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PRES. BUSH: The SEC is also requiring certain investors to disclose their short selling, and it has launched rigorous enforcement actions to detect fraud and manipulation in the market. Anyone engaging in illegal financial transactions will be caught and persecuted.

JOHN: Well, it's good to know, Jim, that we're going to persecute anybody. Maybe Guantanamo Bay is going to have a new use.

JIM: Short sellers.

JOHN: Short sellers, you will be persecuted. So there it is. My gosh, Jim, if we were doing this show at the beginning of the summer, and we had told listener that GSEs would be bankrupt, the world's largest insurance company would be put into receivership and that four out of the five top Wall Street investment banks would be bankrupt or gone, our listeners – I mean, you think you get hate mail? – our listeners would have thought we were on weed or something else like that. But we've been talking about the perfect financial storm heading our way, and that's exactly right now at the end of summer what has really happened. We're really living in very historic times. We haven't seen anything like this since the Great Depression, and it really isn't quite like the Great Depression. It's a little different.

JIM: Oh, yeah. And the thing about this too, John, this isn't over. There’s going to be more pain ahead. You're going to see a lot more financial institutions that either are going to go under, or they are going to disappear through either mergers or takeovers – and I suspect probably when this whole thing plays out on Wall Street, Wall Street is going to look much different than it does today. The Investment banks will disappear and the banks will look like they did before the Great Depression. In other words, after the Great Depression, they came up with Glass-Steagall, they separated the banks from the brokerage firms, JP Morgan was separated into what became Morgan Stanley and then also JP Morgan bank.

And if you haven't noticed, the banks have been taking over the investment banks and the brokers. That in itself is kind of a scary thought because behind every single assets bubble that we've seen in the last century and in this century, you'll always find the banks because the banks are the mechanism of creating credit. They are the transmission mechanism. And what we saw in the last two decades is the investment banks also became a mechanism. They became what many have referred to as the ‘shadow banking committee.’ Now you're seeing them all rolled up into the banks and you're seeing the government take on extra ordinary powers that we've never seen before. So as the banks absorb the investment banks, you will have the engines of credit expansion and inflation getting refitted with turbos. [3:06]

JOHN: Well, basically, then, there is more trouble ahead for the credit and financial markets. I mean, despite the fact that after every single blowup, they tell us the worst is over. I always like the pattern. First they tell us there is no problem and then they say, “You know that problem that there wasn't any problem? Well, we fixed that problem.” And then they promise that it's over. It seems they try to handle these crises on weekends, you know, the Saturday huddles we were talking about last week –

JIM: Well, we've got another one coming, by the way.

JOHN: Another one this weekend. Okay – when most people aren't paying attention. So this weekend, what's in the huddle and who is making the call?

JIM: Well, they will be huddling with Congress, some kind of RTC that they’re going to fold all of these assets into that the Treasury will be buying. It’s very similar, John, to what you saw happen with the S&L crisis. I think you're going to have some new regulations placed on hedge funds, you're going to have all kinds of areas that you can't short; the SEC is working on proposals, so there is going to be a big change coming to Wall Street.

And what they are going to do is I think what happened is we're going to go to a clip here, but I think the administration went to Congress and said, “Look, I know you guys have to go home and get reelected, but this is something that can't wait.” Had they not acted and announced these measures, by next week we would have been in a full-blown crash very similar to 1929, 1987, and that's why they acted in the way that they did. So I think there was enough closed-door sessions with members of Congress that said, “Look, you can't go home and campaign because this is what's going to happen if we don't act on this and do it expeditiously.” And that's what they are going to be working on this weekend. [4:57]

JOHN: All right. So basically for now, they staved off disaster. Like you say, by next week there would have been a full blown just like in 1929. But the problem really ultimately hasn't been solved. They have rolled this forward in terms of, I'm assuming we're going to see invisible taxation in the form of inflation again with loosening credit involved in this, the ARMs are going to reset more than next year. So what is it we don't know so far? We know banks have problems. Who else is in trouble as a result of this that is more or less behind the public visibility right now?

Well, let's get back to this idea about the Saturday huddle. Obviously, there is going to be another one this weekend. They're hoping people will go out –the weather is still nice here in the northern hemisphere –and they aren't going to notice. But most likely we're going to see them paving the way for another massive government intervention or takeover. I think they are becoming just a hair more proactive trying to head this off rather than going on a reactionary basis weekend after weekend. So what do you think is going to happen in this weekend's huddle, and are we laying bets on this like a football game, or what?

JIM: I think you can put some pretty strong bets down here. I think the way has been paved to find a buyer [of], for example, Washington Mutual, one of the largest shareholders has agreed to forego compensation as a result of the share price dropping, so I think they are going to end up being owned by somebody else. You've got Wachovia and Morgan began are talking about emerging, so that leaves Goldman; and in this kind of market you can't say even they will be around even a year from now. So events can change rather rapidly when financial markets begin to deteriorate.

Case in point is AIG, an insurance company, John, with a trillion dollars of assets on the balance sheet. I was talking to somebody that we know in Asia that was having lunch with the head of AIG in Asia on Monday. He said, oh, no, this isn't going to be a problem. We'll raise 20 to 30 billion dollars within our subsidiaries and this will go away. Well, guess what? The next day they were taken over. So even somebody as large as AIG – and here is the thing, AIG's insurance business was sound and that's what this guy in Asia that headed up insurance, “hey, we're in great shape, we've got assets, we've got a great business here.” The problem was located in its derivatives-trading subsidiary which was AIG financial products. If their financial products division was a major player in the mysterious and dangerous business of credit default swaps, these credit default swaps are what brought down the insurance giant. [7:39]

JOHN: So if we look behind the scenes now, there is a lot of invisible activity going on and a lot more at risk that just doesn't meet the eye, let's face it. I remember last week Frank Barbera was talking about another crowd of ARMs that were getting ready to reset next year. We know banks have problems, but where is the domino effect here? Who else is in trouble as a result of this?

JIM: If we look at credit default swap spreads they have widened and it's clear that, for example, Ford and GM are going to need between 25 and 50 billion dollars in government guaranteed loans because, you know, who is going to loan these automobile companies that are hemorrhaging money? And then after when everybody is lining up at the trough, John, after the automobile companies, next is going to be the airlines. And then I think you're going to see some of the media companies that have problems and then you have some of the commercial property REITs, so there is another sector to watch. So there is all kinds of elements and when we're in the bail out business, everybody is lining up at the trough and saying, “me next.” [8:47]

JOHN: This would seem at first value to be somewhat like the S&L crisis in the 90s.

JIM: A lot of comparisons have been made to that, but I think this is much worse. First of all, if you take a look at the assets of the major investment banks, they have risen 10 to 20 times in terms of their size and scope since 1990. And another factor is the amount of leverage today is enormous. I mean just look at the explosive growth in derivatives which has now grown to over 500 trillion dollars worldwide; and much worse is now you have to worry about counter-party risk and the number of players is more concentrated. I mean, John, you can count the derivative players on two hands, who are the majors, so you're going out and taking risks and you're saying, “all right, I'm going to hedge my risk and off load some of it to maybe somebody else.” The problem is it's a small band of individuals that are in this game; it's very concentrated. You've got maybe ten major players who dominate this market. One goes down and it impacts everybody else's hedges. You thought you had good insurance to protect yourself and it turns out the person that you have your insurance hedges with just went bankrupt. So that's why you've seen so many of these shotgun marriages and government takeovers because you would have done just exactly what you were talking about, you would have done a domino effect and that's why they are meeting this weekend because I think Paulson and the Fed basically said, “Look, you guys can't take off and go campaign and try to do your finger pointing at everybody else because, you know what, Rome is on fire and it's burning and we need to put this fire out.” [10:37]

JOHN: Well, we have to ask the logical question, why is it that all of these people –we're talking about Paulson and theoretically Bernanke and others – all have this deer in the headlight looks? Why didn't they see this coming? I mean after all, if you remember, go back to, let me think, 2005, you wrote about this in your Day After Tomorrow series, you were talking about this very thing; and then again in December of 2006 in The Next Rogue Wave, and those have been published on our website since then. So this was a year before subprime hit and two years before where we are today almost. We've been talking about these issues here on the program since then, and now the people who never saw it coming want the power to oversee it. There is something wrong here.

JIM: You know, the problem is that the way that the whole system is set up – when the government inflates, as it did in the 90s and again in this decade, you know, it's like that Jens O. Parsson comment that we refer to so often: Everybody loves asset inflation that comes with it. In the 90s, as long as the stock market was inflating, everyone was happy. Then it came to a bust, and as a result of the bust, then the government ran the printing presses and we got the real estate and credit bubble bust.

It is only when these bubbles burst and we're in the midst of a crisis do politicians do something about it, and when they do, they actually make matters worse. I mean after the accounting scandals of the 90s, we got Sarbanes-Oxley which drove the IPO market overseas; and just as the credit crisis began, the SEC removed the uptick rule for short selling and brushed aside naked short selling under the carpet. And on top of that, you have these FASB rules which have marked-to-market accounting recognizing gains and losses on assets on a quarterly basis.

A good example –it's so insane – is that, for example, Morgan Stanley had a profit this week, they reported profit, but where did the profit come from? The profit came from the downgrading of their debt that drove the value of their debt below market value and the drop in the value of their bonds, they get to recognize it as profits in their income statement.

And so as you can see, as we got into this mess, what does the government do? The government inflates, it creates the bubble, then they react to the bust with more regulations which makes matters even worse. It's like the blind leading the blind.

And this whole mark-to-market accounting that we have, you know, if we go back to the 70s, and there was a period of time when you actually could look at a financial statement and, you know, if there was something there you had some questions on, you could go to the footnotes, but since then the financial markets have become more complex, opaque, you've got off balance sheet financing – even the government has off balance sheet deficits. John, you don't really know that the numbers that you're looking at are real anymore, and we just keep adding layer upon layer of regulations. Accounting – it's become so complex the whole system is breaking down and that's exactly what we're seeing here. [14:04]

JOHN: Yeah. Maybe the most sober comment this week was made by Senate Majority Leader Harry Reid.

Well, because no one knows what to do. As I indicated in an earlier question, we are in new territory here. This is a different game. We're not out here playing soccer, basketball or football, this is a new game and we're going to have to figure out how to do it. I think you could ask Bernanke, you could ask Paulson, they don't know what to do, but they are trying to come up with ideas and you know, all of their conversations…

JOHN: Well, you must admit --

JIM: Isn't that scary?

JOHN: We run the country, we don't know what to do. But you also must admit, you know, Congress has been trying to duck this whole thing and Investors Business Daily did a couple of op-ed pieces taking the subprime mortgage thing all of the way back to 1992 when the Clinton administration and the Congress at the time rammed through legislation requiring banks to make unsafe loans largely for social engineering purposes to minorities, to poor people, people who couldn't afford it, so they actually forced them, and very rigidly oversaw this –to throw this out – but of course they are trying to dodge that responsibility now.

Also, you have to look at the fact that legislators are probably corrupted by lobbyists. Let's face it. Everybody knew Fannie and Freddie were cooking the books. This was nothing new. In fact, Bush's first team, the Bush administration back in 2003 actually tried to rein in Fannie and Freddie, but they were rebuffed by Congress at the time. That was about the very same time, if you remember, Jim, when Congress was denying there was really a problem with the Social Security system, so that shows the kind of world that Congress has been operating in right now.

Fannie and Freddie spent several hundred million dollars on campaign contributions, and here is a quote from the Investor’s Business Daily article. It says:

Since 1989, Fannie and Freddie have spent an estimated 140 million on lobbying Washington. They contributed millions to politicians, mostly Democrats including senator Chris Dodd who was the number one recipient and senator Barack Obama who was the number three recipient despite only three years in office. The Clinton White House used Fannie and Freddie as a patronage job bank. Former executives and board members read like a who’s who of the Clinton era Democratic party including Franklin Raines, Jamie Gorelick, Jim Johnson and current representative Rahm Emanuel, and collectively they and others made well more than 100 million dollars from Fannie and Freddie [JOHN: whose books as we know, Jim, were cooked Enron style] during the late 1990s and the early 2000s to insure executives got their massive bonuses.

And as Investor’s Business Daily says here: they got the bonuses and you got the bill.

If we take this all of the way back to the Carter administration and you discover this really kicked off with the Community Investment Act during that time, which was, as I mentioned earlier, according to the IBD report expanded under president Clinton. But it's really sobering when you look at who got the money from Fannie and Freddie because right now there is this scurry in Congress to keep a low profile. Have you noticed that? And the reason is as follows: If we ring down the campaign contributions that were received from Fannie and Freddie, Chris Dodd received $133,900; John Kerry, $111,000; Senator Barack Obama, $105,849; Senator Hillary Clinton, $75,550; Paul Jigorski [phon.]$65,500; Republican Robert Bennett, $61,499; Rahm Emanuel, 51,750; Barney Frank, 40,100 and House Speaker Nancy Pelosi 32, 750. That's where the Fannie and Freddie campaign contributions went. So we're back to square one here. If they didn't see it coming – although, frankly, Jim, I think a lot of our Congress critters did see it coming – but theoretically, the rule is if they didn't see it coming, they won’t know what to do when it gets here; or they really just didn't care because they were making some decent money off of it at the time. [18:15]

JIM: You know what has been tragic here is that this is the thing that just astonishes me: The government knew that this crisis was coming and there were methods of handling the crisis. You know, it's been haphazard. They knew about the loss numbers over a year ago and they were told over a year ago. The longer you wait, the worse it will get, and one can assume they knew the magnitude of the losses, however their responses have been done almost on the fly. I mean policies have been determined by hurried responses to crises that generally could have been anticipated, but instead reaction has been sort of trial and error. They make a bad decision and then after seeing the bad consequences, they then change direction again and then trying to go in and fix their mistakes. They bail out one institution Bear Stearns, then they let the next one, Lehman, go under. They back away from Fannie and Freddie, then they come back and ask for extra ordinary powers and then they say they will never use them, then they put them into receivership. So after letting the system go over the edge –and basically the car drove off a cliff – and seeing the damage that came in, they are now putting together a safety net. The SEC, finally, after all kinds of requests from the financial industry has begun to enforce naked short selling, and they are going to ban certain short selling – which I think is a mistake. Hopefully they are going to reinstitute the uptick rule; and the government more likely this weekend will put together another RTC, which means they are going to set up an entity, use the Treasury and the Fed to buy up these illiquid assets from institutions. I mean if you just take a look at our top banks and investment banks –JP Morgan, Citigroup, Bank of America, Goldman, Merrill and Lehman – you have over 500 billion dollars in Level 3 assets, so tax payers, you know what, you've been forewarned: Hold on to your wallets and be ready for about B-52 and helicopter drops. [20:31]

JOHN: So basically they are now coming up with a new RTC. The SEC is going to stop short selling, enforce naked short selling rules, you may get your wish –

JIM: Finally.

JOHN: Finally. – And the government is going to bail out the banks and brokers and people who took out war loans, so how is this all going to be paid for? I had someone call here this morning into the office, Jim, saying “well, because they've taken all over this, does this mean our taxes are going to go up?” I said, no, it's going to come around through the invisible mechanism of inflation, and probably other sources.

JIM: Well, we got our first helicopter drop with rebates at the beginning of the year, and I think you have to at this point – they are revving up the engines of the helicopters and probably they've hired the Air Force with the B-52s, so you're going to see B-52 runs. You're looking at probably the greatest and biggest reflation effort since the 1920s and 30s, but it's going to be global. I mean the United States is the epicenter of this inflationary storm. It originates here, you're going to see the socialization of risk. I mean we've seen it all year, it's going to get even more socialized. You're going to see government intervention in all aspects of the financial markets, the economy and then also coming up next, they are also going to get involved in socializing health care because as Laurence Kotlikoff has written in the current issue of Forbes, he's written a new article, it's called Is the US Going Broke?

Now that the federal government has bailed out Fannie and Freddie, who is going to bail out the federal government?

And he talks about here – now this is a very sobering statistic:

Given the current demographics of the country, in the next 10 years, 78 million baby boomers can expect to head into retirement collecting Social Security and be eligible for Medicare. Its cost will be 50,000 dollars in today's terms for these programs each and every year of retirement. Multiply 75 million boomers by 50,000 annual payment and you get an annual bill in the next decade of 4 trillion dollars.

And then he goes on here and he goes:

For example, FDIC. There are so many bank failures ahead that FDIC is going to have to be capitalized, and he said, the true liability facing our government right now is 70 trillion dollars. And that figure goes up each year because of unfunded social security and Medicare, so when they talk about they are going to be involved in health care, they are going to ration it. And as David Walker, comptroller of the currency, in a special report last year as he left office –David Walker was the nation's highest accountant – he says there are only two ways you're going to fix this. He goes, you have to raise taxes between 44% and cut government spending 20, or the longer you delay this, then you get into the worse case scenario where you raise taxes 88 percent and cut government spending 40 percent. And he said outside doing that, he said there is only one road to solve this problem and that's hyperinflation.

And John, what do you think politicians are going to do? Can you imagine if Barack Obama or John McCain got up and said, you know what, let’s be honest with you, here's what we have to do to put this country on a sound basis. There is no way they'd ever get elected. They would get attacked for being fiscally and socially irresponsible, so that's why all of this, like all government promises, is going to be paid for by debasement of the currency, and that is why there is a worldwide rush by smart money into gold and silver. You know, they had gold down, now it's up, silver is up. And they are going to drive the paper price, they can drive the paper price of gold and silver down as they did, but the physical market is taking over. That is why it is now difficult to get your hands on silver. That’s why you have eight to ten weeks delays, and why gold will also be difficulty to get as well. For one thing, it will become too expensive for most people to buy, the government has just told you that they are ramping up the printing presses. They didn't say that officially, but they did tell you unofficially, which is the topic we're going to cover next with John Williams from Shadow Stats. [25:07]

JOHN: And this also means that most of the promises that politicians are making right now about medicine, health care, keeping Social Security afloat, there is nothing behind it to back it up. That's all just campaign rhetoric at this stage.

JIM: No. It's just make you feel good; promise the voters cookies and candy just to get elected. We don't have the money to pay for what we have. [25:32]

JOHN: Yeah. Much less what is coming. Like you said, 70 trillion dollars. You're listening to the Financial Sense Newshour at www.financialsense.com. Coming up next, we're be talking to John Williams.

Other Voices with John Williams, Shadow Government Statistics: Helicopter drops & B-52 bombing runs
JIM: Well, what a historic week. We've seen one of the largest insurance companies with a trillion dollar balance sheet go under, investment banks, guarantors of most of this country's mortgages. We truly live in historic times. And what are going to be the consequences of all of these government actions? And this story, folks, is still unfolding. Joining us on the program is John Williams who follows a lot of the economic indicators, including not only what’s going on in the economy and M3 inflation rates from Shadow Stats.

John, as I hear about these massive bailouts –whether it's the takeover of Fannie, guarantees of Bear Stearns, now AIG, and now it looks like of course it's still in the development stage, some kind of RTC that may cost half a trillion dollars – how can people be talking about deflation?

JOHN WILLIAMS: Well, the neo-deflationists, as I call them, are somehow trying to envision a scenario where the money supply collapses. You can't have deflation –and I'm talking deflation in terms of prices on goods and services – without a contraction in the money supply. Where I think all of this goes back to or comes from is what happened in the Great Depression, the banking system then collapsed and the money supply imploded. And with that, you went into a deflationary great depression. Bernanke indicated back in 2002 when he was a board governor how he would fight such a circumstance and prevent deflation. And indeed, I've been arguing for some time that the government, as represented by the Treasury secretary and the Federal Reserve with Mr. Bernanke, would do everything in their power –and I say everything – and they will print/create whatever money they need to bail out system. They will switch whatever arms they have to, they will intervene in whatever markets they have to in order to save the system. They are not going to let the system collapse as it did in the 1930s, which would indeed most likely trigger a collapse in the money supply and could bring about a deflation. They are doing everything they can to avoid it, they've been successful so far and barring some surprise I think what we've seen this last week is confirmation that the government is going to do whatever they have to, and they are trying to work through the potential surprises now. A lot of the mistakes they made – I don't like the way the government generally handles things, but in the current circumstances you have to understand these are indeed extraordinary times and they have to do what they have to do to keeps things afloat, but there is a cost to it. That's what people began to sense this week when they bailed out AIG and then the next morning the government is going to lend AIG 85 billion dollars I think it was. The next morning the Treasury and the Fed created 40 billion dollars of new currency to cover the first payment on that. The numbers that have been tossed around here literally hundreds of billions of dollars pumped into the markets around the globe in the last couple of days, and wherever this new program goes and we’ll get, I'm sure, some details over the weekend. I wouldn't trust too much what you’ve heard so far, but I think conservatively the costs are going to top a trillion dollars. And considering that we have a GDP of 14 trillion, we have total official debt of about 10 trillion and we just took on another 5 trillion or so with the Fannie Mae and Freddie Mac that has to be netted against assets, you're going to see a tremendous surge in the money supply here, tremendous surge in inflation. So what we're saying very simply – the system is being bailed out, but there is a cost to it. The cost is inflation, and the debasement of the dollar. There is not much they can do about it, but they would rather take that than the deflationary Great Depression. [29:49]

JIM: John, you follow statistics, you follow the old M3 and you also follow the way we used to measure inflation before all of these hedonics adjustments, geometric weighting, quality adjustments, all of the kind of goofy things. What are you seeing in those statistics versus what is reported? We do know, for example, with headline inflation the year-over-year comparison should look better as we head into the fall because of the sharp jump last year. We know that with energy coming back down from 145, goodness how they play with those numbers they should look a little better. We should see a little bit of a pullback here with inflation, but my goodness, with all of this monetary stimulus that they're talking about and fiscal stimulus, what are your real numbers? In other words, what does the real M3 look like and what does the real inflation rate look like right now? [30:44]

JOHN WILLIAMS: In terms of the inflation rates since you started with that, you look at it the way it was calculated back in 1980, back in the costs to inflation reporting from the various methodological changes that were made, and I'll contend that most of those were done largely for political reasons to bring down the reported rate of inflation. They may have some academic reasons for being in there, but they don't relate to the real world. That is the problem with the government numbers. And if you look at that, you're somewhere around 13%.

And I don't think you're going to see much of a decline in the inflation rate, and the official CPIU for all urban consumers right now is I think it's 5.2 percent, around that, maybe 5.4. It's over 5 percent, and you're basically at 6 percent for the CPIW, which is the wage earners measure. That's after taking a big hit in the drop of oil prices from its sharp spike. You're going to start seeing the money supply taking in, we've been seeing strong money growth for some time here. That will have some pressure in terms of what we see as we go into the fall. I do think you're going to see actually oil prices moving up some from where we are now. I mean it may have some blips in it, but even as the government is reporting it, you're going to be seeing about 5% and I'll contend by early 2009, you're going to be up there in the double digits, 10% or more, even as reported by the government.

What we're seeing with the money supply, it's been telling an interesting story in terms of the ongoing estimate I put together on M3. M3 being the broadest measure and the broadest measure is the one that gives you the best indication of where inflation is heading. It started to pick up with the financial crisis about a year ago in August, and that was because the Fed was liquefying banks that had run into trouble with the quality of their assets. Banks were able to respond more normally as banks lending money which created money supply. That reached a peak in all time high of about 17, it was around 17 ½ percent – 17.4 percent back in April, and that was the all time high. That's going back as far as 1959 when the M3 has been calculated by the Fed. In terms of historical perspective, the only time you’d ever come close to that was peak of 16.4% back in June of 71, which was two months before Richard Nixon closed the gold window and imposed wage and price controls. Now, since then, the money growth has slowed. We're down to about 14% as of August on a year-over-year basis, but that's still historically a very powerful growth rate, and where we've seen some slowing in the M3 growth –and what I've been speculating, it seems to be proving out – is that because of what the Fed has done with this lending –it's getting stale – they roll over all of these loans with the bad collateral that are holding the system has been tightening up. They haven't been putting much in the way of new liquidity until recently into the system, and so the money supply growth was slowing down month to month staying positive and against the rapid growth of last year, the annual growth started to slow with what we saw this last week which was effectively a run on the banking system. You can see that where treasury bill yields has actually turned negative in trading. When people consider it's worth paying money to have the treasury hold their assets as opposed to banks, you know there is a run on the banking system. We may have some funny fluctuations in the money supply tied to that, but at the same time, we have the Fed flooding the system with liquidity, and regardless of what happens in the next several weeks of reporting, a month or two down the road, you're going to be seeing much higher money supply growth. I figure it could slow down maybe trough out at 13% in the latest month, but that's without the full benefit of all of the new actions taken. You get into October, Jim, I think you'll see a pretty good spike. [34:28]

JIM: Now, as we take a look at this, and you're talking about double digit money growth, and John, I've got a Bloomberg screen. You've seen Russia close its markets, it's injecting reserves into its banking system. And one of the head officials in government said they are willing to tolerate a 15% inflation rate, which they are proposing. You've seen New Zealand cut interest rates, Australia, China lower its bank reserves. They are cutting interest rates, talking about more. So like the 2001 recession that the world went through, it looks like we're ready for another round of global reflation at a time that inflation rates are already high. Unlike 2001, when we came out of that global recession, we had oil prices were at 18 to 20 dollars a barrel, gold was at 250, silver was in the three dollar range, copper was 60 cents, the grains – this time the things that people need are at much much higher levels, so when this round of reflation, your double digit inflation numbers don't seem out of line given what we're seeing happen globally. [35:39]

JOHN WILLIAMS: Well, your analysis is I think right on the mark in terms of the global, and one other thing to consider with the Fed. And as most people view it, particularly the financial media, it just drives me up the wall because they are so far off the mark. There is a point to consider with the Federal Reserve and it's something that the popular financial media misses, and that is the story that you get if you listen to some of these popular TV shows on the stock market that run around the clock during the day, is that the Fed is either fighting inflation or it's trying to stimulate the economy. The big debate is “oh, my goodness, are they more concerned about deflation or about the economy?” That's nonsense. Those are secondary concerns to the Fed when you get to the big picture. The big picture is that the Federal Reserve Board is set out to basically keep the banking system intact. That's their primary purpose in life, and when you have a threat to the system, it doesn't make any difference to them where inflation is going, where the economy is going; those are secondary considerations that they can look at after the fact. They have to save the system and that's what they've been working on, that's where we've been seeing all of these unusual packages come together. Again, the cost there is inflation but that's not a primary concern to them. So again, the Fed is, at this point, I believe, willing to take almost any inflation rate that comes from holding the system together. [37:00]

JIM: You mention a word ‘liquidity,’ and this is a word that people need to understand. Whenever you hear the financial commentators say the Fed is adding liquidity to the system, I translate that into money printing. We are going to make sure that we create enough money and credit in the system and that we keep it from deflating. And then of course, as you and I know, John, when you create money and credit, it goes somewhere, so when people pull into gas stations and they are paying close to 4 dollars for gasoline, or they go to the grocery store and they are seeing their food bills –whether it's meat or vegetable and you're seeing some of the stuff you used to see back in the 70s where you're looking at a box of cereal and you notice the price is up a little bit but the box is smaller – and that's the consequences. And what we do is we take the side effects of all of this inflation and we say that's the cause when it's more of a symptom of this. And I wonder if you might just explain this liquidity is really whenever you hear the word liquidity, you need to start thinking of money printing. [38:04]

JOHN WILLIAMS: Generally that's true, there are times in just the day-to-day operations the feds add and subtract liquidity to the system, and it doesn't have any net impact. But what we're seeing now will have net impact on the system, and in fact, we have two players at work here, both the Fed and the Treasury. Now, the Fed can pump liquidity into the system through the banking system. They can get the cash to the banks and enable them to lend the money which with its multiplier effect goes through something like 10 to 1; 100 dollars deposited in the bank becomes 1000 dollars in money supply. You also have the treasury which can spend money and spends money that it creates with the Fed.

And what we're seeing and what we'll see how this package gets put together, but I think a lot of the cash is going to be checks written directly out of the US treasury. And if the treasury writes a check and it ends up deposited in a bank account, which is where most checks usually go, you have the same effect, hence money supply growth grows. So we're going to be shifting more from the traditional view of the Fed creating liquidity to I think a little more of the treasury actually through its borrowings and fundings with the Fed pumping cash into the system. It has the same effect. [39:12]

JIM: There was an article that was published – and of course we're seeing budget deficits go up and one of the problems that we're seeing emerging in the financial sector, John, is we've seen a lot of off balance sheet debt that's been removed and the government is doing the same thing, for example, the clean up for Katrina and Rita is off budget, the Iraq war is off budget, and all of these supplemental spending programs are also off budget. But you know, there is one item of our debt that nobody talks about, and if you were running a corporation today, you have what is called ‘pension liability’, so if you have workers each year, you may have a pension program where you set aside money so that somebody who has been with you 20, 30 years, they decide to retire, they have a pension plan. [39:59]

JOHN WILLIAMS: Right.

JIM: And Lawrence Kotlikoff did a story in the recent issue of Forbes and the title of his articleIs the US Going Broke? And he took a look at these unfunded pension liabilities, and one he wrote about in particular is that 78 million baby boomers will be heading into retirement over the next decade. In today's dollars, it's going to cost the government annually per person $50,000, which if you multiply 78 million boomers, that's 4 trillion dollars a year in income. Then he goes on to talk about all of these failures, for example, FDIC, which will have to be replenished. And he says we talk about this ten trillion dollar national debt and 5 trillion that we took on for Fannie and Freddie, but he said the real liability facing our government is 70 trillion, and that's why the name of his article, Is the US Going Broke?. He said now that the federal government has bailed out Fannie and Freddie, who is going to bail out the federal government? [41:01]

JOHN WILLIAMS: Well, the federal government is broke for all intents and purposes and it has been for some time. And one point, I'd like to emphasize is that although we're in a inflationary recession right know, we were in the recession before the housing crisis, before the mortgage crisis. There is a lot more going on here than just that mortgage business, but indeed then the government publishes estimates similar to that. If you look at financial reports of the federal government and add in the unfunded liabilities of Social Security and Medicare which are what a corporation would look at in terms of its retiree benefits, the total shortfall as I last saw it was around 63 trillion. I have no problems with 70 trillion. That's probably an updated number, probably very close to where we are right now.

In fact, if you look at the government statements that are prepared using Generally Accepted Accounting Principles, what you’ll find is the average deficit over the last six years has been four trillion dollars per year. That's trillion with a ‘t’. That's not counting anything that's happened in the last month or so here. That's just the way the system had been mismanaged before. Putting that in perspective, if the government wanted to for some crazy reason to balance its budget in a given year just by raising taxes, it could take 100 percent of everyone's wages, salaries, corporate profits and it would still be in deficit. It's beyond containment. That's why I say the government effectively is bankrupt, and where this all comes to a head, it’s a process that’s being accelerated a little bit by the crisis, and you still have a lot of dollars sitting outside the USA that are being held by foreign investors. I believe those dollars are going to get dumped at some point as the dollar gets debased with inflation, it is also less attractive as a currency to hold and as you get heavy dumping of the dollar there, you have the potential of triggering with the current circumstance a hyperinflation. We're for sure going to have one within a decade just given the general condition of the government but it comes sooner, and the problem is that governments when they are broke –this has happened many times before – they don't declare bankruptcy, they don't renege on their debts, at least usually not, the way they handle it is very simply revving up the printing presses and paying everything off with dollars in this case, but the dollar has become worthless. And when I say worthless, I know I've used this example before and I hope those of your listeners who have heard it will forgive me, but I think it's effective because the way I would define a hyperinflation is if you take the largest denomination note in circulation before the inflation, in this case a hundred dollar bill and it becomes worth more as functional toilet paper than as currency, you’re in a hyperinflation. This is the type of hyperinflation that was seen in the Weimar Republic in Germany. You could go into a restaurant and normally you'd negotiate the price of your lunch and pay it in advance because the price would be up at the end of the lunch. If you ordered a fine bottle of wine for dinner, the next morning that empty bottle of wine was worth more as scrap glass than the fine wine was worth the night before. That's what lies ahead is the type of thing that is terrible for someone on a fixed income and it's tough for anyone to keep up with regardless of income. It's a very dangerous and scary future. I wish I could come up with a happier one, but I’m afraid I look at it in terms of possible solutions. I for sure don't see one. And that's eventually where we're headed. [44:19]

JIM: You know, it was amazing because just before he left his post as comptroller of the currency, David Walker published a report on the fiscal imbalances of the United States and he had two scenarios. And this report was published last summer. And that was if we did something right away, and the second scenario, John, was if we delay addressing this issue so it becomes a full scale crisis. Now, if we did something right away, he said we would have to increase taxes 44% and cut government spending 20%. He goes, if we wait until it gets to the crisis stage, we would have to increase taxes 88% and cut government spending 40%.

Now, I don't care what political persuasion you are, whether you're Republican, Democrat or independent, if you take a look at the two main candidates, they are all talking about all kinds of programs and especially, I don't know where in the heck Obama thinks he's going to get the money for all of this stuff, or even John McCain is going to get the money for some of the things he wants to do. You know, John, we take a look at our current account deficit which is a little over 5% of GDP, so you're talking over 700 billion we need to borrow from foreigners. Now you're talking about massive on and off budget deficits for the government that could be easily approaching 700 billion, eventually a trillion. Who is going to lend us money? [45:50]

JOHN WILLIAMS: That's the problem. No one. And when it gets to that point, the one who does is the Federal Reserve. They monetize the debt and you're off and running with a hyperinflation. I certainly wouldn't put my money into long term treasuries, granted in a time of crisis with the banking system on the brink of failure, maybe having your money in T-bills is as good as having it under a mattress and that's why the yields went negative. But looking at it long term, you I don't want to be in the dollar and that's why assets such as gold or some of the stronger currencies such as the Swiss franc getting some of your assets out of the dollar makes some sense in terms of being able to maintain your assets and wealth. That to me is the key concern from anyone who is looking at this from an investment standpoint is you want to preserve your wealth at this point. Don't worry about making short term gains in a market that's absolutely irrational, extremely volatile and subject to intervention by the federal government. Batten down the hatches and ride out the storm. My outlook is for the long term. I tell people I look at gold as a hedge. Look what happened to gold. It was up to 1000, it went down to close to 700; now it has started to jump back up again. Very volatile. Over the long term, and I'm talking out here still a couple of years before maybe the worst hits, I don't care if you get it at 500 bucks, 700 bucks or a thousand, you'll be getting a great buy because the upside to gold is a hedge against inflation. It does have a dual role, both as a hedge against inflation and also as a flight-to-safety mechanism. Both of those factors are coming into play. But as a hedge against inflation – the point is with gold the upside to gold is the downside to the dollar, and even though you may see extreme volatility in the days, even the months ahead, I can't tell you where the gold prices is going to go over the short term, but over the long term, as inflation takes off, as you get a hyperinflation, there really is no top to where gold can go. You’ll see gold at 10,000, 100,000, a million, as and if and when you hit the hyperinflation. Separate from that, it's still going to be rallying higher, with just a higher standard inflation that lies ahead. [48:12]

JIM: Don’t you think that's exactly what was going on in the physical market where, you know, we've done a number of stories, I'm sure you've read, John, as they took the price of gold and silver down over the last seven weeks, we've had record breaking buying globally from the United States to the Middle East to Mumbai to South Africa to Hong Kong and Asia. I mean the stuff is disappearing off the shelves. If you were to try to call a coin dealer today and buy large quantities of gold and especially silver, they'd probably tell you 8 to 10 weeks delivery time. I mean I have never seen anything like this, and I think even though the paper market went down in gold and silver, just the opposite was happening in the physical market. [48:55]

JOHN WILLIAMS: I think that's very true and in fact it indicates that you saw a very major distortion in the paper market; and don't think that the government doesn't intervene there. I don't want to sound like a conspiracy theorist, although there are some legitimate points to conspiracies that you see with this. The President's Working Group on the Markets founded by president Reagan after the 87 crash was designed to help maintain orderly markets. And headed by the treasury secretary, chairman of the Fed, heads of the various trading regulatory bodies, that body had the ability to do anything that it had to in the markets. I know there are very specific times where there has been intervention in the stock market.

Alan Greenspan talked one time, I believe it was around the time of the invasion of Iraq, that they were afraid of what would happen in the markets, nobody knew the exact time of when the invasion was going to take place, but the Fed was advised in advance so that they could help to keep the markets stable and what did they do, they went in and sold gold, they sold oil. They bought the dollar. Aside from the intervening stock market and credit markets, which I think most people recognize that they do do on occasion, so given the right crisis, there is nothing to prevent this group from orchestrating any kind of move it wants in the market to the theme is in the best interest of holding the system together.

If you go back to the Bear Stearns crisis, which I think was the time when you had the peak in gold and they realized they were facing something as threatening to the system as anything they'd ever faced, and anything that they likely will face. We're seeing a crisis today, I mean people draw parallels to the 30s, but we've never seen anything like this. I mean this is – the entire system is at risk with the years of abuse and everything is coming home to roost at the same time and they are just trying to hold it together. And when I say they'll spend every dollar they have to create, twist any arm they have to twist or manipulate any market that they have to manipulate, let me add also manipulate any statistic that they may need to do. It’s a very cheap form of intervention. I can't prove that intervention took place in the gold market but you sure can make very strong circumstantial evidence case for it, especially considering that the system was on the brink and they were trying to contain the panic.

One way to do it is to discourage the owning of gold and that's been a traditional sore point for central banks and governments over time because usually when gold is soaring, it's a good sign they've been doing a bad job. And I think a lot of what happened with that, not only the selling of the gold, but the buying of the dollar was very much orchestrated, very much supported with heavy intervention. Again, the fundamentals, the underlying fundamentals haven't changed a bit. If anything, they've got worse and the fundamentals for the dollar couldn't be more negative. The fundamentals for gold couldn't be more positive. And those fundamentals will in the end dominate the markets irrespective of whatever intervention, games playing, jaw-boning, whatever's done in the end the gold price will prevail on the upside. Unfortunately, for most of the us living in the United States, the dollar is going to come under very heavy selling pressure. [51:57]

JIM: Well, I'll tell you, the best you can do is just like giving out weather forecasts to warn people and just hope they take appropriate action. If you live along the coast and the weatherman says hurricane coming, well, you know what you need to do. Listen, John, as we close, I want to thank you for coming on the program. If our listeners would like to follow your work, tell them about your website. I know you have a number of excellent free primers on various government reports, whether it's GDP, deflation or money supply, but please give out your website. [52:20]

JOHN WILLIAMS: Thanks, Jim. The website is www.ShadowStats.com and we do show alternate measures of economic activity for people that are interested. We do have absolutely at no charge available to the public a report of hyperinflation as well as a report on the money supply that can maybe help explain why I differ from the neo-deflationists. [52:41]

JIM: And also you publish a monthly newsletter on the economic statistics, which really gets behind the numbers. Talk about that for a moment, if you will.

JOHN WILLIAMS: In terms of what's happening right now and the current data, we highlight that in the newsletter. The newsletter is a subscription based, we're always happy to take new subscribers and we do in the archives have samples of everything that's been written that's older than six or nine months, so people have a sense of what it's about and can find it there. And again, we welcome visitors and also welcome questions. There is a feedback area on the site if anyone has got a question.

JIM: All right, John, listen. Thanks for coming on the program and sharing your thoughts and wisdom with our listeners. All of the best, sir, and have a great weekend.

JOHN WILLIAMS: Thanks. Best to you and have a good weekend as well and again, thanks for having me.

Part 2

Band of Brothers
JOHN: Well, last hour we covered the whole subject of credit default swaps and how they brought down the largest insurance company in the world, AIG. So now we’re going to cover what they are, how they work and why they are a ticking financial time bomb. So let’s begin – well, I guess we need to do a backgrounder here, Jim, so people understand the run up to this.

JIM: You know, John, I think probably the analogy I’m going to use here is car insurance. In its simplest form, credit default swaps are bond insurance. If you own a bond that carries some degree of risk – whether it’s a sovereign bond, a corporate bond, a mortgage bond, a junk bond – basically what you’re doing is going out and buying bond insurance against default against some kind of credit event, such as, for example, the issuer misses a coupon payment. So this entity – you have two parties: you have 1) the protection buyer, someone that owns a bond who wants to protect against a default; and 2) the second party is the protection seller. In this case, think of them sort of like the insurance company. The buyer of the protection pays a fixed fee or premium to the seller of protection for a period of time; normally the maturity period of a bond.

And what you do in the contract is just like an insurance contract. There are pre-specified credit events that if they occur, the protection seller pays compensation to the protection buyer. So just like you have an automobile insurance policy that cover, you know, all kinds of things like you get in an accident, your car breaks down or you get hit by an uninsured motorist you have all these clauses. Usually you can take all of these credit events that are spelled out in the contract; and there are three main ones: one is bankruptcy – the inability of the bond issuer to repay its debt; 2) failure or meet an interest or principle payment; and 3) restructuring – a change in terms of the debt obligation that would be adverse consequences to the creditors. [2:23]

JOHN: So in many ways it’s really just like auto insurance, but in essence it is insurance on bonds going into default or missing payment on interest principal. What does this kind of insurance cost and how can the cost of insurance change if the financial conditions change?

JIM: Well, if you take a look at how they price these policies, credit default premiums are quoted in basis points and are paid quarterly for the term of the contract. So let’s you own $10 million of ABC bonds. Now, depending on the health of the company and the credit risk involved, that’s what sets the premium. Low credit risk, healthy markets, a good economy – premiums are lower, just like for example, catastrophic insurance against hurricanes. There was a period of time in the late 80s and 90s where we didn’t have hardly any hurricanes; premiums on hurricane insurance goes down. The same thing in California. You go a long period of time without a major earthquake, the premium of earthquake insurance comes down. Then you get a Northridge – boom – all of a sudden the premiums skyrocket. However, in depressed economic conditions as we have today, volatile markets as we have today, premiums can rise substantially. [3:44]

JOHN: If we’re talking about these credit insurance premiums which are designed to back up bonds can you give us, first of all, a few examples of who these companies are. Let’s start with that one, and then typically what these premiums cost to people who peddle bonds.

JIM: Let’s take a look at, for example, Morgan Stanley. During the period when things were going okay, going back to last year, credit default swaps on Morgan Stanley were running at about two percent. So meaning that on a 10,000 dollar bond, two percent of that would be 200 dollars. However, if you take a look at just the last week or two, you had the credit default swap premiums on Morgan Stanley go from two percent to ten percent, or one thousand basis points. Now, as a result of the announcements over the last 24 hours, you’ve had credit default swap premiums drop to roughly about 800 basis points, or eight percent. But when things were okay, you know, normal insurance premiums on bond defaults were one to two percent. And we’re going to get into why, given the risk parameters that were in the economy, a lot of people that were writing these insurance premiums were really underpricing the risks that were involved. I mean if we look at for example, Washington Mutual, and we take a look at their credit default swaps – let me just call it up here on my screen – we had a little bit more risk here. Washington Mutual default premiums were going for roughly 500 basis points or five percent, and then beginning in July we saw credit default swap premiums go from about five percent to as high 4,000 basis points, meaning almost 40%. Now, in the last 24 hours, they’ve dropped back to roughly about 15%.

If we look at another entity that is probably going to need some kind of government assistance; let’s take a look at the credit default swap premiums for some of the insurance companies or automobile companies. So if we look at Ford, we had going back over let’s say the last six months, we had credit default swap premiums going for 1200 basis points, then they dropped down to 800 and from then they went all the way up to currently, they’re somewhere in the neighborhood of somewhere around 1800 (or 18 percent).

So let’s try another one. Let’s go to Goldman Sachs, we take a look at Goldman Sachs credit default swaps – here’s another situation where you had insurance premiums once again on Goldman Sachs only going for 100 basis points, meaning only one percent; and then they shot up all the way up to almost 600 basis points before dropping back down in the last 24 hours.

Let’s take another automobile company. Let’s go to GM. GM’s credit default swap were going roughly for about 10 percent, and now they’re roughly at 25 percent. So you can see this is people who are writing these policies are saying, look, there’s a lot of risk here, our probabilities and all our models are saying there’s a good chance of default, and so obviously now with all of this credit turmoil, now risk is being priced into these policies where six months to a year ago – and more importantly, when these things really began to take off in 2003, they were only charging between one and two percent because nobody expected anything to go wrong. [7:13]

JOHN: Well, this is pretty much the same as what’s going on with the FDIC right now, as far as insuring bank accounts, they’re only covering a certain number of accounts and if everything begins to blow apart, they’re hard-pressed – they have to capitalize that somehow to be able to continue doing that. But what about the risk here to the bond area, where does it really emerge?

JIM: Well, the credit default swap market really took off during this decade and it’s now somewhere in the neighborhood of around 63 trillion dollars. As this derivative market expanded – and we’ve seen derivatives grow and compound at almost 15 to 20 percent a year – as the credit default swap market expanded it became more competitive, which means you had more people coming in, writing insurance coverage on the bond market. And as you get more people coming in, you get more competition, which meant the premiums were lowered as a result of the competition. You not only had the banks get involved, you had investment banks move into this sector, you had insurance companies like AIG and then you had hedge funds get into this business. And what happened is competition kept driving down the premiums; the more people getting the business –and if you were going out and buying insurance you were saying, you know what, you shop the market. Who’s going to give me the coverage I need at the cheapest amount.

So competition drove down premiums and whoever was writing protection at the lowest prices got the business and John, during good times as we had in the early part of the decade, when things began to boom as the Fed created all of this excess liquidity in the market, during these good times, very few people saw the economic boom coming to an end. So risk was underpriced with virtually everybody thinking the good times would never end, and of course, it became a very lucrative business. And to get into this business, you had to book your profits up front – that’s what made this such a profitable business for a lot of these players that got involved. This made for big bonuses at investment banks, at hedge funds, at money center banks – everybody saw this as an easy way to make money much like the securitization of mortgages, with CDOs. They grew in proportion to the securitization business, but we all know what happens. [9:31]

JOHN: But like all booms that are created with too much cheap money, I mean the boom ultimately has to turn into a bust. It just collapses of its own weight, which is really what we’re seeing now. It is unavoidable. You can delay it for some time, which is the game that’s been going on all this time. So let’s take us to the problematic past in this whole area. Let us show how the insurance companies basically wanted to insure something – whether it’s Lloyd’s of London or FDIC – it’s really based on probabilities.

JIM: Yes. You have to take like any insurance company, you run probabilities: what are the chances of a hurricane. In this case, with credit default swaps, what are the probabilities of defaults; and then what you do is you make these probabilities regarding the risk, so you make some allowance for the possibility that a certain number of policies that you write are going to go bad. So just like an automobile company, auto insurance company writes insurance – they know certain drivers are going to have an accident; or if you’re writing insurance against hurricanes or earthquakes you know there’s a certain probability that’s you’re going to have an earthquake or you’re going to have a hurricane. So you set aside a certain amount of reserves so that when these events occur based on your probabilities you have the money there to pay for it. Or in many cases, you go out and buy a credit default swap from another company to sort of hedge. It’s like what insurance companies do when they take out reinsurance. They’re saying, okay, we’ve insured for these events but we don’t want to assume all of the risk for these events so we’re going to off-load some of the risk with another insurance company.

So let’s say you were to insure – and I’m just going to give a hypothetical example just to make for illustration purposes this easy. But let’s say that you insure 100 billion dollars in bonds with one 100 different companies from Ford to GM to Lehman – whatever. Now you estimate that there is let’s say a 5% chance of having to pay out half of that, or 50 billion or so, of loss. And so if you take that probability that maybe half of your 100 billion is subject to potential losses and then you estimate a chance or probability of how many of them will default. So 5% of 50 million is a loss of 25 million. However, you receive, let’s say, 30 million in premiums so your profit hypothetically is 5 million. You may have to pay out 25 million but you collect 30 million in premiums so your profit is 5 million. [12:21]

JOHN: Okay. Well that sounds all well and good, and basically you’re following a bell curve of probabilities and as long as life goes rambling along, things tend to fall along that scatter area. But there are rogue events. And the rogue events are what throw spanners in the whole works and cause this whole plan from working perfectly.

JIM: Sure. But what you do though, and here is what a lot of these players were doing – and it’s almost like statistically we could eliminate risk, and so if you want to increase your profitability – we saw this with banks doing this, we saw this with hedge funds doing this, just like banks have to set aside so much for loan loss reserves and heading into this crisis we had the lowest loan loss reserves in banking history. They were basically saying, “look, the boom times, the good times are going to last. And so we don’t need to set aside as much money. We keep lowering the probably of bad events happening.” Now, in the case where I said that, let’s say that you were estimating that 5% of half of the bonds that you underwrite were going to go bad, and you would have to set aside this 25 million.

Now let’s suppose that the economy is booming, things are going well – and what you want to do is book profits. Now what you do is you play around with your probabilities and you lower your loss from let’s say a 5% probability to a 4% probability. So now your probability of losses of having to pay out money dropped from 25 million to 20 million. You collect the same 30 million dollars in premiums from your clients, so instead of a 5 million profit, you book 10 million dollars in profits. So by playing around with your risk models and your computer models, you can theoretically reduce your risks and make more profits, which means bigger bonuses, bigger returns to shareholders so as long as your lower risk assessments hold up.

However, in good times the odds are in your favor because the economy is booming, companies that even are marginal are doing well. But we always know, John, the bad times always show up. And what happens is when those bad times show up, those assumptions that you made – lower risk probabilities – don’t hold up. And unfortunately, when you sold those contracts because you were bidding against other players, you locked in your premiums – those premiums that I told you earlier. For example, in many of these companies where they were only collecting a one to two percent premium when times were good, now those premiums are 10 percent. But when you lock in those premiums, you can’t go back to whoever you sold these contracts and say hey look, these models and assessments we made aren’t panning out here and we’re in deep doodoo, we need to raise your premiums. You can’t – you’ve locked in those premiums based on the good times, and as we know, the bad times always follow artificial booms and that’s where the trouble shows up. [15:29]

JOHN: You remember what happened with Lloyd’s of London. How they basically underwrite and then the underwriter of a particular policy on a ship or whatever it would happen to be would go next door and he would get someone to underwrite a problem on his policy and before you know it, all around Lloyd’s of London, everybody was underwriting everybody else. When it all came due – a big thing came through – that was it.

So don’t insurance companies in this case – those who are writing CDSs – hedge their position by taking out credit default swaps. Isn’t that how it works?

JIM: Sure. Just like any insurance company, they use reinsurance. Let’s say in the case of our fee of 30 million dollars, let’s say, instead of taking all of that risk yourself, you take half of that money – 15 million dollars – and you buy credit default swap protection from three other firms – 5 million at each firm – just as a hedge because you don’t want to take all of this risk yourself. So you think things are covered but here’s what happens: The bad times arrive, instead of these four or five percent probabilities of defaults, the number jumps or doubles. So instead of five percent, it could be ten percent or even larger percentages of the bond pool; so instead of 25 million in losses, you could actually be facing a hundred million dollars in losses. And well, you only have 15 billion to pay the 100 billion in losses, so you’re looking at counterparty hedge risk. And however, the problem is these events occur, you only have 15 and everybody else only has 15 so you have 30 million or billion to pay – the problem is you have 70 billion in defaults. Even worse, some of those parties that you took out these credit default swaps with – like a Lehman or a Bear Stearns or even a Merrill – they’re broke or they’re gone – or AIG. Now you have an idea of what can go wrong here. Now I use some simple examples for illustration’s sake, I used for example a five percent premium when in reality most of these premiums were written in a period when the economy was doing well and it was booming, and they were only collecting one and two percent premiums; and during the good times when nobody thought things would go bad, well as we know, the only way to cover these large potential losses is to charge higher premiums. But John, that wasn’t being done because we had all kinds of players move into this space – you had the banks which started it, then you had the investment banks which came in, then you had the insurance companies and then you had the hedge funds get in. And that’s what happens in good times.

And all of this competition drove down the premiums on risk and instead of pricing – if you would have tried to raise your premiums and say, “look, we all know that we get recessions after booms and we need to charge instead of one or two percent premium. Our risk models show us that we should be charging five or six percent premiums.” The problem is you would never have got the business –you would have priced yourself out of this business – which meant lower fees, no big bonuses and lower earnings. So from 2003 to 2007, risk wasn’t being priced into the market. Now, these institutions are paying the price. In the case of AIG, they were writing credit default swaps on a lot of the mortgage CDOs and other toxic debt. And AIG had sold somewhere in the neighborhood of credit default swaps on almost 500 billion of fixed income assets, including almost 60 billion in subprime. So when the credit agencies downgraded AIG credit ratings, it triggered counterparties – these credit provisions that go into these contracts to make calls on over 13 billion dollars of collateral; and talk about the perfect storm for AIG. The downgrades also triggered earlier termination of swaps which triggered another call of maybe five to six billion dollars in payments; in addition, when the US Treasury took over Fannie and Freddie, AIG was sitting on a bunch of Fannie and Freddie preferred stock which became worthless; then they got hit with hurricanes Gustav and Ike. So you take a look at all of this stuff – and then you had Lehman’s bankruptcy, which also wrote credit default swaps – so the parties that you were hedged with almost became worthless so what you have now is counterparty risk – the dominoes all falling – which is why the government is huddling this weekend because had they not done this we would have been looking at a 1929 and 1987 stock market crash probably as soon as – it could have happened today, it could have happened next week. [20:27]

JOHN: So basically what you’re saying is it’s really risk implosion is almost what it is. Everybody was making hedged bets against something and the bets haven’t gone their way. The dark horse came in all of a sudden. Does that encompass everything or are there really more problems hidden here that are sort of missing to the average person?

JIM: Oh no, this is just the tip of the iceberg. For example, there was a type of derivative contract. It’s CPDO or CDPO – I forget what the acronym was – they would go out and put money into bank CDs. Now, as everybody know with the Fed cutting interest rates, interest rates on bank CDs came down. What they decided to do is give it a turbocharge – an equity kicker - they would go out and write credit default swaps which would boost the yield to investors by anywhere from one to two to three percent. So they were investing in bank CDs at the same time they were writing credit default swaps.

Unfortunately, John, they were writing credit default swaps at one and two percent premiums and a lot of the contracts that they wrote at one and two percent premiums are now going in this market at 15 percent premiums, ten percent premiums; so a lot of these companies – these contracts – they have to go out and try to buy back these credit default swaps and unfortunately the price is maybe two to three times bigger than what they were at the time that they wrote these insurance contracts. So here’s another area that hasn’t surfaced yet, or will be surfacing. And so when you were writing risk at two percent, now premiums are ten percent and you go out to try to buy that, they don’t even have enough money, and not to mention even some of the banks that they have the CDs under – maybe they had IndyMac CDs, or Washington Mutual. It is just unreal. And you also have issues where you even have today in the market rogue traders that are going out and taking unhedged positions in credit default swaps trying to drive down the credit rating for a lot of these financial firms and trigger a problem because when you have credit default swaps go up as you did on some of these financial firms where the premiums are ten, fifteen percent, it just makes a problem where a lot of these companies and makes it difficult for them to go out and raise capital because the credit default swaps are saying this company is in trouble, and it is forcing even good institutions to go out and having to raise capital at very expensive rates.

A couple of Fridays ago we had Wells Fargo, which is in better shape than many companies, had to go out and raise preferred stock at 9 ¾, or bonds at 9 ¾ percent. How can you raise money at 9 ¾ percent or at double-digit interest rates – whether it’s a preferred stock or a bond and go out and make mortgage loans at 6 ½? You can’t; it just doesn’t work. And so despite all of these efforts that are being made, that’s why I think this whole situation is hemorrhaging and it’s the reason why you’ve got the oil indexes up today almost 7.6%, you’ve got the gold indexes up three and four percent, and you’ve got many of these mining companies and mining stocks up six, seven, eight, ten percent because everybody knows what is coming: You’ve got a massive reflationary effort and it’s why the gold market’s turned around. It’s why the silver markets have turned around, it’s why the oil markets have turned around because everybody knows what is directly ahead. And that’s what you have. [24:27]

JOHN: It’s funny – I always thought CPDOs were droids on Star Wars. We had to throw some humor in!

Any closing thoughts on this section of the Big Picture, Jim?

JIM: This reminds me – and I have quoted this so many times – it’s amazing, my middle son – we drove him to the airport this morning – he’s heading out for his honeymoon – and my son, Chris, just passed his second level CFA exam and I said, “Chris, while you’re studying for your exam, I don’t want to give you some Austrian textbooks because it’s going to make it difficult because Austrians look at this much differently.” But I gave him a copy of Jens O. Parsson’s, and Adam Fergusson’s book When Money Dies and you know, may favorite quote –and it gets back to why you get the moral hazard, why politicians don’t do anything when times are good. And this is from Jens O. Parsson’s – but it is so appropriate here because it tells you where we’re going. And it goes like this – and forgive me for repeating this for those of you who have heard this before, but for those who haven’t I think this pretty much summarizes where we’ve been and where we’re heading. And this is from Jens O. Parsson’s Dying of Money.

Everyone loves an early inflation. The effects at the beginning of the inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets and spectacular general prosperity all in the midst of temporary stable prices. Everyone benefits, no one pays. That is the early part of the cycle. In the latter part of the cycle inflation on the other hand, the effects all become bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock prices, rising taxes and still larger government deficits and still roaring money expansion, now accompanied by soaring prices and the ineffectiveness of all traditional remedies. Everyone pays, no one benefits, and that is the full cycle of every inflation. [26:57]

JIM: And that is what the gold market has been sniffing out, it’s what the commodity markets have been sniffing out, it’s what the oil markets have been sniffing out – and that’s what we’re seeing unfold. We are entering what we call the crisis stage – the terminal stage of inflation and it is at this stage when recognition is given to these circumstances that you start to see the increase of money velocity. And that will be a key factor to watch going forward. [27:30]

JOHN: Financial Sense Newshour continues here at www.financialsense.com.

The Next Major Crisis

JOHN: You know, I can just hear myself sitting in the doctor’s office, Jim, and the doctor has just basically told me I’m dying. And now he says there’s worse news.

JIM: It’s going to be painful.

JOHN: It’s going to be painful. We could go on with that analogy for a long time but we won’t. And the reason I bring that up is here we are sitting in the middle of, what, I think we started talking about it in 2003, wasn’t it, something like that in terms of the credit crisis? You coined the term perfect financial storm and the perfect financial storm is just one leg of the crisis window the world is going to face here starting next year really – that’s when things will become rather abrupt. Part of this crisis – let’s face it, we talked about the credit crisis three years ago – is here. Part of this crisis window is a crisis much larger than that which is now growing. It is going to get acute by 2012 and 2013, but unlike the credit crisis you can’t print your way out of this one. You see the Federal Reserve and the central banks of the world can’t create barrels of oil, and the problem is right now we aren’t substituting energy fast enough. In fact, if you look at our Congress this week and some of the idiotic debate that went on there, and over the past couple of months not only are they not working towards it, they can’t even figure out what they should be doing about it. Now, look at our situation here. We haven’t built new refineries in almost 20 years; no coal plants, nuclear plants – these were all for largely environmental reasons. We had a number of hurricanes – Katrina and Rita came roaring through the Gulf of Mexico in 2005; Gustav and Ike in 2008; and the majority of our refinery capacity is concentrated along the Gulf coast. And what people don’t reckon – you know, when you hear this on the evening news – that when we get a hurricane, they have to shut these platforms down well in advance of the storm and there is a whole shut down procedure; they don’t just flip a switch, you have to do all sorts of things to cap off the drill hole and everything else, and then you have to undo all of that after it’s done, so there’s quite some time. Now, you would think – given the fact that this oncoming energy storm is roaring in rapidly that the majority of our refinery capacity is located along a weather fault line on the Gulf – that’s a good way of putting it – we might want to sort of diversify our energy sources. You would think. But that’s reasonable. That’s probably why Congress isn’t thinking that way. [30:28]

JIM: When we left 2002 when oil began to rise from that 18 to 20 dollars a barrel, and we started moving towards 30 – and of course, everybody thought that this was an aberration. The Gulf war was in 2003, so it was political scares, and of course we were trying to work our way out of a recession and we had all kinds of reasons why it should come down. And that is exactly what we have seen from 2002. And on the day that you and I are talking, oil is back over 100 dollars a barrel, natural gas is over 8 dollars per cubic foot, and we have all along – now you hear demand destruction. And what happens is every time we get these oil spikes which the Interagency Task Force said were supply and demand driven, when you don’t have something that people want of and it’s in short supply, what happens is the market comes in and it rations that supply through the pricing mechanism. So you have this spike jump to 147 and then we got back into the 90s, and everybody is saying, phew, boy, you know, now we’re going back to lower prices. And then what happens is everybody relaxes. I was reading some statistics on automobile purchases. The purchase of fuel efficient cars dropped off, the increase in gas-guzzling cars increased because the automobile companies are running incentives and people are saying, okay, gas prices are going lower, they’re below 4 dollars where let’s say, just a couple of months ago we were looking at gas prices here that were closer to 5 dollars. So everybody breathes a sigh of relief and we go, okay, we can postpone this, we’re not going to do this. And actually, given all of this, and the public which says start doing something, Congress. We need to do something. We can’t be dependent on imports, and especially with people who don’t particularly like us, number one; and two, sources of our suppliers whose major oil fields are going into rapid decline. And what was amazing as we covered during summer break, I think it was the last show we did in August before we went on vacation, we were talking about in one week we had two reports: we had the Interagency Task Force that was put together with seven government agencies and we had the midyear Midterm Outlook that came out from the IEA. And what was really significant about that, if you really look at it, they’re saying, you know what, the world’s oil fields are depleting at a much faster rate than we thought. And so instead of 4 percent, we have 5.2 percent. So that’s 3 ½ million barrels of new oil that we have to find.

Then they took a look at demand destruction, and that’s all you hear when you watch cable channels, “demand destruction, demand destruction…” Well, yes. Demand for energy – people are conserving in the US, but this is a bigger world. There are more countries out there that have more people that are industrializing. I hate to tell you, folks, but China is not going to trade the cars in and they’re going to go back to riding bicycles. That’s not happening. And many of the OPEC producing countries where the price of energy is insulated from world market prices because the government subsidizes – when you subsidize something you don’t have the market mechanism coming in and rationing the price of energy, so –as the IEA pointed out – you may have a reduction of demand in OECD countries, but within OPEC and other countries where the price of energy is subsidized you’ve got nearly four percent growth in demand. So if you net the two figures together, we have one percent increase in energy consumption globally; so that means to meet that demand we have to have 1 ½ million barrels of new oil found each day. So, depletion we have to replace, that’s 3 ½ million barrels; we have 1 ½ million barrels of growth – that’s 5 million barrels of new oil every single day – the equivalent of every two years we must find a Saudi Arabia.

We know, John, from looking at the oil companies – the international oil companies – the easy oil has been found. Places where this is a lot of oil, like the Middle East and the Caspian, they don’t have access to it so they have to go deep offshore which costs more money, they have to look in the Arctic and then they have to look in areas like, let’s say, off Nigeria where you have a group that has declared war against the government with the idea that they are going to shut down oil production completely. And MEND, the rebel group in Nigeria has declared war on the government. They have warned the oil companies to get their workers off the platforms because they’re going to be attacked and if they’re there, they’re going to be killed. And so you have production taken off line, you’ve had production taken off line in the Gulf of Mexico and just to give you an example of how serious this is, at one time, the Energy Information Agency was talking about at some point production in the Gulf of Mexico would ramp up to two million barrels a day and hopefully offset the decline in production that we were seeing in Alaska and the lower 48 states. But what has happened is as a result of these weather events that we saw in 2005, Katrina and Rita – Katrina and Rita, we lost permanently 300,000 barrels of production in the Gulf of Mexico. It is estimated in the next three to four years, and especially now after these last two hurricanes, we are going to lose an additional 200,000 to 300,000 barrels of production. So instead of producing at two million – and even a large project like BP’s Thunder Horse which has now come online, you’ve seen a lot of these projects be delayed; so it’s taking more time to get them up and running, a lot of these rigs – I think we had 29 rigs destroyed with Ike and a lot of these rigs are older rigs that are over 25 years old, that should be rebuilt and replaced but they’re having to run patches on them because if they don’t run patches on them, we just don’t have the rigs. We don’t have the equipment, it’s an aging infrastructure, and at the same time, our largest supplier, you have Mexico in three to five years – we’ve already been told by the Mexican government (Mexico’s Cantarell depletion rate is running at 30% a year) that we are no longer going to be getting the amount of oil, that we’re going to lose Mexican oil production.

And John, it’s amazing given all of that we had an attempt this week to virtually make it impossible to drill offshore, to build clean coal power plants or build nuclear power plants, and we’re going to be playing some of that debate here. But it’s just absolutely astounding that we are probably going to be the most impacted nation of all the global powers in the world because we consume – we are the single largest consumer. We consume with four percent of the world’s population, we’re consuming 25 percent of the world’s oil. And even as a per capita – energy use per dollar GDP is less – it’s still a larger figure today. [38:27]

JOHN: Jim, what I don’t think people are really grappling with whenever I talk to people about this whole situation, “oh well, we can’t drill our way out of this. We’ll bring alternatives on line. Oh well, you know, there’s all this oil up in Alaska, or the oil sands. You know, they discovered these new fields down here…” And I go – you don’t understand. You don’t understand what it takes, the time required and the permitting and the process to do all of this to get that online. So unlike the credit crisis, the energy crisis is going to be bigger than anything we’ve seen in modern times because it takes a long time to build a power plant, to put in pipeline, to drill, to discover, and bring into production and deliver the output of an oil field.

This crisis is going to have two facets: 1) it’s going to be bigger than anything we’ve experienced recently; and it’s longer lasting. It’s like a window time. That’s very hard for people to understand. This isn’t going to happen in 24 months. This is going to drag out over ten or fifteen years. And what we should be doing right now is taking emergency steps, and in reality if you look at what the Congress has been doing the last three months, we’re doing everything to prevent anything being done, while masquerading that something is being done for political purposes during an election year. And that’s what this bill was earlier in the week. If you listen in the first hour to Richard Loomis enumerating what this bill does, it really doesn’t do anything but for political fodder. It just looks good. [39:57]

JIM: It provides cover. Hey, look, we did something.

Let’s just stop and think for a moment about what our constituents are dealing with tonight as we stand here. And all they’ve got – concerns about the economy, concerns about keeping their own jobs. They’ve got concerns about whether they’re going to be able to put gas in their car tomorrow considering the high price of gas. Or we’ve got the home heating crisis about to come to us as they’re filling their propane tanks, filling their oil tanks and looking at the heating bills that are coming this winter. And then what are we doing? We’re sitting here tonight in the middle of the biggest hoax I have seen in the 18 years I’ve been in Congress. It’s a sham. And everybody in this chamber knows it’s a sham. Now I know those are strong words, and words that I don’t use lightly. But I want my colleagues to consider this for a moment. We have a bill here that purports to be a compromise, but I don’t know one Republican member who was involved in one meeting with regard to this compromise. It was written by the Democrat leadership that runs this Congress in the dark of night on a napkin. It showed up here last night at 9:45, a 290 page bill, 9:45 last night, that no member had ever seen.

And guess what? As we stand here tonight, no member has read. All right. Anybody? Member? Show me. Some member stand up and tell me you’ve read this bill. That’s what I suspected. Not one member has read the bill that we’re about to consider. No hearing on the bill, no committee action, no one has read. And the bill purports to increase American energy. But I want you to consider this: 85 percent of the known reserves off of our coast, on the Outer Continental Shelf – 85 percent at a minimum – are locked up permanently under this bill. And of the 15 percent are purportedly opened, the states would have to comply to open those Outer Continental Shelf reserves. But there is no revenue sharing to the states like there is in Texas and Louisiana and Mississippi and other areas. There’s no revenue sharing. So the states have no incentive to want to open up the Outer Continental Shelf. So, how much new drilling do we get out of this bill? Zero. It’s just zero. And there isn’t a member in this chamber who doesn’t know it’s zero. So when I call it a hoax or I call it a sham, I think you all understand what I’m trying to say. No new nuclear plants in this bill, no new oil shale drilling in this bill, no clean coal technology in this bill. We’re the Saudi Arabia of the world when it comes to coal, we have clean-coal technology, whether it’s gas – I mean, coal to gas, coal-to-liquid, we have ways to use our coal in a clean way. Nothing in this bill will allow it to happen.

What does it have in it? It’s got a big old tax increase in it – you can be sure of that. What else does it have in it? It’s got a big earmark in it. 1.2 billion dollars for the city of New York on behalf of one member. In this bill! Here we are trying to take some step towards energy security and what do we have to do: We have to load it up with a big old earmark. 1.2 billion dollars. A compromise, huh? This is no compromise. The compromise might have been amongst a bunch of Democrat chairmen who wanted to have some bill, but there’s no compromise here. Let’s describe this bill for what it really is. It’s nothing more than political cover on the eve of an election. To say: We voted for an energy bill. Except there is no energy in it.

Congressional approval today is at the lowest point in any time since polling began, and our member wonder why. And it’s stunts like this that have the American people so cynical about their Congress. They expect that the Congress is going to do something about increasing energy security in our country, that we’re going to do something about bringing down the high cost of gasoline, that we’re going to do something about bringing down the high cost of heating oil or propane or natural gas this winter, and what are we doing? Playing political games on the eve on an election. The American people understand that 70 percent of our oil comes from overseas, more than half of that comes from OPEC who’s considering lowering their production in order to maintain the high price of oil. We’re just teetering. They’re just teetering with us. Got to have us on a string because over the last 30 years my Democrat colleagues have stood in the way of more energy production in the United States. That’s why we’re in this box that we’re in today. And we have a chance to do something. We have a chance to move in the right direction, but this bill isn’t it and there’s not a member in this chamber who doesn’t understand this bill doesn’t do anything about bringing us any closer to energy security.

In a few minutes, we’re going to have an opportunity for all of the members on both sides of the aisle to do something of substance. The motion to recommit tonight will be the Abercrombie-Peterson bill. No changes. No tweaks. No nothing. And it’s paid for. And it may not be everything I want, but let me tell you – this bill is a bipartisan bill worked on by serious members from both sides of the aisle. It’s a bill that does do all of the above. It gives us more drilling for oil and natural gas in an environmental sensitive way off our coast. It does allow revenue sharing; revenue sharing to the states so that they have an incentive to participate in helping to open up this area off our coast. It’s got new nuclear in it. It’s got oil shale drilling in it. It’s got clean-coal technology in it, and it’s got a lot more money than the Democrat bill when it comes to putting money into renewables trying to speed up their development to bring those renewables to market as soon as possible.

And so we’ve got a chance to do the right thing tonight for the American people. We can show them once and for all we can work together across the aisle. We can show them we can do something to move our country toward more energy security because most Americans understand that energy security is paramount and is in effect national – our national security.

This bill we’re going to bring up under the motion to recommit. We’ll create a million new jobs here in America, and with all the talk about a stimulus bill, the greatest stimulus we can give our economy is to create a million new jobs, lower the cost of gasoline, lower the cost of heating oil, lower the cost of energy. That will actually even create more American manufacturing jobs.

The question is do we have the courage – do we have the courage to do the right thing. Do we have the courage of our own convictions about doing what we know that we have to do as a country to move ourselves toward more energy security. Or, are we going to show our constituents that once again Congress is up there playing political games with our future. See, the American people, it’s their jobs, it’s their budgets, it’s their concerns. They send us here to represent their interests and it’s about damn time that we represent their interest and by voting for the motion to recommit tonight, we can show them that we’re working in a bipartisan fashion on their behalf. And now you’ll back.

[applause] [48:18]

JIM: And the amazing thing about this, John, is when you see all of the warning signs that we have had since 2002, every time we have a sharp spike in energy there’s a very standard response: Let’s find a scapegoat and let’s do some finger pointing. And believe it or not, that’s exactly what we’re doing now. We’re doing finger-pointing and looking for a scapegoat. The latest scapegoat has been the speculators. People should start questioning, wait a minute, the economists said if the price went up, we would have more supply. Well, that hasn’t happened. We’ve got the largest amount of rigs operating and we have not seen a supply response. That should tell us we’ve got a problem. With Mexico’s production going into peak and now into rapid decline, that should tell us something.

With Russia, which has really been one of the big producers in this decade that has ramped up their production with them saying their production has gone into peak, and Russia, like so many other national oil companies have chosen to get as much as they can out of existing oil fields rather than take some of that money and reinvest that capital for exploration, well enhancement and everything they can to extend the life of what it is they have – much like Venezuela, much like Mexico, they have been bleeding the oil coffers to run the state without making the necessary investments. So the very countries that we are looking upon to – say “we’re not producing it, we’re into decline. But as demand goes up, you make these investments and increase supply” – that’s not happening. That’s the very reason that the IEA is doing a comprehensive study that they’re doing of the 250 largest oil fields in the world where we get the bulk of our oil.

They’re essentially doing and covering and doing an update of something that Matt Simmons did about seven years ago. That’s also one of the reasons why they raised in their midterm report the world’s depletion rates from 4 percent to 5.2 percent because I would suspect a lot of this field data and oil field studies that they’re getting in all of this information is saying, “wait a minute, this is a big field. It used to produce this. And this has been the annual decline rates.” And so we’re going to get that information in November. That will be another warning sign. And it’s unfortunate in the last crisis we had in the 70s, it was a political crisis, but the oil embargo and at the same time we were fortunate enough to make two of the last major oil discoveries in the world which were the North Slope of Alaska and the North Sea. Now, we discovered those in the late 60s, so as oil prices were ramping up to 40 dollars a barrel at the end of the 70s, just at that time we were changing the oil market, there were enough new producers that were coming in, we had both the Alaska discovery and the North Sea discovery – that came in. There is some political problems in the sense that you have the war in Nigeria, you have the problems with national oil companies and their incentives, but this time it’s a geological problem and it’s much different. And unlike the 70s, where you had for example in Europe and Japan where much of Europe went nuclear; they increased taxes on gasoline, so if you look at the car fleet in Europe it’s much more fuel efficient, they drive smaller cars, smaller engines with better gas mileage; they drive diesel cars which are more fuel efficient; and then also they’re way ahead of us in solar deployment, wind, ocean energy. They’re moving on all fronts because Europe wasn’t endowed with the oil endowment that the United States had, when you consider up until 1970 the United States was considered the world’s Saudi Arabia of oil. And so we have not taken those steps.

In fact, we have done everything to prevent because of this wacky, out of control environmental extremism – or irresponsible environmentalism. John, we talk about clean energy but you just can’t put up a solar array, you can’t put up a wind turbine, so you can talk the talk but they don’t walk the walk. And other countries took these steps to avoid these problems so that today France gets almost 75 to 80 percent of the power from nuclear energy. They have a mass transportation system throughout Europe, their rail system which is wonderful. They have fuel efficient cars and they’re now going to not only solar-powered homes, they’re going to wind turbines offshore, they’re going to ocean energy, they’re deploying. In other words, they are decades ahead of where the United States should be as the world’s largest economy and the world’s largest consumer of energy.

And John, what have you seen in the debates when oil was approaching 147, you had specials done, and all it was was a bunch of people pointing fingers at each other yelling and screaming, and you walked away totally confused and not understanding the situation before us. I think people know that the sentiment is now turning in this election for drilling, and as we have pointed out on this program on numerous occasions: it isn’t one thing that’s going to solve this. It’s not answer a, b, c, d. It’s all of the above. It’s conservation. It’s drilling. It’s alternatives. It’s new research. And I don’t care if it’s a refinery that could take seven to ten years, a pipeline, an oil discovery, or even redoing the transportation fleet, you’re not going to sit there and wave a magic wand and the next two years all Americans are going to be driving fuel efficient hybrids or plug-in hybrids because most of the oil and energy we consume in this country is in the transportation system.

And so that’s why we’re heading into this crisis and if you’ve thought of buying at least one fuel efficient car and you’re thinking now that the price of gas has come down, maybe we’ve dodged this bullet and you know what, I’m getting a great incentive to buy some gas-guzzling SUV, please do not do that because at some point in the next two to three years we’re going to be going to gas rationing and you know, maybe what they say, is each family only gets 20 gallons of gasoline a week and you better have a fuel efficient car because it’s going to make a difference.

And just as the recent interview in Barron’s with Charlie Maxwell when he was talking about what life is going to be like, there are going to be some horrendous adjustments to our lifestyle, and they’re going to be broad and forced upon us. There will not be alternatives. Government will not be able to turn on a printing press to solve it. And he talks about, you know, when you look at it, we will much closer to where we work and where our friends are, and our vacations are going to be local. This idea that I’m taking a trip this weekend and instead of getting on a plane, I was going to have to take connecting flights because the airlines have cut back dramatically. John, between layovers going to cities in the opposite direction it’s going to be more time efficient to just get in a car and drive to the location than it is to get on an airplane. I think air travel is going to be dramatically curtailed and the cost of flying will be only available for those of means because it will become so expensive. So we’re looking at this crisis, and right now I can understand why people are focused on you know, will my bank open on Monday, are my deposits or my money market funds okay and secure. There are much, much bigger issues here and we’re not addressing any one of them, and that is probably one of the most alarming things that I see here. [56:17]

JOHN: It’s almost like being in a dinghy and being worried about the next wave and not realizing that the waves that are following it are much, much larger. You’re just trying to get through this wave at this time and on an individual basis.

What has always amused me or I guess fascinates – ‘amuse’ is probably not really the right word – is how when cultures are going into crisis, they have this denial mechanism that kicks in that fails to see danger coming, and usually what happens is they try to dodge the bullet rather than defend against the bullet. And I’m thinking clearly of Neville Chamberlain coming back from the Munich conference in 1939 with a piece of paper proclaiming peace in our time - that very famous piece of film clip there. And it was the same deal. They felt if they could just sort of keep dodging and negotiating and haggling they could avoid the problem, and in reality the problem was going to come. And all you can do is deal with the problem.

In this case it’s not a geopolitical thing in terms of warfare or something of that nature, but the problem really is going to be here, it is not dodgeable, we’ve used up over the last, what, three four five years since we’ve been talking about this, precious time that we needed to get this thing going and all we’ve done is dicker and haggle over whether we need to drill or wind. No one seems to really comprehend the immensity of the storm heading this way. [57:45]

JIM: How could a society that is so technologically advanced as we are and where we were the epicenter of the energy development of the oil age could be so blind to this is I’m sure historians if Jared Diamond were to write his book Collapse ten years from now, he would certainly be looking at the United States and how we have had warning after warning after warning and we simply turned a blind eye on this myopic belief that somehow when we need it, it will magically appear. And yet that’s what they have told us from 2002 upwards, every time it spikes up they look for a scapegoat – it’s the war, it’s terrorism, it’s weather, it’s the oil companies, speculators – and that’s all they can do is play the blame game. So it’s unfortunate, John, but it may be too late. And like Matt Simmons has contended on this program and I agree with Matt one hundred percent, it’s going to take a major, major series of crises – one after another – following each other before we finally wake up and it’s a question of that point of what would be the consequences of our inactions. [58:55]

JOHN: And then you have to get through the political static and noise in order to be able to do something because if you can’t correctly identify the problem you can’t fix and you’ll only make it worse. And unfortunately, this is the historic cycle that governments go through. First, there’s no problem; then, okay, there’s a problem but they incorrectly diagnose it – the fingerpointing goes everywhere else; only later on, usually out of the private sector does someone say, “I know what to do. Let’s fix this.” And that’s just the path that things tend to run on. So, right now, we’re on track, the throttle is open, the bridge is out ahead, but everyone is saying, Full Speed Ahead. So unless we get diverted…

You know, there is some growing awareness but we’re chasing the clock here. That’s the important thing – there’s a clock and volume on it, per diem issue, and that’s what we’re facing is this beating the clock. And right now the clock is winning as opposed to the country or the world for that matter.

Anyway, you’re listening to the Financial Sense Newshour at www.financialsense.com.

Part 3

Q-Calls

JOHN: Well now, you might imagine that on a week such as the week or two weeks that we’ve had we would get some Q-Line calls, and indeed we have done that. It’s time to take your Q-Line calls. The toll free number, US and Canada, is (800)794-6480. That works toll free from the US and Canada. For people who live outside of those countries it does work from wherever you are in the world but you wind up paying for the call.

And as we talk to you about your questions here, please remember that the content on the radio show is for information and educational purposes only, and you should not consider it as a solicitation or offer to purchase or sell securities. And our responses to your inquiries are based on the personal opinions of Jim Puplava because we don’t know a lot about you, about your suitability, your objectives, your risk tolerance. These are generally generic answers based on the information that you provide, and as such, Financial Sense is not liable to anyone for financial losses that result from investing in companies profiled or advertising on the program. Always consult someone who shares your philosophy about investing, but who is a good investment advisor before you make investments.

That’s 1-800 794-6480.

The first call comes from La Mirada, California.

Hi, Jim and John. This is Mike from La Mirada, California. I’d like to ask you to critique my current line of reasoning. As you know, the junior market recently went on sale and some quality companies are currently selling at incredible discounts. There’s one company in particular that I’ve had on my buy list for a long time; it’s a junior exploration company that’s currently in production and making a healthy profit. And this particular junior also released some drill results to alert almost bonanza grade. How to buy shares in the company then? I could do this in two ways: Buy shares that are traded on a Canadian exchange and pay extra fees to my brokerage to do so; or buy shares that are traded over the counter in the US and pay my discount brokerage’s usual low fee. The difference between exchange traded shares and OTC ones is about 6 cents. The fee to buy shares in Canada will work out to about three percent of the total cost, which is a bit too high. I’m leaning towards buying the OTC shares. If the company dropped to under a dollar I want to buy as many as possible without worrying about transaction costs. The company’s OTC shares are fairly liquid, about a quarter million today I think, and I guess there’s a good chance the stock will be listed on a major exchange in the future. Am I missing something here. What should I be worried about when purchasing a stock like this over the counter.

JIM: Mike, I would definitely go with your inclination to go with the OTC. The spreads are less. It will cost you less. And that’s what – no, you haven’t missed anything. That’s where I would go. [2:46]

Hi Jim and John. This is John from Utah. Jim, you deconstructed the argument that lower oil would mean demand destruction and that lower oil prices would also mean better economic growth – those two things couldn’t possibly happen. And yet, I’ve listened to the Big Picture three times this week and you seem to be arguing for greater inflation based on a two trillion dollar housing market default and credit default swaps and other things that just seem to scream deflation. The markets seem to be screaming deflation right now. My position is prejudiced a little bit by the fact that I’m long silver futures, but silver and gold seem to be going down day after day; oil seems to be going down; the bonds are screaming; the stock market is going down. It just looks like a total deflationary collapse to me. Could you explain to me how you can argue for inflation and use as your arguments all of the destruction of credit?

JIM: You know, John, I think you’re confusing a decline in asset prices with inflation and deflation. Deflation occurs when the money supply contracts, inflation occurs when the money supply expands, and the fact that you saw oil and commodity prices going down – this is a short term event that was more market oriented caused by deleveraging. If you have the amount of leverage in the system and you get a margin call from the margin desk, you’re liquidating anything that you can get your hands on. And just to give you an example, take a look at what happened – I don’t know which day your call came in but we had silver prices, for example, hit I think a low on September 11th of $10.21 and on this Friday we have $12.48 roughly. We had a 22% increase just in the last couple of days. Likewise, we saw gold prices at 720.80 on September 11th, and then on this Friday we had 873.55; we’ve seen an increase of likewise in just the couple of days. And that’s the same thing that’s happening in the oil markets. So don’t confuse an asset with price with inflation and deflation – you’re talking about symptoms versus cause. And I can tell you, the last time we had deflation is when Eisenhower was president. [5:21]

Hi, this is Gary from Los Angeles. Jim, first of all, thanks for the education over the last two years. I’m just getting a little bit a feeling of hopelessness in regards to the gold and silver markets. It’s just getting harder and harder to hold on and no one seems to be explaining what is really going on behind the scenes, and it doesn’t seem like it’s a fair market anymore. And if there are any answers you can give us we would appreciate it.

JIM: You know, Gary, there’s been intervention in these markets but there’s also been deleveraging in this market. And the trade of the year was long commodities and short the financials. And then with the intervention that we saw in July where they intervened in the gold and silver markets through shorting; it began on the TOCOM where one major Wall Street firm had 50,000 contracts short. We saw a ten-fold increase in gold and silver and at the same time you also had deleveraging. You’ve got to remember – a lot of these hedge funds – I mean when you go into commodities and take out a commodity contract, you’re leveraged 10-to-1, assuming you put up the 10 percent equity. And when you have most of these funds leveraged 20, 30 to 1 – Goldman Sachs, for example, keeps track of the 75 largest holdings of – gosh, I’m trying to think what the number is – 750 or 850 hedge funds, and it was exactly these stocks that were sold into this downdraft as hedge funds scrambled for liquidity, as margin loans were called in and you had the sell off that occurred. But then what happens is once again, this is why we talk about dollar-cost averaging, adding to your position in these downturns because when it’s over, it’s going to depend on how many ounces you own and how many shares you own, that that’s what you do. And look at this great turn around that we saw in just a three-day period where it just moves. And then we’ve just got indications from Washington and we’ll probably learn more about it the beginning of next week in terms of this trillion dollar bailout that they’re going to have. All of that is inflationary. [7:27]

Hi, my name is Ron. I’m from Richmond, Virginia. Now that I feel that the 1987 event for gold and silver has happened and all technical indicators have broken down especially for silver, I’d like to know: where do we go from here?

JIM: Up. That simple. You know, it was amazing – last couple of weeks – this is what we do in the evening, just like the president has his inner working group on markets, I have the same group of friends that are either friends or in the business and you know, we are at night – I’m sitting here reading. I’ve got the television on mute to Bloomberg Asia, I’ve got a portable phone taking phone calls from people around the globe that I talk to. And it’s amazing – you can sit there and look at something technically and you would say, Aha, this is what’s going to happen tomorrow. You wake up in the morning and you turn on the TV and just the opposite. And that’s just kind of the topsy-turvy market that we’re living in today with all of the things that are going on in the financial market – the leverage, the deleveraging, the bankruptcies, the intervention, all of these cross-currents, and that’s why I think you have to take a longer term view on where you think things are heading rather than just looking at what is going on just short term. [8:47]

Hola, Jim and John. This is Richard calling from Malaysian air flight 201 somewhere over the south Atlantic between Buenos Aires and Cape Town, South Africa. Jim, you’ve often spoken about the tremendous upside potential of buying gold exploration juniors. But Jim, would you be so kind as to share with us what your strategies are for when and why you might be selling them.

JIM: You know, Richard, I think right now there are two things you need to be looking in terms of what’s going to happen in the junior space. Number one, a lot of juniors and especially exploration and also companies that don’t have access to the financial markets, they’re going to be going under. The more defined deposits in geopolitically safe areas with good management and access to the financial markets – because remember, the juniors don’t have a way of generating revenue – those are going to be the ones to save. When you take a look at – would I be selling a junior? You sell juniors sometimes because 1) they’re not proceeding in a way that you would like them to proceed; 2) management is not delivering on the promises they made; 3) they don’t understand the capital markets, the games played with investment bankers and they tend to get sucked into these pump and dump schemes. Those are three that I would give.

But also, sometimes, you would swap them for upgrades or better opportunities. In other words, if you take a look at what has happened to junior producers – companies that are producing stuff, making money, have cash flow streams – they have been beaten down to such a level that you might want to be swapping some of your juniors or taking off some of your junior positions and swapping up because they represent better value. And then I would only keep the large deposit juniors and defined-deposit juniors in a safe location with access to capital markets. [10:41]

Hi Jim and John, this is Willie from Reston, Virginia. I’m looking here at Agnico-Eagle mines. At the end of the day it went down five dollars in the last 8 minutes of trading, so this is one of the many examples that you guys have been talking about in the program. On a separate question, I’m trying to figure out how to buy gold coins and silver coins. Would you please point me in the right direction.

JIM: You know, Willie, you’re in Virginia. I would google “gold coins” and just try to take a look at what kind of dealers are close by to you – maybe you have something in your area. If you’re not going to buy from somebody local – in other words, you’re going to buy over the phone and then have it shipped to you – I would definitely go to Dave Morgan’s site, Silver Investor. He did a study on who had the cheapest cost for buying bullion. You might want to look at that study and take a look at that list because Dave did a survey. It was quite extensive the number of bullion dealers that are located in the United States. So those are two sources for you. [11:47]

Hi, this is Doug from Maryland. Love the show. Commodity investors have been subject to and hurt pretty badly by a set of dirty tricks this year from changing the rules on shorting the financial stocks to interventions in the currency markets, and it seems to me as things get worse there’s going to be even more dirty tricks. So maybe for a second hour guest you might want to bring in someone like Paul Blustein, who has studied currency crises and talk to him about what sort of dirty tricks were played by the governments on their own citizens. He’s an expert on the Asian currency crisis and on the Argentine currency crisis. Anyway, somebody like that who could us some experience on what kind of dirty tricks to expect coming up would be pretty helpful.

JIM: We’ll take that into consideration. I know we’ve done some – we’ve got a couple of interviews coming up in late October and November that we may be covering this topic. Thanks for the suggestion. [12:55]

Hi Jim and John, this is Andrew from Colorado again. Thank you very, very much for your show. They’re wonderful and the debt of gratitude just gets greater each week. My question to you guys is if you could dedicate some part of the show to going into real detail about how like small investors like myself can analyze different mining companies ie really explain what it means the difference between a resource and a reserve, what measured and indicated and inferred means, and also the kind of probability of an explorer turning into a producer or a late stage producer – what kind of obstacles they might have in their late stage – so we just get an idea of the probability of actually being a successful investment and therefore how we would split up the money we were investing. Do we need to invest in five companies, ten companies and so on?

JIM: You know, there are a couple of things. We’ll probably cover topics like that in this year’s upcoming holiday weekend gold show – our annual gold show. But there are two things I’d like to recommend is you pick up a book called Mining Explained by the Northern Miner. There’s also a new book out called the Gold Watcher by Frank Holmes who will be a guest on my program in October. Two great books on understanding the fundamentals behind gold – that’s the Gold Watcher book – and then the Northern Miner book which would be a good primer which gets into a lot of those questions you talk about: measured and indicated, feasibility, what to look for investing in mining, making sense of the numbers, understanding mining financial statements and the various ways the business of mining works. And I think that is almost must reading for anybody that’s in this sector. [14:41]

Hi, this is Julia from New Jersey. My question: would it make sense right now to take a fixed rate 30 year primary mortgage for investments? The reason why I am contemplating that thought is that because of the currency devaluation going forward, mortgage rates are still low and to repay the loan using cheaper money in the future sounds like a good idea, and I have heard another financial advisor actually advocating that idea. I currently do not have a mortgage and was wondering if that was a good idea, so I’d like to hear your opinion about that.

JIM: You know, Julia, I’m really not a proponent and going out – if your home is free and clear, keep it that way. If you had a mortgage on your house that wasn’t fixed, I would say, yes, go ahead, lock in a 30 year fixed mortgage at these low interest rates because they’re going to inflate their way out of this and that mortgage will depreciate as inflation takes over. But you know, going out and putting a mortgage on your house, unless you’re an expert investor, experienced, I just don’t like that. I just don’t like using leverage because when you get these downdrafts as we’ve seen here through July and the early part of September, you don’t want to be on margin. You don’t want to have borrowed money to make those investments because when you own your investments free and clear – like you own your house – you can afford to weather, ride out the storm because you’re not getting margin calls like a lot of these hedge funds did where they had to scramble and sell perfectly good investments at ridiculously low prices because the bankers wanted their money. Don’t put yourself in that position. [16:28]

This is Steve from Toronto. I’m the guy who bought the house with no money down and has made a variety of investments. In any event, I bought silver at 17 dollars an ounce and saw it go up to 19, made a decision with my wife not to sell because we figured it would do better probably December and maybe January of 09 with a correction in between. The correction has been a lot deeper than I thought. Why I’m calling is I watched with great horror on Sunday 14th that silver traded on the Globex at $3.45 an ounce, which of course would have meant basically a catastrophic 13 dollar an ounce loss and a pretty bad thing. I’m wondering for any of those metals analysts who use a chart, would that low be reflected on their charts and their calculations because of course that would mean that Globex low would have corrected the entire advance from basically the 1990s; and this would either mean that a real bull market is starting yet again or we’re due for some really heavy duty correction – basically a total wipeout in commodities. I hope you have an opportunity to answer my question.

JIM: You know, I don’t show that on the site. That could have been a misprint or something because I show – at least on my Bloomberg – the low reached on silver was on September 11th where silver got down to $10.21. So you might want to look at that as being a misprint. [18:03]

Hello, Jim and John. I want to say I listen to your show every week. My name is Beverley, I’m calling from Trenton, New Jersey. I was lucky enough to have a history teacher whose relatives went through the great inflation of the Weimar Republic and he had told a lot of interesting anecdotes, one of which is that during that period, bankers would actually run away from the people they’d loaned money to because they didn’t want to be repaid back in very, very, very cheap dollars. So if we are going into hyperinflation, wouldn't we want to be really, really in debt and pay back with really cheap dollars.

JIM: You know, Beverley, the only way you would want to be in debt is if you have debt levels that you can reasonably afford and not put yourself in a position where you would have to make emergency sales or find yourself in a very uncomfortable situation as many hedge funds did with debt. If you have a good paying job - because remember, in a hyperinflationary depression a lot of people will be put out of work, so you don’t want to indenture yourself to the point if you lost your job or you took on more debt than you could afford to keep, that you get yourself in a very difficult financial situation. [19:19]

Hey, Jim and John. This is Ed calling from Toronto, Canada. My question is I’ve been investing heavily in silver bullion over the last little while and I’m currently in a discussion with my investment advisor and he says that one problem with precious metals is that we’ve witnessed in the last couple of weeks the prices can drop due to manipulation by central banks and hedge funds hammering the precious metals. And while he agrees with the overall thesis that we should be coming into an inflationary times, my advisor believes that it’s possible for these external sources like central banks and hedge funds to manipulate and artificially depress the value of precious metals for another four or five years. That seems like an overly long time. I just wanted to get your perspective. Do you think that central banks and hedge funds can actually suppress the price of gold and silver for four or five years? Or, how long do you think they can actually continue to do that before the general market takes over?

JIM: You know, Ed, I don’t buy that argument because certainly if you take a look at the price of gold and silver which bottomed in the summer of 2001, certainly they have intervened in that market and there have been corrections sort of – I call them those Maalox moments when you go through them and certainly what we’ve seen in July and August is one of them. But look where we are today and how fast it came back, and so there’s a very good possibility by the time we get to this winter that precious metals prices will be much higher. You know, they can’t control everybody and as they drove the price down, look what happened. You had gold and silver disappear off the shelves and also I think the mine set of a lot of these central banks in the world and especially OPEC money is changing and saying, “Look, dollars are deflating, currencies are deflating, we want real money.” So they can manipulate things in the short run, not the long run and certainly they couldn’t manipulate things for four or five years or you and I wouldn’t be talking on this Friday with gold prices at 873 and silver back up towards close to 13 dollars again. [21:33]

JIM: This next question: we got a caller from Ohio that talked about his IRA and 529 plan, which is with a company that could be in financial trouble. Look, if that’s making you lose sleep and the company is having financial difficulties, then you’ve got to put your money in a safe place, what you’re going to be able to sleep. And we don’t mention names on the air here because we don’t to create scares, but you know, if you’re uncomfortable with it then you need to take action. [22:01]

Hi guys, this is Luke from Boulder. Jim, I had a question regarding what happened yesterday. I think that was a strong piece of evidence what we saw, bullion kind of held sideways and was up during most of the sell-off, and yet the miners, such as the larger miners, they were up for about 15 minutes and then they got slammed. And so, I’m wondering about your thesis and how when you spoke with Frank Barbera a while ago, he mentioned that sometimes the miners will act like actual stocks and trade away from the bullion, and so my question is: what’s to prevent that from happening? Because I know you have large positions in gold miners. I mean I’m looking at Goldcorp today and it’s trading at 25.72 and those prices don’t kind of reflect the underlying bullion prices. So I’m wondering what your take is on watching Goldcorp, Silver Wheaton and all of the large producers trade away from the fundamental bullion prices.

JIM: Well, just take a look the way we ended up Friday. Goldcorp is not at 25, it’s at 32. It’s had a big jump. The same thing with Agnico-Eagle up almost 5% on Friday. You can look at Yamana which was up 8%, you can take a look at Kinross which was up 9%, Lihir almost 10% - just all away across the board. Silver producers up 4 and 5 percent, some up 8 percent. So you just don’t look at one day, take a look at the movement in total over a period of time. [23:32]

Hey Jim, this is David in Los Angeles. I have just thought about this major price correction, today is Tuesday 16th, we were down to 90 dollar oil, down from 145. I wonder if this couldn’t have been an intervention by the Bush administration and its allies around the world aimed at hurting Russia in response to what happened in Georgia. We did it once in the 80s, and of course there was a lot more wiggle-room back then, more room to manipulate the market back then, but perhaps the Saudis had enough spare capacity to do this at least on a temporary basis. Certainly we were primed for a correction at 145 dollar oil, but I wondered if, as I said, the Bush administration and its allies didn’t take advantage of this correction and just drive it lower in some way. Anyway, no way to know it for sure but I was curious about what your thoughts were.

JIM: I think it was a number of things. Anytime you see a parabolic move as we saw in oil, especially as we went through 125, you always have pull-backs, but I think it was helped along. That’s a possibility. I wouldn’t say…the world’s in a different situation than where we were in the 80s. There were 10 million barrels of excess spare capacity within OPEC. There just isn’t that there today so I don’t know if – I mean I’m not saying, that it didn’t happen, but I just think that’s not what really happened. I think we had the spike; I think they went in there, they needed to bring the commodity sector down because of inflation, because of the current financial crisis, because of where the dollar was, because where the banking index was. We were looking at imploding. Indeed, we almost imploded this week which is why we’ve got this emergency weekend meeting and maybe emergency session in Congress next week. [25:29]

Hi Jim and John, this is Tom from New Jersey. I really appreciate your show. I was wondering – on the Q-Lines last week in response to one of the questions you mentioned that the price of gold paper was being manipulated by the futures market. If that’s the case, I was wondering why the same couldn’t be done by speculators driving up or down the price of another commodity, namely oil. Would appreciate your thoughts on that.

JIM: You know, Tom, usually the small speculators have little impact. The Interagency Task Force actually said that the commercials were actually short oil and the speculators – these small speculators – were actually short oil. So while oil was going up, they would have benefited by being short and so it’s just the opposite. Small time speculators – and I’d highly recommend you google the Interagency Task Force and read their conclusions on energy because it lines up with the International Energy Agency. [26:27]

Hi Jim and John. More and more we are seeing families that are flat broke, jobs are gone, stocks have tanked, the banks are left holding high amounts Level 3 assets that will have to be written down, and if these Alt-A and the ninja loans that you’re talking about and these option ARMs are going to hit, it’s just going to get worse and worse. If this is the case, Citi and other big banks are going to have to take it on the chin like AIG, but unlike AIG I don’t feel the government is going to be able to bail them out. If they had problems trying to give a bridge loan for 100 billion dollars, how are they going to deal with 3 trillion in capital required over the next year and a half. The way I see it is that there has to be a financial collapse. The banks have to go insolvent – or many of them. If this happens I can see gold going through the roof. Now, no matter what happens with the gold stocks over the next little while, do you think when the fat lady sings and the stock market finally collapses from insolvencies of these banks that everything will be raided including the gold stocks because investors will have to sell everything to raise cash to compensate for the massive failures in the core indices. If this is the case, isn’t prudent just to buy bullion, store it or just keep in cash, wait for this apocalyptic ultimate collapse in the stock market and then go in and buy with liquid cash.

JIM: Actually – you didn’t mention your name – but just take a look at what happened on Thursday night and Friday and what may happen this weekend where you’re going to have a government agency that’s going to go in and take all this toxic waste that’s on the balance sheet of these financial institutions and take it off, and we’ll probably just end up printing the money to do it. And in periods of hyperinflation, actually you can have stock markets going up in nominal value. [28:09]

Hi Jim, this is Howard in Louisiana. I just caught Jeff Christian’s commentary that there is no manipulation in the silver market. And it reminded me that when I was listening to your interview was struck when you said you had to wait for silver. His response was, well, when you buy little bits in small, consumer amounts like 100 oz bars, 10 oz bars, you have to wait a long time. I really wished you told him you’d bought a tonne and hear what he said. I would really like to find out if these 1000 oz bars are hard to get or really as easy to come by as some people are saying they are – not that I’m going to run out and buy three of them, but I’d just to know the reality of it. If you have any insight on that, I’d love to hear it.

JIM: You know, you can get 1000 oz silver bars. I don’t like 1000 oz silver bars because if I want to sell off a portion of silver for whatever reason, I like smaller quantities and it’s the smaller quantities that are very difficult to get right now. The 1000 oz bars, from what I’ve been told, are still available and easy to get. You can line up on the COMEX and take delivery; if you have the means to do so, you can do so in Australia through the Perth Mint, so you can still find places where you can get 1000 oz bars. It’s the smaller denominations that are still difficult. [29:28]

Hello, Jim and John. This is Paul. Hope all is well with you and continued success on a great program. One brief point: Because of all the rigmarole going on in the silver market, perhaps when you get a chance if you haven’t thought of this already is to do a silver roundtable in the near term on one of your programs. Perhaps maybe having somebody on such as a David Morgan or a Ted Butler along with a Jeff Christian and along with perhaps maybe an executive from the mining industry, you know, such as Bob Quartermain, et cetera – by the way, Jason Hommel would be another excellent person to have on as well. So give it some thought. continued success all of you and let’s look forward to a great rally in all these great things.

JIM: All right. Thank you so much for the suggestion, Paul. [30:15]

Hi, this is Cheryl from Sarasota. It appears that the government is going to form an RTC-like entity into which these guilty parties can dump all the bad paper that has been issued. What do you think the short and long term impact of such a move will be on the various market sectors and would the impact be affected by when this entity is actually created?

JIM: Well, Cheryl, you saw a bit of this in the rally that we’ve seen over the last couple of days, and especially on this Friday, where we’ve had the markets up – you know, the Dow 3 percent, you have the S&P 500. I think in the short term you get a rally as we do, but the underlying reasons and causes still exist and they’re still out there and we still have more problems. We have not only the financial sector to deal with, we’re going to have to replenish the coffers at FDIC, the Fed is going to have to print a lot more money, we’re going to have to deal with the automobile companies that are going to need to be bailed out. So, you know, when you go through this deleveraging and crisis, it took us 30 years to get here, it’s not going to be unwound in three months. We still have a lot more problems in front of us. [31:32]

Hey guys, this is Keith from New Jersey. Actually looking for your comment on – I’m watching a major financial news service. Gold is up some 80 odd dollars and I’ve seen during the day, they have a breaking news section. There’s been one article on the rise of gold, and then actually it was removed as gold went up from 60 to 80. I’m looking at it right now about 2:00 eastern time, and there’s not even one article on it. Could you guys make a comment on, you know, the relationship of the news service to what’s going on with the price of gold.

JIM: They usually don’t cover it, Keith, until it gets to be so obvious everybody is looking at it. I think they were looking at that anomaly, where it started up during the day at 25 and worked its way all the way up into the 80s. They would just as soon not believe it. I heard one financial anchor commenting on the rise in gold and oil. It’s like, “Oh no, you don’t think we’re going to have go back and do this all over again.” That’s just the attitude. They look at it as an anomaly. They don’t understand it, and when it goes up they can’t explain it. [32:43]

Hi, Jim and John, this is Todd from Valley Forge, Pennsylvania. Given that the Fed has bailed out Bear Stearns, it’s bailed out AIG, there’s bailouts pending for the FDIC and other entities like GM and Ford – you would think that there would be a flight away from US bonds, but instead what we’re seeing is the exact opposite. We’re seeing a flight to safety. And today, on Wednesday, the 3-month T bill is yielding 7 basis points, the 10 year Treasury is yielding only 3.42 percent. How long can this low yield on the 10 year Treasury last, and I’m curious to know how much of the government debt gets rolled over, say, every 3 or 6 months, and is the US Treasury smart enough to try to issue more and more debt at the long end of the curve given these low yields right now in the market? When are we finally going to see foreign investors give up on US Treasuries?

JIM: You know, you’re already seeing some of that, Todd, in terms of the TIC flows last month (in terms of money coming into this country). And you’ve got to remember, when you’re a large institution – let’s say you run a mutual fund or hedge fund, you’re trying to deleveraging, you’re looking for a safe place to park your cash – what do you do when you have very, very large amounts and you’re worried about the banking system? If you deposit 100 million at a bank and the bank goes under, you’re out of a lot of money, so that’s why sometimes that’s the only vehicle that’s available and that’s why you saw the negative – at one point during the day we actually had negative yields, so you were actually paying the government money to hold your money. [34:37]

Hello, this is Brian. I’m calling from Greenville, South Carolina. Several times you’ve recommended the Canadian ETF, CEF, it’s a precious metals bullion exchange-traded fund. I’ve looked in their prospectus, they’ve got a large number of silver certificates. I’d like to know who’s on the other end of those silver certificates and how reliable they are, especially in times like these.

JIM: Brian, you can call up the fund and they’ll tell you directly who they hold that with. They hold that with several players and it’s allocated silver. [35:11]

Hello, Jim and John. This is Grant from Indiana. My question involves street name securities. If my broker that I deal business happens to have financial problems and they go under, if my stocks are in street name can you let me know what risks are involved in my portfolio at this particular point.

JIM: Grant, depending on how long it takes SIPC to sort things out, you may go through a period where you don’t have access to trading in your account, so that’s the real risk. [35:40]

Hello, Jim and John. This is Jeff from Phoenix, Arizona. As you have mentioned on your program, I too have had problems the past month purchasing precious metals. In the past, I’ve purchased them from two sources; one of them a local dealer and one of them a wholesaler. My local dealer is completely out of silver, and has limited amounts of gold. The wholesaler that I’ve used would sell me silver, but the delivery’s been delayed on purchases for up to 2 ½ months. My question regards what will happen in your opinion when the average investor decides that precious metals are important to own, won’t there be a huge shortage of gold and silver such as we’ve experienced in the last month, and possibly can’t find it because it’s not available. What will that person turn to? Will they turn to the ETFs – GLD, SLV; will they turn to it seems like the Central Fund of Canada? I don’t own any GLD or SLV. Is it time to perhaps buy that in anticipation that’s what the average investor will do in the future? I’d appreciate your thoughts on this.

JIM: I think, Jeff, they’ll go right down the food chain from actually owning physical bullion, to the ETFs, to things like Central Fund – although I prefer Central Fund over GLD or SLV. And from there, they’ll also go to the stocks as demonstrated in all those entities the last couple of days this week. [37:08]

JOHN: Well, Jim, we have to hurry and close the program because I need to get to New York for the Saturday huddle. They’ve invited me in, you know.

JIM: Oh, okay. And we’ll have an exclusive on that next week on the program. You’ll be the fly on the wall.

JOHN: I will indeed. I’ll call you midnight Saturday and tell you what’s up.

What’s on this show next week.

JIM: A couple of things coming up. Doug Noland, author of the Credit Bubble Bulletin will join us. He’s the one, probably more than anybody else, who has chronicled all of this as it has unfolded and as it originated. So Doug will be up here to update us on where he sees things going. Also, October 4th, Frank Holmes The Gold Watcher, and then also we’ll have some excerpts from this year’s ASPO conference – that’s the American Society for Peak Oil – so a lot of great things coming up in the month ahead.

In the meantime, well, as usual, we’ve run out of time. We’d like to thank you for joining us here on the Financial Sense Newshour. On behalf of John Loeffler and myself, we hope you have a pleasant weekend.

© 2008 James J. Puplava, Financial Sense ® Newshour

Friday 3 October 2008

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