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How the Fed Affects Interest Rates

Posted On: 2006-12-13Length: 1:02:30

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Hello, hello, hello everybody. This is your host, Johannes Ernharth and you're listening to Vigilant Investor live, the weekly alternative to your conventional bubble vision kind of commentary on investing, on the economy and your alternative to MSNBC, or alternative to smart money magazine and all the other investment magazines [...] and the whole ball of wax. So, you're here, our final Wednesday episode. We're moving our show as you might have read on our web site and through our introduction, at least our title tonight, on tonight's show, and we're going to be heading onto Fridays next week. So, Friday, 3:20 PM will be the time when we are going to be having our regular show. And what we've kind of switched over, over the past week and a half, two weeks, three weeks has been a daily show, we are now day to day, having a 15 minute update at about 4:15 and most everyday unless we have something that comes up, sometimes we get in meetings here and there where we cannot make it, but the usual routine is that we were having a show and it goes about 15, 20 minutes, it just gives a quick recap of the day, and it's a great thing to Podcast subscribe to if you're a regular listener. And you can just do that via iTunes, go to the talkshoe.com site and find the Vigilant Investor show there in the business section and there's a little link there you can click and can subscribe to it via your iTunes system and then every day that downloads just about an hour after the show is done. It's available for download, and when you turn on your iTunes it just automatically happens when you subscribe to Podcast via iTunes, which is great, and then you can for the morning drive on in, wherever you might be going, hopping on a train going for your two hour commute into work in New York or L.A., and listen to the show. So, you can get that and plus we're doing this show now of course, the hour long show will be on Fridays so you can have it for download first thing Saturday morning if that's what you want. So, in any event, it's been a great week here, this again is Johannes Ernharth you're listening to the Vigilant Investor and you can always catch up on our day to day commentary at vigilantinvestor.com, which is our daily journal web site, and my co host, Stephan Ernharth is here. Stephan are you there? I see you're online.

Stephan: Yes I am Johannes, how are you doing?

Ah, doing well, you're a little bit quiet tonight, I'm not sure if that's something related to your connection or not, but quieter that usual.

Stephan: How about this?

How about what?

Stephan: Can you hear this?

I can hear you, yeah, yeah... That works, yeah... In any event, yeah we're going to, like I was telling everybody, moving to the Friday slot and so forth. But you know today I was thinking that we could hit on a number of different things, I mean it's been an interesting week, the Friday format's going to be doing a weekly recap and we're going to try to broaden our discussion a little bit get into you know, some of the different things that we don't do on a day to day basis and hopefully tie a lot of the loose ends together, you know without being redundant and so forth. And we'll be shifting the format a little bit as we massage things going forward. But, any thoughts on today's events, the week's events, Stephan that you want to lead off with?

Stephan: Well, I think you had some, you know, the big news initially was what has happened with interest rates, the Fed holding steady with interest rates and the bond market rallying anyway. The Fed not dropping interest rates, but the bond market rallying and in effect saying, we think you're going to have to drop them anyway. You have to spin aside economic advisors making comments that you know politicians, the Federal Reserve, the bond market itself said, that's great you've held rates steady, but we think they're going down. And there was actually a bond rally yesterday, even though rates stayed steady.

Yeah, it definitely is interesting. I was at an event today where I heard Morgan Stanley's chief bond analyst doing a discussion on what was happening and his, boy his name is escaping right now off the top of my head, it will come to me in a second, but he was saying a large portion of that is coming from the Japanese investors who are the private side of things actually, but not necessarily the central banks from abroad. Central banks he's saying just kind of continued to do their purchases at a steady basis, but from what their analysis was able to determine was a lot of the Japanese private money that is betting on the Fed being stuck in, you know between a rock and a hard place and basically having no choice even though they're having a little bit of an inflationary problem that they're going to have to consider you know, reducing the rates in order to prevent a total slide in order to provide that liquidity out there. And you know this really is a from there perspective they're looking at this as something that, you know, they've seen this movie before it's happened to them, they've seen the housing bubble [...] the stock bubble burst and then followed by a housing bubble, a real estate bubble and they're suspecting that the tune is going to be pretty much the same where the Japanese, the bank of Japan had pushed their rates down into the low, low, low super low level where we actually had our Fed rates just a few years ago, and that the consequence of that in Japan was that you know still they have not recovered the stock market has never returned to its previous highs and of course the real estate is not there and you also had some observations relative to their growth still being you know stagnant and they're having issues relative to trade is that right?

Stephan: Yeah, I think what the Japanese, the Japanese are seeing it first hand. You don't hear of in our media today, occasionally you'll catch it on something like Bloomberg you'll see a blurb, but in a nutshell what happened, the figures that came out last month in Japan showed that from October '06 back to '05 the Japanese trade surplus with the entire world dropped by about 25 percent and largely due to declining, rapidly declining and significantly declining consumer demand from the U.S. And that's significant and you don't hear that, you don't hear that [...] a lot but that' really, really important. So, the bank of Japan may be doing certain things from a political standpoint just like other countries are doing by buying U.S. dollars and sort of trying to keep certain things afloat. But the private investors in Japan are you know, they're doing things for different reasons. And that's type of a, you're not just quote propping up a currency, you're taking advantage of, you're saying, yeah, that's great Ben, you're going to have to [...] drop rates next year and we're going to be there taking advantage [...]

It was David Greenlaw who I had heard speak earlier and again he's the, one of the managing directors and he's the chief economist on their U.S. fixed income at Morgan Stanley, that's who I was listening to making the commentary. Now generally speaking though, Greenlaw's opinion was that you know this is not the same situation that there are too many variables that are not similar and while I might acknowledge that in a lot of ways I wouldn't say that some of the other areas that typically are not seen being you know, covered by, you know the Stephen Roachs of the world. The interesting thing about Morgan Stanley research side of things, at least what they publish is that you're getting you know, arms around a part of the problem without fully digging into some of the other areas and you know whereas I'd think that they'd fully understand that there's issues relative to the trade deficit and you can read Roach about his comments on the disequilibrium and trade when you have this massive trade deficit and all the money that's flowing over there and the U.S. consumer is driving so much of global consumption, I think something in order of 60 percent of all global deficits are U.S. consumer oriented. You know clearly there are you know from that standpoint, it doesn't take rocket science to understand that there's got to be some sort of reallocation, there's going to have to be a restoration of order and there's going to take some cleansing and you know from their perspective and even Greenlaw was looking at it though this lens, is it going to be a hard landing or a soft landing kind of question is really how they're assessing it, and from David Greenlaw's perspective it was, you know this is going to be a soft landing, expect the housing to maybe drop 5 percent, and we'll see [...] will consumer spending slow down from that, but nothing all that bad. And that kind of echoes what you know generally you hear with the mainstream assessment of the problem if they're willing to identify a problem and a lot of them won't even you know, I mean, I think Morgan Stanley kind of is out there relative to a lot of other groups that are simply saying, you know this is not even an issue, they're really isn't even a housing bubble, what we're seeing is just a natural slowdown, and don't expect it to go down any further than it already has.

Stephan: Yeah, you're right. So, I think it's going to be interesting right now, and you've had the dollar somewhat stop it's slide this week but you know, how far lower is it going to go, that's the question. You're hearing news about you know, consumers in effect basically, consumer spending is up a little bit in December, retail sales in the U.S. rise for the first time since July on holiday discounting. But, again, holiday discounting, then the stocks gain on retail sales. As we've said, all bets are of after the election but you're really going to find out we feel what's going on, or start to find out what's really going on, reality is going to hit in the new year. The Christmas buying season is over, you know you can talk about buying and you know when those retail sales rise due to holiday discounts, those discounts they cut into the profits of your Wal Marts and your Targets etc... So, it's going to, post holidays what's going to happen, that's going to be quite interesting.

Yeah, no doubt about it and already we've talked about it previously on the Vigilant Investor daily and so forth. But Wal Mart has knocked down its earnings estimated several time since October just sensing that there's going to be a weakening in consumer you know, demand through the holidays and really I think that's indicative of a lot of the problems. I think that there's an interesting separation that you're seeing and that there's really a two-tier element in our economy now. And whereas used to see everything kind of going in sync a little bit more together where a recession would kind of all go together for the economy as a whole. It's almost as if you do surveys with some of the people who are the middle income or the lower income side of things, they're the ones that are dramatically tighter right now, they're the ones that are seeing the manufacturing jobs get dried up, they're the ones that are getting rehired by the Wal Marts of the world. They're losing, what with the recent numbers, some of 300 thousand was it, or was it 30 thousand manufacturing jobs just vanished in the last report. And you know, that compounds over and over and over again and you know, your average guy who is out there doing blue collar work, or gal who is doing blue collar work in the manufacturing sector is not going to be you know, getting rehired in the mortgage market right now to be you know, mortgage brokers, it's just not the way it works. And you know what you're seeing is a conversion of lifestyle conversion of income and that's being reflected in some of the numbers relative to the wage growth which has been lagging and it's interesting now that Fed is noticing that some wages have been picking up a little bit, but over all the trend over the last 6 or 7 years has been you know generally, wages, benefits, the whole ball of wax have been progressively going down and the purchasing power of course is going to happen with that, and I think that is largely attributed to the you know, 50 years of having you know maybe overpriced our labor, overpriced a lot of different things and now we're seeing that global labor arbitrage with globalism where you know why should be paying someone to be doing menial labor here in the United States that can be cone in China for 17 cents an hour why should we be paying them union wages in the U.S. as an entry level worker, it just doesn't add up, it's just doesn't, it's not sustainable, it never really was, it was only in a temporary sense and it was basically you know robbing Peter to pay Paul in the long run.

Stephan: Well I think what's really interesting too, I mean again you know, when you're taking a look at things in life in general let alone economics you want to be as objective as possible and we have talked before about even in the worst of market times, the investment industry, the vast majority of signals or buy signals, recommendations or buy recommendations and not sell recommendations, even in the market meltdown, and you start to hear comments like rising incomes are helping mute the effects of the housing slump. You now, wait a minute, you know hey, average hourly earnings apparently have risen a little over 4 percent from a year earlier, matching the biggest increase since a 4.2 percent 12 month gain in February '01. You know a lot of this is inflationary, okay? But you know you have a lot of money floating around in the system, floating around in the markets, and of course it's going to trickle into earnings, but you know relative to what? And you can go, you can debate forever, what's the real inflation rate, is it really the Fed's rate, the low ball rate or is it really the equivalent, really is the equivalent of the expansion of the money supply, which depending on who you're, whose debt are you looking at, the real rate of inflation could be 10 percent a year, okay? And the news that you're hearing right now regarding you know buying during the holidays, you know don't take it too seriously. You've caught it, you've got a country of people that haven't been able to contain themselves and have driven themselves into debt, and having a saving rate of minus one and that's down from a positive 10 percent on a historic level. So, and the same people that have extracted trillions out of their homes, all of that is falling though the floor, why would you expect a culture like this to all of the sudden get disciplined around Christmas? Okay, so what we're going to see, let's just wait to see what happens in January and February and not get too excited. Yes it's a positive to have retail sales to be pretty good over the holidays, but let's just wait and see.

Yeah, it's always interesting to see what kind of revisions you get after initial numbers come out as well and you know things get adjusted you know, a month, two months, three months later and sometimes things are not what they appear. Separately, you know of the topic of the tendency to overspend it will be interesting to see next week, December 15th, as usually when we get the U.S. Treasury report on the fiscal situation of the United States of America, what is the Federal Government doing, what's the deficit, what's the official deficit for 2006, the fiscal year of course ends on 9-30, on September 30th in the United States and published with that we'll have the official deficit, which I'm sure is going to come in under the 315 billion dollars because of just some of the various moving arounds of some of the figures as well as some of the extra revenue that came through last year, one time revenue. But what's not going anywhere are the massive gap deficit, that's the generally accepted accounting principle deficit, which is printed, at least it has been since 2000 in the fine print out there, and that came in just to give you perspective, if the deficit was officially in 2005, 315 billion, the gap, the generally accepted accounting, which is anybody has to use out there if you're a business account, you're supposed to use gap accounting. Well, that's what's applied to our businesses, we apply it to the government, they can only do near gap because of course the government has so many black holes that they justify between the CIA, NSA, all these other areas, who knows how much they're really spending. But the bottom line is that the gap deficit, I think is close to 680 billion, so over double the official deficit that all politicians like to quote. And I know that Bush for example was touting prior to the election that it looked like we were only going to have a 280 billion dollars deficit, compared to 315, well, you know, let's see what the real number is going to be at the gap level, and then pushing that forward let's also look at the net present value of all the free lunch promises that have been kicked out of Congress over the last 60, 70 years to buy votes, to give you know, one free lunch after the other, you know you can have your cake, you can eat it too, don't worry about the taxes, we're not going to raise taxes, don't worry about this or that, we'll just promise the sun and the moon. And of course, Bush, you know the Republican party being the supposedly the fiscally conservative party is interested in saving its own bacon and knows that there's a lot of political pressure out there for a prescription drug program and it's one of their weaknesses that the Democrats are going to exploit, so what do they do, they push one through and you know you add all those numbers together and it goes from 315 billion and the net present value gap number, 3.5 trillion. And you know it's nothing new, we've talked about it before, but our listeners need to keep that in perspective because that's one of those things also that has ultimately come back to you know, it's a reality that cannot be avoided. And the Federal Reserve of St. Louis had their publication just a few months back in August, where Lawrence Kotlikoff was commissioned to do a study on, he published it, Is the U.S. Going Bankrupt, and his conclusion was absent a two thirds cut in benefits and a doubling of all income taxation. All taxation in the U.S., you're going to basically be facing bankruptcy, and you know, here we are in an environment where we are at generational low interest rates. You know there's so much money supply out there, so many dollars sloshing around because they keep cranking the printing press in this country that foreigners are, and we're spending like it's going out of style, foreigners are stuck with these dollars and they're buying treasuries and depressing our interest rates. It can't last forever.

Stephan: Well, I think [...] and that's the macro, but what's interesting is the non-macro and you have to be able to read the data, read the tea leaves. You know 11 of 13 categories registered sales gains last month including electronics, sporting goods and grocery stores, restaurants and online retailers. Now, look, online retailers, electronics, sporting goods, that can tie a lot into the holidays. However, what's really notable, purchased dropped at furniture stores and sales were unchanged in clothing. Purchases dropped in furniture stores. We've talked about the effective home equity extraction on the economy alright? And you know a lot of people have pulled, or had their houses reappraised, pulled a lot of equity out of their homes, have made improvements upon their homes, have bought their granite countertops, have bought new furniture etc...that going through the floor is a very intriguing fact, and we've always said that the real, I mean the housing market may have somewhat of a soft landing, we'll se as to home prices, let's see. But the real trigger, the real catch with the whole housing bubble was the extraction of newly created liquidity from the equity of these homes [...] they were reapprasied. And people tended to take that money and plow it into new furniture among other things. And let's see you know as we mentioned before, home equity extraction is going down, down, down, i.e. the home equity ATM has run out of money, and let's see where this goes. We believe that we're on the front side of this. And we can talk, you know as we always do, maybe people get sick of hearing you know you hear it enough you become numb to it, saying the United States is going broke, but if you really follow, if you could really follow things like the Japanese trade surplus dropping dramatically in one year largely due to U.S. consumer demand slipping dramatically, okay? Or purchases dropping at furniture stores, the stuff that people utilize their home equity that they've extracted to purchase, this is the stuff to really focus on, to really get, catch where this is going. And then, you know, look, you've got the whole Bernanke quanundrum right now. I mean I think it's such a good thing to call it, because in a nut shell you know you hear headlines like Bernanke edges away from threat to increased rates notes a mixed economy. What he's noting, is a stagnating economy with rising prices. And when you have a stagnating economy with rising prices, hello, that's stagflation and that's due to, that is the backside of massive amounts of printing money. The bond investors out there that maybe the Japanese alluded to are catching on to it and realize that Bernanke, that rates are going to have to go down here, and we have predicted this for over a year that rates will have to drop again to try to get this thing rocking and rolling one more time. And you know there's a quote by Stewart Huffman, chief economist at PNC Financial Services Group here in Pittsburgh, "this is the beginning in the change of the tone, which will ultimately set up a [...]" what he's talking about, you know the Fed open market committee yesterday basically noted that, noted mixed economic performance and, and -and, described the year long housing slump as substantial. Okay? And that kind of verbiage tends to proceed rate cuts, you know [...]

Absolutely. Well, at the same time they're talking about how housing is slowing down and one of the issues is, you know, how much of what's been happening out there has been bonified speculation and for that matter, reckless speculation in the housing bubble in the U.S. And just as an update, probably what, 2 months ago, 2 and a half months ago we interviewed Casey Serin, this fellow is a 24 year old who made himself famous by starting a website called iamfacingforeclosure.com, and in fact he has a, had a show about a week ago or so on Talk Shoe himself, which is where we do our show, and you know it just blows me away that here's a guy who is 2.2 million dollars in debt and he's facing foreclosure on his 6 remaining properties and you know, went out there and leveraged himself to the hilt, did it fraudulently, I mean he fudged his applications and you know overstated his income by just a little bit and basically said on all his properties this was an owner occupied property, which is one of those crucial things a lot of mortgage companies want to see because they're attitude is if you're living in the home you're not going to be you know jumping out of a mortgage. But by the same token, the mortgage environment is so reckless these days that they didn't bother to check with the 24 year old to see if his income was what it was and that he was actually going to be living in the house. They just went about and shoveled out 2.2 million dollars for him so he could go out and buy 8 properties. Well, you'd think the lesson of going through this foreclosure process where he's basically learning that he's very likely going to have to do some jail time for mortgage fraud and you know, here he was being reckless and so forth, and what you end up seeing today is he still believes, he still believes that he can do it right, he still believes that he can make money in this down market and you can go to his blog and read some of the things he's doing there. It's almost like you have to be in disbelief, is he in the business of you know, buying Brooklyn Bridges, it's almost where you know you start coming to that conclusion. And yet, you know how many other people are doing that? You got a 24 year old in California able to do that, and you got to figure that the lending situation in this country has become so lax and not only that, you know compared to prior bubble environments where we've had housing run ups and then a subsequent decline, this is not typical relative to the mortgage environment. I mean back then you had to have 20 percent down, back then you had to you know most people were doing 30 year mortgages and maybe a handful of 15 year; these days, something in order of one out of every 5 mortgages in California are these option mortgages, where you have the option if you want to pay interest in principle, which is sort of the standard 30 year mortgage environment where you're constantly paying down principle. Initially it's mostly interest and then progressively after you cross over the half way point it's mostly principle and you slowly pay down that loan. Well, the option with these option loans is you can just pay the interest if you want to or you can pay a part of the interest. And it's just the next evolution, I mean it started off with these adjustable rate mortgages with the tease rates and you know a lot of mortgage brokers out there are very interested in getting paid, you know get somebody into a mortgage and they're letting [it be] somebody else's problem and I think that's one other thing to understand is that the banking environment in the U.S. is a lot different than back then. It used to be that banks held on to mortgages, very common for a bank to sit on portfolio mortgages and progressively over the last 30, 40 years since the advent of things like Fanny May and so forth getting a sort of quasi governmental organizations, you now have all this repackaging that goes out there and the mortgages themselves are broken up into smaller portions and then re-sent out there into the market. And everybody is under the belief that, oh that's a great way to diversify the risk and there's less to worry about, but it's almost like we've crossed over the line where you know, there's so much belief that there's, the risk is diversified, the risk has been washed out of the market that, it just keeps getting more and more reckless without really looking at the underlying factors. And again it goes back to the presentation I heard earlier today from Morgan Stanley, from David Greenlaw there, and you know their attitude is that you know, compared to prior bubbles no big deal, looking at some of the superficial things that are related to it, and we don't have a whole lot to worry about. But structurally, let's dig down a little bit here, you know?

Stephan: Yeah, I mean absolutely. I think it's also interesting too, you hear, you hear, before you hear talk about before the Fed will cut, it needs to weigh weakness in housing manufacturing against an expanding labor market and rising wages. Weakness in housing, manufacturing is key, there's weakness in manufacturing, what the [...] market expanding into? How are wages going up, and how long can that continue, alright? And that [...] be seen and part of that is inflationary. But you know, the wage is going up, and what's your dollar buying, buying you? And Bernanke you know, one of his quotes yesterday was, outside of the housing and motor vehicle sectors economic activity has unbalanced at a solid pace. In the case of inflation, the risks to the forecast seem primarily to the upside. Now you have two major sectors, housing and automotive, two major sectors you know that are hurting right now. And there's still a concern about inflation. And you know there's comments about housing undergoing a substantial cooling. Substantial cooling in Fed speak is like the housing market is collapsing. [...] and if you run it though a BS detector. But you know and then comment that recent indicators have been mixed in the broader economy, to me that might mean recent indicators in the broader economy aren't so hot either, okay? And the fact is, let's say it like we mean it, yo, and we do mean it. Basically the Fed's going to look for an excuse to cut rates because they know they need to cut rates because this economy is really cooling off. We've got two major sectors that are cooling off and this is no where near even the beginning of it.

Absolutely, and getting back into the housing, U.S banks even though they have sold off the mortgages still have today these derivative products of mortgages, mortgage related assets, in other words they do have a record amount of them on their books, and if this housing slowdown really cranks in an exceeds expectations, which it has, excuse me, which is has to date, I mean how many consensus assessments have been surprised by, the consensus estimates have been surprised by just how dramatically the housing has come back, has dropped, and how much the slowdowns have actually kicked in. And again if it gets worse than expected, especially with some of the things, we were posting up something from Bill Gross of PIMCO. In his most recent, the investment outlook out there, Bill Gross was talking about again another way that people are trying to manage interest rate, with interest rates being so low how do you get extra rates of return? So, he talks about a derivative out there that's being used, it's a triple A rated derivative by a ratings agency. And what they're using as a lot of leverage to get about 2 percent above the risk free rate of return on conventional triple A rated investments. But just the way they've designed these things with leverage and so forth, it just, one thing after the other is being done to try to eek out extra return in a very, very low rate environment, which is sort of compounding a lot of the risk variables. And again, getting back into these mortgages, if the housing market starts unwinding faster or worse than the consensus estimate and it really starts digging in and again people are missing out on the whole bubble premise behind it, which is you know getting that Austrian without getting too technical, the Austrian business cycle, which says you know these are all engineered by too much credit, too much money supply and the repercussion is always that you're going to you know, most recessions and severe recessions are engineered by the Fed to begin with, and by the only, the natural thing is for there to be a contraction on the backside of it, because it was based on an artificial premise in the first place, which is money invented out of thin air. So, on the backside of this, eventually things have to restore, you've got to get all these different behaviors, the Casey Serins of the world that were financed though the expansion of credit, cheap credit money supply, that has to be cleansed out. And when it does, you know how many dominos are going to get hit? I would say, you know there's not guarantee, like you say that we're going to see a hard landing or a soft landing. But people better not just have their heads burying in the sand and being on autopilot through this because this is not like anything you've experienced before.

Stephan: [...] and I think what you keep pointing out are facts. I mean people can agree with us or disagree with us based on our overall view. But when you look at something like this, okay, since the Fed's last meeting on October 24th and 25th new economic data provided the mixed signs sited by the Fed yesterday. Orders for U.S. durable goods declined in October by the most in more than 6 years, while manufacturing in the U.S. shrank last month for the first time in more than 3 years, that's substantial, okay? Orders for U.S. durable goods declined by the most in more than 6 years and manufacturing shrank last month for the first time in more than 3 years. Basically, you know, they site a fellow named Keith Hembre, Chief Economist of the Minneapolis based U.S. based Bancorp's FAF advisors basically says the Fed has little choice but to acknowledge the economic weakness that if they didn't, they'd be out of touch with reality. So, you know and then you have contradictories or sort of weird information regarding job growth. You know last week the labor department said, U.S employers added about 132 thousand jobs in November, and averaged about 138 thousand in the past 3 months, and the jobless rate inched up to 4 and a half percent from, 4.5 from 4.4, which is a 5 year low. My question is what types of jobs are these? And you're seeing a lot of government jobs, you're seeing a lot of healthcare related jobs, we have an aging population and we need that, but you know healthcare and government, I mean healthcare and government, they're overhead. And while healthcare is necessary, it doesn't create anything, you don't sell anything. You don't build your national economy on it.

Moving on to less technical and maybe out of the economic aspect, maybe under the geopolitical side of things, which of course is one of those things that people need to I think pay better attention to than they do, especially in the world as things are evolving today stability wise. Interesting news of the past week was that you have the Russian President Putin basically deciding that Shell, you know one of the world's largest energy companies is going to have to divest itself out of one of the largest natural gas field in the world by about 27 percent to lose about, I think I think it had a 53 percent stake in the field and was involved in developing it and basically forced to offload that stake so it's down to about 25 percent. But what you're essentially seeing is you know the state run energy company of Russia taking over that asset and basically saying, look this is for national security. And just as an observation there, it's interesting how that's posited in the news out there in that you know you talk to a lot of people on the financial side of things they say, well this is just another example of Russia turning more third world relative to its attitudes about resources and private sector verses government and so forth. But, again if, and fundamentally what it's telling people, is you can't do with your ruble what you want to do in Russia, because if you want to get in energy, ah ah ah ah you can't do that. But it's interesting to see how a lot of the high horse takers in the U.S. observing that and knocking Putin, and I'm not a huge Putin fan myself, but at the same token, you know this is the same country, this is the same United States that would not allow foreign purchase with U.S. dollars of Conoco, would not allow ports to be purchased all for national security reasons, similarly, and you know is what's good for the goose good for the gander?

Stephan: Yeah, I mean it's interesting.

Do you think we're going to see a lot more tension on hard assets going forward? I think that's one of the things that we're seeing here is that there is a geopolitical alignment you know between Russia, China and the East and it's lining up against the U.S. and you're seeing South American oil interests lining up against the U.S., and the Mid East has sort of a, I mean a lot of the relationships there are merely business relationships and it's certainly not you know, not a lot of people in the Mid East are excited about the U.S. bombing out Iraq, you know with the exception of maybe Israel. I mean, you know, the Saudis were not pleased to have U.S. troops in their country for a long time, it creates a lot of tension, and you know there's a monarchy that's entirely dependent on the U.S. in order for it to stay in power and so forth. But, you know natural resources are crucial, wars have been fought over them and we're seeing you know sort of a redistribution fight over that and especially with oil now, sitting still above what is it 63 dollars, I didn't look at the closing price today. But, so I mean you know it's not dropping back down into the 30's like everyone predicted it would after Hurricane Katrina was you know sort of washed out of the system.

Stephan: Right and we thought that it will. And again you've got a couple of things taking place with [...] right now, you have an inflationary environment and all governments are printing more money. Okay, that's what governments do, they can just borrow and [...] spend etc... and so you're always going to have that going on in the world coupled with the fact that you have countries that are no longer third world and backwards but they are merging into the second and first and there's going to be a greater and greater demand on commodities like you know, energy and oil and you know, fresh water. It's going to be maybe the most precious and scarce commodity in the world right now, that's drinkable water. You know, we talk about it every week, [...] look at the real money, look at gold, 632 an ounce and you know what was it a year ago, 500? Sub 500? And it's really you know, do you see gold going back to 480? You don't know for sure but boy, you know you're starting to read some analysts reports that are a little bit more main stream like some of the big investment houses that in effect are [...] a lot higher, significantly higher than where it is today. And look at silver, something that's definitely used in manufacturing etc... I mean where was silver a year ago relative to today which is 13.9, 14 dollars and ounce? And you talk to people that use silver, and we talk to people that use silver and in their manufacturing and you ask them will you ever see 5 or 7 dollar silver again and they say, no. And again, that's their opinion.

Yeah, it's, we don't talk about it in those terms. I mean the U.S. has the benefit of having you know what is functionally an imperial currency, it's the currency of the world. So many things priced in our own currency and our borders being as wide as they are we don't tend to look at what the dollar is doing and it has no meaning to the average American and yet it is a huge and very important think to be considering in that you know your dollar is losing purchasing power relative to other things globally. And it's losing purchasing power obviously relative to oil, relative to you know certain commodities and so forth. But that's something that it seems that other people, a lot of other nations in the world are waking up to maybe a little more quickly than we are. And just because we're top dog and have been for so long, which I think is exemplified in the arrogance maybe in U.S. consumption. 70 percent of our economy is driven by consumption, and our savings rates are now in negative territory. We don't have to worry anymore, we're the United States, we have arrived, we're on top of the world and you know it bleeds all the way down to the attitude. Let them sweat and we'll do the thinking. You know we don't, who needs manufacturing, we don't need to do that we'll just sell each other mortgages until the cows come home...

Stephan: Well it's really intriguing. And what's really important is what type of leverage does the U.S. have anymore? And look, right now it still has a lot of leverage. But your currency basically you know, it's viewed as, effectively as gold. And it is the reserve currency. But there's evidence out there that if already other countries and other investors are starting to divest themselves of the U.S. dollar. And in a nutshell, what's happening is you're seeing the price of gold and other resources being driven up. You're seeing the Chinese start to take that money, put it into natural resources and energy and you know, ensuring that they have the right to oil and pipelines etc...So you know, basically what you're seeing is a divesting already [...] expected to [...] so further. You're talking about the Arab countries saying, look, we're holding so many dollars due to this oil, the oil price increase [...] basically the U.S. indicates they need to just diversify themselves to get out of the dollar. And you're hearing the Chinese, they're talked about getting out of it more. We talk about you know, who needs nuclear bombs, who needs weapons when you have the ultimate weapon which is basically the, the dollar is vulnerable and foreigners hold a ton of it. Now on one hand if they sell too much, too fast [...] it all they're going to degrade the dollar [...]. But I will tell you what, it's an intriguing trump card that they do hold.

It is, it puts your financial future in the hands of foreigners and you'd better hope that they want to maintain good relationships with you and not wanting to maybe do you know, take you down and see what happens afterwards because, you could, foreigners could do that financially and it wouldn't surprise me if you begin to see a huge offloading of U.S. assets, you know outside of just the euro. Which I mean, euro was the big drop, and mostly the dollar drops verses the euro, couple of weeks back verses the yen it hardly did anything, verses the yuan it hardly did anything. So, shifting gears again, I want to get maybe the show off of some of the overly technical things and onto you know some of the other interesting side of things. And incidentally if you want to call on in, you're always welcome to give us a ring into the show, which is (724) 444 - 7444, that's (724) 444 - 7444, talkcast id. is 982 and of course you need a 10 digit PIN number in order to dial on in and converse, we'll through one out there that we have for our show, which is 111-222-3333, so if you have a question feel free to dial on in and we'll happily take your call. Also there is always a Talk Shoe chat interface where you can get in there and you can type questions and so forth. We've had a few people come on through this evening, listening and commenting and so forth. So always feel free if you download that chat interface you can be part of the conversation and ask questions that way, if you'd rather do it that way and avoid a toll call or a, or these days toll calls are kind of getting shifted away, we get a lot of people calling in with Skype and so forth. But in any event, shifting gears back again. Reading today that the, and this is the Dallas Morning News, the Cowboys are working on, and this of course is the NFL, a new one billion dollar stadium, and this sucker is scheduled to open in 2009 and it's supposed to include two quarter mile long steel arches and a rectangle roof mimicking the famed signature hole in the roof, and it's the largest and most expensive stadium in the NFL, and it will feature the world's largest moving glass walls, open air end zones, field bubble suites and everything. 80 thousand fans, one billion dollars, what the heck is going on here? I'm sure this sucker is going to be public financing, I thing the city, yeah, the city share of the cost is 325 million, people just burning money, what's wrong with the old stadium? It's just, it's almost, I'm reminded of the tall building indicator, when you see the world's tallest buildings being built, something's about to break in the economy somewhere...

Stephan: Yeah well [remember] a billion dollars doesn't go as far as it used to. And [...] Dallas [...] What can you expect from the Dallas Cowboys, America's team?

The most audacious you know, of everything.

Stephan: Yeah, here's something else I wanted to chat about, you know there this constant pressure on [...] Paulson over there in China trying to pressure the Chinese to strengthen their currency, okay? And you know, but you have to wonder, if the Chinese increased, or strengthened the yuan, really what you would have is an increase dramatically, you know, U.S. interest rates would shoot higher as other central banks, all central banks would sell treasuries which are dropping in value, you'd have rising prices in the United States, okay, i.e. the American consumer would be paying a lot more for everything. The Chinese economy, due to the rise, increase cost of their goods would grind to a halt and you may have some social instability over there. And then you know, you may also have American companies being a lot more cheaper to acquire with the Chinese currency becoming a lot stronger, and you know you may have a lot of things in the world becoming much cheaper to the Chinese to purchase, i.e. further enabling them to continue to buy up natural resources in the country. So, you know and if you want slower growth, go ahead. If you want all these problems you know, I don't understand fully the pressure on China to you know, the failure to recognize potential longer-term problems as if the yuan is actually strengthened.

True, true, true.

Stephan: [...] something, I mean, we'll see where that goes. And you know, I think that, and I don't know if there's going to be any pressure in India or anything like that, but you know it's sort of interesting. It's really intriguing, there's been so much manipulation going on out there that it you know, and again, everyone [...] lies and we all traipse on through and do what we need to do on a day to day basis, but at the same time you know, we need to think about the corner that we're somewhat painting into here.

Other news, U.S. mortgage delinquencies, foreclosures are growing, and that's according to MBNA, or excuse me the MBA, Mortgage Bankers Association. They're saying that late payments and new foreclosures on U.S. homes rose in the third quarter and are likely to grow, as a massive wave of adjustable rate mortgage resets are starting to hit. And they're resetting it higher interest rates. And we've talked before about how that's just been a ticking time bomb and you know here we are they're beginning to kick in. And you know you could talk for hours about all these small little details and it's as if you have, you know, a thousand little dominos all set up, any one of them wouldn't be an issue, but you know this domino is next to that domino and that domino is next to the next one and this line is next to that line and it takes is a couple of them to really get kicking. And you know, I was just reading somewhere else today that the derivatives market is hitting a new record high and everybody is so overly confident with these derivatives. These are the same derivatives that you know, Warren Buffett, one of the most astute investors of our time refers to as financial weapons of mass destruction. And you start digging into some of the derivatives out there and how they're all put together and you start, you know, scratching your head a little bit. And you know, a lot of people out there with PhD's are designing these things very, very smart, but you know all it takes is for a couple of key things to shift and you're whole pricing mechanism ends up being wrong and one of the big things we always talk about here is that we're coming out of you know, we're in the midst of a giant credit bubble. The money supply just keeps blossoming and blossoming, M3 continuations are showing that they're now well above 10 percent with M3, which again that's feeding into the derivatives market a lot, you know, carries a lot of purchasing power. And you know there's a point at which, just, the bigger these things get and with the risk premiums, and that the risk premium is anything that's paid above what's considered to be a risk free rate of return, in the U.S. traditionally, that's the U.S. Treasury. And you get into the risk free premium and the spread beyond that is you know, really what is the price? And, risk premiums between conventional assets, safe assets and risky assets keep narrowing further, and further and further. And it just reeks of just complacency, reeks of indifference and this is not the economy of the 70's, we actually be a lot better off if we had the infrastructure issues, the balance sheet we had in the 70's. But we don't, it's completely different, and it's just been restructured greatly but you know, with zero savings rate personal savings, we have tremendous amounts of debt relative to GDP. You know, one thing after the other, it just makes you want to scratch your head and you know, you sound like the Cassandra out there that you know, in the end is you know, perhaps right but, nobody wants to you know, to listen. I don't know? What do you do?

Stephan: Yeah, along other lines you know, from what to spend your money on, don't spend money yet, don't buy that plane ticket yet to the 2010 World Cup in South Africa, it looks like crime is off the charts there and it's to the point where people now, the police system has broken down and the citizens there are going to have to, basically are forced to hire their own private security. The government is saying that they're going to need to hire an additional 10 thousand police for the World Cup, but in the year ending March 31st there were 18 thousand murders in South Africa, 8 times the rate of murders in the United States. And the government, you know, basically people are cowering behind electric fences and the comments are that the police have lost the war, which [...] maybe if there is a way to invest in security companies in South Africa. But in a nutshell you know the government is sort of sticking their head in the ground and making comments like people are whining about crime should leave the country, only if they could. But our bet is don't bet on the World Cup actually taking place in South Africa. I have read some interesting articles on how they're getting ready to shift it to Australia.

It wouldn't surprise me in the least. It's definitely worth having spent time in Uganda, and you know, granted it's not South Africa, but you get a feel for, things just run on a different time schedule and anybody who has been to South Africa knows that as well. And the sense of urgency tends not to be there, relative, and it strikes me from reading some of the updates on the World Cup. Now of course Stephan and I are both big soccer fans, and just came through the World Cup disappointed that our mother's native Germany did not succeed, but alas here we are. But in any event you know, following some of the things going on there it's just you know, they had a meeting about a month ago there, where the organizers the World Cups execs. were all down there to meet the local World Cup committee in South Africa, and they didn't show up. And I remember when I was in Uganda, you know, you'd have a meeting scheduled for 11 AM or 10 AM let's say it's 10 AM, and you'd show up at 10 AM and people wouldn't start arriving until, earliest maybe 11, 11:30, and that was perfectly normal. And just sense of [...] but you can't pull of a World Cup, this isn't going to fly on African time, it's just not going to work.

Stephan: It's not going to fly, I bet on Australia. I wouldn't be on, I would not bet on Brazil, one of the best soccer countries in the world, but in a nutshell, another headline, Rio airport broke [...] target Supreme Court Judges [...] So I don't think, Brazil may win several more World Cups, but don't bank on it being held there in the next 10 or 20 years. So for all you big time soccer fans out there, don't buy those tickets [...] yet. I would try to get a cheap one lined up right now for Australia.

Now, I'd work on Euro 2008, I guess it is right? So, work on that first and get some good soccer in there and move on.

Stephan: Yeah, I think that is in Switzerland. Yeah, but, yeah so, yeah Johannes you know, it's very interesting right now and I think to all the listeners out there, really you're in a situation where it seems like it's a holding pattern, but there's a lot of heavy stuff that's happening out there. If you [...] through the facts quite carefully. You listen to the Fed speak, things do not look very good at all, relating to housing and maybe even automotive, and the general economy is limping along too. You've got bond investors in other countries not central banks, saying, look you may be holding your rates [...] now, but we know you're going to have to loosen credit and [...] to get your economy going because it's hurting. You have, you've got a little bit of rising wages, if you really have [...] you really have manufacturing taking the hit out there, housing taking a hit. So, the rising wages is somewhat due to the inflationary trickle down due to the whole monetary system. So what lies ahead for the United States is going do be darned intriguing, and we'll hit very interesting [...] there are charts out there that show, basically the last 10 year the S&P has very closely trailed the housing index with a 12 month lag. The housing index has dropped about [65] percent annual rate of this year. Well now we're [...] January of '07 and will the S&P trail it down 50 percent? And that sounds almost ludicrous, but at the same time, I think objectively you have to [...] a 10-year trend will have to break for that to happen. So [...] it's not predicted, nobody has a crystal ball, but it's something that you can't ignore. So, I think our advice to everybody is pay attention and remain vigilant.

Well, here's a creative way to get your homes moving and obviously the home market's not doing too well. But, Reuters is reporting that a Texas real estate agent who has been trying to get things moving a little bit there is now offering clients in law enforcement free Glocks if they buy a home from her.

Stephan: What did you say?

She's offering free Glocks, pistols basically. Anybody who is in law enforcement, if they buy a home from her...

Stephan: Yeah, so that helps [...] in South Africa.

That's right, they should maybe do that there, that would get the houses moving. But, that's down in Houston. So, interesting, whatever it takes, right, to get those houses moving. Mortgages aren't working, the arms aren't working anymore. Although this a record month for, the most recent numbers are showing that mortgages are really picked up, so people are dashing out there. It wouldn't surprise me to see a tremendous amount of refinancing going on for the mortgage broker industry to really actually have a little bit of a kick here with these arms going on and the real question there is, as these arms are resetting will the people needing them be able to qualify for a 30 year, and will the market still be able to, with the prices having gone up in some of these regions so dramatically, people were getting into these adjustable rate mortgages because that's all they could afford. And with them coming due, converting over to a 30 year, you're going to have to roll that sucker into a new adjustable rate mortgage, it's just a never ending shell game and, you know people are also starting to use those interest onlys. I mean interesting only is functionally renting.

Stephan: Right, right. Well you know, and basically what [...] you may see interest rates dropping so that people can refinance and maybe get the 40, 50 , 60 year mortgage so they don't lose their home. And at least the banks don't have to foreclose on a ton of properties out there. But the bottom line is key is you know, if there's no more [...] how are you going to get more equity out of the homes, how are you going to extract equity out of the homes Johannes. You know, you can help somebody stretch their payments out another 20 or 30 years [...] homes, but real estate prices are really not going to go up dramatically, okay? Or up at all, or maybe dropping. And the fact that real, that home equity extraction is dropping through the floor tells you there's no more equity to extract, or the desire, remember, Americans are turning 50, and that is an age where you've just passed your peak spending years, and Americans are realizing look we've got to get our financial [...] in order. [...] 15 years ago, so it is now [...] now we wait, let's see what happens [...]

Yeah, once we get through the holiday as well, the holidays tend to boost, people will do a lot of things to get their kids that special toy, they'll pile up a little more debt, and then it's you know it's time for New Year's resolutions and we'll have to see what happens. You know, what's going to happen? Who knows but something's going to have to happen, because it just can't keep going on indefinitely, there's no doubt about that.

Stephan: Right.

But, well -

Stephan: Darn interesting times.

Yeah, no doubt about it. Well, we probably should wrap our show up here, we're pushing on into an hour and with that, it makes sense for us just to kind of clean things up here, and remind everybody that we'll be on again next week. Our usual time no longer is going to be Wednesday, but for our hour long show, we're moving it to Friday at 3:20 PM Eastern Time, that's minus 5 hours Greenwich Mean time if you happen to be listening from abroad. And anybody can call on in, and that's the interesting thing if you have questions and so forth. We've been getting some good questions on the web site lately, people putting in comments and asking about different things and regions and so forth. But worth we think participating if you'd like to but, otherwise we have our daily show on 4:15 every day that you can tune on into and of course we encourage everybody to subscribe Podcast wise to that and get themselves a good old education on what's happening out there and some different perspective from the conventional. So, without further adieu, this is Johannes Ernharth and Stephan Ernharth, you're listening to Vigilant Investor and everything that we discuss here, please do not construe this to be any investment advice or recommendation and so forth, it's purely for informational purposes. So, take that and we will catch you tomorrow at about 4:20.

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