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The Credit Bubble

Posted On: 2006-10-18
Length: 1:02:07

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Hello everybody, this is your host Johannes Ernharth and this is Vigilant Investor, live streamcast net radio show, every night, or excuse me, every week Wednesday 9PM. We're available for live call in. So, anybody interested in asking a few questions and touching base with us do so by giving a call to our dial in number through our host service which is talkshoe.com. You can always get more information from talkshoe.com if that's something that you're interested in. But the dial in number if you have a few questions are (724) 444-7444, that's (724) 444-7244. Our talkcast id. is number 982, just hit 982 then # and then the Talk Shoe pin number that they're going to ask you for if you haven't already registered with Talk Shoe, which we highly recommend because if you do that you are able to get a personalized set up with their IM interface, instant messaging is what IM stands for and you can get inside the system and actually chat with other people who log on in to the Talk Shoe system. So, but if you don't have a pin number, we have a couple set up for callers, one pin number is 222-333-4444, and the other, it happens to be 333-4444-5555. So again the number is (724) 444-7444, that's the phone number, so call in with any questions. But, again this is Johannes Ernharth and you are listening to the Vigilant Investor live streamcast. And it's been an interesting week since last week when we interviewed John Williams, and discussed all the fudging that goes on with CPI, GDP and most of the government statistics that come out from the bureau of labor, or excuse me, the various departments of the government, whether it be the actual bureau of statistics, or it be the department of labor and so forth. And, this week we have a very special guest, his name is G. Edward Griffin, he is the author of, he's probably best known as being the author of The Creature From Jekyll Island, which is an excellent expose of the Federal Reserve system and banking, and we'll be talking with him a little bit, we expect him to be checking in here within the next few minutes and until that time arrives, what we are going to do is just touch on a couple of things that have happened in the past week and a few headlines and so forth just to get everybody up to speed on some of the things that we're thinking about at the Vigilant Investor, and things that we believe are maybe being missed by the mainstream to help you connect some dots out there and just you know, keep everybody's eye on the ball because there's some pretty crazy things happening or at least as far as developing beneath the surface, we think that there's a lot under there that is just being glossed over and if being eyed and dismissed far too greatly by the general mainstream and the ever so bullish Wall Street, which we can't ever forget, it makes its money by making sure that you keep staying in the market, and keep buying more and more and more. So, all that said markets today well just touch on that quickly, the Dow has touched over a new record, at least in nominal terms it crossed over the 12,000 mark during intraday trading and it ultimately finished up at about 42 points at 11, 992, which for it is also a record, and it couldn't quite stay over that, the 12, 000 point when it did get over there it reversed. And the other indexes pretty much followed suit as well. S&P 500 was up to 1,365 today, that was only up about 2 points, just under 2 points, and the Nasdaq actually raced up along with the Dow early on, but gave back that gain and then some, dropped about 7 points, 8 points. So, all and all not a whole, you know, big movement in the market percentage wise in any of those indexes. We're talking, you know, 3 tenths of a percent for the Dow and the Nasdaq and the S&P about 1 tenth of a percent. So, all said and done, not a whole lot going on in there. Bonds actually gave up some of the yield that they had there, so they're getting a bit more attractive. But overall the trend has been continuing relative to driving other markets. And one of the big markets that the bond rates tend to drive is the mortgage rate. And of course as the mortgage rates were going up along with the bonds in spring in the past couple of months, in the summer, there was a re-fi boom going on and a huge retest of, maybe not the previous lows that we had in mortgages, but definitely a lot more attractive than we had in the spring, so a lot of activity is going on. A lot of that wrapped up in the past few weeks and in fact mortgage, new mortgages had dropped a good bit from the past couple of weeks, and re-fi's have dropped fairly dramatically at that. And, probably the bigger news related to that would be the news that came from the Homebuilders Association, which said that their, on one hand good news, they were up at about 5.6 percent I think it was from, or 5.9 percent up from their August number in September. But also, when we still look back 12 months ago to this time last year they're down dramatically which is about 18 percent. Now, relative to both of those numbers while we often talk here about the housing bubble, is it going to be a hard landing, soft landing and so forth, where's it going to go? And we can't always say for sure but heck, it seems that enough writing is on the wall there when you have as much of a big jump that if you did in a lot of geographic regions around the country especially in your coastal areas, your L.A.s, your San Diegos, your Miamis, your Bostons, your D.C.s and so forth. When it goes up 100 percent in 3 years or something along those lines, you know that things have to get back to normal and to average as being the normal, and ordinarily when you far exceed the averages you usually have what's called regression towards the mean and that usually means sub par averages for a while. So we still thing that we have a long way to go just to kind of restore order in those markets especially the most dramatically ballooned areas, but beyond that we take a look at this year's numbers over last year's in terms of new housing starts is definitely telling that clearly the activity is slowing down. A lot of people still tell you, well heck we're growing by 6 percent, 5.9 percent is pretty darn good, from, you know, up this month from last year I think that the starts were, if we do an annualized, close to 1.6 million, in that ballpark, 1.7 million, and that's not bad at all if you're speaking from the context of being in a vacuum. But, when you consider the 18 percent drop from last year, that kind of thing reverberates around through the economy and has a tendency to slow down everything that was related to it for a long time. So we should still see what's going to happen if that shakes out or not. Now, we talked about it last week where we think, you know mortgages think, you know that they're a little big out of whack and that they still have a lot of issues related to that before the housing bubble really gives a good indicator where it's going. We happen to be pretty bearish about it on our end just because of the nature of the credit cycles and being of the Austrian economist types around here, we don't like to see huge injections of money supply out there which cause, in our opinion big problems. So, all that said, moving onward and upward. Other news out there today that we can take a look at, excuse me, bear with me, Stephan, while I pull a couple of things up here, do you have any comments on what's been going on out there? Stephan Ernharth is my brother, he's also here today, my business partner and also co-host of Vigilant Investor. Are you out there? Stephan: Yes, I'm here.

Excellent, great. Anything that you want to touch on from the past week that you came across?

Stephan: Well, it's interesting to notice the hubaloo made about the Dow peaking, and continually hitting little, new highs. But as we had mentioned last week, if you adjusted for inflation the Dow is really somewhere in the 9,000 range as we speak. And, it's important to know also a few other things. The Nasdaq and S&P are not near their previous highs, and when you take a look at gold, it has been, you know exceptionally resilient relative to its run up from around about a year ago at about high 400's to about 727 in May, and then you had thumping by central banks of a lot of gold on the London Exchange in May, driving prices back down to 540. It then crept up to about the 627 range and has been wavering somewhere between 570 and 590. But, you keep hearing bad news about gold, you keep hearing about oil prices supposedly being contained driving the metal down, but, as we always say it's like trying to keep a balloon under water, ultimately it will rise to the surface and we see it floating again you know, close to the 600 range, which is 25 percent gain over the last year. And as we know it is the one true form of money and we, as our government, the Federal Reserve expand the money supply, well call it legalized counterfeiting, you're going to see the price in dollars of that metal, we feel, continually rise. So that's sort of a perspective retainer for lack of a better term. We also find it extremely interesting that we reach a really intriguing point on the calendar, which will be next January and at that point we'll see whether a 10-year correlation between the S&P 500 and the housing index continues to go on. If you look back at January 96, the S&P has basically lagged the housing index almost exactly, or let's say it's mirrored the housing index almost exactly with a 12 month lag. Because we all right now the housing index if off about 45 to 50 percent this year, and the question is, will the S&P follow next year. Now, we don't have a crystal ball, we don't know if that will take place, we do know that for it not to take place the 10 year correlation will have to end. And, we shall see. But, we do know, history shows us, and we're taking a look let's say at Japan, which that we tend to be following, you know, with a 15 year lag there. You know, housing crashes tend to have 3, 4 times the negative effect than a stock market crash does have. So, it will be interesting as we watch this all take place.

Yeah, and there's always the unknown variables that are out there, there's issues that, you know, you don't want to be conspiratorial about it, but you definitely hear talk among traders about the Hail Mary trades and so forth that come out there. And the interesting thing is that when you have so many, so much liquidity out there, a lot of your reference points tend to get washed out, which, what we mean by reference points is ordinarily, a lot of people in the market take a look at different indicators and so forth and try to get a better gauge of what's going on and try to operate around what's happening. And, all that liquidity starts sloshing around out there with the money supply having been increased as much as it has been over the last few years, again we talked about this last week with John Williams from Shadow Stats. If you look at, you know at 20 percent increase in M3, if you were to continue projecting it out where it was and reconstitute it, you know darn well that there's a lot of money sloshing around. And the big gripe is that that money is being now moved around by hedge funds and so forth. But, the movement of that money just tend to defy the ordinary, more, I guess orderly process that they used to have, and things tend to shift from asset class to asset class a little more quickly is what we're seeing. So with the big drop in energy prices and so forth there's a lot of people complaining about that king of thing out there, that the hedge funds maybe need to be regulated some more and so forth. So, that's one thing to take a look at. And I meant by the Hail Mary trade, that's simply the belief that the plunge protection team as it's called even has been acknowledged, out of Washington and out of the White House that when markets don't obey a certain direction, and the people just don't seem to have a good enough sense of stability in their minds because we're all fallible, I guess is the argument, and all the way down to central banking if you think about it. But, because we have a little bit of an irrational streak, the plunge protection team steps on in and tries to put a bottom on the market. And the Hail Mary trade is one of those trades that kind of comes in out of nowhere and ends up alerting the entire market that it's showing up and everybody, a lot of traders tend to follow that. Now, that used to be reserved more for the big drops in extreme situations a la the rules passed for the 87 type of a drop that enabled this kind of thing to go on. But, what some people are arguing is what is actually going on for market drops that are a lot less dramatic than that. So that raises some questions to a lot of people as to, you know what exactly is going on. So, we take a look at something like an indicator, like the S&P merging together with the housing industries outlook for, the Homebuilder index for example that Stephan was alluding to. You know that 10-year, think that pretty closely there but you never know what could happen. So, it's one of the reasons why you have to keep your eye very much on what's going on and your finger on the pulse.

Stephan: well, that 10 year correlation between the, you know, the housing index basically leading the S&P by about 12 months, and you know, the S&P basically, exactly mirroring it with a 1 year lag over the last 10 years. I guess the question is, why would that not continue? And, when you take a real look at what has happened in Japan, from a demographic, history is the study of human nature, economics is certainly the science of if. And if you look at Japan verses the United States, we've almost mirrored each other in our cycle and we have lagged them by 15 years. And, you know, Bill Bonner writes in you know, Financial Reckoning day and Empire of Debt, that the Japanese baby boom started in the late 1920's and early 30's and peak spending age for human beings is about age 49 or 50 years of age, and Japanese for lack of a better term were turning 50 in the early 80's, the late 70's, and you know, the Nikkei was 40,000 and everybody was bringing in Japanese consultants, and we had to do it that way. And then all of the sudden, age 50 hits, people tend to see age 60 down the road, pull in their horns to pay down their mortgages, they start to keep their cars longer, save for retirement etc.. and they stop spending. And, Japan climbs into a recession, the central bank dropped rates basically to zero to try to stimulate the economy for borrowing and it in effect, created cheap money, easy money, which flowed into real estate, creating a real estate bubble. Does this sound familiar? Then that bubble burst in the early-mid 90's and that had far worse of an effect on the overall economy, that real estate bubble, then did the bursting of the Nikkei, and in effect their recession lasted from about 93, 94 to this spring. Now, were told in this country that this can't happen, that Americans are different than the Japanese, that the Japanese historically saved 20 percent, while Americans saved 10 percent. And our savings rate right now, you know, during this cycle of a stock market boom, a recession, lowering of interest rates, massive indebtedness to keep things going, and then using money creating a housing bubble, during that time period, that process, the savings rate in America has dropped from this positive 10 percent of income to minus 1 percent. And the end game may come soon in that Federal Reserve as even I think, and as some very intelligent people think, we'll once again try to re-stimulate next summer. And the big wild card is, will the Americans who are now in mass turning 50, will they bide on one more rate drop, will they go further into debt to keep the party going. So, that's going to be intriguing and that's something that everybody should pay close attention to probably starting following the election.

And what we're talking about here is, not to get overly technical, is the Austrian cycle, business cycle theory, theory of business cycle is one that really is critical of the monkeying that goes on with the money supply, and this is something that hopefully we'll be able to chat with Mr. Griffin as he comes on a little bit later. But you know, essentially with the type of system that we have set up in the United States, the banking system, largely our economy functions on the injection of credit, and money supply increasing. And that's not necessarily the natural state, it's a fairly recent phenomenon in terms of the history of the United States, at least in the last 70 years where it's really become a driving force behind a lot of what goes on. But the problem with increasing money supply is that it's just not a benign kind of injection of activity. What you do when you increase money supply is you're actually taking purchasing power out of existing dollar holders' hands, and you're shuffling it around into new people's hands and the new recipients of the first money supply get wealth that really wasn't there prior to that and they did nothing really to earn it other than be the first recipients of it. Now, the first recipients typically are going to be the banks themselves, or the Federal Government, and that generally gets spent into circulation. But the bottom line is that when you're simply creating money out of thin air, you're not creating anything other than you know, printing, you know, either digits, zeros on a computer screen or actually printing dollar bills, and they don't even do that so much anymore as much as the computer entry, but the bottom line is that purchasing power comes at the expense of the existing economy, the existing savers, the existing entrepreneurs, people who have demonstrated that they know how to grow wealth, how to build things with it, and really not be wasteful with it. And it puts it into the hands of movers and shakers. And, at first that cycle is not so harmful but the more iteration that cycle takes, where you keep injecting more and more money supply into the system through credit or directly, however you want to do it, you end up with situations that ultimately distend into bubbles. And, people look at the dot com bubble and they say oh it just kind of happened, people just got crazy, people got kind of reckless, but that largely is fed by the money supply increasing where the money got removed from the hands of people who were saving in CDs or saving it in their businesses or trying to grow it more organically, and it was shifted over to the dot comer's where 26, 27 year olds who had degrees in web creation would come up with an idea and simply because you put it on the Internet, suddenly it was supposed to be worth 500 million dollars even though it never demonstrated that it could even earn a dime. And you know the pets.com sock puppet, everybody remembers that thing being advertised on the Super Bowl and low and behold a few years later, poof! it's gone, nothing to show for it except some pretty expensive furniture and obsolete computers that today people can't even use anymore, so that's the kind of thing that happens.

Stephan: you make a very important...yeah, the key point that you make is that all massive run ups in financial markets are created by massive infusions of creation of liquidity/ new money. And the two biggest ones, the second biggest run up, was, took place during the roaring 20's, and the most recent run up in the 90's basically is the biggest one. And, you know as Mr. Griffin writes in his book, and not to steal his thunder before he comes on, but there was a massive infusion of cash coming in to markets in the United States during the roaring 20's simply because our government in cahoots with the fed created money out of thin air to lend to England and France to re-pay our big bankers who had lent them the money. So they had the newly minted money, that amount of money basically was equal, that amount of money that was lent and repaid to those banks is equal basically to the money in existence at the time in America. And sure enough, the counterfeiter always gets the highest value of the dollar, that money was infused into the system, or spent or invested by the big banks and it in effect doubled the money supply in America during that time period, and it caused a doubling of prices. You know you double the money on the monopoly table, you're going to double the prices of everything and that is what happened in the six years following WWI, the cost of goods doubled. All right? And it is no more complex than an individual who gets a big line of credit, it's party on, early on, and later on the hangover comes when you got to pay it down. And if you look at, go ahead -

A lot of people really misunderstand and it's mis-taught in our schools how the depression came into being and what basically happened during the 1920's and everybody knows about the irrational behavior of the people involved, but very few people know of what really ginned up that behavior that enabled it to happen. If you think about it, when people get all this hot money in their hands, they see it circulating around, they see everybody else is starting to earn more money and earn more money, they don't understand that all that new money when it's being printed out of thin air, when it's basically just being ginned up money supply wise, they don't fathom that really it doesn't represent growth in the economy or a growing economy rather it represents a fractionalization of the economy. So what people start doing is operating as if this is something that is going to continue indefinitely, and really the big problem is it's tied to the spigot being open. And all you have to do is begin tightening that spigot, or money supply, tightening credit availability, raising interest rates, doing those things that we often hear talked about in the media, the financial media. Those things will in effect, slow down an economy and cause the spigot to be tightened, and suddenly a lot of people who were expecting that to continue or believed it was actual genuine growth, suddenly wake up to realize the next day that it was just an illusion. It wasn't real, genuine growth, it wasn't organic. When you, you know, a business person who goes out there and bakes up you know, quarry marble, or whatever the heck it is they do and produce or they offer in terms of a service actually does something; and that service is exchanged for currency, for dollars in the U.S. and they expect that that currency is worth that basically, that whatever service they're providing or good they're providing in exchange, and they don't think that, well if you compare that to what you're really doing when you're just printing money, you're not doing anything for that. And that money out there is competing for goods, they're, you're using that same money it's printed out of thin air, nobody did anything to create, and you're then acquiring that person's bread or that quarry person's marble or whatever it is they put all that effort into. And you're basically getting it in effect for free if you're basically printing the money yourself. That's why it's illegal for counterfeiters, but for some reason through the banking system they've legitimized this all for the purpose of growth, and the reality, it's not very genuine growth. And probably the dirtiest secret, and we're seeing this right now relative to the housing bubble is that as that money begins slowing down suddenly, no longer can you keep prices rising as they have been, and that's happening with the housing because mortgage rates started rising, and frankly they didn't even have to rise, they just had to stop going down further. Because there's a point at which, all but purchasing activity will take place at that new level. If you can't drive interest rates any lower on mortgages, you can't make monthly payments smaller and enable them to fit more house into their monthly payment, especially when you're in an environment like we've had over the last 10 years, where generally incomes have been stagnating. But, you're kind of getting of on tangents there, but they are some good points Stephan.

Stephan: Yes, and that's what we face right now. And, the key is, will Americans bide on [...] if they're savings have hit that negative 1 percent, will Americans bide on another rate of, a round of borrowing? And demographics tell us, and Japan tells us if we look at that example they lead us by 15 years, that maybe they [won't] And in the end, you know, our economy is nothing but, now 3 hundred million individuals, and you know, it's just a combination of all the behavior, but you know, when the average baby boomer has 50 thousand in savings, and the average savings rate is minus 1 percent, from plus 10, when the biggest age group in our country is pushing 50, okay, to a reasonable man let's say, it doesn't seem like they're going to go any further into debt. But, that is the wild card, that's the wild card, it's something that everybody should pay a ton of attention to and not get caught up in the "euphoria" of an index made up of 30 companies hitting a new high, but really not a new high if you adjust back for an inflation of over 5 years, wow other major indexes [...] are far, far away from their past high, especially if you adjust [...] for inflation.

Absolutely, well that's what, when you get, what we've had over the past couple of years, and this has been something we've been talking about pretty much regularly on the Vigilant Investor website, the daily journal which you can subscribe to if you want to, we have a RSS feed, you can use your aggregator, whether it's myyahoo.com or blog lines any number of them, the NewsGator, get our daily feed, or you can just subscribe with your e-mail if you want too. But our objective there is to help people connect the dots on these kinds of subjects. Because you don't hear a lot of this discussion out there and really it is a sub theme that's been going on for a while and yet, the superficial of what goes on in the economy, all the excitement over the Dow, I mean heck I watched MSNBC a good bit of today and, every, the whole discussion is over the Dow's new high and, the media likes to drive this, it's the financial news media, it's looking for a story, it's looking for excitement, and you know, they're interviewing a number of people and the interesting thing is that the average Joe on the street is very excited about the Dow hitting it's supposable, it's nominal new high, not a real new high, a nominal new high, and a lot of the traders seem a little bit indifferent to it that they were talking to, they just sort of said it's just another mark out there. Probably because it's you know, they perfectly are aware that it's not a new high at all. In order to get a new high you need to get the Dow closer to 14,000 where you adjust for CPI. And as we know from the discussion with John Williams last week, we recommend you also tune into that show, you can download that Podcast at your convenience, we are Talk Shoe portion of the web site, on Talk Shoe, the Vigilant Investor portion, where CPI probably is running closer to 9 or 10 percent if you were to calculate it as it's original intended purpose, which was to be a stagnant basket of goods that just reflects the cost of prices in that basket of goods, they monkied with it so much that it just no longer does that it turns out to be closer to 4 percent rather than what it really is. And if we were also to take a look at something like GDP, which has a deflator to it relative to CPI, when you understate CPI, you overstate GDP, and of course they monkey with that number as well, and that's something that goes back apparently to the days of, excuse me Lyndon Johnson where they, where Johnson would literally say, "you know, this doesn't look good on the numbers, you know make it look a little bit better," for political reasons and I know he was doing it with a budget, not entirely sure if it was GDP but definitely with the overall, you know the fiscal deficits and budgets and so forth just to make sure everything looked good. So there's politicization going on there with those numbers, including unemployment. Unemployment is running closer to 12 percent verses the official 4.6, which they just announced last week. And, you know, the average person on the street on one hand gets excited about seeing the Dow going up because it's been ingrained in them that that means the economy is doing well. But on the back side of it they also know, at least if you're not tied into the financial community which is a huge beneficiary of the inflation aside of things, because I'll tell you what, if you're in the investment banking world and you've had access to a lot of credit and capital, you're the ones that are making the high bonuses. I think the average Morgan Stanley person I just saw, last past couple of days, are making 300 grand a year on Wall Street, which is you know, pretty darn good salary there. And, well of course you can pay it if you're in the business of being very closely tied to the printing of money and credit and debt all that kind of stuff. But, in any event [...]

Stephan: it's important to understand, and it's important to understand the [...] I think that the average person under-, feels in his gut that the true inflation figures are higher. And again inflation being expanding of the money supply resulting in rising prices. I found an interesting article today, you know, all over the Internet, Social Security benefits this year will be increased, monthly benefits, 3.3 percent for inflation. And if you really think about what inflation is, the increasing of the money supply, that is the hidden and most unfair tax. So over the last year and a half roughly, the money supply has increased at an annual pace at about 10 percent. So, if you got an increase on your Social Security of plus 3, and the real inflation figure is minus 10, you just lost 7 percent of your purchasing power from your monthly benefit that you got last year, if you're collecting on Social Security. That's massive. Go ahead...

Oh it is, no doubt.

Stephan: It's massive, and it is utterly hidden and an unfair tax. And the average person just, they feel it, but they can't wrap their brains around it and they can't understand it. It's a crime actually to do that to people. But again, as we have discussed before on prior shows, the reason that inflation is rigged, one of the major reasons that it is rigged [...], is that if it was calculated like it was in the 1970's Social Security benefits would be 70 percent higher per month than they are right now today.

True, true. Well, you know what, I just got word here that we're going to not be able to have G. Edward Griffin on today, so we do apologize for that unfortunately, so we'll be rescheduling that as soon as we get word as a time that we can do that. But we'll continue with the show as we're going here, but we do apologize for that. So, if you do have questions though you can call in and enter our discussion via talkshoe.com, the number is (724) 444-7444, our talkcast id is 982 and when you dial in they're going to ask you for a pin number, if you have your own pin number you can just punch it in at that point, otherwise you can use one of our show pins which is 222-333-4444 or that's 222-333-4444 and other pin number that we use is 333-444-5555 so either of those pins will get you in and dial on in. Also, we have the Talk Shoe IM instant messenger or interface, whatever you want to call it, but we have in the past and we have a few people on there that are listening but they're not necessarily chatting. But, we see users that log in through the Talk Shoe interface, and people can chat, carry on conversations there. And, oftentimes we can, if you wan to ask a question through that system you can do that, if you want to chat among other people and carry on a conversation about what you're listening to you can do it through the service as well. So, we encourage you to do that and again, you're listening to right now, I'm Johannes Ernharth and Stephan Ernharth is also on here as well. But, as far as...oh, go ahead Stephan...

Stephan: In essence again, Johannes just mentioned that Mr. Griffin was unable to, we were unable to get him through today, and he will be coming on at another date. But, it's important to mention the book that he had written, The Creature From Jekyll Island, because it is what I think, one of the best exposes on the Federal Reserve System and what the Federal Reserve bank really is, which is nothing but a cartel of private banks granted special privileges by Congress and really one of the privileges is to create money out of thin air for the use of the government and to get paid to do so. And that is the reason that the dollar as we discussed before has lost 98 percent of it's purchasing power since the Federal Reserve was created. Yet, it held from1914 to [1780?] the dollar held steady, take your 20-dollar bill so to speak and get your ounce of gold. Today gold sells for what, 590 plus. And when you look at, when you think about that, and the importance of that you see articles on the Internet, MSN and what have you, the latest benchmark means little psychologically, but one analyst calls the first step to Dow 20,000. Johannes, what do you think? What do you think about the possibility of Dow 20,000?

Well I think that you know, anything is possible relative to inflation. And, one of the things we're experiencing right now is a fine balance between the faith in the dollar, and the reality is once you got off a dollar that is backed by anything and you have a currency that is purely fiat and one that if fraction reserve related. One thing that typically happens historically is that you get a lot of inflation coming out of the process. And we've been very fortunate over the last 10, 15 years, Stephan was talking earlier about how a lot of, you know the elderly people who are depending on Social Security for their income were expecting to get a cost of living raise and that raise, what was the percentage Stephan, 3.4 percent for this year?

Stephan: 3.3

3.3 percent, that's your raise for Social Security, your cost of living. And real inflation is running at 9 percent, we said earlier and again if you want to engage in a real discussion on what real inflation is relative to CPI, we recommend listening to the John Williams interview last week, that's available for download. But, the issue is that, what people don't understand about inflation is that it does not cut through everything evenly. And, you know, you look at different prices, some things go up, some things go down at the same time. And, you know, one of the core things about inflation in the United States is that if floats through the credit system. So, we look at different areas where inflation has been hitting hard recently, well definitely housing has, but with mortgages, that's a credit related issue and that was directly tied to the rapid drop of interest rates and so forth. But you also look at things like education, people wonder why college costs, a lot of people come to us through our firm, to ask you know, why the heck are college costs going up 14 percent this year? Or, you look at every year in Newsweek that it's annual report as to what's happening and boy we got a good year it only went up 9 percent last year. Well, that's because it's coming through the credit system and when you have below market rate loans, a lot of people take advantage of them and when anybody can get a loan and the money supply is getting increased, well people are paying that much for college because they can. It's going up 14 percent, because that's where the money supply is going. And then it gets injected into the economy. Now, again as I was alluding to, or began saying earlier, we've been massive beneficiaries of the trade deficit over the last 15 years, and that may sound like, a bit of sacrilege to a lot of people if you're just new to the subject matter, but they think of the trade deficit, people think it's costing us manufacturing jobs, well yeah, most certainly it is costing us manufacturing jobs but we need to think about why it is costing us manufacturing jobs. Well, largely it is related to the money supply increasing, and it's also related to other things, I mean you look a the business climate in the United States has become so darn complex, regulated, over-regulated, overtaxed. When it is taxed, it's so complicated it's scary. Part of what we do is we help people do basic IRA work and those things get, you know, Stephan you remember we were doing a few years back, back in the mid 90's we were teaching the Allan County Bar Association about IRA distribution rules, and you want to talk about not just arbitrary but punitively just complex. And, some 72-year-old is supposed to deal with this, well, that kind of stuff is business environment, is the same way. So you end up losing a lot of jobs that way just because it's much easier to do business believe it or not in communist China. But, back to my point about inflation, is that as prices, if we did not have the ability to do trade with China and other emerging markets that are supplying us with these really cheap goods we would have seen the prices in U.S. go through the roof because all that money supply that was being ginned up in the United States would have been forced to reverberate throughout the U.S, and we would have seen prices go through the roof. Instead what happened is U.S. consumers having the choice, thanks a lot largely to the trade liberalization that happened during the 90's and the 80's, had more of an opportunity to go out and buy things manufactured elsewhere. So, instead of having higher prices, for, especially things related to technology, the prices started going down. So, we know we get a much faster computer or a much cheaper, you know, big screen TV and so forth. But, on the other hand, you still have prices going up in other areas and we've seen again, as I was mentioning before, education, but healthcare is another area where first order type goods and services, things that people absolutely positively need, they'll throw that money there first and foremost, health care is one of those areas that is really being driven up because people will pay anything to live. And, you know of course part of that is also the socialization factor where you have a lot of people who are paying, picking up the freight for people who don't pay. And we have you know, as things get socialized, you get more and more payers paying more and few of them can afford to pay [...] falling off and -

Stephan: you're keeping in the spirit of the intended interview, which we will have later, you know, with Edward Griffin on The Creature from Jekyll Island, the expose on the Fed. It's important to keeping with that spirit, you know, we, you can't, ultimately the bill comes due, okay? And ultimately, you know this hidden tax, now at a rate of 10 percent is paid by every American at an annualized rate, that's [...] the increase of the money supply, and that's why the Fed has stopped tracking the total money supply or M3, because they don't want it to be that publicized. And, a couple of comments about the Fed. You know, there were people that fought - the history of this country and Mr. Griffin talks about it in his book, is one of certain individuals fighting central banks because not only were foreign interests involved, it gave to de-peg a currency from gold is horrible. And if you look at, you know, some of us who are you know, maybe not 22 years old remember a fellow, a famous senator named Henry Cabot Lodge, but in 1913, when the Federal Reserve was actually being debated, he basically stated, and this is a quote, "the act as it stands seems to me to open the way to a vast inflation of the currency, I do not like to think that any law can be passed that would make it possible to submerge the gold standard in a flood of irredeemable paper currency," and he was right. Up to that point, every dollar was backed by gold. And your 20 bucks got you your ounce of gold. All the way back to 1780ish. And since that time the dollar has shriveled to 3 cents, okay? And our debt as a percentage of GDP makes the depression look, that level look relatively low, and our government has two choices that you had mentioned in a prior show, the study on the St. Louis Fed that stated you know, is the United States bankrupt? Their economists wrote that study. And in a nutshell he said in about 20 years we're going to have a 65 trillion dollar spending shortfall if we don't do one of two things, and that is cut all benefits by two-thirds and that includes Social Security and Medicare etc.. immediately, or to double the tax rate immediately. Two things politicians never do, okay? So, what you're going to see is the steady inflation has totally eroded the dollar over the last 100 years, it is accelerating now, okay? And if you can imagine that's going to get worse. And this is simply done by our government to boil it down to it's basics. When our government, or our congress is short 25 billion or 50 billion or whatever they need for a Chrysler bail out, or First Pennsylvania Bank bail out or Penn Central Railroad bailout, and they can't find somebody perhaps foreigners who own a ton of our debt to buy the bonds so they can raise the money. The Federal Reserve Bank in effect buys those bonds, but what they do, is they stroke the check out of thin air. And if you don't think that's true, so basically that money is just created through a mechanism which Mr. Griffin summarizes as the Mandrake Magician Mechanism, but in effect that money is created out of thin air. Checks written out of thin air. And if you don't believe it, this is a quote from the Boston Federal Reserve Bank from an article, Putting it Simply, and it states, "when you or I write a check there must be sufficient funds in an account to cover the check, but when the Federal Reserve writes a check, there is no bank deposit on which that check is drawn. When the Federal Reserve writes a check it is creating money," Okay? And that is an admission, if you listen carefully to the Fed at times you get these admissions of truth. But basically that is the fact and that is how money is created. And, what Mr. Griffin writes in his book too, and it's hard for everybody to get their noodle around it, but in effect, without any debt, once off the gold standard without any debt, there is no money in the United States of America.

That's [...] to understand, but what basically happens out there is that the Federal Reserve is lending money, it's a private banking system, a private cartel of banks that lends money into circulation and in effect the U.S. tax payer, the U.S. citizen is forever required to pay interest on that either through government interest or directly through debt that they borrow through the banking system. It's kind of, you know, it's almost futilistic, that sounds kind of conspiratorial but functionally, that is what is going on. And it's you know heck, a lot of people would shake their head when they hear that but that's the truth of the matter and people just aren't just taught about it.

Stephan: Well yeah, and we are not taught, and we're sort of miseducated, but again this is the former secretary of the British Treasury, [...] .states and I quote, "banks lend by creating credit, they create the means of payment out of nothing," and in effect you're creating digits, okay? And one bank, you know, your bank is able to, you make a deposit of 10 million in your bank, your bank tomorrow can lend 90 percent of that out. And whoever borrow that deposits it in their bank and their bank can lend 90 percent of that out the next day. So in effect, money in effect is being created out of thin air, chiefly, originally coming out of government debt. And if everybody paid all their debts off, every cent of it there would be no money today in this country. And that is something that is hard for people to wrap their brains around.

Let's try to bring this into more real terms, because that is a little esoteric but let's talk about maybe how that ends up effecting people in the end game. And I think that, you know while that functionally is what's going on, and you know I think that understanding how the Fed came into existence and all of that and some of the things that went on behind the scenes with the J.P. Morgans of the world, very interesting. And again, hopefully we'll be talking too Mr. Griffin about that in the future. But, when we take a look at the current environment, you know the current market environment on Wall Street, the environment related to the big, major investment banking firms, your Goldman Sachs, your Morgan Stanleys of the world, and even you know a lot of people who work for the federal reserve and so forth, a lot of people who are part of that system are even oblivious to exactly the origins of that, and it least in a way that, you know boy, I'll tell you what, it's worked for so long that you know, without a huge number of problems; and I'll tell you that every school of business, every economics class, most every economics class in the United States, boy from day one you're indoctrinated with, maybe indoctrinated sounds like a strong word, but you know your given the Samuelson, which is the standard textbook of economics in the United States and it was when I in college, and it's my understanding that still most people start off with that, very little discussion of the Federal Reserve, or the use of credit and the money supply issue outside the context of basically the conventional wisdom, you don't get any Austrian economics put in there, you don't get Mesus credit theory, critiques about ginning the credit supply and bringing up the other side and you certainly don't get any Roth Marding analysis or anything along the lines of Mr. Griffin's you know, critiques of functionally why it's so harmful. But the bottom line is Wall Street basically has a lot of people you know, out there who work on Wall Street, who are basically schooled to do things a certain way on one level, and number two they're like anybody else, they want to get paid for the job they do and they know they can make a good living doing it and, you know, Stephan, you and I see a lot of this in our own industry, most people who are out there in the retail side mostly are sales people who are taking information they're getting from Wall Street, you know, verbatim and just basically regurgitating it out to their client base, and you know, if you take a look at most of the major wire houses, the major fund houses, the bottom line is that they're looking at being profitable at the end of the year. They're not in there digging around and critiquing you know, the functioning and the basics of the banking system, does it make sense, you know, it works, number one. And number two it bring in the billions of dollars a year, huge profits and if that's what it takes, so be it. And everybody kind of operates, you know without really questioning the environment. So, you know, it may sound as if we're trying to pin a lot of people as being some sort of insidious you know, group of people behind the scenes, you know running this, you know all through Wall Street. But really, a lot of people just kind of go along and go with the flow, and really have never really been, you know, even would know why they should question how the system functions. So, you have a lot of that going on, and you know, I thought it was interesting I came across a quote earlier today Stephan from Paul Volker and something I'd seen before and you may have well seen it as well, but I thought I'd read it. This is from Paul Volker, Paul Volker was the former Federal Reserve Chairman, he was the Fed Chair in the late 70's, early 80's, amid the hyper-inflationary environment then, when boy, things were just going through the roof for a lot of bad reasons, and largely inflationary reasons and largely because the U.S. had gone off of the gold standard and basically defaulted on the U.S. dollar and basically told the rest of the world saying central banks were no longer going to exchange dollars for gold which was the original agreement. And when that happened you started getting everything out of whack and then Nixon decided price controls, Carter decided price controls and then the whole system started breaking down. Paul Volker helped fix that with some of the policies that he engineered through the Federal Reserve, but a lot of that basically temporarily staved things off. But even with that in mind, one of his critiques and one of our critiques in our system is that everybody is just too complacent and it's along the lines of what I was just saying about Wall Street where everything just kind of goes along, it's working, it ain't broke, why go fix it and why even question it because you know if 2000, 2002 is as bad as it's going to get, you know what's the big deal and yeah, you know a lot of people tell you maybe if this was 1985 and we looked at the debt levels and the amount of credit out there and the debt to GDP ratio, there's all these different things that are very alarming, or might have been very alarming back then and would have scared the pants off of most people to think that such an environment could actually exist. Well a lot of people today will say well the system's just different, they can handle that, how it's not a big deal anymore. And you know, meanwhile on the fringes are such, you know, people like Bill Gross, and Bill Gross runs PIMCO Investments, which is one of the world's largest bond managers in itself; Bill himself runs the largest bond fund in the United States, but, this is a guy who basically is saying, "where in the heck are the responsible bond managers out there?" It used to be the bond market would see bologna and say, "hey, that's a load of B.S. there, we're not going to tolerate this and demand fiscal restraint, fiscal responsibility," and he's been complaining for 4 years now, 5 years and you know, where the heck is this? He's also said recently that he believes that this is the last bond rally, we better start expecting interest rates to start climbing over the next decade but, that's an aside. But back to my Paul Volker quote, because even then he was getting concerned about the complacency out there and this is just his quote, "in some to remind central banker's themselves of what they are want to warn others about excessive zeal and confidence, among other things I found myself reminding my fellow [...] that history has provided little support for the simple proposition that the creation of a central bank in and of itself would provide much assurance against inflation, nor was there much evidence that we could look out towards any simple rule book to determine when to ease or when to tighten, any unknowns could only multiply in less developed economies with poor functioning economies." Again this is a formal Fed governor, one of the most responsible we know, the hero if you will, Paul Volker, "we sometimes forget," he continues, "that central banking as we know it today is in fact largely an invention of the past one hundred years or so, even though a few central banks can trace their ancestry back to the early 19th Century or before. It is a sobering fact that the prominence of Central Banks in this century has coincided with the general tendency towards more inflation, not less." Now, keep in mind that long time central banks have been sold to the public and to Congress and whoever else that it would be a good steward of the dollar and protect the citizens, but I digress, I'll continue with Paul Volker here, "by and large, if the overriding objective is price stability, we did better with the 19th Century gold standard, and passive central banks with currency boards, or even free banking. The truly unique power of a central bank after all, is the power to create money and ultimately the power to create, is the power to destroy." Writing at a time when central banking is at a pinnacle of influence and respect, the tone of questioning and even skepticism that pervades much of the book is surely justified. I guess I'm getting off on a different area there but he goes on, "we are reminded again and again that central banks are human institutions with all the limitations of understanding and a foresight which that implies." It's just important to understand that. And I think that, you know when you have Paul Volker himself saying that kind of thing -

Stephan: Paul Volker in the 70's, he was hung in effigy in Washington, D.C., literally hung in effigy because of his tight fiscal policies trying to get some semblance of a reasonableness back in the system and part of that was raising interest rates, Johannes, dramatically.

Yeah.

Stephan: And I think, the [...] points you make also is that we are extremely poorly educated in this country and I do believe that when it really comes to true history and what's going on out there. And people are taught forms of economics that are extremely benign, but you know when you really get to understand what's going on out there, it can actually get you concerned or riled up. You know Henry Ford, what is it, I think the Ford quote is, "it is law that the people of the nation do not understand of banking and monetary systems, for if they did I believe they're be a revolution before tomorrow morning." And that's Henry Ford. And -

Yeah, the corollary to that though is that at the same time, and I think that you know, while your point that Paul Volker was hung in effigy speaks volumes too about the lack of understanding among the population. And we were talking before about you know the deficits in this country and the fact that we're running, you know the Federal reserve had that report done by Kotlikoff, who said, you know, "cut all the benefits by, you know two-thirds or double taxes." And that's not just politically viable. The people don't, they want I both, they want their cake and they want to eat it too. And that's the interesting dilemma that we find ourselves in because if Paul Volker does the right thing and he's hung in effigy, these days politicians are even more willing to sacrifice common sense or good sense to the whims of you know winning the next election. It seems like they'll pretty much say anything and that it's getting you know awful, granted that's the history of politics largely. But, will a politician go out and demand that a Paul Volker do something like this, or will he actually be in front of the line to hang the next Paul Volker in effigy if that's needed? Now, I think also the environment that Paul Volker inherited in 1979 or 78 when he became the Fed governor is completely different, our balance sheet is a lot worse, our benefit situation is so much more bloated, the obligations we have are massive, our deficits are just not only just massive and hitting new records all the time, we're entirely dependent on them. We just can't you know close the borders to trade deficit and say you know, we'll just have to buy American, that will grind the economy to a halt immediately.

Stephan: Well, Johannes though you're answering your own question, or I should say, what do you think the answer is? Politicians are the half of it, yeah, they cannot, they loathe to raise taxes by a hundred percent, they loathe to cut benefits by two-thirds, simply because people want [...] Interesting about what is going on in Argentina, people refuse, the citizens of the country, and that the same case here, refuse to really suck it up in the end. And I think the answer is going to be, the inevitable trend is going to be the inflation card.

Well, we're running out of time here, and I think that leads us right back where we kind of were last week a little bit with you know one of my favorite quotes out there which is from H.L. Mankin, which is, you know, "democracy is the theory that the people deserve to get what they want and good and hard," and that is what we're going to see unfolding over the next 10 and 15 years as our economy, our environment our culture, the whole United states and even you know the Western world, I mean Europe is facing similar problems, albeit a bit differently, Japan similar issues, you know what are we going to do as people to respond to these sorts of problems? I think that, you know, collectively, frankly given the trends we've seen and the, you know, you look at history when the mob decides to make decisions they usually aren't good ones and that is one of our core themes here at Vigilant Investor folks, which is you've got to think for yourself, number one, number two, you better be making sure you're not just taking the information as it's being plopped out there from MSNBC because it's getting there, it's pretty ripe as it stands and you're going to be reacting to the events and we encourage all of our listeners and all of our readers and your friends and so forth to start digging through this information because you know we're pretty confident that things are not healthy. And you know if you read enough of the information on our web site and a lot of the links we provide help you connect the dots as to why we believe that. You'll probably come to a similar conclusion that at bare minimum you should have your finger on the pulse a lot more than you do today. And you certainly should not be on the auto pilot that a lot of Wall Street recommends and a lot of the economists, Fed, Washington tells you, "oh, don't worry about it, we'll take care of it, you know," you better be in the driver's seat folks. So, those are my 2 cents. Any closing comments Stephan on your side?

Stephan: I think that's well said.

Alright, well, again this is Johannes Ernharth and my co-host Stephan Ernharth over yonder. This is Vigilant Investor, live radio show on the net via talkshoe.com. You can reach us every Wednesday evening, 9PM. We are live, you can call in, do all sorts of fun things, ask us questions. We didn't get any today, unfortunately we had a few people tune in and drop off when Ed didn't show up but, we promise you we'll work diligently to get that rescheduled and not have that happen again. And in the meantime, tune in next week, 9PM, we are going to have an interesting guest, I thought long and hard about having him on. His name is Casey Serin, he is famous for, or I should say infamous for his website iamfacingforeclosure.com. This is the kid I talked about last week who unfortunately managed to get 2.5 millions of loans and bought 8 properties with various loans and pulled it off largely by fudging his information on his mortgage applications. But, bottom line is, we're going to chat with him to get a feel for how was it that a 24 year old without a whole lot of income and you know, really not a whole lot of evidence to justify, managed to get 2.5 million dollars and purchase 8 homes with the intention of flipping them as he had learned in a real estate get rich kind of seminar. Those ads are still out there folks. So, anyway tune in next week, we'll talk to you then.

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