy.  I think we are in a long term inability to pay for all our promises, and it just happens this time that it’s our promises to house people who can’t afford housing.  Next time it will be to give medical care to people who can’t afford that.  And after that it will be something else.

RANDALL:  Actually, Tom brings up a good point.  I think the current financial crisis takes us away from the real crisis in decades to come of entitlement and debt that looms over us, which is in the trillions, as David Walker has outlined.  I have not heard in this entire presidential campaign hardly any words about this.  To me that is the greatest –

THOMAS:  The only words you've heard are the words to promise to take care of it and not let anything bad happen to anybody.  And I think we've heard that before.  The Medicare, Medicaid, elder care time bomb which isn’t only due to the fact that there are many baby-boomers who are about to retire, it’s essentially due to the way in which our healthcare system was set up.  It has been something that the Congressional Budget Office for one has been trying to alert the Congress for several years.  Their projections I think are a little bit more useful:  they point out that within about 30 years most of the federal budget is going to be eaten up by –

RANDALL:  I think it was more the GAO that has run the –

THOMAS:  Most of them have provided all the information that any reasonable person could need, but they don’t happen to be reasonable about this topic in Congress. 

GENE:  There’s some sort of irony about this because I’m wondering whether – and I won’t venture to predict who’s going to be the next president since others have already done that – whether the next president of whom ‘I promise so-called universal healthcare’ is going to be able to deliver on that promise, given the way the Treasury debt is ballooning right now.  I think that’s an odd wild card in the situation, as to what it will actually happen, because it has been predicted that if the Democrats control the White House and the Congress, we will have the extension of the nationalized healthcare that is already Europe and Canada.  But we may not.  I think it’s gotten a little dicier at the moment as to what will actually happen.  [16:02]

RANDALL:  I think that nationalized healthcare is not a good thing, and if anything this financial crisis, given the budget burdens it will impose, might stave it off for some period of time.

THOMAS:  I would very strongly doubt that.  I think that from my perspective here in Washington, the problems that we have in the financial economy will justify taking large risks with a national healthcare system.  We will get an expansion of the role of government in healthcare, perhaps something purporting to be universal.

GENE:  Tom may tragically be right about what he just said, but I’m sure he hastens to add that he hopes he’s going to be proved wrong.

THOMAS:  ‘I hope’ is one thing, but you know, they’re going to get their chance to try that and they’re going to get their chance to find out if it fixes everything they think it will fix.

RANDALL:  Tom, don’t blame it all on Washington.  The business roundtable are 100 percent in favor of that.

THOMAS:  Excellent point, Randy. They look at it as a short term cash flow improvement.

RANDALL:  And they look at their global competitors who also – whose employees are taken care of by the state and they want exactly the same thing.  That was what pushed through Medicare Part D, which was one of the greater outrages to me of this outgoing administration.  But the Fortune 500 want nothing more than national healthcare.  [17:25]

THOMAS:  You’re absolutely right.

GENE:  Picking up on what my colleagues said, in response to a question that was raised earlier about politicians warning us what was to come, my own presidential candidate, who is unfortunately not really running seriously anymore, Ron Paul, warned about the housing bubble and the harm it would do as certainly by 2003 and probably earlier.  He did co-author a book called The Case for Gold and he does point out, in keeping what Randy and Tom have just agreed to, that there is a clear – we do live in a system of crony capitalism in which those capitalists and businessmen who we think might be on the side of free markets are actually not, because naturally they prefer rigged markets.  [18:05]

RANDALL:  I put the blame much more broadly.  Everybody wants something for nothing.  That’s why you were able to get people to sign on for mortgages that were ridiculous; that’s why people would buy cars and boats and so forth on credit, they just think about next months payment.  And business wants something for nothing also.  We are reaching the end of that pot.

THOMAS:  The end of the free lunch.  Yes.

ERIC:  Let me move on with the three of you to the stock market here because we've obviously had this tremendous decline from around 14,000 on the Dow to around the 8,000 area before we started this rally.  Where do the three of you see this stock market and all of this.  Meaning, should people be buying as Buffett says, or are we still in a secular bear market, and Gene, I’ll start with you here.

GENE:  Okay.  I can only say that I still tend to believe in the long term potential of the stock market and the safest statement one can make is historically even to this moment is that on a 20 year basis it tends to do quite well.  It’s a good place to put your money; and certainly at these depressed prices, probably the 20 year performance will be quite good.  Maybe even the 10 year, but that’s as far as I’ll go.  [19:23]

THOMAS:  I’m not sure how far I will go.  We constantly have a debate between the folks who are buy and hold and folks who are market timers, that is people who want to get in and out with the ups and downs of the market.  There’s lots of evidence that trying to time the market is only successful for a very few people who are either much smarter than everybody else, or much luckier than everybody else and buy and hold has it’s own problems.  I prefer buy, buy, buy slowly and moderately in good times and bad times and congratulate yourself when the market is going down if you are continuing to buy, even though it is down, because it is cheap; and slow down when the market is high.  Slow down on your purchases.  If you just sunk all your money in the stock market on one day, you have much less chance of doing well than if you over a lifetime gradually put a small percentage or a medium percentage of your income on a monthly or quarterly basis.  That’s the only advice I can give you.  And the reason why you do that is as Gene said because over the long term, the stock market has always outperformed the alternatives.  [20:29]

RANDALL:  I think we have stock market valuations have come down to what I would consider to be fair value.  I don’t think the stock market is still overvalued; I don’t think on a broad basis it is undervalued.  That said, over time, yes, equities do outperform other asset classes, but in terms of a specific investment strategy, there is no reason that common stocks have to be the only part of your portfolio.  The one thing that should have taught us is that diversification is very necessary.  Actually, in this downturn, diversification has not paid very well.

THOMAS:  Everything went down.

RANDALL:  Exactly.  But we've gotten to the point I would say that corporate debt is, for the risk that you’re bearing, a better buy now than corporate equities in the United States.  Investment grade debt is paying over 9 percent if you take a baa index; that is an extraordinary spread over the risk free rate and it is the long term return from equities.  Now, if you go to the junk market, it’s being paid 14 percentage points over Treasuries.  It’s been clear over history when you are paid such a large risk premium that it will pay off over time.  So I think that those two areas are very attractive.  Municipal bonds are also yielding more than taxable Treasury securities.  If you look around the world, many other countries’ stock markets have been hit as hard, or as hard, as ours.  I would say that the growth potential for the emerging markets over the next 10 years will be greater than the US economy and now their valuations are coming down where you’re not paying for that extra future growth.  Before it was a mania to invest overseas and the valuations were very high.  When you pay a lot for an asset, you know that your returns in the future are going to be much lower.  Therefore, I think that a diversified portfolio of US corporate debt, of foreign equities, of foreign debt will do well but there’s no reason that you have to go out and buy them all tomorrow.  As Tom said, you can dollar cost average into these securities.  And I would also add that I think that in 10 years, I would be fairly certain that gold will be higher than it is today.  [22:59]

THOMAS:  I think everything will be higher because the dollar will be lower.

RANDALL:  Yeah.  I think gold will return to its real peak of 1980, which will be equivalent to a current dollar price of 2000.  So if the dollar has structural problems then we’ll tend to go down.  The only problem is in the rest of the world no country wants to have the mantle of a strong currency.  There is a kind of race to the bottom which will lead me again back to gold.

THOMAS:  Yeah, I think that’s a good point.  Incidentally, there’s something structural about the United States market and corporates that we haven't mentioned yet.  China has a major advantage over an American corporation because it doesn't have a pension system and pension regulation that will require virtually every large and especially unionized companies in the United States to make very large restorative payments to their pension funds.  [23:47]

ERIC:  Well, wait a minute, Tom; now wait a minute.  They’re already crying to the government and saying come in and rescue us, our pension funds are out of whack because the stock market fell.  So they don’t want to cover it, Tom.

THOMAS:  Of course they don’t want to cover it, but we have laws which make them cover it and we may or may not pass more laws that will let someone else do it.  But it’s a problem for all the large communications companies, all the large manufacturing companies.

ERIC:  Agreed.  But do you think the government will step in and rescue many?

THOMAS:  Current law says that the pension funds get rescued at least to a significant extent but only in bankruptcy or a virtual bankruptcy.

RANDALL:  But that is not such a far-fetched –

THOMAS:  No.  It’s hardly as far-fetched as it was.

RANDALL:  When you look at Detroit.

THOMAS:  Yeah.  There’s a really interesting question.  Do you guys think that the US government – whether the administration or the Congress will ever let a Detroit auto company actually go into bankruptcy and discharge its pension obligations, its healthcare obligations and for that matter, it’s union contracts?

RANDALL:  In the real politics of now, I don’t think it will happen.  Again, as you say, Tom, it will become put on the public purse.  [24:56]

ERIC:  Tom, obviously you asked the question – Eric King here – but, no, absolutely not.  I don’t believe that.  I don’t think they’ll let those things go up in smoke.  No.  No way.

THOMAS:  Then you probably ought to buy some of those high yielding General Motors bonds that Randy was talking about.

ERIC:  You know, I think there are others like Schering-Plough or some of those.

THOMAS:  What do you think, Randy?

RANDALL:  Okay.  In full disclosure, I do own some of those bonds and they have gone down in price.  They fell to about 20 cents on the dollar.

THOMAS:  And what do they yield now?

RANDALL:  Close to 40 percent.

THOMAS:  Well, if they’re not going bankrupt that’s unbelievable, isn’t it?

RANDALL:  Well, I’m gambling that I’ll be bailed out by –

THOMAS:  Everyone is to blame, even Randy Forsyth.

RANDALL:  I will admit to that, but in Chapter 11 reorganization I think they have assets worth 40 cents to the dollar and the bonds are selling for 20.  Now, here’s a very interesting point is that GMAC bonds have rallied.  They’ve almost doubled in value in the last few weeks very quietly because GMAC is going to connive to be qualified as a bank and be able to have their commercial paper through some weird conduit be bought by the Fed.  Now, here’s the back door is really being used again here and before anybody even knew about it.  [26:20]

ERIC:  You know, I listen to what you’re saying there, Randy, and it’s kind of unbelievable.  You know, now they would become a bank, which I guess they kind of acted as a bank so now they’re going to get bailed out.  But I agree with you that in the end there will be some type of a bailout or some kind of rescue thing.  Although I’m not a fan of GM.  Look, guys, when you look at GM, GM doesn't look like it’s going to make it, certainly when you look at the books – or a Ford – so then it just becomes how much money printing are we going to have or how much debt are we going to issue.

RANDALL:  I think GM and Ford would make it if we did not have a downturn in the economy.  I think they very, very much too late did get religion; they are actually for the first time in my lifetime selling some good product and a product that I might want to buy.  And unfortunately there is kind of a social contract that results in there will be a bailout for the workers.  There have been so many people who’ve already been sacked and suffered, so I think we've extracted a pound of flesh and I think a lot of capital has been reallocated away from this industry and it’s being shrunk.  [27:29]

ERIC:  Let’s go on to the Fed now because we've briefly brought it up earlier, but let’s get some comments on how the Federal Reserve is handling this situation, but before you comment let me mention about the Dr. Anna Schwartz interview.  She’s 92 years old, you know, one of the world’s most respected economists and she co-authored with Milton Friedman the brilliant work, A Monetary History of the United States.  She worked at the National Bureau of Economic Research, but I wanted to talk about a point that she made in her commentary that was in Barron’s.  And this is the quote:

Since midsummer, Fed credit appears to have ballooned greatly and that’s behind the upward pressure in the Consumer Price Index.  The Fed pooh-poohs inflation because of the perceived slowdown in oil and gas prices, but theoretically, any increase in the monetary base must be met with a tightening if inflation is to be avoided.  Right now the Fed is pursuing a slow inflation strategy by lowering interest rates and showering the banking system with liquidity.  They’re not even considering inflation.

So gentlemen, what about the Fed, how they’re handling this crisis?  And there’s all this talk of inflation, but isn’t Dr. Schwartz correct when she seems to suggest that the likelihood is extremely high that we have inflationary problems as a result of this?

THOMAS:  I couldn't have said it any better than she did, so I’ll let somebody else go.

RANDALL:  You can accede because I’m going to disagree because this is why I’m no longer a high church monetarist.  What is happening in monetarist terms is that velocity of money is collapsing which means that more money is just being held.  It is effectively sterile.  It might as well be stuffed in mattresses.  People, because of the financial scare, they are holding – again, using monetarist terms – precautionary balances.  Most of the money that the Fed has pushed into the system is being held as excess reserves, which now do actually pay a rate of interest; it’s a pittance of 65 basis points now, but there is a sharp drop in the velocity of money.  The basic tenet of monetarism is that over time velocity is relatively stable.  This is not the case now.  The demand for money is soaring.  That is why gold has fallen, why commodities are plunging.  There is a shortfall of dollars and the Fed is the only demand for dollars.  I had the A Monetary History of the United States on my bookshelf for years and I read it and reread it, but I think, I’m sorry to say, Dr. Schwartz is wrong.  [30:12]

GENE:  Well, I see your point and I agree with you in the short term that is the case, and I think you describe it very well.  You sound even more of an Austrian in that sense when you speak in those terms, but down the road don’t you agree that the Fed’s policy in the year 12 months from now – 24 months from now – are going to be inflationary?

RANDALL:  I think that the credit that they are trying to create is nearly offsetting the credit that is being destroyed with the collapse of asset values.  And that is why when asset values were exploding it was an error for the Fed to ignore them because that didn’t count as inflation, that the excess dollar creation during the 90s and then after 2000 and 2006 which was obviously inflating asset values.  It wasn’t going into the CPI, it was going elsewhere.  It wasn’t going into the CPI because there was a supply shock from the rest of the world.

THOMAS:  You don’t have to say Dr. Schwartz is wrong in order to accept your view, which is correct in the data that the velocity of money has gone to heck and that the Fed is intentionally, as she said, ignoring the potential of inflation by creating amazing amounts of money.  The question is can you trust and are there adequate mechanisms even if you do trust the Fed, for it to soak up the money it has created when it becomes appropriate?  On the record you were just citing, the Fed will not soak that money back up; it’s out there for good.  And as assets rebound, we’re going to all have 2000 gold, 400 dollar oil and 3000 dollar cars.

RANDALL:  I hope the Fed will heed those market signals.  [31:58]

GENE:  Well, it would be real nice if they did, but –

ERIC:  Tom, let me ask you here because you initially agreed and kind of passed it on, but when I spoke with Dr. Schwartz and this was yesterday, but she said to me that the likelihood was extremely high on this inflation situation.  So I’m not in the camp with Randy but I do understand where he’s coming from; I respect his opinion but I do respectfully disagree with him and I agree with Dr. Schwartz.  My money is on the 92 year old woman here.  So where do you stand in this, Tom?

THOMAS:  I think Randy is absolutely right in describing the situation as it is, and my political judgment as well as my economic judgment is that Dr. Schwartz is right in the longer term because there is a systemic bias toward inflationary – towards liking inflation in our entire system because inflation is good for borrowers and it’s bad for lenders; and how many of which do we have?  We have lots more borrowers than lenders, so in order to make them happy we will always have some inflation and we will tolerate policies that run the risk of inflation a lot more than we will tolerate policies that run the risk of deflation.

GENE:  The only question is, Tom, whether we are looking at more of the same in terms of CPI inflation as we've had in the last several years or whether we're looking at some acceleration.  [33:17]

RANDALL:  If I just want to put my chip on red or black, it’s definitely on the inflation color.

GENE:  I would still believe that 12 months, 24 months down the road we’re going to see more serious CPI inflation and the Fed possibly reacting to that.

THOMAS:  I hope so.

GENE:  And by the way, just bringing the argument – the whole focus in a different direction, even those terms, ‘inflation,’ my colleagues are probably aware, are a bit of a misnomer as expansion of the money supply does not necessarily always to lead to higher prices, but it does lead to the surplus expansion of credit, that leads to malinvestment, leads to a bust down the road.

RANDALL:  And again, I think the markets will tell us when the central bank is creating credit in excess of what the economy needs, and I think is merely replacing what’s being destroyed by the debt deflation.  I mean debt deflation which was articulated by Irving Fisher in the 1930s and is I think really the touchstone that Bernanke is following now.  Essentially, when you have deflation and a very high level of indebtedness, well, the asset prices go down but the liabilities associated remain unchanged.  I think to some extent we're solving that by walking away from a lot of those liabilities because people who bought houses for 500,000 and borrowed 500,000 and now they’re worth 300,000; even if they can pay the loans they’re walking away –

THOMAS:  Because they can buy another 300,000 house just as nice as the one they’re in.

RANDALL:  Or rent it for probably 1200 a month.

THOMAS:  Exactly.

RANDALL:  But in any case, to combat this debt deflation requires a monetary expansion and I think it is now – you’re just replacing the water that is leaking out of the hole in the bucket.

GENE:  Soon we’ll prime the pump; right, Randy?

RANDALL:  Oh yes, and the markets will give very adequate warning when that happens, and then the other thing that I’ve written about recently is the TIPS market.  Well, the TIPS have shown a massive contraction in inflationary expectations and, in fact, deflation in future years – I mean out to the next couple of years.  Longer term, 10 years down the road, I don’t pretend to be able to anticipate.  [35:34]

THOMAS:  I don’t think any of us really do.  We're just taking a wild guess.  Economics is basically the science of mass psychology, which is quite well-done.

RANDALL:  It is not a science, and that is one of the problems that us got us –

THOMAS:  Neither is mass psychology.

RANDALL:  Exactly.

GENE:  I disagree with my two colleagues.  Economic forecasting and economic prognostication is more or less what they describe.  Indeed it is an art.

THOMAS:  Indeed, it’s an art, Gene; I apologize.

GENE:  But honestly, there are certain fundamental insights.  Thank you, Tom, we all agree about that then – go ahead.

ERIC:  Let me talk about the dollar here.  Let me bring that into the conversation because – and I’ve said this to listeners and not to get technical, but here you had 40 years of support on the US dollar give way around the 78 to 82 level and we went down towards 70 and we're having this rebound.  But I will tell you and I said this last week and we've had the dollar move lower, but on the other side of all of these dollar purchases –and some arguments have been made that they’re temporary and artificial (and to a degree I agree with that) – the other side of all those trades are the commercials and the commercials are very, very, very heavily short the US dollar.  And I’ve said to listeners on this show that when you break 40 years of support and then you have a retest or a rally back into the teeth of that the way we are right now (and ultimately, I think the US dollar will be substantially lower), but that will be the thing that people will look back and say, “I should have” – that was the warning sign.  That was when the warning bells went off; that we should have known we were going to have a much more devalued US dollar.

And I look at what’s happening right now and I talk all the time about a speech that Greenspan gave in Belgium, you know, where he talked about the fact that the banks make off-table bets in the form of – and as they’re making these off-table bets in the form of derivatives, that if they win they keep those bets, but if they lose, systemically, the taxpayers stand ready to bail them out.  And basically he repeated five times that the Federal Reserve stands ready – and that would even include the Treasury – stands ready to create money without limit; and I took that as a disclosure.  Now we're entering that timeframe where we’re having this money created without limit; or some may argue the Treasury is out there printing money increasing the debt.  But isn’t there a danger here that we could have this tremendous dollar devaluation as a result of all this?  And then how is it any different in France in the 1700s where the government would meet and the economy was struggling and they would say, let’s print some more assignats, and they would flood the economy and then it would get better for a few months and then it would start rolling over, and then the government would meet and they always came to the same conclusion: let’s just print more money.  Isn’t that a valid comparison today and isn’t the US dollar in trouble here longer term?  [38:27]

RANDALL:  What I described was that the dollar’s rise and then demand for dollars is a very short term phenomenon resulting from the whole world has borrowed so they are effectively short.  Again, this is a very short term phenomenon of the current cycle, or within the current cycle.  I think a better comparison with the US dollar is the British pound from 1914 on.  We have enjoyed a huge advantage because just like Coca-Cola or Band-Aid, “US dollar” is a brand name that is accepted around the world, and we have enjoyed enormous benefits as a result of that.  The dollar is used for transactions; we also have the deepest financial markets, so we are the depository for the world’s liquidity.  As a result, we have been able to print those dollars and spend them and we print up the paper and we get the real goods.  This cannot continue ad infinitum; and there will be at one point a good substitute for dollars.  I do not think the euro is a sufficient substitute.  I don’t believe that you can have a currency without a country.  I think, as with the British Empire, the pound was strong because Britannia ruled the waves, and I think so long as we are the sole superpower for now that that is another reason why the dollar is the universal reserve currency.  This has been called ‘China’s Century.’  At some point I believe China, from its military and economic strength, will have a currency equal to the dollar.  I don’t know whether it is in my lifetime because their financial and banking system is still very suspect; but we are being supplanted in this regard.  There’s also another theory that when countries have built empires and have their military resources are stretched too thinly, that’s another problem that saps their strength.  The British Empire was a net creditor.  They were the world’s biggest creditor when it ruled the waves.  We have tried to be the world’s policeman on a credit card, so I don’t think that can last.  Over the very long term I think the dollar’s demise, unless there is a fundamental change, is inevitable.  Or, if we have a new monetary system with something other than credit based.  I don’t how the path would lead to that, but I think that is a possibility.  But this is something over decades, not days.  [41:05]

THOMAS:  Absolutely.  Let me pick up on a couple of points that Randy made.  First, I agree with him as far as it goes, but of course, what he’s implying is that the downfall of the dollar is probably years away.  I would add that the whole role that the British pound played as the reserve currency and the exchange currency of choice, and the way the dollar has played that role over the last few decades, gives the lie to the idea that markets really like foreign exchange.  The balkanization of currencies by nation states is not the way international traders like to transact their business; they all have short pencils and they want to deal with one currency and that should be gold.  And in a sane world it would be gold.  Indeed, in a saner world than we're likely to have in the near future, we’d all be sitting down and thinking through how to go about – I shouldn't use the word ‘return’ because the gold standard was more than not honored in the breach – but a true free market gold standard that would make it impossible to incur the problems of inflation, and that would actually give an economy in which savings decisions and investment decisions were related to each other, rather than the crazy world we live in in which investment decisions are decoupled from savings decisions.  But short of going to gold, which would be the sanest solution to the world, we’ll probably continue with the dollar.  [42:32]

RANDALL:  And we’ll keep lurching forward from crisis to crisis.  The dollar will become undervalued and then over-valued, and the medium of exchange is supposed to have a stable value.

THOMAS:  Yeah, if we ran the dollar as a public service for the world then it probably would be every bit as good as gold and every bit as stable as all three of us would like it be.  But since it is also a political tool, I don’t think you’ll see that.

RANDALL:  Americans will one day wake up to the fact that the dollar as a reserve currency has been the single biggest free lunch that they’ve ever enjoyed.  And when it’s gone –

THOMAS:  You don’t know what it’s got until it’s gone, as Joni Mitchell said.

RANDALL:  Right.

GENE:  The question is:  is that just over the next hill?  Probably not.  It’s years away.

RANDALL:  There is no good substitute.  That’s the only reason the dollar standard –

THOMAS:  Gold is a good substitute and nobody is thinking of it.

GENE:  As anybody who was warning about the mortgage crisis would have said, things that are inevitable eventually do happen.  [43:34]

ERIC:  Tom, when you look at via a George Soros because he talked about this bear market being I think being secular in the US dollar and so having a ways to go obviously in that scenario, but he talked about the fact – and I’m going to quote him here – there is no suitable alternative.

THOMAS:  That’s what Randy was just saying.

ERIC:  Right.  So, meaning if people are kind of wallowing around from currency to currency here, but in that environment then because I’m going to turn to gold here, in your book, Tom, World of Wealth on the cover you have a gold bar.

THOMAS:  That’s right.

ERIC:  Why the gold bar?

THOMAS:  Because that’s what the art department at the publisher thought would get the idea of wealth across and that it shows you that people really do have – people as far removed from economics as an art director at a publishing house – really do have a notion about gold, that it’s more special than silver or platinum or oil or any of the other commodities that we trade freely – relatively freely.

I have a lot of faith in Gene Epstein and I’m sure that if you give him half a chance, he will explain to you how we could have an international gold standard.  And my only objection to it is that it doesn't serve political needs of the people who would have to put it into effect.  [44:55]

GENE:  Yes, that’s true.  The slave owners were not likely to give up their slaves, although I wouldn't necessarily argue for civil war.  But go ahead.

ERIC:  You brought up gold and economic freedom from Alan Greenspan, Gene, and in there he talked about the absence of a gold standard.  And I’m going to summarize here, but the only way to protect yourself is through gold.  True today, and why the transformation of Alan to abandon what he said in 66 and run the Fed and get us into this mess?

GENE:  He caught atomic fever.  That’s all.

RANDALL:  He wanted to be accepted into the halls of power.

THOMAS:  He wanted to be a powerful person, and a powerful person who has principles is almost an impossibility.

GENE:  I wonder if Barron’s has something to do with it.  It is little known that he was promoted greatly by one of our former editors in chief, Bob Bleiberg, and then he got his name in the papers and then Washington called him and he never looked back.

RANDALL:  How many Georgetown cocktail parties do you get invited to if you aren’t a man of such principles?

THOMAS:  Speaking for myself, I would like to – may have you believe that I’m a man of steadfast principles, but I can give you one piece of evidence:  I am never invited to any Georgetown cocktail parties.

RANDALL:  Wear it as a badge of honor.

ERIC:  So, Tom, are you bullish gold for the long term here or do you not have an opinion?

THOMAS:  Well, I don’t have an opinion really.  To me we have a – in the short term it’s subject to lots of manipulation but in the long term, markets pretty well come out where they ought to and things that are valuable remain value, and things that are not valuable decline.  The dollar will decline relative to gold, but that doesn't mean you are increasing the value of what you held if you held gold.

GENE:  I guess I would raise a question with my colleagues, and say it was 1987 or 1988 and we were asked if the Berlin Wall is going to fall, will the Soviet Union unravel.  Well, probably as late as 87 or 88 we would have said, echoing Tom, that the Kremlin is not likely to give up its power voluntarily.  Things do unravel, and what rankles me especially is that the view has been held that the recent catastrophe is the fault of the unfettered free market, when in fact, if you just allow the unfettered free market in gold, in money, then this would not have happened.  It is, strictly speaking, the fault of the monetary regime government’s have created, that they imposed on the markets and that has created the catastrophe.  [47:19]

RANDALL:  And one last thing on gold – during a debt deflation when paper assets lose their value, gold has gone up.  During the general deflation of the 1930, gold prices rose.  That was the one reliable store of value and then, of course, the US government made it illegal to hold it.  But in any case, I don’t equate gold with the CPI; I think that it is an alternative asset and will be the one that maintains its value.  And the worse things turn out, the more I feel that someone should hold a portion of their wealth in gold.

GENE:  Well, you think it will beat the CPI, Randy, and I think you may well turn out to be right.  It’s a dicey forecast, but plausible.  And I would add as well the very fact that gold trades at a value that is so far in excess of its ornamental and industrial use indicates that it is still regarded as a monetary metal fundamentally; and that’s important to keep that spirit alive and the market keeps making that point.

THOMAS:  I think the example of my publisher’s art director shows you that people want the dollar to be as good as gold.  They believe that wealth and gold are kind of interchangeable.  If I had had my choice, though, I would have had a large symbolic perhaps a factory on the cover of the book because that’s what actually creates wealth.  How you store it is not as interesting to me as how you create it.  [48:48]

ERIC:  Let me move on to something and shift gears entirely because you know, and Randy has said, we don’t have necessarily a valid comparison to compare the Depression to today and certainly we're not there and we may not get there.  But when you go back to the 30s, and this is from Barron’s, I’m just going to read this and then I’m going to ask for some comments from the three of you, this is from Barron’s in 1933:

Sometimes openly, and at other times secretly, we have been longing to see the superman emerge.  The question of whether Mr. Roosevelt properly belongs to that category is not now answerable.  The point is that for the moment is that he acts like one.  And yet, well, a genial and light-hearted dictator might be a relief from the pompous futility of a Congress as we have recently had, only let our semi-dictator smile as he semi-dictates.

Now, that was from Barron’s of February 13th 1933.  And my question to the three of you is, it was interesting to me – and I’m going to use the bailout as an example here – the public was against this in record numbers; and then the stock market was crashing and all of a sudden they were in favor of it – I don’t know if that was ever clarified.  But how quickly the public opinion changes.  And they were in the midst of a depression and it was almost like this idea that we have a dictator emerge was sort of being considered.  Do you ever look, if things spiral out of control in the United States; two things – do you think we risk our constitutionality and our freedom evaporating and a dictator taking hold?  And if that was to happen, are some of these things disturbing to the three of you when you look at the monitoring of citizens of the United States and some of these powers that have happened since 9/11?  Maybe just a comment on that.

THOMAS:  Please remember that comment, as apt as it was, was I think ironic.  My predecessor editorial writer was horrified by the possibility that Roosevelt might turn into a dictator because people were so desperate.  Remember, that comes one month after Hitler was elected into power.  [51:06]

ERIC:  Well, I’m horrified by the thought that we’d have a dictator.

THOMAS:  I’m horrified by the thought we might think one necessary.  I think that the ‘eternal vigilance is the price of liberty’ is we should always act as though it were a danger because indeed, it is a democracy and it is possible.  It is something we should be as concerned about as possible.  But those of us who are concerned will never be in the majority.

RANDALL:  Well, perhaps – I don’t know whether I’m sanguine or complacent.  First of all, I would note that the Supreme Court struck down many of Roosevelt’s actions, the NRA and so forth.  As it happened, I’ve been helping my daughter in eighth grade who has had a test today on the Constitution and the Bill of Rights, and after having to drum them into her head I don’t think a dictatorship can really take hold here.  I’m disturbed by some of the parts of the Patriot Act, but I think if anything there is something different in this country.  We are reluctant to give up civil liberties.  I don’t think in many other countries there would have been the objection to something like Guantanamo and both presidential candidates have decried it.  So I don’t think that there is a true threat to liberty, because of the vigilance and just the general nature.  We were founded on ‘don’t tread on me’ and I think there is still that strain that runs through us.  [52:43]

GENE:  I agree with my colleagues that anything like speaking of dictatorship by the White House is paranoid talk; on the other hand, I would stress that the increased authoritarianism of the state vis a vis the economy ever since Roosevelt has been a creeping danger.  Economic liberty and political liberty are fundamentally inseparable because the only way to truly exercise free speech is to have private ownership of the means of production; and I’m sure they would agree with me that it is disconcerting that government is going to have an increasing role in deciding how capital is allocated.  We don’t want democracy when it comes to the economy.  Indeed, we don’t want democracy when it comes to most things.  We want freedom.  We want my right to move my fist, stopping at your chin, but we don’t to take it to a vote as to whether Barron’s gets published; if several hundred thousand people want to buy Barron’s that should be good enough for everyone else.  [53:39]

RANDALL:  When we have to worry about too many people in the rest of the world trying to get into the United States of America, I don’t see how we have to worry about our liberties.

THOMAS:  We still have a very good product.

GENE:  We have a very good product compared to the competition.

RANDALL:  And we have an economic system, more than any other country, where it’s one dollar one vote.  And that’s a comfort.

ERIC:  Well, gentlemen, I want to thank you for joining us this week on Financial Sense Newshour.  A tremendous roundtable there from the three of you.  Lots of information.  So thank you to Tom, Randall and Gene again for joining us.You’re listening to the Financial Sense Newshour at www.financialsense.com. The Big Picture continues right after this.

Part 2 Big Picture with Eric King & John Loeffler

JOHN:  And welcome back to the last part of the Big Picture.  And Eric, Jim wanted us to go over a couple of things here on the program.  (As everybody knows by now, I’m sure if you've been listening to the show, Jim is out this week and will be back next week.)  A couple of things that we have talked about for quite some time here on the Financial Sense Newshour; the first one is we have been predicting that there would come this move to begin nationalizing private retirement plans in one form or another because this represents a large amount of money out there and governments around the world – ours in particular – are becoming more and more rapacious in trying to find funding sources.  So we said that would just provide a temptation that was just too big to deal with.  Now what is interesting is the fact in Argentina the president there, Christina Fernandez de Kirchner, she announced on Tuesday that the state of Argentina would, quote, protect private pensions from “policies of plunder,” she’s calling it, by proposing to hand them over to the government.  Now, Jim and I said, Eric, at one time we were going to call this baby the Retirement Security Act of 2010 or 2011.  Do you follow what I’m saying?

ERIC:  Absolutely.

JOHN:  It’ll have some nice warm fuzzy name on that.  So that’s what Kirchnerr is proposing in Argentina.  Well, it just turns out there is an October 23d report from US News & World Report.  Let me read you a couple of lines here.

House Democrats recently invited Teresa Ghilarducci, a professor at the New York School of Social Research to testify before a subcommittee on her idea to eliminate the preferential tax treatment of the popular retirement plans, 401(k).  In place of the 401(k) plans, she would have workers transfer their dough into government created, guaranteed retirement accounts for every worker.

Now, remember, Eric, Social Security is a guaranteed account which is getting more and more unguaranteed as the days go by.

ERIC:  Absolutely.

JOHN:  The government would deposit 600 dollars, inflation indexed, every year into what are called GRAs.  Each worker would have to save 5 percent of pay into the accounts to which the government would pay a measly 3 percent return.  And then it goes on and describes the whole process and the danger.  But here it is.  In other words, 401(k) plans – just like Jim predicted – 401(k) plans invested in the stock market they’re going to come along and they’re going to say, “My gosh, you just can’t be trusted to have your money in these accounts, we’re going to have to take care of it for you, you’ll put the money into these accounts and we’ll give you an IOU assuring you that your money is safe.”  In reality, this will just be another government revenue stream.  You can see this one coming here.  [2:51]

ERIC:  Well, I’ve never talked about this on the air and John, you know this from me, I don’t like to get political at all; I’m kind of an apolitical person.

JOHN:  Me political animal.

ERIC:  Well, here are my thoughts, and I’ve said this privately off the air: I always believe the government was going to take people’s retirement money – and I always thought, and I guess I’m wrong, but I always thought they were going to just stick a US Treasury in there and say, “Virginia, you’re getting a US Treasury.”  I guess in a way they’re doing that, and as you know, Jim on the air has talked about this.  It doesn't sound like they’re stealing their retirement.  To me, they’re stealing people’s retirement; they’re looting it.  Just call it what it is.  Now they’re going to go and loot people’s retirement money because we're going to have this tremendous inflation down the road, so they’re going to go take your money and they’re basically going to say, We’re going to give you 3 percent.  That 3 percent is not going to mean anything when we see the interest rates skyrocketing down the road because we go towards hyperinflation, or tremendous inflation.  As Dr. Schwartz pointed out in Barron’s, we have a big likelihood that we're going to go into a tremendous inflation later, so you’re getting looted; you’re getting your money stolen from you.  [3:52]

JOHN:  I always wonder why people buy the line: “Well, we just didn’t see this coming.”  Most of this stuff was foreseeable all the way back to the subprime and before that.  You know, here on the program we've been talking about this stuff for a while – Five years?  Six years?  Something like that – forecasting that it was on its way and it comes in.  I had to laugh the day Alan Greenspan said, We just didn’t see it coming.  I thought, Wow, if I can only make your salary for not seeing these things coming.

ERIC:  And be knighted by the Queen, mind you.

JOHN:  And be knighted by the Queen.

The next item that I think is really important to read.  You know, there’s been all this talk about soaking the rich or wealth transfers or spreading the wealth around; and the real question is in evaluating the tax policies of McCain versus Obama, what tax brackets are we really talking about.  We got here at the Financial Sense Newshour a letter by a small business owner and he’s given his consent to let us read this on the air, providing that we keep personal details out of it.

But this is a real life example of what it means when say you you’re going to tax companies that make over x amount of dollars.  Here it is:

Dear Mr. Puplava,

This is a real life example of how taxes affect the “rich” small business workers.  My mother and I employ 80 people at our family owned manufacturing plant.  Sixty percent of our business is the manufacture of parts for various aircraft; about one-third of the business is also involved in sports equipment.  We had a very good fiscal year that just ended September 30th.  Our sales increased from 10.4 million dollars to 15.4 million dollars; a record for our company.  We also had record profits of about 1,500,000 dollars.  Wow, 1 ½ million dollars!   We must be really rolling in the dough.  We should be able to pay our fair share of taxes and have plenty left over to buy whatever we want.  1 ½ million dollars.  Most people never see a bank statement anywhere near that much.  Well, neither have I.

This is how it really works.  Our additional sales came from new aerospace contracts.  An additional 5 million dollars in sales in one year was a big stretch for our company.  We began the year with a small balance on the 2 million dollar line of credit from our bank before the new work began, generating a positive cash flow our line of credit had grown to over 1.9 million dollars.  Getting the new work started also consumed all of the profits and cash flow from all of our existing work.  We even stretched out our payables an extra week or two.  We cut spending as low as possible because we knew we would be close to running out of money.  We used the money to hire and train new employees, plan manufacturing methods, build fixtures, program machinery, buy cutting tools, buy raw material, support additional work-in-process inventory, support additional finished goods inventory and support a larger accounts receivables.  [John:  And they offer their customers 30 day terms]  There were always tight deadlines on projects like this so we had to spend extra money to expedite the first several orders through plating and on overnight shipping to our customer.  In addition to the line of credit, we purchased two new machines for this project.  Each machine’s cost is about 200,000 dollars with a 6,200 dollar monthly payment.

And I should point out Eric, as you well know, under depreciation rules for equipment like that, they can’t just write that 300,000 dollars off in the years that they purchased the equipment related to the income that they received that year.  They have to depreciate that over time.

ERIC:  Correct.

JOHN: We spend all this money and effort hoping we price the parts and assemblies high enough to make a profit because you’re never really sure you’ll make a profit until the parts are running and the actual costs are measured.  In the end, the new contracts turned out to be profitable.  Some people consider all of this exciting.  Most people consider it to be stressful.  I find it to be a lot of both.  Significant errors in one step of the process can cripple or bankrupt the company.

So what does our bank account look now?  Our inventory has grown by about 2.5 million dollars since last year and our line of credit has been paid down to about a million dollars.  Due to our line of credit we have one million dollars less than last year, but we have to still pay income tax on 1.5 million dollars profit.  I guess being a rich small business owner means you get to pay income tax on money you don’t have.  It looks like we will have to borrow about 600,000 dollars to pay our tax bill.  Cash is tight right now as we're trying to pay down the large debt we incurred starting the new work.  Borrowing to pay income tax will significantly delay the repayment of our business debt; it will hamper our ability to take on additional business and hire more employees in the future.  We would not dream of taking 600,000 dollars out of the company as salary.  Cash is still very precious.  We were attempting to pay down the large debt we incurred starting up the new work before any economic trouble hit us.  Unfortunately, workers at one plant went on strike in September;

That means one of their people to whom they sell their parts to, okay.

We will have to borrow from our line of credit to weather the strike.  That, combined with borrowing to pay our tax bill will put us dangerously close to our 2 million dollar credit limit.  This is particularly stressful for my mother.  She doesn't feel like she has saved enough for retirement, and we don’t have any spare cash with which to add her retirement fund.  Also, since the death of my father, she has to personally guarantee any bank loans.  So if the company goes bankrupt, she could lose all of her personal assets too.  My father invested his whole life building this business, he worked seven days a week and did not play golf or have other hobbies.  This business was his life.  My parents risked everything.  The business almost went bankrupt twice.  We have had to deal with intense worldwide competition, difficult customers and disgruntled employees.  We have to be sure we're not violating any of the countless rules and regulations that would subject us to large fines and attorney fees.  Every time we went through a growth spurt we would be desperately short of cash and yet we would have to borrow money to make tax payments.  I doubt our politicians understand how difficult they are making the business climate in this country.  I hope they figure it out before the government parasite kills the host upon which it is feeding.  Feel free to use this example on your radio show.

And that was from the president of this company that employs 80 people.

If the abuse gets much worse, the obvious [outcome], Eric, is that people are going to have to be laid off and this type of small business is what provides the majority of the jobs in the country.  [10:37]

ERIC:  Now, wait a minute.  Stop right there, John.  That is what provides the jobs in this country.  That’s it.  Meaning, you’re not seeing growth by these major corporations.  The jobs come from the small companies.  And you’re absolutely correct.  This guy is correct.  You’re going to go in right now, and you’re going to be raising taxes on people or changing accounting rules or do anything to stifle economic growth when we’re in this downturn.  It’s going to have a horrible effect on the economy; just like it did in the 30s.  It’s no different today.  We're struggling.  Things are bad out there.  This is not the time to go hitting people over the head.  And people talk about the wealthy.  Let me tell you something.  There’s people in California making a couple of hundred thousand, but they’ve got houses that are expensive; it’s not cheap to live out in Southern California.  I’m not there anymore but many of these people don’t have big savings.  They’re not rich.  In fact, I would argue have negative net worth, so to call them the rich because they make a couple of hundred thousand is absurd.

Now, with regards to these business people and that we’re going to go in now – and as you said, John, what you really said is this is the engine of growth in terms of jobs for the United States, it’s the small businesses.  That’s exactly what it is.  So you’re going to go in now, you’re going to monkey around with these people and you’re going to force them to fire people, and that’s going to increase unemployment.  But I would also argue to you that there’s a secondary effect there, and that has to do with these people that own these companies and their own spending habits; on less vacations, cut back in their own lifestyle.  And if you follow for instance the hotel industry, I don’t want to say it’s death right now but it’s bad, John.  It’s bad.  I was talking locally here because they have this Super Bowl coming and I was talking to the guy who runs the Hyatt and he said to me, Well, you know, GM would come in and take 350 rooms and this year it’s 50 rooms because the economy is so bad.  So everything is being cut back.  Those guys have had occupancy rates on some days of 11, 12, 13 percent.  Do you know how bad that is for the hotel industry?  That it’s a major corporation as an example, but my point here is there’s a ripple effect.  And if you’re going to take and you’re going to do something to actually crush spending or collapse some spending or take some monies out of this economy, this is the problem with government.  So I’m going to put it back to you:  What do you make of the fact that a guy sitting behind a desk – and I always say about CFOs, they’re guys with glasses who sit behind a desk and don’t have a clue about how the real world works – don’t send me an email please.  But what I mean by that is that they’ll sit there and say, Well, we can just manipulate this or do this; they don’t think about the impacts of that.  So I’m going to throw it back to you; what are the impacts that you see if we go in and we cripple the small businessperson?  Besides the layoffs, what do you see happening?  [13:27]

JOHN:  I think the biggest impact is going to be on jobs.  I did work for a small company one time when I took a hiatus out of my broadcast career, and we had 120 people.  It was about the same size as this man’s business who wrote us this letter, and so because of the sales that we had and every year we would turn about a million-and-a-half profit; that’s what it was.  But everything was touch and go.  We were just doing broadcast equipment on request; meaning that before equipment would be designed, you would have to get an order from a client and then you had to spool up and produce it and design it, test it, do all of these things; and then hope you could get it delivered on the customers deadline date.  And so everything was very if and go.  What people don’t realize about people who have their own businesses; you work for somebody else, you collect a paycheck, you work 40 hours a week; people who have their own businesses, number one, work 40 to 60 hours a week in order to keep things going.  Their heads are in the business almost all the time.   A lot of times they can’t take vacation because of the nature of what’s going on in their business they have to keep it running.  And there’s a lot of personal investment time, like this gentleman’s father, when the crunch comes, the only thing they really have to cut back on – you know, you can cut certain expenses like, what, power; you can shift the work schedules around a bit; you can stagger how things are done on the assembly line – you know there are all sorts of management games you can play.  But the bottom line on this, Eric, is they just simply have to start laying people off and then ask those employees who are still there to do double time work and just be grateful that you have a job.  It’s not the first time, but that’s what happens because at some point it’s not worth the effort of these people to continue running their own business.  [15:18]

ERIC:  I agree with you, John, but when you say 40 to 60, I think you’re being –

JOHN:  Conservative?

ERIC:  I agree with that, don’t get me wrong, but I’ll tell you growing up my dad put in 70 to 80 hours a week every week, and that’s all I ever remember.  So, yeah, I agree with you, these people are working very hard, but what about the fact that they want to go in and impact this businessman.  He’s got 80 people.  He’s going to have to start firing people, so what I’m saying to you is that the idea behind this is we're going to go in, we're going to raise additional government revenue. I mean that’s what we're talking about, right?

JOHN:  Right.

ERIC:  Okay.  So we're going to raise additional government revenues, and we're just going to put the squeeze on the small businessman.  What we're saying in this interview, this has nothing to do with Ds and Rs – Democrats and Republicans – it has nothing to do with that.  This is just the realities.  When you go in and put the squeeze on people, for every action there’s a reaction.  It doesn't work because you see this tail off and this drop off in the economy.  It doesn't have to be the extent we saw in the 30s, but what you see is the contraction of the GDP; or somebody might say, even the velocity of money – you know, changing hands – begins to slow down and retard any type of spending that would normally occur.  The point I’m making is in the end the numbers go down so that whatever you thought you were going to make, not only did you not make that but you usually are bringing in even less than when you started.  [16:34]

JOHN:  Yeah, and then you’re forced into borrowing money just to pay the tax bill on the whole thing because you can barely keep anything else going.  But this is the path we seem on right now.  By the way, I solve the political issues sometimes by calling Socialist Party D and Socialist Party R because they’re both on the spend – you remember the Grace Commission back in the early 90s, and they after extensive study said, you know, you could whack out about 50 percent of the federal government and we wouldn't notice anything; we wouldn't notice any change.  In other words, there is so much bloat and uselessness.  And the only answer you hear coming from Washington and from a number of state legislatures, some are responsible – others are not.  But it’s “we need more revenue, more revenue – don’t you care about the kids.”  Maybe that’s the next letter I want to read.  This one really struck me because I’ve been watching a local election in the state of Colorado, Jefferson County, which is on the west side of the Denver area, it’s called Jeffco – remember where Columbine was? – it’s in that county.  Just so you have some geographical reference to the whole thing.  And they want to increase property tax for purposes of education.  Now, education in this country has turned out to be a disaster.  You know, we have spent – I can’t quote the amount of money we have spent, and yet we are still cranking out some of the lowest ranking students on the scale as far as education anywhere.  So despite the disaster, the mantra has been perpetually for the last 30 years that if we just give them more money they’ll reform education.  Well, they’ve had billions and billions and billions of dollars of more money and reform never came.  So having said that here, here we go again, they want another increase.  Now, of course, property taxes really impact those people on fixed income and if you look at the official ballot guide that Jefferson County is putting out on its website, they have opponents and proponents of these measures and this is 3A, and they ask them to write commentary on this.  Here is what is says.  Listen to this:

Senior citizens with fixed incomes are hard pressed to shoulder increases in property tax; these people should recognize that their reduced productivity calls for them to be replaced by the youth of our nation.

Notice this is treating them like an asset or a resource rather than a human being.

This measure calls for some of the property taxes to be earmarked for expanding options for career job skills and technical training to prepare students for today’s work world.

This is part of the school to work program that educrats have been pushing for a long time.  They said half of these should be committed to the following:

Seniors on fixed incomes to whom the school tax is burdensome need training as well as compassion.  They must be offered the opportunity to learn how to locate more modest accommodations than those they currently occupy and how to cope in other communities if necessary.

Do you hear what they’re telling the seniors?  “We want to raise our taxes and if you can’t afford to live in your house, get the heck out.  We don’t care about you.”  Now they use the word compassion in there, but it’s like, Tough pumpkins, kiddo, you’re gone.  [19:30]

ERIC:  I think the point that I was making, John, is going back to the 30s and we can use the example of Hoover raising the income tax rates to 70 percent.  I know that’s been brought up before.  And I’ll just ask you this, John, do you think that when all the smoke clears and the dust settles, do you think when they raise those income taxes and stuff just continues to go into a free-fall collapse, do you think the government ends up with more revenue –which was their purpose of raising taxes – or less?  Let me ask you.

JOHN:  Well, we always know historically they wind up with less revenue.

ERIC:  That’s right.

JOHN:  Even the World Bank did a study on that.  I don’t have the study in front of me because I didn’t come prepared for that, but as you increase the tax rate, they have found all the way up to about 9 to 10 percent, the revenue goes up in direct proportion.  Right?  As you exceed the 10 percent – remember the three rules of flight, fight or fraud that occur when taxation becomes excessive – as you exceed 10 percent the revenues begin to fall off until you get to a position at about 50 percent – somewhere in there – where in the former Soviet Union, people just quit paying their taxes.  They all laughed if you paid your income tax, and it was Putin if you recall, former President Putin, now prime minister, who had to come in and he had to slash the capital gains, slash the income taxes and get them back to 14 percent or something like that in order to get the Russian economy back on its feet.  Then they were able to be able to begin collecting taxes and revenues began flowing in to the Russian treasury.  So there was a direct inverse relationship above about 10 percent that if you keep increasing the rate, you get less and less tax until finally you get no taxes; people just scoff the laws and just quit trying because they can’t pay the tax and survive.  [21:23]

ERIC:  I think the bottom line, at least for me from where I’m coming from, and again, you know me, I’m really not a political guy, but I don’t think ‘-isms’ are good and I don’t mean capitalism, I’m talking about from a government structure:  communism, fascism.  You know, when you’re so far left of right, there’s other issues besides just economic and sometimes these people on the far right or the far left don’t really realize what it means.  And I’m not talking Democrats or Republicans, I’m talking about the individuals on the far left or right, they don’t understand that your civil liberties go away.  You know, people talk about gay rights, or these people’s rights or other people’s rights – that all goes out the window under those -isms.  All those freedoms and all those liberties just disappear, right?

JOHN:  There is a fundamental relationship between the right to security of private property – and that would include your money – and freedom as well.  They are intimately tied historically with each other.  And if you think that you can deprive a people of their property, which is why we have a 4th Amendment, although for the most part we’re not using our Constitution much anymore here in this country.  That’s why we have that.  And that is going away.  And both parties – major parties in this country – have contributed to that demise, each for their own political agendas, depending on which of the particular rights in the Bill of Rights they chose to attack.  And that’s where it’s headed right now; each, by the way, while blaming the other party.  [22:52]

ERIC:  We’re talking about this from an economic perspective, right now, John.  You bring up this guy’s letter and we have a discussion on this, but besides just the economics of it because this guy basically what you would do is you would change this business owner’s ability to allocate his capital to ways he may, say, have budgeted it in 2004, 05, 06, 07; you know, when you start talking about like an 06 budget, if you had a five-year plan, you've changed his business model for him.

JOHN:  Well, you know what, Eric, I think the big concern that I have here in the midst of all of this is I really do care about the working class and people.  And I like to see a fair taxation system and whenever it becomes lopsided for one group or another group, then we have all sorts of problems.  In my mind you really need to scrap the IRS and I think Ron Paul and Alan Keyes and others are right:  you can’t reform it; just scrap it because it is so convoluted.  And even if you do try to reform it, within two or three years the Congress-critters will be in there jerking, tugging on the levers.  They just cannot keep their hands off of it.  There’s got to be a more equitable system of collecting tax.  But right now America can’t decide whether or not it wants to play this little socialism game, and that’s what it is because these ideas came from the Communist Manifesto, and socialism is simply Marxism-lite.  They simply can’t figure out why socialism is a good idea or not. And of course, if they flirt with it they’re going to find out there is a lot of pain ultimately which has been the hardcore lesson that history has taught us about; in virtually all socialist countries in one form or another.  So we’ll see.  We’ll see how the elections go, and of course we're in a crisis window here which will last about another 1400 days or so – 14, 15 hundred days, I think is our real big window here as the energy issue and the furtherance of the perfect financial storm collide with each other.

And I guess you have an interview coming up here with Eric Sprott shortly, as I recall, so we will move on to that.  And you’re listening to the Financial Sense Newshour at www.financialsense.com. [25:01]

Eric Sprott, Chairman, CEO & Portfolio Manager, Sprott Asset Management

ERIC:  These have been crazy times for so many markets globally, and joining us today is Eric Sprott, Chairman and Chief Executive Officer and Portfolio Manager of Sprott Asset Management. Eric, you've been in the business for 35 years and I know you were positive going forward on resource stocks from the interview you did in Barron’s.  But before we talk about the resource sector or sectors, what is your take on what is happening in markets globally today with the massive declines we have seen across the board in equity markets?

ERIC SPROTT:  Eric, the way I describe it is we're going into a deleveraging process where in my view the whole banking system progressively over almost 100 years got more and more and more levered and obviously didn’t worry about the risk of not being repaid; and once the subprime started everything else followed suit and now we're in a situation where everyone worries about almost anything being repaid.  And I think that all of the financial institutions – I include in that banks and insurance companies and even levered hedge funds – realize that you can’t be that levered when we have kind of like this black swan event that’s happening here, and it’s going to take some while to delever for all those groups.  [26:43]

ERIC:  You know, on the US side when you see people or politicians come on – and maybe this applies globally – but they sort of act there – I don’t mean to laugh, it’s not funny but they sort of imply that nobody saw this coming and that’s just not true.  Many of us, and I think including yourself, including John – and I don’t want to put words in your mouth because I don’t remember precisely – but many of us have been sort of sounding the alarm bells on these derivative markets and what the implications were for that type of leverage in the banking system.  True?

ERIC SPROTT:  Well, I can tell you we saw the bear market coming before the 2000 NASDAQ meltdown in late 99.  We believe we're in a secular bear market since 2000; that some of the signs were very easy to see, for example, the housing problem, the lending mania, the overvaluation – it was all quite obvious and the whole derivative thing, as you’ve talked to.  The fact that we're at 600 trillion plus of derivatives to me is still mind-boggling and I don’t think we've seen the tip of the iceberg as to what that means.  [27:48]

ERIC:  Warren Buffett talked about those and referred to them as “created and devised by madmen,” and I seem to say that on the show every time, but it is important to know; he likened them to hell, “easy to get into, hard to get out of.”  When you look at the derivative situation and I don’t know if they’re trying to clean these up finally or not, Eric, you talked about this deleveraging.  I don’t know if they’re serious about it or not serious about it, but it was almost like a domino effect as you started to have Bear Stearns go under, Lehman go under and these various counterparties holding these things and saying, I know we said we’d insure this, but you know, we don’t have the money for this.”  Correct?  I mean, hasn’t this been a domino effect all over the globe, Eric?

ERIC SPROTT:  When I think of the size of the 600 trillion, and the point of reference I would make is that the world collectively has never made a trillion, and yet we have 600 trillion on the line here.  Now I wonder why did we ever get that big.  And the only explanation I can give to myself is these are in over-the-counter markets, and presumably, two people entering into a contract, each one of them thought they got the better of the trade; and each one of them would have their computer trained to say, That was a profitable trade.  And I think that as maybe some of the trades went bad, it was a logical thing for the guy to put on another trade because the computer would say, That one was profitable.  And then all of a sudden, in my mind, you just end up with this big trading room in the sky where everyone is putting on trades and all the computers are saying they’re making money, but the bottom line is it was a zero-sum game.  And I fear that, one, plenty of the profits have been booked, and two, the winners who might have written the better part of the contract will have a difficult time being paid by the people who wrote the bad side of the contract because these people were way in over their heads.  [29:35]

ERIC:  Was it easy for you to see, Eric, as the first domino started to tumble, because Al played a clip last week from a show I did on August 16th where I talked about the fact that the US banking system – at least in my mind – was insolvent and a big bill was going to be laid on the American taxpayer (And that was before the announcement of any type of bailout.)  But was it easy for you to see that part of it coming; meaning, when you go back to that speech that Alan Greenspan gave in Belgium where he talked about creating money without limit and that systemically the taxpayer stands ready to bail out the banks because they make these off-table bets in the form of derivatives; if they win they keep the winning, if they lose the taxpayers stand ready to bail them out.  Did you see that coming basically when you started to see this evaporation of these beginning to unfold that there would be this big tax bill?  [30:21]

ERIC SPROTT:  Well, Eric, I can tell you that we have written very bearish sort of prophecies for a long time, but even if I went back to October of 07, the headline of the article we wrote that month was ‘the financial system is a farce.’  And in January of 08 our headline was ‘welcome to the meltdown of 2008.’  So, yes, could you connect the dots?  Yes, I think the dots were pretty easy to connect.  [30:47]

ERIC:  Let’s talk about financial stocks and some other stocks because I know you guys have been short you know, some equity sectors.  Talk about that just briefly.

ERIC SPROTT:  Okay.  In my mind the financial system – in particular, banking system but perhaps also the insurance system – is an inverted pyramid where you have five percent equity at the bottom supporting 95 dollars or 95 percent liabilities or loans; and when you look at the banking system you have deposits and you have loans and you have this little bit of equity – five percent at the bottom – which is basically a 20 to 1 ratio of debt to equity.  And lots of banks have much higher ratios than that.  The beauty of the liability side is it always has to be paid off, so you’ve got to pay 100 cents on the dollar.  Now lets go over to the asset side of the balance sheet and just run through some of the things that banks might own.  And they might own subprime, Alt-A, home equity, CDS, CDO, MBS, auto loans, student loans, construction loans, commercial real estate loans, auction-rate securities; there’s hardly a category of assets that a financial institution owns that hasn’t gone down by at least double digits, and there’s only three things that might have held their own this year: one is cash, two is Treasury bills and until about three weeks ago or four weeks ago, I might have said gold (although gold has held its value in most foreign currencies.)  So you've only got three assets that have held their value and you've probably got 133 assets that have had major declines, so that five percent equity I don’t think is there.  [32:35]

ERIC:  On the short side, are you staying short the financials here?

ERIC SPROTT:  We've focused on the financial system, whether it be the banks, the brokers, the insurance companies, the mortgage lenders, the mortgage guarantors, and we've also concentrated on consumer discretionary because obviously there’s going to be some profits there.  We've also moved into tech recently because obviously if the economy is weak, tech is going to be incredibly weak because it’s something that you don’t have to order a new system every year.  So those are the areas that we've focused on.  [32:55]

ERIC:  Let’s talk about the bond market on the US side for a minute if you don’t mind, Eric.  Some have said there is a bond bubble; you have someone like George Soros, who, like Sprott Securities, has been short the US stock market and making significant profits being short, but he is also short the bond market on the US side and betting on much higher interest rates in the United States over time.  Where do you see the bond market and interest rates headed?

ERIC SPROTT:  I don’t profess to be a bond expert, but as I view things – you know, the stated deficits and the unstated deficits and the perhaps change in view that should be going around the world as ‘do I really want to own US government paper?’ which I think more and more you see comments to the negative in that regard, and as the debts have swelled and the funding requirements amount here, I can’t imagine that it would be a very worthwhile investment to be buying 5, 10 or 30 year US government bonds.  I think people – the great mistake everyone has made here in the last 20 odd years is underestimating risk, and people for some reason have been trained to think there is no risk in US government bonds and I would in essence violently disagree with that.  I think there is plenty of risk in US government bonds; and when I look at government guaranteeing bank debt and guaranteeing commercial paper and guaranteeing mortgages – I always think:  What is a government?  The government has a right to tax us, but when the populace is already being stressed out economically, I don’t see that tax card as being played here.  Essentially they’ve lost that power.  So I’m not a great believer in owning anything government for that matter.  [34:35]

ERIC:  When you look at the United States – and you talked about government generally – but when you talk about first it was 700 billion which I don’t think any with a brain believed, then it was a trillion and you hear two trillion and now I’m hearing 5 trillion from somebody.  And I joked last week:  can I get a 10 trillion?  But you know, because as you said, there are 600 trillion of these derivatives out there and of course we don’t know how that shakes out in terms of what’s left and what needs to be propped up with the money printing.  But Eric, when you look at the United States side of things, and we keep backing and everything and taking everything over and now we're going to start to take over the insurers, people have to be asking themselves, well, why is that?  Well, they were insuring these things; right?  Weren’t they sort of the guys who said, Yeah, if something goes wrong, I’ll go ahead and back that paper.  Am I right on that, Eric?

ERIC SPROTT:  That; but they also were very much like a bank that your liabilities side, although not totally determined, when you’re an insurance company tends to stay fixed and all the assets for the most part are paper or real estate and real estate is almost a no-bid market these days; so they had that same balance sheet problem where there is leverage and no one will buy the assets.  Plus, they got into these exotic products where you know, you’re going to have a principal protected note or something, or some annuity where you’re going to for sure pay this in the future, and all of those assumed that things would be normal.  But they’re not normal today and we do have our black swan event, and I think the ability of those companies to meet their obligations have become highly questionable today and I think that’s why the weakness is finally spreading to insurance.  [36:06]

ERIC:  A point was made last week about the French government of 1700 and they had their assignat note at the time and they ended up becoming worthless, but they would sort of meet; the economy would be weak and their solution was to print money and it would get better for a few months and then it would start to go bad again and they would meet again…And that would be the solution would be to print money.  You know, we had this stimulus package in the United States, now another one is being talked about, right.  Is this reminiscent to you somewhat, as a student of monetary history?  I don’t mean to laugh – but is that what we're talking about here when we really simplify this?

ERIC SPROTT:  Well, of course, anybody who’s studied history knows that fiat currencies ultimately being valueless.  And I characterize those of us who are bears or concerned about the economy, it’s like we are in a Texas no limit hold’em poker game and every two weeks comes out with a new program and it’s sort of assuages everyone for a while, then you find that just like the fiscal policy plan didn’t work, the Bear Stearns bailout didn’t work, the Fannie Mae conservatorship didn’t work, the TAF, the TARP, the bank bailout – one after another.  It’s like you’re getting a raise to stay in the game.  The no-shorting rule.   And all of those programs have been totally unsuccessful and I think one of the problems that the market faces is every day we get new data points, whether it’s somebody’s earnings, somebody’s sales, somebody’s bankruptcy, and the market – not withstanding all the wonderful things people behind the scenes are doing – have a reality check every day.  And when it does a reality check, it realizes that things aren’t going well.  [37:32]

ERIC:  When you look at the US dollar – because obviously the situation in Canada is quite different, you’ve got a very, I think, fiscally sound situation up north of the border compared to us – two things, I guess, one, do you sort of marvel that our dollar trades at a premium to yours; and two, do you see the US dollar going to zero, or do you just see a great devaluation?  Where do you see that headed?

ERIC SPROTT:  I would be in the US dollar bear camp for sure.  But I think we are today in a process where we are in the midst of this incredible financial crisis, and huge amounts of money are being repatriated and a lot of that money is being repatriated from countries all over the world, including Canada.  For example, we had a lot of foreign money coming into the resource sector and as everyone wants to retrench, they have to sell the domestic currency where they invested it, and typically they put it back into US dollars.  So I think that’s caused this massive run here; but repatriation will diminish in time, too.  So I think to know where the dollar is going to go, if you could ever predict when is that maximum repatriation; and I would imagine that we're very close to it today – [38:56]

ERIC:  Agreed.

ERIC SPROTT:  And then all of a sudden it will just roll over and do what the fundamentals say it should do.  The market – you know, all markets can be irrational for a long time.  We've seen it in a million different instances here, but ultimately the market figures it out.  [39:09]

ERIC:  But on the US dollar side – and I agree with you, the rally was not necessarily based on any type of strong fundamentals on the US side, this was just a repatriation situation that’s been going on that sort of created this artificial strength.  And I think it’s important to not – and this is the second week I’ve pointed this out, but the commercials are taking the other side of those trades and they’re very, very, very short the US dollar.

ERIC SPROTT:  Right, and that’s exactly what I think is going on.  I mean you see the chaos going on in various countries around the world, and when you have chaos like that – and let’s use the example of Iceland which is the most notorious one these days – the currency I think when they opened up the current Forex trading and the currency went down 80 percent in a day.  And people would naturally think, Well, gee, if I would had the US dollar I would have been okay.  Now, for my money, they should have – nobody goes to gold yet, but that’s ultimately the place that everyone should go.  But that’s the knee jerk thing – get me into US dollars, get me out of the Argentine peso, get me out of the Icelandic krona, and so on.  And when people get away from the knee jerk reaction and start to sort of assess the real situation that the dollar is likely to roll over here; particularly when you have to fund the current account deficit every day.  [40:24]

ERIC:  Before we go onto the resource side of things, John Embry was over at RBC if I remember correctly, and I think he was at that time the number one fund manager in the world; or maybe that was when he came over to you – but it was close to that time frame.  I’m not so sure the banks – I don’t know exactly what happened at RBC, so I’m not making any claims here, but I’m just not so sure that the powers-that-be have always liked somebody going out and pounding the table on gold.  Of course, this was when gold was very cheap.  But you actually welcomed John over to your firm and I think instantly gained a lot of fans on both sides of the border by doing that.  What was the situation when you picked up John Embry because I kind of thought that that was a great move on your part?

ERIC SPROTT:  John did establish his record when he was with Royal Bank of Canada, and for sure he had the best performing gold fund for that year.  I think at the time it was up 158 percent in the year.  You’re right that banks don’t really like gold, and I’ll tell you one of the reasons they don’t like gold is gold is not a deposit so when some depositor takes his money out and buys gold, that’s money that leaves the banking system, which of course would not please any banker.  John was a great partner to have join us.  We think very similarly about the outlook for precious metals and our concerns for the economy, so it was a very easy fit for John to join our group, and for our group to join John - because we're essentially joined at the hip in where we thought things would evolve to economically and resource-wise.  [41:54]

ERIC:  Let’s move onto resources.  When you look at oil, and of course you had that interview in Barron’s where talked about this, but for those who didn’t catch that, oil has fallen from around 145 dollar area per barrel to around the 60 area.  When you look at the oil market, Eric, is this shake-out going to ultimately exacerbate the upside for oil.  Meaning, the fact that oil has fallen too far, too fast – and maybe it went up too fast with some of the configurations that were in there and some short coverings that needed to be done – but the fact that we've fallen too far, too fast and we have some production shutting down; does this create an even more bullish forecast for oil that you hadn't previously counted on, so the upside target becomes that much greater?

ERIC SPROTT:  I’ve liked oil for quite a ways here, simply because I believe in the peak oil theory which means conventional production will go down, and every data point we ever see suggests that.  And this is being a bear and knowing there might be some economic fall out of a financial crisis of some sort or another.  But we always thought, well, fine, we’ll get ourselves through that and ultimately the peak oil thesis – which means supply going down every month – will cut back in again.  The fact that it’s gone this low, coupled with the fact that we have this incredible financing problem is going to cause the supply of oil to fall off even faster.  Oil companies used to be able to borrow against their cash flow to drill, they used to be able to do equity issues to drill; neither one of those avenues is available.  In fact, it might even be the opposite now; you got to take your cash flow and whatever the bank says you don’t have to pay them, that’s what you have to drill. We're already seeing signs of drilling coming off here.  We're seeing lots of people delay projects.  I mean the whole tar sands thing – you’re not going to see any development whatsoever at these prices, so all the projects will ultimately get shelved.  I think, knowing how important it is to stage drilling, you can’t stop drilling with the kind of decline rates that we have, we’ll see an effect on supply in a three to six month period and I’m not going to predict that the price necessarily goes higher, but I think it will bring in a bottom real fast.  [44:02]

ERIC:  When you look at the OPEC meeting – and I think obviously, you know, when you look at a countries like Iran or Venezuela, clearly there was Russia – there was clearly some confrontation with the Saudis, which is basically the US voice; right?  So the Saudis were saying, “the global economy is so weak and we can’t possibly have these big hikes.”  But they did kick out a million and a half reduction on the supply side, and I’m just guessing that Iran and Venezuela and some of the others wanted to do more than that.  Are the Saudis losing some of their influence?

ERIC SPROTT:  Well, I think that each of those partners has their own interest to take care of too.  I was just reading something today where I think it suggested that Venezuela’s cost of production is like 89 dollars a barrel, so you can imagine them being by far the most vociferous of the group, and if they’re going to act together they’re going to have to act together.  So I think that I’m always a little suspicious that the price of oil peaked whatever number of months ago it was, but it was quite a few months ago; and it’ll probably hit its low the day of the election is my guess and then we’ll see it go back up again.  And perhaps with this meeting just last week, the cutbacks starting in November, we won’t really see anything before the election but as, you know, the last election the oil price came down right before the election because it gives everyone a feel-good feeling and typically helps the incumbent.  So I’m a little bit suspicious of the price decline.  I absolutely know that peak oil is here, so it’s just a matter of time till we get back to the old highs.  [45:35]

ERIC:  There’s been an attack I think on the – politically at least – against these oil companies, calling them greedy and sort of attacking their business models, which I’m not sure that’s well founded or well thought out.  But as an oil - because I’m in agreement with you tha