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Riskless Economy

Posted On: 2007-01-12
Length: 1:02:28

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Yes, yes, yes. This is Johannes Ernharth and you are listening to the Vigilant Investor live. It's Friday and we've got a beautiful, beautiful cold day out here in Pittsburgh for a change, we've been having that unseasonably warm weather. Friday, January 12th today and thanks for tuning on in if you're listening out there. Welcome aboard if you're a first time listener. Today's show, we're going to be hitting on a number of things that we think are of course valuable as always, but just to run down a couple of, just sort of the background details I suppose for the show, which are always important. If you want to call on in live, feel free to do so always, the number is (724) 444 - 7444, that's a Talk Shoe line number, this is a Talk Shoe Podcast as you understood from the very beginning of the show, always intro with the Talk Shoe intro there. And what you can do with Talk Shoe is pretty wild, you can actually tune on in live, you can just listen to the streamcast and a lot of people end up doing that we see from our numbers. You can also come in and download the Talk Shoe chat interface, where you can participate as a chatter if you will. There is a instant messaging kind of an interface where the people sit in there an communicate back and forth by typing. And of course the most interactive way you can get about involved with the show is to call on in at the number I provided before. Now if you haven't registered yet with Talk Shoe, I recommend you get online and do that, because you get your own PIN number and you can dial on in and you can communicate most effectively that way, with your own PIN number. But if you don't have a PIN number and you just want to give a quick call on in, again that number is (724) 444 - 7444 and our Talk Shoe id. is 982, as it always is. And you can use a caller in for our show Vigilant Investor, sort of temporary password if you will, and that number is 111, excuse me, scratch that, 222-333-4444, that's 222-333-4444 as a PIN number than gets you into the show. So, feel free to call on in and be a participant. Now we were listening to as the show opened up there, that was Dr. Mark Faber, who has been all over the place the past couple of days, in the last week he appeared on Bloomberg television, fantastic interview, we have a link to that on our site, vigilantinvestor.com. We encourage you to listen to that front to back. It's one of the best interviews we've heard in a long time. And for that to be getting on Bloomberg TV certainly is a step up from the usual fare given how much we think sensible a perspective, how little of it is actually getting out there to the consumer who needs it, and that's people like all of us, basically that, you know are having a hard time finding really an ability to connect that. And of course that is what we do here at vigilantinvestor.com. The intent is to help you connect the dots, to find all sorts of information out there that is available if you had the time to dig through all of it. But as part of our research with our separate firm we come across a lot of this info. and we figure it's very valuable for people to have it available to them, so there you have it. It is there, updated daily, at vigilantinvestor.com and you can also access the Talk Shoe site through there and the Vigilant Investor Podcast and so forth. Now, of course we do the show live once a week and you can subscribe to it via iTunes and download it into your iPod automatically, pretty fancy little feature, if you subscribe, you can have it automatically update in sync every time you connect your iPod to your computer. Pretty fancy technology these days and it's better than anything you'll ever find on the radio. So, make sure to do that and become a regular listener and pass it on to your friends, because of course, yeah, important stuff we talk about on a day to day basis. Well, hey, just reviewing things, we wanted to hit on a little bit today the duration of time that has gone by without an adjustment having taken place in the two major indexes, Dow Jones Industrial and the S&P 500. We're really reaching a long period of time where we have not seen a reasonable correction. For example, the Dow Jones Industrial has not seen a pull back of 10 percent for a total of 959 trading days. That's never happened before. With this current streak dwarfing the prior longest days runs of 839 days lasted, that ended at 3-30-1994, 806 days ending on 10-13-87 and 772 days ending on June 9, 1953. So, we're clearly treading into territory that is unprecedented and we often times talk about the lack of, seems like the complacency, the lack of concern among so many analysts out there respecting where we are with the market, we noted that in the turn of think year the 12 largest Wall Street firms all are in agreement that the S&P 500 is going to be heading upwards, north bound for a new record high. We're not just talking new record highs, we're talking about you know, breaking into the 1,400 level and you know, closing at higher and higher and higher above that. And you know, it's just, last time we had a complete agreement among all those major firms was in 2001, and we all know what happened in 2001 was basically continuation of the slide that had begun in the fall, or the spring of 2000. And just as a reminder to everybody, you know, we hit another record high yesterday in the Dow Jones Industrial but these are not record highs. Even when you adjust them to inflation you're still coming up far short. And I know it sounds like we're probably beating a dead horse on this because we talk about it every week, but MSNBC and all these other news publications you can read out there, very few people are actually pointing out that you just adjust the Dow Jones Industrial average for inflation and basic CPI, you're still far below a real record high. The Dow Jones Industrial average needs to hit a new high of 13, 731 just to break even with the old 2000 high at 11, 723. So, you know, we're 1, 217 points below the inflation adjusted Dow at yesterday's close. Now, we're going to be looking at today's numbers a little bit and we'll give you an update on that. The S&P 500 of course is much worse off and has yet to break the old nominal high, but you adjust that again for inflation, the 2000 high of 15, 027.46 [1, 527.46] is equivalent to inflation adjusted value of about 1,789 today. Now we're about 366 points, that's 25 percent below the, where we need to be with the close yesterday at 1, 423. Now you know again, as long as we're flogging that horse one more time, and we're not even going to touch the Nasdaq, the Nasdaq is still half of its old high, so why even bother to get into adjusting that for inflation. Let is suffice to say it has a long, long, long way to go before it gets back to 2000's level. And you know really, that being the biggest reflection of the bubble that was created in the late 1990's is an expression of the credit bubble that was you know vented into the stock market so dramatically. Technology obviously took it on the chin the worst and the Nasdaq dropped some 78 percent and it's going to be a long while before that gets even remotely close to even a nominal comparable high at what was it, the 5, 800 or something like that, I think 5, 048 excuse me was its old high in 2000. So, we'll just shelve the Nasdaq because that's really where the biggest element happened. Going onward though if we just take a look at the Dow Jones Industrial and the S&P 500, we measure them against oil, and things like gold, I mean you're looking at half the exchange value that you had for, what you could get in 2000. In other words if you could sell the equivalent of the Dow Jones or the S&P 500 back in 2000, you could get twice as much oil and twice as much, over twice as much gold, over twice as much oil that you can now. And that's because you're seeing adjustments happening to the dollar. The dollar is basically weakening, and even though things might be going up price wise in dollar terms in the U.S., you're still looking at issues on the background with inflation kind of eroding your real return in the Dow Jones and S&P 500. And measured even in other currencies that are, it's less dramatic, and this is another one of our points that we make from week to week is you just can't measure inflation or what's happening with the dollar relative to other currencies. But if we take a look at the Dow Jones Industrial, which was up 14 percent in 2006, it was only up just about 2 percent if we were to measure it in euro terms. In other words the dollar slid against the euro, and if you were actually, you had euro, exchange at the beginning of the year verses the end of the year, you're only up about 4 percent. And you're taking on a lot of risk to get that kind of return relative to these other asset classes and so forth. But, enough about the inflation adjusted. Getting back to the earlier point, and I can see that my co-host Stephan Ernharth is on board. Hey Stephan, how are you doing?

Stephan: Fine Johannes, how about yourself?

Doing well, I was just telling listeners about the excuse me, the duration that we've been going here relative to prior periods where we have not had any really meaningful corrections in either the Dow Jones Industrial, and I'm going to talk a little bit about some of the other equity indexes that have yet to correct in any meaningful way. For example, I was mentioning that we've gone up 959 trading days, actually more than now, because I was looking at an article that was written a few days ago, I think about the 5th or the 6th of January. So we're actually a little further along the way, actually by a couple of days. But not seeing a pull back of at least 10 percent in 959 days, plus a couple and that has been the longest streak ever. And it breaks the prior longest [...] streaks of 839 days that ended in 1984, 806 days that ended in October of '87, and 772 days that ended in June 9th, 1953. So these long periods where you don't have any meaningful swing are really far and few between. And as we've talked about Stephan, you know, from day to day, it seems like the equity markets really have seen well below average, unusual amounts of lack of volatility if you will. In other words, your day to day swings in prices just seem to get more and more narrowed, which is itself another indicator that often times when you start narrower and narrower trading patterns, something is building to break. And the irony of it all is that human nature tends to be that you know, the longer something doesn't break or go wrong or you don't have a 10 percent correction in the market, it almost builds confidence, that you know, you're that much more confident that it's not going to happen the next day, when in all reality, the probability of it happening is actually higher going forward. But [...] that's, what I was touching on there as we go forward, maybe I'll pull up a couple other time periods as well. I think the S&P 500 has gone on to a new record with respect to having not even corrected more than 2 percent, and that's unusual as well.

Stephan: Well I think you make a good point, Johannes and there is certain technical analysis out there that shows or states or projects that the U.S. stock market, the Dow has not hit and the S&P have not hit their 4 year cycle lows yet. And you know, nobody has a crystal ball, but that's intriguing with a 12, 5+ Dow as high as it is and, numerically anyway, you know if it has not hit the 4 year cycle low, that's a substantial way to go down if in fact that still must be hit. Secondly, I think we ought to, as we have done on our web site, on vigilantinvestor.com, ernharth.com, the same site, you did a post regarding the interview that Dr. Mark Faber did on Bloomberg, I believe it was on Monday or Tuesday -

We in fact opened up with a slice of that for listeners and referenced that it is available online.

Stephan: And the point that's really, you have to respect Faber in so many ways, but you know the chief point that he does make, back to what you're saying, the bullish sentiment has almost become ridiculous. And Faber points out that, look, people who sell stocks are bullish in stocks. People that sell real estate are bullish in real estate. And the bullish consensus in the equity world, let's say, is almost unprecedented at this point in time. Which means, watch out.

No doubt, you're absolutely looking at a lot of the sentiment indexes out there, the indicators of you know, bullishness among traders, expectations of what's going to happen, and oh, at very, very, very high levels compared to historic averages. And you know, I was talking about earlier in the show before you came on as well, you know the 12 largest Wall Street firms are all in unanimous agreement, we're looking at the market, the S&P 500 hitting new highs, the Dow hitting new highs in 2007 and they are rarely all in agreement, yet 100 percent of them all believe. And of course as we always do, we monitor the VIX, and we can touch a little bit on where the markets are today, but the VIX is the CBO Chicago Board Volatility Index, and it's just a way that traders can insure portfolios by you know, again volatility to some degree, but in fact trading volatility if you can imagine that. And that's down 5.3 percent today to 10.29 and that's been trading at a range in the last 52 weeks anywhere from 8.60 to 23.81 and even in the 10.29 ballpark we're looking at in its 98th percentile, 99th percentile in terms of where it trades reflecting a complete indifference to risk at the moment. And it even was just a few weeks back trading in the 9's and even dipped down during intraday trading at 8.6. But you know, its high point in the 52 week period was back in May when the market started to adjust, but even that adjustment was less than 10 percent for the S&P and the Dow and so forth. So there's still again, when everybody gets unanimous, when the crowd is unanimous, you start having to scratch your head and making, you know, you better darn well make sure that there aren't other factors that you ought to be monitoring because it's definitely an indicator of overconfidence and you know, at times maybe that confidence is well placed, but at other times, as history has shown, just as you know, all the time it's shown over and over again that people just get so comfortable with what's happening that just like in 2000. I mean Stephan, you and I have been in this business for how long, how many Wall Street firms, how many groups were saying the market was going to be due for a correction, a substantial as it was in 2000.

Stephan: None. None. And during the correction I'm reminded of David Lereah now who is the Chief economist for the National Association of Realtors and this alludes to what you were talking about before, read him every week to week and he keeps saying, he keeps calling for you know, it's the bottom of the housing bubble, it's, correct a little bit, but it's at the bottom now, now is a great time to buy. And he's been saying that steady for 12 months. And I'm reminded of all the inter industry information that you know your retail advisors, people who are out there explaining to what's, you know, actually handling people's portfolios out there on the street. You know, you go down to your local brokerage office, your independent, whoever you work with, and they keep telling you, hey, we're at the bottom, we're at the bottom from 2000 and 2002 because that's what Wall Street was telling them. And you know, you've really got to start scratching your head through that because every explanation of why the bottom was there failed to materialize accurately as predicted. And finally when it did bottom out in October or 2002, you know, the answers didn't really add up at all.

Stephan: Well, remember Johannes, we heard the same thing in between 2000, 2002, 2003, okay, in the equity industry let's say, the stock market industry, it has bottomed, it has bottomed and there was a heck of a lot further to go before it really did bottom. And but for15 rate cuts by the Fed and extremely low interest rates in the mortgage market and the auto market, everything that we've talked about, God knows how much lower it would have gone. With that said, there's a vested interest, we believe, in the, let's say, the investment industry for markets to do well. There's a vested interest in the real estate industry for markets to do well. And I think it's human nature to hitch your wagon from a belief, and belief standpoint in your industry and it's a natural human tendency for people to lose their objectivity because of that. And our point of view has always been, really learning a lot post 2000, that you know, the investment industry, the investment world is just not the only, the only market is not the stock market. And there are other ways to make money, it just takes a little more effort, it takes the ability to, it takes the desire and the ability to be objective and to admit things for what they really are. And to think out of the box. I'd like to make another point, what's really intriguing as I look at my screen here today, the fact that gold jumped up another 13 dollars today, back to the 627 range, and the resiliency in that metal along with silver has been very interesting especially since the last time, and I'd like you to get into this later in the show Johannes with the Goldman Sachs Commodities Index you know trimming initially their unleaded gas weightings in pre election and now trimming their oil futures waitings as part of that index. The first one before the election, it did effect gold. Gold dropped down into the 575 range and then it got dragged down a little bit with gas and oil, and then it has since bounced back. And then gold has sort of dropped again during the latest cut, trimming back by Goldman Sachs and their commodities index of oil, and I dropped it from the 630ish range to about the 609 range, but all of the sudden gold is back to you know, 627 and the metal has hit an interesting resiliency and a nice holding point at the 600 level and this, I think will be for gold for those that are bullish in gold a good sign, we believe over the longer haul.

Right, right. And just to the point that you were making there about the gasoline, you know, oil having dropped as much as it has, you know, like you said, everybody is attributing it to other things. But what you've got, you know, it wasn't just the warm weather. I mean there's more to it than just the Goldman Sachs commodities index, but that definitely has some pull in that you knock down the representation of crude by half and some of the sub indexes that make up the Goldman Sachs commodity index and suddenly you're looking at you know, a sell off that's triggered because so many institutional investments funds use the Goldman Sachs commodity index as their bogies, their sort of model that they're emulating so that if it adjusts by you know 70 percent, 75 percent, which is I believe what they did to the unleaded gasoline representation back in August, you're going to see a big sell off of investments that represent you know, gasoline in the same way you saw oil get sold off and out of it by all these hedge fund managers and major institutional managers and so forth, just to keep in sync with the Goldman Sachs Commodities Index. And that kind of stuff works for a little while, but eventually things start shaking out. And back to gold as well Stephan, one of the things that happened that was interesting at the end of the year, it was kind of quiet but there's this big gold agreement among some of the major gold holders, central banks and so forth. And generally what they've been doing over the last you know couple of decades is been slowing selling or leasing off their gold. And recently, one of them, they didn't mention which one, had a small purchase, which is a you know, hasn't happened in 13 years I believe. And that's telling you if they're beginning to you know starting to scratch their head as to you know maybe we need to have you know, gold in our coffers maybe a little more than we do going on there, and lest we forget, gold in the United States used to back up currencies and used to be part of every central bank when they first, for example in the United States, when we first had the central bank foisted on us, thanks to a completely negligent Congress, what you had was a dollar that was still backed by gold by the old terms. And the gold was exchanged 20 dollars to an ounce. And by the time The Great Depression was created thanks to excessive expansion of money supply, and we won't get into that today, but if you want to read about that, read Rothbard's Great Depression, you can get the whole scoop as to how the Fed and its mistakes you know, relative to its policy to Great Britain, WWI and so forth, basically created the environment that led to The Great Depression. You had a competition for precious metals relative to the dollar and you had FDR trying to print more and more dollars to try to bail us out of a Great Depression and people were saying, the heck with that, we're going to hold on to gold. So what did FDR do? Keep, this is America, this is the land of the supposed free, he makes its illegal to protect your wealth by holding gold. Confiscates all the gold, at least he tried to, but law. Now, a lot of people didn't turn it in, but he passed a law that basically said, you cannot hold gold. And that was because, you know why, it's arbitrarily? Absolutely not, it was because it presented an viable threat that the government was trying to basically inflate, deflate your purchasing power by printing more money so they could use it for their own purposes. And you know, we thing that that's you know, that was back then, The Great Depression was such an odd period and you know, why would that ever happen again? And well you know, what happened in 1972? Nixon basically defaulted for the second time on the U.S. dollar by basically saying that they were closing the gold window. No longer could you exchange dollars for gold. Now back with FDR, I never actually finished with FDR. When he made it illegal to hold gold, he also changed the exchange rate, only central banks were then allowed to exchange their dollars for gold. And he basically reneged on the old agreement, which was 20 dollars to an ounce, and he said from there after, it was 35 dollars to an ounce. So that was a defacto default on the dollar. We think of the U.S. as you know, being above and beyond, but you know, that's something your banana republics do, is they default on their currency and we did that in 1935 I think it was and then 1972 we totally repudiated our obligation to exchange dollars for gold as foreign central banks began to line up to do just that, after we inflated the living daylights out of the currency, destroying its purchasing power during the 1960's to create the hyper inflationary period we had in the 1970's and all those interest rate problems. Doesn't happen by accident, it happens because of stupidity and the Federal Reserve and in government, and these policy makers still believe that they can engineer this kind of stuff, which is reflected in, to tie this all up Stephan, was reflected in this lack of risk perspective in the markets today, [...] the comedy, there are actually people who believe that the Fed has tamed the recessionary cycle, that we don't have to worry about deep recessions anymore, let alone even mild recessions. The one we had in 2001 was just a little pinch on the cheek compared to a real recession. And you have people out there believing that we can perpetually live in this environment where it's almost like we've figured out a way, you know, it's like modern alchemy where you can inflate the dollar without any consequences and have a perpetual Goldilocks economy. And there are people out there that believe that that's where we've arrived. We have arrived, it's a new economy, the old rules don't apply, don't worry about debt, don't worry about massive deficits. It's the, you know I refer to it as the Alfred E. Newman perspective on the economy.

Stephan: Well, I think the important thing to, excuse me, I think the important thing to focus on is history always shows us that there's a front side to an inflationary cycle and there's a backside to an inflationary cycle. And the front side, it's like you're getting your own line of credit, and not worrying about just running through it. It's a lot of functionally on the front end. But on the back end, you have to ultimately pay down your debt. And as a nation, what you end up seeing is massive inflation. And the inflation initially, it really got rocking and rolling to new levels beginning with the Reagan Administration where there was a lot of deficit spending done to help fight the cold war so to speak. And then you had a lot of borrowing by American consumers, money going to foreign markets, but the inflation basically spilling back over into the American financial markets, when you make, when you create those new dollars, and remember when a bank lends money in this country, they basically create money out of thin air, since they're only required to have 10 cents on every dollar on deposit. So you put a hundred grand in, they can lend out 900 tomorrow to somebody else. That person puts the 900 in 8.1 million and so on. The bottom line is the inflation initially was in the stock market, then it spilled over into the housing market, and now it's spilling over into the supermarket. And people are making comments and you're hearing, you're talking to folks and they're wives are saying you know, things are just getting so expensive in the grocery store. And we, the, whatever imbalance you have on the upside, ultimately has to be corrected on the downside. And the worst that the disconnect gets on the upside the more severe the correction is on the downside. And we are no where near that correction. Now, is it going to be a stock market correction? Look, it would not surprise us Johannes, right, we talk about it all the time, if ultimately central banks got involved in investing in the stock markets to profit up. And in effect, that's really a bail out, because when the Fed or the government bails somebody out whether it's GM, a major savings and loan, a railroad, a mega bank, whenever they do that, that money is created out of thin air. And that is inflationary in its own nature. If central banks, if our Fed ultimately starts investing in the stock market, you could very well see a 20 thousand Dow. But as we always say, you're going to see a 50-dollar pizza. And as Mark Farberson, not to cut you off, if the market goes up two or three times, gold will go up 6 or 7 times.

Well, if you think it's far fetched to listeners too listeners, Lorne Sumners who is a former big fed official, I think he's currently a professor at Harvard in the economics department. He is writing papers out there, encouraging central banks to consider you know diversifying their reserves into the capital markets, which is another way of saying, you know all these boring treasuries that we hold at the Federal Reserve or other central banks hold of their own government bonds and their own reserves, what they ought to be doing is instead investing it into the stock market. And you start having that kind of discussion happening and people actually believing that's a good thing, watch out, because that's, you start, you've talked about, you know, already you've unsettled the realities of the bond market by doing what we do, relative to the private sector and so forth, and totally get things out of dislocate, get things dislocated, just think of what's going to happen in the equity markets as well. Moving on, you were talking about what goes up kind of you know, has to come back down. One of the posts that we put up this week, as home equity withdrawals dry up, what about GDP? It's worth taking a look at, we have a couple of charts up there where you can take a look at the home equity withdrawals contribution to the economy, we decided before [...] attributed about two and a half percent per year to the average of 4 percent GDP growth, which has been the average from 2002 to 2006. So over the last 4 years, they've attributed about two and a half percent of that to home equity withdrawals. And that's largely been engineered by these artificially low interest rates, which was the byproduct of recycled dollars and expanding money supply recycled though the trade deficit off to foreign central banks, and then reacquired through the depressing yields and rates in the United States as they try to offload those dollars and recycle them back to the U.S. You can take a look at those graphs there you can see that the contribution of home equity and credit expansion to the GDP of the United States is just unbelievable. And we're not seeing obviously home price appreciation anymore, in fact we've seen a deceleration in home prices and I think that it will be interesting to see how that all unravels, especially now that we're dealing with this year being the year of the adjustable rate mortgage coming due, which you know, it's like you're saying, you know, the fun side of the inflation is the front side, but the back side is always the best part.

Stephan: Well I think the point you're making Johannes cannot be understated because in effect what you have said is that half or more than half of GDP has been a byproduct of home equity withdrawals. If Bill Fleckenstein of the contrarian chronicles writes on MSNBC, he you know he has termed it as the home equity money machine, bank machine, ATM machine. And you know what? It's dried up. Because the borrowing rate has fallen through the floor. And that extraction is basically dried up. And if over 50 percent of the economy was dependent on that and to boot you have real estate now, not being, you can't go now and get your home reappraised for another you know, 15 or 20 percent increase and take, extract that equity. With the real estate slow down you're not going to be able to borrow more let's say. And now comes the not so fun part of all of that. And over 50 percent of that was GDP was dependent upon that, I mean are you kidding me? And it's something that you never ever, ever hear in the financial media.

Well, I mean it's interesting that Goldman Sachs publishes it but it's certainly not [...] down by a lot of people it's just sort of brushed over and you know that's again, that's the point is that a lot of this information is out there and as we say at Vigilant Investor, we're all about connecting the dots to help you avoid that kind of stuff. Moving onward Stephan, for 2007, interesting things that we're seeing developing now, I think, you know, from the standpoint of, is there going to be a trigger that's going to cause, maybe the bubble to finally, you know, hit the wall, what's going to be sending the markets maybe downward and different things. I see a couple of trends that I just want to note. First and foremost on the geopolitical side I think you really need to be watching what's happening in Iran. And the markets have since closed since we started this show, and we seen oil trading you know well below it's averages lately in terms of where did we close with oil today? It's you know, as we mentioned before, it's sort of coming down at the turn of the year. Today, crude oil opened at 52.20 and it closed at 52.99. So up just a little bit. And while we're on the markets, we may as well talk about the dollar, the dollar traded down a little, although it's showing some reasonable strength lately, I mean relative to other currencies as measured by the USDX, which is against a basket of your five major currencies outside of the dollar, and it's trading at 85, and 85.05 last, that's down just a touch form where it had been at the opening, about 2.3 down. And you know, earlier, at Thanksgiving it was actually breaking below the 83 mark, which is sort of one of those seminal points that you need to [...] but as we always warn people, the dollar verses other currencies is not your best indicator, it's the dollar verses your things that cannot be printed, like money. So we take a look at gold today, opened up at 612.25, was trading as high as 627.40, closed at 626. And again as we talked about earlier in the show, as I was talking about Stephan, you take the Dow Jones Industrial and the S&P 500 and those, hey, those have been up since 2000, people have been feeling pretty good if they had been an index investor in the S&P 500 index like Vanguard and everybody always telling, yeah just go in the index, but you take that return and you compare it to what you could exchange for oil in 2000 or gold in 2000 or you know, even in the last year, you 're finding that you're not getting as much of a return as if you had those hard assets which you cannot print out of thin air. You cannot go out and just crank up a printing press, and that's the reality of what's going on in the economy and those dollars are sloshing around. And I think a lot of you know, back to Mark Faber's point, you know, if the Dow does go up, it's going to be inflationary and not necessarily earnings driven because what you're seeing right now is actually a slow down in the U.S. economy, you're seeing the consumers lacking off as you've mentioned as well. But, back to the whole issue with Iran, you know, there's a news report that was leaked last week, and I guess the news report was basically talking about a leak that apparently Israel is really seriously worried about, we know they're worried about the Iranian nuclear situation, but in terms of what was leaked, they're seriously contemplating, according to this news report, the British Press, a tactical nuclear strike on the site where they are building their nuclear plant in Iran, where the Iranians are building a nuclear plant. And they have about an 18-month window I believe it is before that sucker is supposedly an active nuclear reactor. And after that point, the political consequences of bombing a live nuclear reactor are dramatically escalated or just become almost insurmountable because you bomb something like that, you're basically creating nuclear fallout over an entire region. And obviously the Israelis want to avoid that, they feel that they're threatened enough, and the word is that they have a plan and they're going to enact it, and that was what was apparently, according to the news report leaked. Meanwhile in the U.S. you have obviously a build of ships in the Persian Gulf, and a lot of people are attributing that to U.S. preparation to actually do something about Iran. On the face of Iraq, basically getting to be a fiasco where the president has basically announced he's going to increase the troops into the Baghdad region to try to quell some of the problems they've been having there. But it just, you know, we're dealing with a situation there that's somewhat stabilized if only in the context of it slowly deteriorating in a [...] fashion. You know you haven't had a blow up where the U.S. is you know, lost a, had a huge problem there, but clearly the U.S. is not having a great amount of success there, but if it were to escalate in Iran and especially if you have a nuclear detonation in Iran around that nuclear facility, watch out what's going to happen, because especially from the context of not just, what would the Middle Easterners do, but the rest of the world is really beginning to question the U.S.'s use of force in that region, and the justness of it. And when others start questioning, the you know the dominant powers use of force and whether they start questioning whether they should finance it, whether they should be holding as many securities in the dollar and so forth. And you know, you already have central banks starting to back off their dollar, and we're very dependent on the dollar's value as it is today, especially when we talk in context of interest rates and so forth and the demand for U.S. treasuries to finance the home equity withdrawals that were done over the last couple of years, you know financed a lot of debt. And now we're on the hook for it, but if those interest rates start rising with those adjustable rate mortgages for example maybe being the tip of the iceberg for a lot of consumers, look out. And we're already seeing the sub prime mortgage market in the United States running into some serious problems with nine bankruptcies in the last four weeks alone.

Stephan: I think that you make an important point there Johannes, because look, if you're going to look forward into 2007 you have to really examine the housing industry and I don't think the other shoe has even come, the first show may not have even dropped yet fully. And the second shoe certainly has not dropped, this has not played out yet. What, if you sort of think of, sort of like one of those things you blow at birthday parties, and it goes out and it curls back, it's almost like what you've seen in the lending market. It's finally straightened out at the very end, the very end is the sub prime lender, alright? And the curling back at the top is the last to be lent and the highest risk lender is the first one to run into trouble, okay? And what is going to be intriguing is this shake out is going to take time, because not everybody is selling immediately. And you don't really get the real value of a house until you bring it to market or market to market and put it on market, you know on the market. So that's going to be intriguing. There are a lot of industries right now, I think I heard a report that building permits were down 25 percent last year okay, on new homes, on building permit applications. The last, every time in history Johannes, and we need to get this statistic on the web site, every time in history building permits were down 25 percent the prior year, it led to a recession. So, that's an intriguing thing to watch out for. And what I think is that, going to this year, the housing market definitely, definitely has to be, and I have to be kept on it.

Well, and it's very much unlike the equity markets, the equity markets can correct fairly quickly because everything is market to market on a daily basis, you know from second to second, minute. You know the price of a stock and when you see it plummeting and you want to offload that sucker, go to town. Even in an environment, with real estate where you're starting to see the gridlock hitting and the locking up of the mortgage markets, what happened is for example up in a major lender of the sub prime market up in Connecticut was having basically initiated over 100 loans that they could not finance, they were on the hook for them, but they found that their backers behind them suddenly were walking away from lending that money to them. So suddenly they couldn't do it anymore. Well that's beginning to [...] up, up there, and but even in the environment where you know people who are looking to you know refinance their homes can't do it anymore because they no longer qualify and the money is not there or the interest rates are too high, then they start you know, getting to the point where they're nearing foreclosure, that's a drawn out process, a heavy duty legal process you talking not a matter of seconds and minutes in terms of a decision to sell and offload. It's something that moves glacially in a comparative sense. So, if you look at historically at market crashes and then the economic consequences of those, from the stock market standpoint, those happen fairly quickly and you see the cause and effect leaning into a recessionary environment. Similar to what we had in 2000 to 2002 as the market plummeted and you started dipping into recession soon enough in 2001 whereas it can be a lot slower historically if you look at past recessions that were induced by housing slowdowns. And a couple of things to note, number one, when you have a huge increase like you've had over the past couple of years in the housing prices, never have you not seen a correction go to a point that is you know a lot lower that what we've had so far, in other words we've come down a little bit, but based on the seriousness of the upwards slope on the price rise prior to this point. If you compare to prior bubbles we have a long way to go downward before we bottom out. It would be unprecedented for this correction in housing to be over at this point, but moreover the result of that and how that's going to play out is not going to happen in the next month or the next you know 6 months for that matter. It's going to slowly play out in the next couple of years and the consequence of the economy therefore is going to play out over the next couple of years as well. Now, that's separate from you know so many other facts, because you know we're talking about fundamentals here, we're talking about you know global macro fundamentals in some ways and U.S. domestic fundamentals from the economic standpoint that are completely removed from what we were talking about before which are getting a little more into the technical side of things where the stock market is long overdue for a correction. You start combining some of these factors among you know, the many other things we haven't even touched on today and suddenly you're looking at an environment that in the face of all this complacency over risk you just scratch you head and you say, where the heck are people's minds right now? It's almost like you know the, a few years ago there would have been a lot more alarm but today because it hasn't broken, each day it goes by it builds more confidence that it's never going to break when the probability is it's going to you know you're that much closer to an ultimate correction of some sort. And with all these other factors, it may not just be you know a correction and then move on, you could see it reverberate in a lot of different ways and what I mean by that is well, Stephan, is take a look at the sub prime market, what that is doing is creating some issues in the derivatives market. In the derivatives market basically you have mortgages, when you sell a mortgage as a broker that thing gets packaged up and offloaded and investors purchase it and the it gets out into the federal related mortgage institutions there and they repackage them, and those things are sliced and diced into different you know tranches and all sorts of other things and then eventually that risk gets re-broken up into the derivatives market and you know where all of the sudden the price of these things that were previously sold that were considered to be sub prime mortgages, you know start getting re-priced suddenly, people you know have to question these derivatives, and the thing with derivatives, they're a lot more complicated to price, because they're not like stocks and other investments. They're agreements between two parties and while they can be traded on the open market they're not as, the price of where their market, where they're marked is not as verifiable as something like Exxon, which you can go look in the, see where it's trading right now. And there's a lot of issues there, and I know it sounds you know, it sounds like a lot, it gets pretty complex, but it just shows you how, and I'm just scratching the very, very, very tip of the surface here and just getting a little dust off the top of this issue. You start digging into it more deeply and you start scratching your head and you say, you know, no wonder people like Warren Buffett are referring to the derivatives market as weapons of financial mass destruction. Because a few of those start blowing up and then you can you know it reverberates through the markets and so forth. And again, not to be long winded here, but you know you consider why is it that these sub prime mortgages were so attractive and why did people all the sudden adjust on the turn of a dime. Well that's because all this liquidity has been out there for so long and you know we look at the money supply expansion, especially M3 over the last decade, that money is out there, that purchasing power, that claim on assets is there and it's been driving prices higher on one hand but it's also depressing yields. And especially take a look at U.S. Treasuries, you know, Ben Bernanke and Greenspan refer to the bond situation in the United States as a quanundrum, they don't know why the 30 year treasury is staying so low. Why are bond rates staying so low. It's not a quanundrum, it's plain as day. So much money was created that money circulating in the economy, people are trying to find a safe place to put it, so they're buying treasuries with it. And what that's done is it has increase the demand for the treasuries, which has depressed the interest rate that people who are issuing those treasuries, the U.S. government, has to pay in order to borrow money. If somebody is going to give you money away for free, you'll take it and pay the lowest rate you'll possibly have to. That's what's been going on for the past five years and progressively more so, more recently and that has driven down the risk free rate of return or the low risk rate of return. Consequently, you know people who can't live on 5 percent are looking for more rates of return. They can't get the return they need from these artificially depressed rates in the U.S. bond market from the government, they start going into higher risk investments to try to get higher return. And what that has consequently done is it has driven down the rated that high yield bonds have to pay. The spread, the difference between low risk investments and high risk investments has narrowed to such a degree, that again it's out of whack compared to historic averages and its near historic you know, levels of high risk and yet the market perceives very little risk. And this is why you know, it sounds like I'm getting to be a little bit of a broken record maybe, but you look at the sub prime mortgage market all the sudden locking up and rejecting it and bleeding into the derivatives market, it's because of you know, people are having difficulty actually measuring what is the real risk that we're taking on here? Maybe we're paying too much for the amount of risk we're taking and only getting a very low potential rate of return, you know compared to what we should be getting. And that, people are starting to scratch their head there and if that happens more and more you're going to start seeing our credit markets have some issues. And given our economy has been based entirely on the expansion of credit over the last 5 years and what's happened, that's a big problem Stephan: Predominately home extraction credit. And I think what's really intriguing is that you know, as the year progresses and the effect of the decline, dramatically declining home equity extraction, okay, which power the economy for the last several years is drying up. What effect will that have post quarter one, quarter two, you know as the year goes on. And as we have always mentioned, the Fed is looking for a reason hopefully to re-flight, to re-stimulate, to lead the way in lowering interest rates so folks borrow. But the wild card out there is the fact that America, the largest age group in America is basically age 50. And as we have mentioned before, studies show age 49 to be peak spending. The major question perhaps of the year, if rates are lowered is, is age 50 America going to bite? Some say yes, some say no, but I think that's going to be a very important factor, i.e. is the party going to keep going? And if it does keep going, you could very well see new highs in the stock market. But there will be an inflationary effect there. And you know things like energy will then go up in price, gold will continue its march up, silver will continue its march up, water rights will continue their march up, that can of beans in the grocery aisle will continue its march up, if that is the case.

Yeah and even if we were to look at just basic CPI we see that march has continued, what cost 100 dollars in 2000 is about 180 dollars today. And that's with the grossly understated CPI adjustment -

Stephan: - a hundred dollars invested in the stock market in 2000, what's it worth today?

Not a hundred dollars.

Stephan: Okay, so there you go. So what cost you a hundred in 2000 now cost you one eighteen. But what you invested in the [stock market] in 2000 is no where near that. The numbers are bigger, but it's not getting you, it's nowhere close, even to the artificially pushed down Federal inflation rate.

Well, shifting gears here Stephan, before we wrap up and we are getting close to our time here, but looking at what's happening politically, we've had a shift in Congress, the Democrats are not running through their one hundred hours of things and so forth. Minimum wage raises have been hitting a lot of states through their state legislatures, national minimum wage is now on the docket with the Democrats in Congress trying to push that through. At the same time you have the 'governator' out in California just announcing that he wants to provide free health care to everybody in California, anybody who need it can get free health care, you know, these sorts of things, free increase of the minimum wage, free health care here, these are far from free. And the crazy thing that I see is that amid a lot of these economic problems, again we just scratched the surface of them you have politicians out there still pandering to the masses, piling on additional reasons why you shouldn't do business in the U.S., why its getting more and more, basically making it more expensive to do business in the U.S. The price of unskilled labor goes up in the United States is just going to increase more and more, encourage more and more businesses to go abroad, choose foreign labor, or replace their existing labor with robots as soon as they can, some sort of technological alternative to change their processes. And it artificially stimulates that, or encourages that to happen far sooner than it would otherwise, and it's continuing to do that every time you do it and just one more reason why you don't want to do business in the U.S. and again you look at the socialization of health care in the United States, we do have socialized health care in the U.S. even though part of it is controlled by free market, it is heavily legislated to the point where the private market really cannot do what it would do otherwise to help its consumer, because it has to carry the baggage of quasi socialism along with it. And that's not even talking about the free health care the government gives away to people who are in need. And really what you're doing there is you're putting more clamps on the payers and that gets more and more expensive, the payers, you have to pay more, which means fewer people can afford and more people become dependents, because they you know they basically drop off the rules of those who can afford to pay insurance. And it's a cycle that just keeps repeating and I think people, you know, here we are in 2007, the economy is on the skids competitively on a global scale, we're facing severe competition from foreigners and you have this kind of baloney going on in the U.S. government where they're essentially just you know, further throwing, adding weight to the anchor that is dragging this economy down as it stands. They just don't get it. And I think hat we could see between that and even a tax, you know, increase, which is what the Democrats are talking about really sending this economy into a skid faster than it might otherwise at the pace that we were going in 2006 just because of more intervention.

Stephan: Yeah and it's going to be interesting, Johannes, it's going to be quite interesting.

We've talked about education before, they've talked about the student loans, making them more subsidized so they can be lower. And we wonder why the price of college education is climbing you know well ahead of inflation, well above it's averages. Well, it's because all this cheap money is available out there and it can.

Stephan: If you're going to subsidize any industry it allows them to charge you, if you're going to subsidize the education complex that is college education today, if you're going to subsidize them with cheap money it's going to go through the roof just like housing went through the roof, just like the stock market went through the roof. Money that's too cheap has inflationary effects and that's what we have going on. But it cannot continue forever.

No doubt about it. Well let's do a quick market wrap up here because we are getting at the end of our show for the week. And I figure we may as well touch on what the market's done today. The Dow Jones Industrial was up 41 points today, excuse me, closing at 12, 556, and that I suppose would be another record since yesterday was a record, Stephan, so again you know another nominal record but of course adjusted for inflation we still need 13, 7-and some. The S&P 500 of course is up 6.91 and that's up at 1, 430 for the close. And the Nasdaq climbed 17.97 points to 2, 502, still well below its 2000 high of what, 5 thousand, whatever, five it was. It's not even fair to compare the Nasdaq given that it was you know, the true recipient of most of the bubble money back then. And the Dow Jones Industrial and the S&P were a little more level headed, but still again, I mean it's, I think you're going pretty far out there on a limb to get those kinds of returns if you're just out there naked conventionally with the equity investments and so forth. But if you think 2007 is going to continue to chug along event despite, we're going to make sure to put up a post at vigilantinvestor.com to tie you in to some of the information on the length of these market claims without any substantial correction, just to give people a perspective, that's important stuff. Meanwhile we talked about gold already, the VIX closed down 5.98 so about 6 percent down from its, yesterdays or its opening excuse me, down at 10.22. So, again you know, volatility, people are indifferent to it. Google just for an update on Google we sometimes talk about Google as a indicator of maybe exuberance, up 5.28 today, closing at 505, so it's back over 500 and that puts it very just a touch down from its high earlier in the year, last year excuse me which was 513, so Google is pressing along there's nothing to worry about there. And yeah, just gives people an idea what's happening out there. Otherwise let's just do a quick look at the dollar which closed down 85.03, which we talked about. And just to review, oil again closed at, let's see, crude oil, 52.99 so up a dollar eleven. And the U.S. dollar ended up 85.03, which I mentioned, gold 626.30 up 14 dollars on the day. So, interesting stuff there and we suspect we'll continue, going to be seeing a lot more volatility, and that's my theme for this year Stephan I don't know about you, but I think that with all this money sloshing around out there, more and more people are scratching their heads relative to what's going on and having foreign central banks beginning to question their, the wisdom of having so many dollars reserves, dollar denominated reserves. And when they start looking for other places to find that money you're going to see that money moving around but as I always say, the old pricing mechanism, it's washed away the reference points because it's like a river that crosses over the banks and breaks through the walls, a place there to keep it controlled, suddenly you don't know where things were because they're covered with water, in our case they're covered with liquidity and you lose where the real value is. We've seen it happen in housing, what's the real price of, what's the real value of a house in San Diego right now? I don't think anybody knows really what it's worth and that's when people start questioning it, markets start locking up and you have problems. But any other comments for the day Stephan before [...]

Stephan: I think the last comment that I would make is there's talking to certain people, you know, several people in business that I've spoken with and you don't really know what to say, you sort of try to warn them as best you can, but I've seen more than a handful of people expand their operations over the last year or so, and are in the midst of expanding their operations also. And some in industries which are utterly tied to the credit market, i.e. their customers buy on credit, and so as you always mention, the inflation really in a way it fools business people, and it creates a temporary and artificial demand. And that could vanish extremely quickly leaving a lot of businesses in the lurch.

Yeah and I think on that thought, to carry it a little further, we look at the housing bubble, how many people over the last couple of years shifted careers into housing related activities, whether they be mortgage brokers, real estate brokers, construction and then among those people how many people expanded their businesses or put a lot of investment for the mid term return. You just don't start a business and earn profits the first year, it takes a number of years, you sink money into it, you have a losing proposition for a little while. Of if you're a contractor or you're a builder, you have invested in new equipment, if you're a machine operator maybe you figured 2004 was the perfect time to get a 5 year lease on a piece of equipment that all the sudden is going to start running idle. And all this was rigged up thanks to an expansion of money supply that was artificial, artificially lowered interest rates and it created all that activity and everybody thought it was real. And now that interest rates can't be lowered any further, and now that I guess they supposed they could but the Fed's between a rock and a hard place relative to that because the economy is not so Goldilocks as it might, a lot of people say, it's actually almost like the inverse of Goldilocks, where it's Goldilocks without the old middle bowl. It's both too hot and too cold at the same time, and the Fed is in a bind because of it. If they add more liquidity to the party they're going to get hyper inflation, worse than what we're getting right now inflationary wise and they contract the money supply too much and slow things down further, they can really grind the housing bubble to a severe, severe correction much more rapidly than would otherwise happen. So, but hey, we're running out of time here Stephan. Good points as always and a reminder to everybody, you can always catch us Vigilant Investor, talkshoe.com every Friday at 3:30, both Stephan and myself, this is Johannes Ernharth, you can also visit vigilantinvestor.com, find links to that and all sorts of valuable articles and resources and what we tend to do on a day to day basis is go through and post up some of the things that we're finding that's part of our research or commentary that we've seen that we think is valuable. This is not a time to be complacent, this is not a time to be on auto pilot with whatever you're doing whether it's investing or you're an entrepreneur and you're in business or you're just a family person, just you know, kind of deciding hey, maybe it's time to buy something new and take on some debt or something. Don't just sit on your morals and think that this is 1995 or some other period of time. This is a pretty wild thing that we're going through right now. It's unprecedented and I think that you know it's important that people keep that in mind and perhaps we should, you know wrap up with a classic tune that reminds everybody of what is the law of economic gravity.

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