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Long Term Investing Trends

Posted On: 2007-01-05Length: 1:02:45

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This is your host Johannes Ernharth, and we are back after a reasonably long, I don't want to say that long, but definitely took a couple of days off here for the holiday hiatus, and you're listening to Vigilant Investor. And it is our first show of 2007, all sorts of excitement. Who can argue with a brand new year, and I hope everybody had a wonderful holiday and so forth. We had to unfortunately bail out on a couple of shows that we had not intended to but, you know, sometimes that will happen on the holiday schedule and hopefully it wasn't too much of an inconvenience for you through the very, very quiet times of the holidays for the markets and so forth. But, well here we are, again, you're listening to Johannes Ernharth, the Vigilant Investor, of course we are on every Friday and will continue to be now that the holidays are over. Every Friday at about 3:30 PM, and that's going to be our weekly recap, and we're going to do the daily shows as we see fit, when they are more or less, you know kind of crucial and day to day, and that's typically at 4:15 after market close. And of course the markets are still moving along today a little bit, still have about 28 minutes left at least on the East coast where we are, and of course nationally for the U.S. markets, but who knows what else is going on around the world. Most of the markets out the other side of the Atlantic long ago closed and so forth but we thought it would be neat to have our Friday show wrap up or have the markets wrap up amid our Friday show rather than it being kind of a you know, after the fact kind of thing. But, anyway lots to talk about today, incidentally if you're wondering about that music, that's Kenny Burrell, who is phenomenal guitarist jazz wise. But, moving on, markets today generally have been a little bit off in a lot of ways, we're looking at the Dow Jones, currently is down about 87 points, S&P 500 only down about 8 points, and we've got a 21 point Nasdaq drop today so far, and those are pretty much within the past couple of minutes. Elsewhere we have seen that there are some shaky things happening on the CRB lately. CRB is a commodities index and that's something that we are monitoring, if only because we've talked a lot on our show in the past about dollar weakness and so forth. And I see that my co-host Stephan Ernharth is now on. Stephan, are you there?

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

Excellent, just doing the market recap here and welcome aboard. But the bottom line is CBR [CRB] is an index of commodities weighed on you know, across the board among all sort of different things. And it's taken a decent drop over the past 3 days we've seen it drop from about 306, it's not down to about 290, trading right now at 291, and that's a reasonable shift over a couple of days, a few percentage points there. And you know, we're monitoring that because as things slow down during a recession, one of the things that we suspect will probably happen is that commodities will begin to weaken and that's something that we're monitoring there. Of course some commodities will weaken compared to others, and we'll talk a little bit about it later on in the show about what that translates into. The U.S. dollars is trading reasonably well today, it's up above 84, up about 0.3 and of course we always look at the USDX, which is the U.S. dollar weighted index among 5 or 6 of the world's, globe's major currencies, euro, yen and so forth. And that's been, you know, all over the past over the past couple of weeks, it was down right after Thanksgiving as we've talked about in the past, dropped below the 83 figure, which tells something is usually kind of quirky happening, and it was down in the 82's, about 82.5 or so before starting a reasonable climb over the past month. And we have seen it progressively move higher and higher, dip a little bit below 83 again, now it's trading above 84 and a half at 84.64. So, surprising strength there in the dollar, given that you know, a lot of what we've been talking over the past couple of months, but nonetheless, you will see that the dollar will gain strength now and then and we still think that, with a lot of the other things we'll talk about today, the long term trend is going to be dollar weakness. Moving on to other areas, gold has been a little bit on the volatile side over the past couple of days, we have seen, as I move to the gold page, trading currently at about 605.30, and that's down about 17.6 dollars today. It's a drop of about 2.83 percent, fairly sizable drop. If we look at the 5 day trading pattern it was up to about 640 just on Wednesday and we've seen the drop down during that day to just above 625 but it went to 625 and 630 trading around there and Thursday it dropped down to just above 620 and then today it broke 625 and then the bottom dropped out at about noon today and the bottom is a little of course relative in that it dropped from 625 down to 605. So a lot of movement there and we like to monitor gold because that is the primary alternative that we see long term to the dollar, as the dollar grows [...] we talk about the other currencies out there and even though the USDX is an excellent indicator for what the dollar is doing relative to other currencies, we all know that the other currencies out there, the other central banks just like the Federal Reserve like to inflate, it helps them fund their deficits, helps them do all sort of crazy things and of course manage the economy on top of it, at least that's what they claim to be able to do, and of course we disagree. But when you're inflating other currencies at a pace that's trying to keep, you know up with the U.S. dollar, and of course that's what China tries to do. We're constantly inflating here in the United States and China tries to prevent their currency from gaining strength in the trade deficit there. So what do they do? They print money fast too. So, that is why China is constantly exchanging their dollars and constantly trading them into U.S. assets and still we're not seeing any weakening of the dollar, in fact we're not seeing strengthening. Last but not least, we like to take a look at the VIX and we haven't looked at the VIX in a while, the VIX is the CBOE volatility index, that's up 5.39 percent today alone. We've seen a strong rally in the VIX over the past couple of weeks, it had dipped down again actually during intraday trading down to 860 which you know, I don't know for sure where that falls in the whole history of lows but I think it's pretty darn low for its entire history if not a record, very close to it. And the VIX has been trading in its 95th and above percentile for a long while. It got as high as above 20 back in May when we saw the markets dropping and May and June when the equity markets began to fall apart a little bit there in the spring, late spring. And since then it just began to get more and more, I don't know, I guess more and more isn't right, we start seeing people having more and more confidence in the markets, which means that they begin not trading the VIX at a higher price. And the cheaper the VIX is selling for, that usually gives you an indicator of where complacency is or lack of fear or a lack of worry, and what we were seeing is that that VIX is still trading relatively low, it's at 12 dollars above, it was in a 10 dollar pattern there for a while but now it has broken up above 12 and it got there a little bit in early December, and we're seeing swings now. It was very low just prior to the dollar drop out in Thanksgiving Day, the following Monday after Thanksgiving. Here in the U.S. we saw the dollar begin to drop and then there was a 150 point drop in the Dow the following Monday. And low and behold the VIX began rating above 12 again. So, that's basically the market in a nutshell, a quick recap there. Again the VIX trading again at just below 12.20 and we think that that's still abnormally low, even though it's not at the record, record low, but it still tells you that there is a lot of confidence out there in the markets and you know, we'll see how the markets wrap up today. I don't suspect we'll see a whole lot of change in the last 20 minutes that we have left so. Stephan, Happy New Year to you, and any comments that you want to throw in there on the market wrap up?

Stephan: Well, Happy New Year to you, Johannes and to everybody else out there. I think that you know, you pretty well covered what's going on in the market, but I think it's really an intriguing time right now for several reasons. Number one, the Fed is between a rock and a hard place, and in effect you have seen how the market has reacted to potentially inflationary information with some of the jobs data that recently came out today and yesterday that basically job increases were underestimated and really there was significantly higher jobs created. Although, we always throw the caveat in, what kind of jobs? Alright? We continue to lose manufacturing jobs, but nonetheless, this surprising increase in jobs is viewed by the broad-based market as inflationary, and the Fed has mentioned that they are concerned about inflation. And in this credit-slash-borrowing stimulated economy dependent on low interest rates to continue on, the Fed faces an almost impossible task of controlling the inflation that they and our banks and our government has created, you know trying to keep rates higher or potentially raising rates without choking off this credit based economy is going to be extremely difficult. You know, because the lifeblood of this economy has not been savings, it's been cheap credit. So, and again as we have reiterated before, all this borrowing has created or continued to make the inflation and really the money supply which is what inflation is to grow. And you know attempting to try to balance, or to try to control this inflation so to speak as they mystify it as rising prices by keeping rates higher, it could very well choke off the economy. So, the data that we saw today, you know, what you saw today was some earning disappointments by companies like Motorola, right? And which sent the market lower, I think it's down as you mentioned in the minus 80 point range for the Dow, you see some economic data from an earnings standpoint, which is not so good, and you see data from a job standpoint which is not good the other way, okay? And I think that this month will be extremely interesting, almost on a day by day basis as to what type of news comes out. Secondly, I'd like to make another point, and that is historically the first week or so of the market's performance is very indicative of what is going on, what's going to happen out there for the rest of the year. And both the Dow and the S&P are down for the year, now, under a percent but again we're only, what, three trading days into the year, so that's sort of intriguing. And lastly, we are within now what we call, you and I call the all bets are off period. And that is, as we have mentioned before there's an intriguing correlation, trend over the last 10 years where the S&P 500 has pretty closely mimicked the housing index with just a 12 month lag. Well, in January of '06 last year the housing index began its 50 percent drop. Now is the S&P going to drop 50 percent this year, we have no idea, but for it not to it will have to break a 10 year trend. So we answer a very, very intriguing point in the markets in the economy.

Intriguing indeed. The big longer-term trend that we always talk about Stephan is what's going to happen with the U.S. dollar. And I think that, you know on the shorter term we're going to see volatility and I think that when we talk about all the time the inflation going on, and a lot of people are saying, we're not necessarily seeing it in prices and CPI seems to be somewhat under control, you know, what are you guys talking about with the inflation? I think that people need to understand oftentimes what we're talking about is, well the CPI indicator is not really the best indicator out there. You're going to find that it's really been a fudged number over a lot of years, it's been rigged or what do you want to call it, gimmicked a little bit, a lot for political purposes. But CPI, you know, tracking in at around 2 percent right now in the CPI-U, which is the one that most people monitor to tell us whether we have inflation or not, is supposed to be an indicator of our prices rising or not. And just for the benefit of some of our newer listeners, we talk about this a lot, but what they've done over the years is they've done a lot of biasing to eliminate a lot of the indicators that would demonstrate that prices are going up while they definitely aiding and abetting things that will indicate that prices are heading downward. So, if you actually go back and there are people out there who do it, John Williams is one of them, his organization, there's several others out there, go back and begin to reconstitute CPI as what it was intended to be, which was a simple basket of goods. You take cars, you take this you take that, food and energy and all sorts of different things, slop them together and you get an average that tells you if you know, if prices are going up or down on average. And instead of what they've created today, which is all sorts of statistical shenanigans in a lot of ways to help the numbers look different and we'll talk a little bit about that. But the bottom line is you go back and reconstitute it to the pretty much the pre Reagan period, and that's when you begin to see a split in about 1983, you start seeing that real CPI, non gimmicked CPI if you will, is tracking ordinarily a good bit higher, for a number of years about 2 percentage points on average to 2 and a half and then in the Clinton years a total revamping of how CPI was calculated happened again, and all the sudden you see a complete divergence of how the old CPI was calculated verses the new CPI as if inflation vanished in terms of price increases. But if we go to a different indicator which is a more traditional indicator of inflation, which is actually the old definition of inflation, that is money supply growth, we can see that over the last 20, 30 years especially when we measure by M3, money supply has simply been bursting forth and especially since the mid 90's M2 and M1 have been growing largely as well, although M1 has definitely slowed over the last couple of years as the Fed has been trying to get some inflation under control, and in fact that's one of the more public numbers that people think of in terms of inflation and as well if they're more into the finance and economics side of things. But interestingly the Fed discontinued M3. Now, M3 is a broad based indicator that gives you a lot of the more sophisticated instruments out there that really are kind of like money place holders they're not actual cash and it's not like an actual dollar in your pocket, but it does the equivalent of holding a place hold for, it's a claim on goods nonetheless and it ends up driving prices. You can bid something up with something else, if I can collateralize for example a bunch of bonds against some goods or services then I can drive the price up by simply saying I'm going to pay for them with these bonds, okay? It's over simplification, perhaps a gross over simplification by nonetheless it gives you an indication of what M3 is capable of doing. Now, ironically, the Fed basically discontinued M3, announced in November of 2004 and, excuse me, 2005 and ended it February of 2006 and of course there are people out there still continuing the M3 indicator. When they discontinued the M3 and it was chugging along at about 8 percent and from there after they stopped publishing it at the Federal Reserve others still are working it and putting it together, it has chugged above 10 percent now and it's very close to 11 percent. So back to prices, back to inflation, we're seeing a lot of weird things happening out there because of all this money supply out there and it's beginning to, in my estimation really starting to create havoc in terms of the pricing mechanism in the markets. I think what you're going to start seeing more of Stephan, is people having difficulty, knowing what to do with all this purchasing power if you will, where they invest it, how do they get their money where it needs to belong and that's not just the M3, that's all the way down to the M1. Especially when we talk about the trade deficit. What are all these foreigners going to do with these dollars that the U.S. has spent at record levels abroad? What are they going to do with them? They have a whole heck of a lot of U.S. Treasuries, what are they going to do with them? They are starting to figure out you know maybe other places belong with that money. It's a lot of uncertainty because, inflation, one of the first things it does it starts, or one of the latter things it does in the later stages of inflation is it starts wiping up a pricing mechanism.

Stephan: Johannes, I agree. And you know, I've heard it said, and I think this is true, the U.S. is the biggest exporter of inflation in the world. You know and as a matter of fact, you can basically say it's our biggest export. And for our listeners it's not complicated, simply what our government cannot raise via bond sales to other nations or investors, they sell their bonds to the Federal Reserve who strokes checks out of thin air. In effect creating money, printing money, whatever you want to call it. Every time a back lends money in the United States, most of that loan is money that did not exist prior to the loan. And so we have a lot of money created here, and then it is spent abroad on buying foreign goods, and you're right Johannes, those foreigners do have a lot of our dollars. And I think what's going to happen, they know the writing, it doesn't take a rocket scientist to look at the American balance sheet. And what foreigners are seeing are an increasing supply of dollars, which they're combating by you know creating more dollars, more of their currency so as to not create trade imbalance, i.e. have their currencies be too strong. But nonetheless, those foreigners are seeing, they're seeing the bottom line, that America keeps printing dollars and printing dollars and devaluing their own currency. So, what they're going to do, they're not going to hang on to that currency at the current rate, you know, yes, M3 as you mentioned it's not being tracked, but you know, there are some out there that are still tracking this and say, hey you know the dollar's being created or increased to the level of maybe 9 or 10 percent a year. And that's a significant real rate of inflation. And those, that will cut the dollar's purchasing power in half in about 7 years. So, foreigners are not going to hang on to a continually devaluing, dramatically devaluing asset for a long time. And I think we're seeing it Johannes already. I mean who is buying all this gold out there? Okay? Who is converting their currency into euros, alright? I think foreigners are going to be forced to ultimately divest themselves of their dollars unless politicians in America get their act together and stop spending more money than they're taking in. and when has that ever happened?

Alright. Well if we look at CPI, and again John Williams group Shadow Stats out there does an excellent job of calculating the old fashioned CPI just looking at the raw number without it being gimmicked. And CPI right now is below 2 percent, at least year over year, excuse me, if we were to annualize it officially. But if we take a look at how it used to be calculated, it's up between, you know, somewhere between 8 and 10 percent, and it's you know, very difficult to get it exact but probably close to 9, a little above 9. It was higher when it was, the official CPI was at 4 percent, you were looking at real inflation being closer to 10 percent. And you know, the prices are going up and the interesting thing is out there that even though CPI is not indicating it, I think a lot of people are feeling it out there, at least if we were to talk about different income levels in the U.S. I think a lot of people who are close to the financial side of things, if you're close to the M3 spigot for example where all that new purchasing power is coming from though high finance system, it's not wonder that Wall Street is getting record bonuses this year. It's hardly a surprise, I mean M3 has been cranking up and you know, chugging along at close to 12 percent, you're generating a lot of money and probably creating a lot of fees and commissions based on all those transactions that are related to that. And of course it's going to be a banner year on Wall Street. And that's not surprising at all, but on the flip side, we see what happened to retail sales at the end of this year, came in far lower than expectations. We saw Wal Mart already in November in advance, alerting everybody that you know, this is again, the store for middle America, for a lot of lower income people and its sales came in at well under expectations. And what you're seeing there really is another consequence of inflationary environment is sort of a division between the people who are on the upper income levels who are you know a little more, you know, your higher wage earners, your attorneys, your people who are in high finance, in banking and so forth tend to be doing very well right now. And the Neiman Marcuses of the world and your Brooks Brothers are not having problems, but on the flip side, you're finding that the retail sales for most of the lower income people and middle income people are not doing very well.

Stephan: Right, right. And I think that's a very good point. I think it's also important to point out Johannes you know, as we've described over and over again, and we won't go through all the details, but this creation of money you know, via lending and borrowing or the government doing the same, private or government sector, there was initially a spill over into the financial markets. And really it goes back to the early 80's, under the Reagan era that deficit spending that was done to win the Cold War, okay? And then it translated into the private, the consumer spending that led to the market wrap, basically it was funneled back into the stock market via -look we borrowed a lot of money in this country, we've bought a lot of things, invested elsewhere and those foreigners invested their money in our financial market. And that helped drive our stock market through the roof in the 90's. But you had that spill over -

It's still supporting it too...

Stephan: It's still supporting it. And, but you had a spill over from the financial market [...] to the housing market, so this excess liquidity and easy money. But however, you know, as you always mention Johannes, hey when you first get to tap that line of credit it's a lot of functionally, all right? But ultimately the inflationary, well in the end you have to pay it back but when you have a lot of loose money floating around the front end of that cycle is a lot of funds. So, the spill over from the financial markets to the housing markets, the home equity extraction to the increased borrowing and creating of money, but that spillover from the housing markets now has spilled over to the supermarket. And what you're seeing out there, when you stroll down those aisles, you, you know as a guy that's not big time into a lot of grocery shopping etc... I'm noticing a 2 dollar increase in that bag of coffee beans from a year and a half ago, alright? I'm noticing when I go to the local Mexican restaurant and doing take-out that's 7-dollar salad is now 10 dollars. You know you start to noticeably notice these increases and that is, that real rate of inflation is going to slowly crimp the U.S. consumer that does not borrow any more, or the cannot borrow any more. And that's going to be really intriguing. When will that happen? That's going to be tough to predict, or when will that noticeably happen? We think on one hand it may be happening now with the dramatic decrease in home equity loans, or home equity extraction. But what's also another thing that's being totally ignored by the financial markets because they don't see it yet, and the financial industry and the financial media, is that America this year is turning 50. That's the biggest portion of our population is going to be age 50. And statistics show peak spending for human beings, as evidence with the example we have for Japan, 15 years ahead of us, when people turn 50 they start paying, they see 60 ten years down the road. And they start to make sure their savings are in order, they start to pay down their loans, and what that effect will have on our economy is you can't predict it accurately but you know, statistics show that this is something to deal with and, or to look out for and it is, it could be a, have a real blindsiding effect. And as you always say Johannes, you know financial markets sometimes they draw chalk marks around bodies. You know, they basically react to old news and data. And admittedly not always but they frequently react to old news an old data and this is something I think that's being largely ignored.

Well, it touches on our point, we've talked about it in the past regarding the you know, what is referred to as the efficient market hypothesis. And it's important to, you know, people talk about the efficient market theory as if it's a law, it's gold and that you can never as an investor do better than what the market does just because you know, the market is all knowing and you know, one individual here or there, how are they going to know more of the millions and millions and hundreds of millions of people all over the place. But what that's an abject denial of is, is human psychology and especially crowd psychology and moreover bubble psychology. And it is also not, considering, something that blows me away that mainstream economists don't integrate more but it's the Austrian business cycle, and Austrian school of economics is a school of economics that emerged in the late 1800's through the early part of the century, and was actually fairly prominent prior to Keynes getting to be pumped up is more of less the official court economist by the United States government during the depression. He basically told them what they wanted to hear in the U.S. government, which is you guys can deficit spend, do what you want to do and you know figure out how everything works out and don't worry about anything else, gross over simplification there but we need to you know, the Austrians basically in their business cycle theory say that when you start ginning up money supply, you start creating, you know, each iteration that you do this, you start dislocating people's decisions in terms of responsible spending decisions, you start dislocating what is natural, what is self sustaining, part of that is what we're talking about with the price mechanism, in other words if you start creating a tremendous amount of money supply and that starts shifting though the credit markets, through the mortgage system, you're going to start seeing people bidding up prices for housing. And as rates start getting lower and lower that starts getting bid up more and more to the point where some areas the average person can't afford a 30-year mortgage even though you're dealing with 30 year or 50 year low interest rates, generational lows, almost record lows for mortgage rates that people still can't fit into them with the 30 year. So all the sudden you start getting creative mortgage financing and people use adjustable rate mortgages and all of the sudden the lending standards start going down and before you know it, housing gets bid up more and more until you're in a bubble environment. And there's an example of the pricing mechanism getting dislocated. What's the real value of a home in L.A. or San Diego? Who knows right now. All we know is it's out of whack, okay? Thanks to all that cheap credit for so long. Now, when we talk about the Austrian business cycle and creating a lot of dislocations, think about all the people that have shifted their careers over the past 6 years. I've seen studies anywhere from 20 to 50 percent, now the most recent one I saw was again 40 percent of new jobs created since the recession of 2001 were related to real estate and the housing bubble. In other words people working for Home Depot, people shifting their careers to real estate agents, to mortgage brokers, to construction related work, all these new jobs that were created out of that recession 40 percent were related in mortgage and financing it and building it and so forth. All those people when that thing dries up, what are they going to do? That's a dislocation. Those people never would have been there had interest rates not artificially been rigged downward. And of course again this is what Keynes told everybody, you know it's perfectly legitimate, the monkey with the business cycle and interest rates, gin them up, gin them down and we're, you know just move the levers and everything just works out. And today, your Greenspans and your Bernankes, the Federal Reserve all believe that that's perfectly doable. And at least that's what they're projecting to the people. I think you an I would agree they're probably you know, they're getting pretty worried over there, there's a lot of sweat on some foreheads there. And I think that the long run I think there's a lot that they're facing, not just on the short run but on the long run. And one thing we haven't touched on yet Stephan was the defacto long-term insolvency of the U.S. government. I mean, good God almighty the December 15th, we talked about it again last year, but it's important to remember that our real deficit, the non-gimmick deficit is actually 4.6 trillion dollars for 2006. Now this is in the Treasury report so dig in there, the financial statement of the U.S. government signed off by the Treasury Secretary. You can find these figures in there, 4.6 trillion dollars. Okay, the official one that they talk about is, what was it around 260, I want to say it was 260 million dollars, or billion dollars was the official one down from, maybe we should pull the figures up right here while we speak...okay, the formal cash based deficit 247.7 billion dollars, down from 318 billion last year. So you're going to hear a lot of government people crowing in about a decreasing deficit and so forth that was down from 412 billion the previous year and 374 billion in 2003 and 157 billion in 2002; that's the official one that all the politicians like to talk about. But as we say time and time again, that you know, you can't just pretend that the future obligations like Social Security, you mentioned that everybody is turning 50 this year, that means they're getting that much closer to Social Security, Medicare, Medicaid, all those promises of free lunches that the government has been funneling for votes over the past you know many, many, many decades without setting any money aside to fund it. All they do is put an IOU there in the form of a bond, which means the same taxpayers who have paid Social Security now also owe to pay themselves off in bonds for their won Social Security. It's crazy, or their kids, or their grandkids, I mean it's basically robbing Peter to pay Paul one way or the other, if you're not robbing yourself straight forward. Anybody out there in business who tried to do this would basically go to jail. I mean if you or I offered an investment like that for retirement Steph, we would be long ago locked up as soon as we were found out. It's basically a [...] scheme. But, just to clear up, wrap up that point though, 4.6 trillion dollars as opposed to 247 billion is the real deficit when you consider all net present value of future obligations, the whole kit and caboodle as any business would have to account for it. And that's an increase of 1.1 trillion dollars over last year's 3.5 trillion. So, all this baloney about deficits decreasing and isn't that all great. And keep in mind, the tax revenues that came through last year, I think that will be a great indicator of where things are going in 2007, as [...] tax revenue, it was boosted up a good bit last year by a lot of special breaks on taxes for corporations to repatriate profits, all sorts of other things which boosted tax revenue last year. So look out in 2007.

Stephan: Well I think that you know, folks want to know what's going on and, you know, at the risk of you know, we've been accused of a little doom and gloom and it's not doom and gloom, it's reality, okay? And we've been good naturedly [...] by friends et cetera and certain clients, but you know the fact is as I chat here with you Johannes of looking at the debt clock on our Vigilant Investor site, and as it clicks away I'm watching, you know, thousands of dollars as I'm speaking, we've just you know, I mean I'm just seeing thousands of dollars click by, but that debt clock, the gross national debt is at 8.672 trillion dollars. Now, how to you get ahead of that okay, you've got to make some significant changes. And when you're staring at some of the facts that you had just mentioned there, and when you listen, and this gets into the political side of things, when you have one party fighting a war they can't afford, okay, basically whatever your views are on, whatever the views of the war are aside, this is a war that we cannot afford to fight. And then you have another party coming in looking to make some promises and find some money to spend on other programs that we don't have, there is no way in my opinion that we're going to get ahead of the curve. And I think they main thing that I would tell people to be prepared for is continually increasing real inflation. And if you're ready for that and if you gear yourself for that you can do all right, but that's the main thing you have to consider. And people might say, as we have mentioned before, hey the stock market is at 12, 3, I mean, look in 2000 it was at 11, 7. However if you used the Fed's lowball inflation figures and adjust today's Dow for inflation back to 2000, it's at 10, 4. The problem is the Dow back then was at 11,7. So while the number is bigger, and your portfolio looks bigger, if you are just investing in stocks, that money, even though it is quote, "more in dollars" buys you less than it did in 2000 when the Dow was lower. Alright, and that's the main thing that I think, what you can call it, that we preach or what we mention that we are in, we think, Johannes, we are in the beginning stages, even though it's been massive already in the last 10 years, we are in a what we feel is just lift off. You know when you see those rockets take off at Cape Canaveral, and you hold your breath a little bit, and the boosters start to really, and the platform falls away - that's where we are, on the real inflation side of things. We have not even seen the beginning of it. And investors, individuals, citizens, they really need to watch out for that because the subsequent effect of this massive inflation could be quite dramatic. Painful.

Well, you're dealing with, well it's important to connect the dots as well, we're talking about the deficit and you're talking about the debt clock. The Federal deficit is obviously massive, 4.6 trillion dollars, the debt, federal debt clock on our web site, vigilantinvestor.com, 8.6 was it trillion, was that correct?

Stephan: Yep

In terms of debt. And what we're talking about there is that debt has been fortunately for the United States refinanced and turned over, over the past 5 years so that it's now basically at record lows. For a while there, the U.S government wasn't even issuing 30 year bonds it was retiring old higher rates, re-fing at lower rates, now you look at the 30 year and it's very, very, very low and they're able to lock in some pretty respectable rates. Now it's going to take a while to do that. But the bottom line is you know, good for the U.S. they have such generous lenders, and keep in mind these lenders are overwhelmingly, the majority of them, over 50 percent of them are foreigners, foreign central banks and so forth now. It's critical to understand that as long as we have those low interest rates, we can continue to make ends meet, but we have that 4.6 trillion-dollar figure that's facing us in terms of future obligations. It's not even talking about the 8.6 trillion dollars, which is going to get more and more expensive to finance. We can't have generational low interest rates forever, it's just not going to happen, so eventually that 8.6 trillion dollars is, you know and each year we run short we're going to have to pile up more and more debt. I think we've built up another 460 billion dollars of fresh debt last year, so that tells you really where our finances are, even though they officially say that the deficit is only 260 billion. We piled on another 460 billion dollars of debt. So, that tells you that that number is fudged as well.

Stephan: Actually, Johannes while you've been speaking there, the national debt has increased by 1 million dollars. I was just watching the clock.

There you go. It's, but my question, and we've asked this dozens of times over the history of the show and we ask it all the time on the website is where is that money going to come from if we're short 4.6 trillion dollars today in terms of setting aside money for future obligations for benefits like Social Security and Medicare, Medicaid. And it's interesting, the reason the government says they don't put that money or they don't show that on the balance sheet is because they can always change those benefits. But you tell me what politician is going to cut the benefits by two thirds or double taxation immediately as the Federal Reserve's own report titled, Is the U.S. Going Bankrupt, suggest is the solution to our fiscal insolvency. I think the answer is, the writing is on the wall. And it's a continuation of what the U.S. has been doing to fund a lot of it's deficits over the past 67 years, which is to continue to print money and paper over the shortfall. Which, don't forget, when you're printing money, you're printing that out of thin air. You didn't do anything to create that money, so all purchasing power derived from freshly minted money out of nothing is the equivalent of a tax on all dollar holders. And all listeners need to keep that in mind, because that is exactly what inflation is. The trend for decades prior to the, or for a hundred years prior to the creation of the Federal Reserve was that the dollar would generally gain strength over time unless there was an event like the civil war or of course the government [...] we don't need to get into that. But the bottom line is that inflation was rampant, thank you government and so forth, or if it was an artificially created central bank kind of thing where we had a few battles in our country's history where certain banks would have, would vie to get control and be you know short [...] central banks where you would have these mini inflations and so forth or the war of 1812. You really didn't have any inflation in the United States, in fact you always had a steady increase in purchasing power because that's just the nature of technological advancement. As technology goes forward, things get cheaper and that was just generally the way things worked until the Federal Reserve created a permanent trend of inflation. And that trend has one direction to go when we look at that 4.6 trillion, and one thing is going to happen is that we may think it's slower right now, or you know if you look at the real number, closer to nine percent of inflation at the moment, just wait until that accelerator really has to be hit to start paying people out. and don't think foreigners aren't starting to scratch their head, I mean they have so much U.S. debt, denominated in U.S. dollars, and if they start thinking about what's really going to happen with inflation, then they're going to start questioning the logic of holding so many dollar denominated assets [...] beginning to do that.

Stephan: Johannes, and I think it's important to point out to people too that, you pose the question, what politician is going to cut benefits and say, we need to raise taxes on everybody dramatically? That answer is - none. Never has been, never will be. But what they're going to continue to do as you have pointed out frequently, is they're going to fudge the inflation figures, rig them low. While they're minting dollars, i.e. counterfeiting, if you and I did it, it's counterfeiting, they're going to print massive amounts of new dollars, devaluing every dollar that's out there, we'll get into the tax on savings, but devaluing every dollar that's out there. So all these people that are heading off into Social Security, hey America, wake up on this one. Because what's happening is they're rigging the inflation figures very low, i.e. as Johannes always points out if they calculated them like they did in the 1970's Social Security benefits today would be 70 percent higher. So they're rigging, the government is rigging the inflation figures lower to keep a lid to artificially depress the inflation-adjusted increase on Social Security. And the second kick in the you know what is the fact that they're paying you with dollars that are far, worth far less than they were last month, last week, you know that certainly last year and last decade. So the increase is rigged artificially low for inflation and the dollars you're getting are more and more worthless, and every politician knows it, okay? And that is the cruelest joke of all, Johannes. And back to your point on inflation. People, the reason counterfeiting is illegal is that yes, the counterfeiter gets the full value of the dollar, but what they're doing is they're deluding the value of everybody else's dollars. I.e. we pay income taxes, you pay capital against taxes, whatever okay? However, inflation is a tax on your money, or any asset that you have as it sits there. It's a tax not even on gains it's a tax on its being. If the real inflation rate is 9 percent, your buck at the end of the year is worth 91 cents. The next year it's worth about 83 cents. The next year it's worth 75 cents. It's the cruelest and most unfair tax of all.

The, by the government's own official understated number just for 2006, 100 dollars has lost, well it takes 117 dollars to buy 100 dollars bought in 2000. That's according to the government's own understated figures. So, if you're overjoyed about that, which you probably aren't that was sarcasm, just contemplate it in real terms and you know, it's the environment that we're in and it's causing problems. And I want to touch on something and shift gears here a little bit Stephan, because one of the things that we've seen towards the end of the year and the last week, last 2 weeks has been an unwinding of this bubble a little bit in the area of the sub prime mortgages. And what you've begun to see is all that money was flooding into the housing bubble of course through mortgages were at record lows and of course at the same time now it's politically very attractive, politicians always like to give free lunches and if you know, they can give something for nothing you know, they always want to promise it, knowing, you know, I don't know whether they're just stupid or corrupt or whatever the case but either way it's very damaging for the country. But someone out there thought it was a really good idea for these federal backed mortgage groups, your Fannie Maes, your Ginny Maes, all these sort of, Freddie Macs all that kind of stuff. To be in the business of buying up mortgages that were created and originated by banks. And progressively over the last decades, the standards have just begun declining further and further. Now, we've talked about all that money sloshing around out there in the global economy, and we look at our 30 year treasuries in the U.S. which drive rates across the world and across the U.S. in terms of the mortgage markets having been severely depressed. Now that's largely because all the money sloshes through the U.S. economy, comes through the mortgages, gets out into, through home equity, we had 650 billion 2 years running, pretty close to that number, 2004, 2005 getting yanked out of the U.S. houses in new found home equity or old home equity with all the price appreciation. That money gets spent and it sloshes through the economy, through our trade deficit it goes abroad, suddenly the Chinese are holding hundreds of billions of dollars. What do they do with them? These Chinese companies exchange them with their central bank, that central bank prints some more yuan, they then take those dollars and what are they going to do with those dollars? They now have a bunch of dollars in their central bank and they in turn have been investing them in U.S. treasuries. So what that has done has artificially dropped U.S. 30 year and 10 year Treasury rates down well below their averages because we've been increasing the money supply here and it's getting recycled back into our own debt. Now, what that has done has so severely depressed the rates of return, people are return starved out there for income. So, they start looking for returns that are higher. And the only way you can get higher returns is by getting into higher risk investments. So they start creating, they start chasing with their dollars investors looking for higher yields, start getting into you know, maybe into the B rated or you know, high yield junk type bonds and, rather than Treasuries. So what starts happening there is that the spread between very secure triple A rated bonds and your triple C, your junk bonds starts getting narrower, and narrower, and narrower. And that's because there is so much money sloshing around out there that you know, people start driving that rate down. So, that has helped and aided the sub prime mortgage market because people are more willing to throw money at sub primes because they're desperate for rates, and sub prime borrowers usually have to pay a higher rate. And so again, we talked about dislocations earlier in the show, here we're seeing it in the mortgage market. Now, today what we're beginning to hear in the past couple of weeks to sort of bring this all full circle, this is complicated, which is, you know, one of the difficulties is we're all told very simply, ah don't pay attention to the market, don't pay attention to the economy, we just go asset allocation and you know buy and hold for the long term and no sweat, just go with the indexes and don't pay anybody any fees to do anything, just buy the S&P 500. You hear all that stuff all the time, because I guess you know it's too complicated to explain what we're trying to explain in here. But the bottom line is now we're taking a look at what's happening to sub prime mortgages, a lot of these people are facing foreclosure, they're on late payments, those things are really starting to pick up pace. And not surprising because they probably shouldn't have been given loans to the degree they were, and I mean we're seeing no money down loans, we seeing you know, 120 percent loans, people owing more on their mortgages that things are worth especially now that prices have begun to deflate a little bit. And so all of the sudden, you know what are people going to do as these mortgages start going sour? So, if suddenly now we just saw this happen, a major lender up in Connecticut, I've forgotten the name of it Stephan, they just said, you know what, we're not going to be able to fund these loans that we thought we were going to. They had to reneg on over a hundred and some loans in Massachusetts and other areas because they did not have the financing to back up what they had promised. Basically, Wall Street said, no, we cannot do it at that rate anymore, we're stepping away from it and you're starting to see sort of a crunch, a lock up in the sub prime mortgage market because these things are starting to fall apart. Interesting.

Stephan: Well, here's what's interesting. You know there's a ying to every yang, okay? There's a boom to every bust there are oftentimes, or to every boom there frequently is a bust. And you know, the stock market, again, when it began it's drop of the 2000, 2002 drop, which we feel was largely rescued by massive expansion of credit and credit based spending in a credit based economy, and we don't know that that one has totally unraveled yet. But when you go back to the tulip bulb mania in the 16, 1700's, the South Seed Company mania of the 1700's, you know every stock market boom and bust, you know, it starts out with the solid fundamentals and then it gets to, it peaks at a level of ridiculous frothiness, which we saw with the tech bubble, okay? And then you see a collapse, like you saw with tech stocks, especially in the Nasdaq. And the ridiculousness is always the peak and when the sub prime lenders are you know massively marketed and massively granted loans, that's what we call the frothy stage. And then that's when the reversal, to the over extension result and the reversal begins. And it's going to be really intriguing to see how this all pans out. Now, could it be a soft landing in the housing market? Hey, potentially it could. But on the other hand, I don't necessarily trust the spin that's put out by the National Association of Realtors because they've been wrong a year or so running with their forecasts. And they're part of the industry. So I think you're right, I think [...] this is a darn interesting year, and it's going to be tremendously interesting to see how this stuff plays out.

Well, it's again, it's what a lot of economists that have been ignored for a lot of years have warned about, that the more you do this, each iteration of the business cycle that goes through, I mean you can look back at old you know, depressions and old grass of what was going on with the economy and you'd see the things would pick up and if you ginned them up too much then they would eventually go down. And well even prior to the Fed, I mean you had a natural business cycle where people might get a little bit out of whack but, the natural tendency was that rates would rise when things got a little too much in demand, because the money supply wasn't able to expand artificially and it would control itself. But we now have this belief that we can not only manage the economy, which they blew up in The Great Depression way back when by trying to rig money supply. But now, we've gotten to the point now, and I mentioned the VIX earlier in the show, why we like to monitor that as a sign of complacency, it's one of many that are out there relative to people just being indifferent to risk at the moment, they're all trading very high, or indexes are all very high, and they're lack of concern about the economy and lack of concern about any downward motion in the markets. There are people out there that believe that the Fed has learned how to control the business cycle, there's no longer such thing as a depression. And even a severe recession is something that's been forgotten about, it's believed that you know with the Greenspan miracle, Bernanke has now taken the reigns and he's going to be able to just sort of guide us through this and even though we had a housing bubble, ah, we're already at the end of it, we're being told by a lot of people and really what we're doing is each iteration, let's just presume Stephan that you know by another miracle we can get through this without having a serious dislocation or finally a resolution to this bubble that's built up, this gigantic credit bubble. Let's just assume that the Fed can somehow manufacture another rescue of liquidity somewhere in some aspect of the economy. All you do through the process is create another housing bubble in place of what was there before, and maybe it's not a housing bubble, maybe it's a dot.com bubble. The housing bubble replaced the dot.com bubble, and the hyper tech bubble. And prior to that you know, you've seen these gross distortions out there in various market sectors and again you know I was talking before just about the risk spreads being diminished. And people, what is the real value of a high-risk bond relative to a low risk bond? People are starting to scratch their head, they're not sure. We're looking at oil today having dropped over the past couple of days down to 55 dollars, and went up just a little bit today it was trading into high 70's before and getting close to 80 at one point. And what's the real value of a barrel of oil? What's the real value of copper? What's the real value of this or that? It's very difficult to say because the business cycle has been monkied with so much and there's so much liquidity out there people are beginning to scratch their heads and when you start having that happening you're going to start seeing a lot more volatility in the markets and that's I think going to be one of the things going forward we're going to see in 2007 will be a lot more volatility. Maybe we don't see a large decline in equities but I think that we're going to see a lot more volatility just across the board in other asset classes as people are trying to figure out where to go. And you know the Fed has always said that if things start turning, they always have that liquidity machine there, that little instrument called the printing press, I mean, this is in Bernanke's own words, and they're not afraid to use it [...]

Stephan: The Fed can manipulate interest rates and they can make money cheaper, but they cannot force people to borrow money. Alright? The Japanese who lead us demographically by 15 years with their baby boom, they turned 50 in the 80's and early 90's, they basically went into a massive recession, even though, what their version of the Fed funds rate is what a quarter of a percent? Okay, and nobody borrowed at that point in time. And they were in a severe recession for a long time. The Fed can manipulate interest rates lower, okay? But they can't make people go further into debt and in a debt based or borrowing based, or credit based, let's call it economy, that's crucial, the ability to make people or incite them to borrow. And that is the you know, 60 thousand dollar question right now.

Well, I think that their indication has been that they are perfectly happy to open the spigots of their own money supply, just open the market operations, do what it takes, they've even [...] people floating out ideas that perhaps the Fed's reserves ought to be diversified to equity markets as well, and it wouldn't surprise me if they believe that that might make sense, as a way to get liquidity out in the market. Meaning, you know, actually going out and buying equities and money minted out of thin air to try to keep things buoyed. So, [...] Lawrence Sumners I think is his name, he's a former, I think he himself is a former Fed guy, and he was publishing some things, he was an economist at one of the Ivies and you know he's publishing a paper that people are taking seriously, that they ought to be in the capital markets, the world central banks ought to be out there, not just investing in government treasuries, which has been always the I'll scratch my back, you scratch yours kind of agreement with Congress in the U.S., which is you know, Congress can't get enough money, doesn't want to raise taxes, well, just sell some debt to the Federal Reserve and obligate the U.S taxpayer to pay interest to the Fed forever.

Stephan: Then you're going to see massive, massive, massive, massive inflation.

I think that's the, that's the one problem that we're facing. In the long run, whether it's you know, [...] starts unwinding this year or in the next, you know, by then end of the decade I think we're going to start seeing that realization, everybody's going to start coming to it and when people do then that's when you got to watch out, and it can happen very quickly.

Stephan: Yeah and it's interesting you know for again, any first time listeners, look this may sound you know, bordering on the ridiculous, but remember, the dollars has lost, what, 95 to 97 cents of it's purchasing power since the creation of the Fed in 1913, okay? And it's been accelerating quite rapidly recently. And, you know, the total money supply in the last 3 years increased about 20 percent, i.e. your dollar lost 20 percent of its value. That's the real rate of inflation, alright? And if we have, the synopsis of this is you've got a government that can't afford to pay for what it's spending on, okay? And you have consumers borrowing to buy in this country. And you've got a country, you've got an aging population that's going to be tapping more and more every year into massive social benefits. You've got a lot of under funded and severely under funded pension plans out there, which the government is on the hook for. And you add all this together and then throw into the fact, if the government decides to, again as Johannes mentioned, print money out of thin air and start buying equity or stocks, the writing is on the wall. I think it's already there, massive inflation, we're in the midst, we're in lift off right now.

Well, we shall see. We're getting to the end of our hour Stephan, we probably ought to wrap up until next week. But I think it's important that everybody keeps in mind, and I think one thing we can say for certain, I think that our fundamental look is very crucial and it is very easy to, well, not very easy, but you know, the mainstream is definitely bucking consideration of any of the things that we're talking about, or at least a lot of them. It's getting on the radar screen but I think that we can, I think it be right with our general fundamental analysis, I think what people really need to be careful with is putting their, you know, any kind of fundamental outlook into a practice that makes sense relative to what they're doing. So be very careful and cautious out there folks relative to how you're doing your own personal finances or your own personal entrepreneurial things, because this is a crazy point, and this is where, you know, history is written about times like this, and in hindsight everything seems to be so clear and crisp and everybody dismisses any people in advance of things because you know, how do you know? How do you know the future? And in some defense, a lot of people have been predicting some problems for a long while, but I really believe that we're seeing a much different beast today than we saw in the 70's and so forth. So, keep that in mind folks, and of course just as a wrap up for the show, I want to remind everybody that we are on of course 5:30, or excuse me, 3:30 PM Eastern time, every Friday you can tune in to Vigilant Investor live and also our web site, vigilantinvestor.com, you can find more information about the show there, we're on Talk Shoe live, and I want to make sure that everybody tunes in. So, I have one of my children coming into the studio at the moment, I hope you can hear him in the background there. But, as well you can subscribe to our Podcast, which is available again through talkshoe.com and you can do it via your iTunes if you've got a new iPod, there's a great feature in iTunes that enables you to sync up your Podcast that you down load, recordings of this live show, and listen to it automatically. It will automatically install on your iPod and you have it ready to go each week. And last but not least, Talk Shoe is a live and active environment. So, we could have announced it earlier, but we didn't, it's kind of our annual kick off show here. So, but in the future we will take phone calls, you can call on in to (724) 444 - 7444 if you haven't dialed in before you need to get your own pass code to dial in to Talk Shoe hosted shows. These are broadcast around the world, if you have an Internet connection that enables you to do phone calls that way, by all means do it, or a calling plan. And there's also a chat interface that Talk Shoe offers for people to be in during the show listening and chatting and conversing. And we are going to try to make sure that lots of people come on out. If you have questions, be part of the show, we'd love to have you as part of our audience. So, until further adieu, I want to thank you for listening today and tune in next week. This is Johannes Ernharth and you are listening to vigilantinvestor.com. So, tune in next week, we'll see ya.

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