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Posted On: 2006-11-21
Length: 1:02:06

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Yes, yes, yes, yes this is yet another edition of the Vigilant Investor, it's our special holiday episode. We are Tuesday evening here, instead of our usual Wednesday evening, and that's our bumper music, which is Devo, incase you're wondering who that might be for those more music inclined and less economic and finance oriented. We were just listening to a little Meet the Press interview with, oh boy, you know the new Changing Congress and everything's going to be different now that the Democrats are in charge. And I think that you know of all the things that happened over the past week, I was actually surprised that Bill Clinton of all people actually made a point to the Democrat party that don't, they should not misinterpret this past election as some sort of referendum [...] them and as much as it was a rejection of the existing structure, the existing Republicans but they're Congress and so forth. But interesting stuff, you know again, I'm getting ahead of myself. This is Johannes Ernharth, Vigilant Investor, and vigilantinvestor.com is where you'll find our day to day journal activity. Lot's of great information there the past week, lots of things have been going on in the economy and so forth. And you can also listen to us live on Talk Shoe every Wednesday night usually, tonight's Tuesday episode is a little bit different and we have a holiday coming up here on Wednesday, a lot of people are traveling and moving around, and getting hunkered down for the holidays, so the last thing I suspect a lot of people want to do tomorrow evening is listen to this live. And maybe this enables people to have this Podcast for their drives tomorrow on their travels. So, hopefully that comes in handy. But if you still are out there looking to participate in the show tonight we are taking calls all evening. We'll have a live chat at talkshoe.com, make sure you get there and download the Talk Shoe interface so that you can participate. The phone number if you want to dial on in is (724) 444 - 7444, that's (724) 444 - 7444 lots of fours there. When you get there, they're going to ask you for a Talk Shoe id., ours for Vigilant Investor live is 982, and you need to have a 10 digit PIN to get through beyond that because it is a party line environment, so we're taking more callers than just one at a time, which is always nice, you get a conversation going on at times and people can debate. But, we have a couple of prefabs there if you haven't had a chance to register, but we're going to bounce you out after one question, so the prefab PIN number that we recommend you use is 222-333-4444, that's 222-333-4444. So join on in and be part of the conversation and we'll be opening those lines not too long from now. So, get in there and visit talkshoe.com, download the chat interface as well, a lot of people are talking in the background during our shows and you know, if we have interviews and so forth, like we did last week with Doug Wakefield that were prerecorded, it's nice to have a conversation going on where everybody can participate and chat away. So, anyway, so let's get down to business here. The week has been interesting, we had, boy last week it seemed like oil was going to break down and hit new lows and everybody was excited and all the I told you sos were coming out about how the inflation worries were crazy and especially, there was a big report that was trying to debunk the whole peak oil thing and I see my co-host Stephan Ernharth is out there, Stephan are you available?

Stephan: I'm available...

Hey, there you are, all right. But feel free of course as always to chime in when you see fit. But oil today back up over 60 bucks. They had this report last week that peak oil is a myth and everybody's been saying how oil, when it was getting close to 80 dollars it was ridiculous a lot of people were saying it would get down to the 40's or back down to the 30's and here we are right back up into the 60's again, and post election as we suggested, it might happen, you get the election thing happening and a lot of times you just don't understand why, but boy the markets sometimes really kind of help things around, usually around elections and coincidentally also for that 1,231 closing figure a lot of bonuses are based on 1,231 so it never hurts to have a nice record at the year end. So that was interesting news today, oil right back up, not surprising from our standpoint, but I think a lot of the analysts out there were taken aback because why on Earth would oil be getting up like it has been. And Google today also I think if anything is an indicator crossed over the 500 dollar threshold. Google, the modern day marvel of technology and so forth is very high PE ratio compared to a lot of stocks out there. But it's chugging along and I think that a lot of people are just believing that Google will continue to redefine at 5 dollars a share and God bless it if that's what you want to do, but we think that there's a lot of signs out there that tell us that this market is getting a little bit crazy especially on the complacency side of things. The V-I-X, VIX, which is traded on the Chicago options is a volatility index that you can basically buy into, it's a way that a lot of people who want to insure themselves against volatility, they actually can buy these futures and what happens is people who are selling them will basically have to make good if they are wrong and people who are buying them are basically you know, keeping themselves in good shape and so forth. But, the idea here is that, you know, typically it's an indicator of just how much volatility people are expecting, the cheaper the price is for the VIX. VIX today hit a 13 year low, below 10 dollars, telling us a lot of people are really just completely indifferent to any risk that might be identified or for that matter just very confident that any risks that are out there either don't exist entirely or really obviously don't matter anymore because boy, you know the stock market has been going up the S&P has been going up the Dow has been going up hitting these, not real new highs, but nominal new highs of course when we adjust for inflation and they're still well below their 2000 high points and especially when you adjust for things like oil or you adjust them against gold. I mean you can get, with the Dow today you get about half as much gold as you could get in 2000. So there's been some substantial adjustments there when you measure it against other hard assets that can't be printed out of thin air or for that matter a CPI indicator that is functionally understated and a lot of political reasons for that but really it's understated point blank, we'll say it. Go check out vigilantinvestor.com if you want the details, we're not going to get into it tonight. I encourage you to listen to the John Williams interview we did several weeks ago, you can find that at our Talk Shoe link, our Podcast link on the left side of the Vigilant Investor menu there. So, definitely check that out. But, a big thing that I wanted to talk about today, and again make sure you call on in and hop on the talkcast IM chat center there to get your questions on our docket as well. But the big thing I want to hit today was real estate. Looking at just what's been going on, boy a lot of changes there in the last couple of weeks. And I think that real estate is one of those things that I think a lot of people have dramatically underestimated. You know, at least the consensus has. Now we, now Stephan, how long have we been warning about the real estate bubble, the housing bubble?

Stephan: Several years, more than several years.

Yeah it's been a while, and the logic from our standpoint being of the Austrian School of economics, having a background in that and just you know, looking at fundamentals and largely common sense as well, I mean that's the nice thing about the Austrian school is you don't need a lot of fancy formulas to come up with the logic behind why things happen. But the bottom line is interest rates have been driven so low the environment, the financial community has been so awash with new money supply that it has vented around, circulated through the trade deficit that's come back to us in the form of lending from foreign governments at 50 year low interest rates and all that flooded into the mortgage market and really did a heck of a lot to boost up the housing market, the monthly payment, that comes right down to the monthly payment what an average person can afford and creative ways of enabling that to happen. But, boy just last week, or last month, Alan Greenspan was even out there talking about how you know, some little blip up in the September data, which actually turns out to be somewhat of a [...] indication that was a glitch in the data, but a lot of people were jumping all over that last month saying, you know it looks like this thing is bottoming out, we don't have to worry about housing hitting too hard. Well, here we have a 15 percent plunge in October starts and if anything can dispel the misimpression that we're dealing with something that's just going down moderately or a very slight. It's got to be that, I mean a newly initiated residential construction activity has been falling to more than a 6 year low. This isn't just a slow down, you know the critical point to keep in mind here is that this data only represents the first phase of commitment to building project. In other words, what we're talking about here is that housing starts is just the beginning of things happening. There's a lot of activity going on out there, these construction companies are building, all your builders are out there working but you know there's an empty pipeline developing here. So a lot of activity that's been going on is set to start wrapping up over the next 6 months, 6 months to 8 months as those houses start getting wrapped up with a lack of housing starts going on they're really going to see a decline, and people who are employed, given how many people have been drawn into the housing boom over the past couple of years I think they said somewhere from, depending on whose estimates you looked at, anywhere from 20 to 40 percent of new jobs created since 2001 were in housing. And that reversal is really going to have a dramatic, a dramatic effect we think on where the economy is going to go and it's already beginning to take its toll in some ways, we'll touch on. But anyway, the consensus continues to argue about you know this 14 percent decline in housing starts from September, you know this is the lowest activity again in 6 years. The lowest number of building permits in the last 9 years, there's telling us this is going to solve the backlog, in other words restore balance to the market because there's an over supply, there's a glut of housing right now. And you know, after we get through that boy, everything is going to get back to normal. But that really, really, really just you know is based on comparisons to historical averages in prior real estate downturns. And you know if you try to compare this current mania that's been going on, and this thing started in 1996 and it's continued on steadily and especially the accelerator was pressed down aggressively in 2001 with the Federal Reserve further flooding the economy with more money supply trying to keep that recession from going too deep. You know you try to compare this housing bubble and this boom to any prior real estate boom it's just nuts. I mean a variety of factors have built up and combined to create market conditions today that have just never existed before. And that's the crazy thing, it's what we talk about all the time at Vigilant Investor, is that you know you look at any of these things on the surface value, look at them in little vacuums here and there, you're going to say to yourself, what's the big deal, housing has come down, housing has come down before. A lot of people have told me, you know I've heard about housing bubbles back in the 70's, I heard about them in the 80's, you know they go up, they come down a little bit but you know you don't have to worry about it. But, we're dealing with all sorts of factors today that go, that are just, put this in the stratosphere compared to prior bubbles. We had the widespread elimination of lending standards and down payments and document loans and all that kind of stuff, we talked to that fellow from iamfacingforeclosure.com a few weeks back, about a month ago, you can listen to that interview. You know, lending standards were down, this kid never, he's 24 years old, 2.4 million dollars lent to him, never had his income verified, never had his residence verified, basically it was just the elimination of lending standards. I mean the 24-year-old got 2.4 million over 8 properties in 4 states. Now he's basically facing foreclosure on the majority of them, I think he, last I checked he had 5 that were upside down and rapidly crashing and burning and this kid still believes that if he just simply restructured things a little bit he could have done things better if he hadn't been so aggressive and he actually thinks that with the right guidance as a 24 year old, you know all by himself, he could be investing if he started today, he'd be happy to start investing into this market in its decline. It just shows you how crazy things have been. But you know you've got the rampant proliferation of speculation, I mean that's basically what we're talking about here, this 24 year old still thinks, his name is Casey Serin, that if he got into the market today he could still make money even though the market, the bottom is starting to fall out of this thing. We have all sorts of leverage, we've got overbuilding, the real kicker is the creative financing, the re-financing, we have all sorts of exotic equity extractions from homes. Great Britain just introduced a 125 percent mortgage to help people afford, getting around with housing over there. 125 percent mortgage, I mean in other words you're taking out not just a full mortgage you're taking out 125 percent of the value of the home. Talk about nuts. But that's going on in Great Britain and it wouldn't surprise me to see that here in you know in a few months to try to help solve the inflating asset bubble that is the housing bubble here in the U.S. But, teaser rates have bitten a lot of people, we have adjustable rate mortgages, negative amortizing loans that has been further exasperated by, they're starting to find that a lot of appraisals were phony and people were just trying to build these properties up and flip them and the appraisals themselves weren't even real. This is the kind of stuff that goes on, not in a normal adjustment on a climbing housing market that's been over heated a little bit. This is a full-fledged mania, ladies and gentlemen, this is just not, not normal. I mean you're experiencing phony appraisals, outright mortgage fraud going on, I mean even the iamfacingforeclosure.com kid, he was, you know he was fraudulently answering questions on his mortgage applications. He said he was living in each of these homes when he took a mortgage out which is, you know, he's not supposed to say that, that's a fraudulent answer on a loan application. So, but did they even bother to check? No, they were too busy shoveling the money out the door. And all this money drove prices up and now home prices today for all these reasons are completely dislocated from reality. So, again you still hear the counter argument, people don't have to sell their homes, what's there to worry about? Well, listen to this, the National Association of Realtors Survey in 2005 indicated that 28 percent of all home purchases were for investment. That's 28 percent that were for investment. These are not your first home. This is not your single home that you're buying and you're going to live in there, and it's you know, something that you're not going to part with even if the price drops by 20, 30, 40 percent, it's your home, you're not going to offload that of course. But the bottom line is 28 percent of new homes purchased in 2005 alone were purely for investment purposes. Tell me somebody who all of the sudden is upside down in something like that isn't going to want to offload that. Maybe they're not getting the rent they expected, maybe they got an adjustable rate mortgage that's starting to come due pretty soon, and they were expecting the prices to continue to climb at, you know what was it, Stephan what was it, like 15 percent national average like a year ago?

Stephan: Right.

Something like that and you know, that doesn't happen and now you're left holding the bag on that. Another 12 percent were vacation homes. If somebody loses their job, do you think they're going to be desperately hanging on to their vacation home? So, 28 percent for investment, 12 percent for vacation homes, that's a total of 40 percent of all homes sold in 2005 were not primary residences where you have that rationale that people are going hold on to these things no matter what if that's where they live. So, you know I think this is rude awakening time, Stephan, I think a lot of people are going to get slapped around. You know again, some of the numbers that we saw over the past couple of months, the peak of 2005 to September, existing family house sales have fallen 14 percent and new home sales are down 22 percent from their July 2005 peak. Existing home prices in September fell 2.2 percent from a year earlier, that's the biggest drop in the 38 years that the National Association of Realtors has kept data on homes. Now, the seasonally adjusted existing house prices have declined 4.6 percent from their peak in October 2005. That's some pretty serious stuff, and I think people need to wake up to the reality that you know, this isn't just your ordinary, you know, uncle and grandfather's housing bubble that you just kind of go through and, it's not even, I mean people don't even use the bubble, they won't acknowledge that it's a bubble, they'll just say it was an overheated market. Anything you just heard has to give you an indication that you know, at least, boy I hope you're scratching you head and wondering about you know, is this just something that I should just let slough off my back. It's a pretty crazy environment.

Stephan: Well Johannes I think you're hitting on a really important point there. And that is, it sort of reminds you of the stock market run up in the 90's, there's a spin put on it, and basically it stems from the you know, the phrase, this time is different. And in the late 90's, I remember, you remember, you know we had a new economy. And tech stocks were redefining everything. And then you had a real estate bubble as you've had here, and you know this is a new real estate market. And what's very interesting, there was massive spin and I'd like to hit on both the real estate's side of things and the energy side of things because it's going on at a parallel time. And the stock market's back there and we'll jump on that also but, what's intriguing about the real estate side of things is that the California Association of Realtors, they forecasted going into this year, 2006, a decline in new housing starts of maybe 2 percent, okay? And in California, it was at minus 25 percent I do believe. Going into next year they're also forecasting another minus 2 percent. Are you going to believe that from obviously the realtors themselves, I think that's massive spin right there. Secondly, when you look at energy, I mean you can go onto Bloomberg right now and crude oil trade is at 60 dollars a barrel in New York [...] jumping yesterday. Demand you know, in a nut shell oil rose the most in almost a month yesterday after shipments from the Trans Alaska Pipeline were reduced by high winds at the Port of Valdez. You're kidding me right? High winds at the Port of Valdez all the sudden caused oil prices to go up. You know are supplies really that [thin] and we are frequently told, we're frequently told that there's enough oil in [...] one day the weather's going to be balmy this winter and there's not going to be any problem with oil prices. And the next day you got wind at Valdez and oil goes [...] 6 dollars over a barrel, or a minister in Lebanon gets assassinated [...] should that really affect the price of oil? To me the key issue with oil, the key issues that you have to focus on long term are the demand issues and [...] 48 barrels of oil per capita per year, and the average Indian and Chinese is 2 barrels per year and rapidly growing. That's what investors, that's what the public should focus on. Real estate [...] you just had a massive artificial on real estate due to ridiculously low interest rates okay? Where is demand going to go from here? Everybody's got the home, everybody's speculated very similarly to the auto industry. The last several years our economy is just driven by extremely low interest rates, to deny that fact, to deny that fact, deny that there's [...] forever is absolutely ridiculous. I think the average person when they think about it on their own it makes sense. But all the sudden you get the crowd mentality and people don't want to believe it, people don't want to believe news that they perceive as quote, "not good." But look, you can make money out there, you can do well playing the other side of the game and the key is, it is reality, the word real is involved in there, pay attention to the man behind the curtain, alright? And you know protect yourself accordingly.

Well, I think that a couple of points you make there are great. You know, the thing that we hear a lot these days similar to the new economy, in the 90's it was, oh it's a new economy, we don't have to worry about the dot.coms hitting new highs and technology going crazy because the new economy was different. PE ratios today are justified at multiples way above where they had been you know, years ago. And now we're hearing a different argument that is very similar it's now the financial structure of the global finance market is so diversified. All these very esoteric ways of offloading risk and slicing and dicing risk have virtually eliminated anything to worry about and I think that's what we're seeing reflected in the VIX, people are actually getting so overconfident that there can't be any change in the face of structural problems like we're talking about right here, I mean where do people think the consumer's going to be able to you know come out with their next round of spending? I mean that's an important thing. Now one other point that you did make and I want to touch on Stephan is that, related to energy, you know they do have these stories where, you know, how could the windy, what was it Steph, the wind?

Stephan: The wind, yeah, the wind in Valdez has caused problems in delivery, you know...?

Beautiful, so the wind is one hand, but I was looking at another report where it was infrastructure problems down in Texas. Now, that's a real serious problem as far as oil delivery and I think that's why, you know there are opportunities there when we look at energy, it's because we have a very seriously aging infrastructure. The oil industry has not put a lot of money into reworking the infrastructure simply because environmentalism has made it very difficult for them to do that. Any time they want to build a new refinery or anything like that, forget it, you're dealing with 10 years of lawsuits just to get out of the gate. So there has not been a new refinery built in the United States in over 30 years. Now they do a lot of refurbishing of existing infrastructure, but that gets older and older. There's only so much you can do, I mean you don't go flying around in planes made in the 50's anymore, you know what I mean? Why would you expect your 30 year old aging infrastructure not to be, need to be replaced when it comes to oil refineries and processing and so forth. But, moving along, you know what, I think that the real connection that a lot of people miss and one of the points that I was making before was that the underlining infrastructure related to the economy as a whole, all these dislocations and so forth that you know when people compare the current housing downturn to prior housing downturn they're completely missing. The U.S. economy right now, let's get into the consumer spending and then some of the retail news that's come up over the past week. Hardly great news in retail, still the stock market's going to new highs. Again not real highs, but nominal highs, over 70 percent of the GDP in the United States the Gross Domestic Product, that's how we measure our economic growth is driven 70 percent, over 70 percent by personal consumption okay? That's way distended out of its norm. Now, when you get an inflationary environment that's the tendency, people tend not to save they tend to go more towards consumption, so that's hardly unnatural. And especially when things get overly confident, people tend to start spending more and more and we're seeing that reflected in the savings rate, people don't even bother to save anymore, both consequences of inflation and overconfidence where negative savings territory, pretty much as long as we have ever been for the first time since The Great Depression, since 1933 where they have gone in negative savings for the longest period of time since then. Now consumer spending is now largely dependent on home equity extraction and especially these temporary low mortgage payments. So, you know a lot of people have been saying the consumer is resilient the U.S can absorb so much, you know more than we ever thought expected and you know that's kind of an interesting concept there because the more people get comfortable with you know, something going on longer than they ever thought they could expect, the more they actually come to assume that it is a new norm, a new standard. And the weird thing about that is, it's like you know we posted up a quote from George Elliott earlier in the week, or was it last week, one of here pieces where she talks about one of the characters [...] characters where the longer the event, the catastrophic event that should happen doesn't go on to happen, the more people [...] for human nature to expect that event never to happen. The irony of that is that the further you go on without it actually happening, the greater chance you have of that bad thing actually happening. And she goes on to use the example of somebody who is you know, worked in the mines their whole life, goes on to grow more and more comfortable year after year, because there hasn't been an accident where anything bad has happened and they haven't had a collapse and yet, you know even as the ceiling begins dipping in the mine and you start seeing you know all sorts of problems that would suggest to the normal person that this is a problem getting closer and closer to happening, it's as if well you get more comfortable with it that thing's always been sagging, it's sagging a little more, big deal, it's always sagged. Who worries about it you know? But the bottom line is longer it goes on the greater likelihood you actually have of a problem coming. Now, back into finance, back into the economy, the longer we've been going on with a lot of these distensions in the economy, the dislocations, it's almost like you know, if we were to take a snapshot and show this photograph of what's going on right now to people 20, 30, 40 years ago, their jaws would drop and they'd say what on Earth, how could this possibly be existing? And that's the interesting thing about markets is that as long as enough people kind of go along with it and assume it's okay, it will support itself. But the bottom line is minute people catch on that there's an infrastructure problem, once you cross that point of no return, you can have some serious problems once, it's called the tipping point, once that tipping point is hit, look out below, you're going to be in trouble. Hey Wally, glad you could make it, see you're there on our IM screen, good to have you back with us. Now, back to U.S. consumers. Now, the expectation is that U.S. consumers are just going to keep on spending. This argument has been claiming for a long time, they haven't flinched yet, their not going to do it in the months ahead, whey would they flinch? Well, let's take a look, two months in a row we've seen consumers spend the following 1.8 percent deceleration in the year over year in the rate from 6.3 percent in August to 4.5 percent in October, consumer spending. The October comparison is now the weakest in over 2 years and is literally less that half of the 9.4 percent growth rate that we saw in January, okay? So we're looking at some severe deceleration here. Now, growth and real consumer spending slowed to a 2.5 percent average annual rate in the final three quarters of 2006. Now, a significant shortfall from the 3.7 percent 10-year growth trend, so well below that. Now, again consensus thinking has not contemplated the possibility of a pullback of U.S. consumption you know because their looking at energy prices coming down, saying, oh, energy prices are going to come down and you know that's nearly a 30 percent reduction in oil prices, you know this is supposed to provide consumers with you know, with the number. Something like it's an equivalent of a hundred billion-dollar tax cut, right? Well, I'll tell you what, personal savings rates are in negative territory for the first time again since 1933, we're looking at a bubble driven economy here, where the credit bubble is really what's been driving a lot of things as you know, if interest rates start going up, if these adjustable rate mortgages start coming around we've got some serious problems and even in the face of these dropping interest rates, contrary to consensus expectations, looks like people are not going into to spend this as everybody thought and you know, we're going to see a shift here eventually, people are going to catch on that they just can't keep piling up debt as their adjustable rate mortgages reset and their interest rate expenses start going up, they're going to have to start saving. It's just a matter of fact. And once a 70 percent consumption driven economy starts converting back into a more stable, rational environment, just getting, you know sort of teetering back towards normalcy, back towards the average, you're looking at all of the sudden the GDP that's going to shrink dramatically. Again, you know if we've said it once, we've said it a thousand times now, we believe that mortgage rates are, or excuse me, GDP is over stated dramatically. They're doing things with all sorts of fancy statistical maneuvering with GDP that overstated. If you listen to John Williams at Shadow Stats, he will suggest that GDP has been negative for a little while now and that we never really fully emerged from the recession of 2001. I think if you talk to a lot of business people out there, people in the real world who have been dealing with this, they'll tell you, things never really got all that exciting in less you are in finance of course, you know if Wall Street's making you know record bonuses and so forth with this year and the record profits, of course they're fronting the line of all the credit expansion and a lot of the things that are going on there. Now, one other thing I want to hit on here, and that is the argument the business community is now going to bail us out in the U.S. And where the consumer starts tailing off, the big businesses, there's supposedly a lot of cash sitting around there, they're going to start tapping into that and billing out the U.S. economy. And to that I pose -

Stephan: You're making a great point on the consumer, but that's sort of being poo pooed too, but if you really look at the news just out today, Japan's trade surplus narrowed more than expected as U.S. demand really cooled off. Their trade surplus fell 24.8 percent to 614 billion yen in October from a year earlier, alright? And demand for Japanese exports cooling after the country's largest export market grew at the slowest pace in more than three years. Weak spending in the U.S. household is beginning to affect Japan. The trade surplus will continue to narrow, domestic demand will have to take over from exports. So, you don't hear about that much in America, okay? But that's really important because we you know, Americans are importing so many goods today. And Japan, their economy, their sales are just finally catching some air after a 12 year recession and it's just very important to note that the American consumer is buying a whole heck of a lot from Japan.

Yeah, it's interesting too, I mean Japanese numbers slowing down, just a few months ago people were saying, ah, Japan's finally emerging from it's recession, coming out they have to start slowing things down by raising their interest rates finally and here we are now where that trend has reversed pretty quickly and it looks like they still may be in that prolonged bear market they they've had going on for how many years now? 15 years, 16 years? 17 years? People need to realize that that kind of a recession is a distinct possibility here in the United States given how distended and how distorted the U.S. balance sheet has become with respect to debt. Things were bad in 2001, they've only grown worse since then and compared to 1970's I mean, God, we would dream of having a balance sheet both on the personal side and on the federal side that we had in the 70's to weather a storm like that today. I don't think we're going to handle a storm like that as well because of all these distensions. And probably the biggest factor I think that gives an indicator to the health of this economy right now is the amount of, it's phrased in terms of, what I'm going to tell you here it's phrased in terms of the number of dollars of credit and expansion of money supply it takes to get a corresponding dollar of GDP, a dollar of growth. And going back on to the 60's and the 50's now, as the saying always goes and if we said it again, once, we said it a thousand times at Vigilant Investor, inflations up front, early on really don't cause a lot of problems especially if you do them gradually enough. And of course the Federal Reserve is now Zimbabwe, they know better that to increase the money supply by 1000 percent, and here they do it very gradually. But we go back to the 50's, it took about a dollar of credit, and remember, credit in the U.S. creates money supply, because all of our money is created from credit, created out of thin air, but it's done through debt, it's basically loaned into existence. One dollar of credit would equal one dollar of GDP back then. By the 80's that started shifting where it took two dollars for each dollar of GDP, two dollars of debt, by the 90's we were at three, and four by 2000, five, six, now were nearing seven and getting close to eight. Okay? So eight, seven to eight dollars of debt for each dollar of GDP is a reflection of how wasted, wasting away of our economy that we're experiencing right now. And you know on the surface everybody think it's, ah, it can't be that bad, but look at how it takes two incomes to have a family, comfortably living, it now takes you know how many years of work to afford a house today verses how it used to be. I was reading a stat earlier that it took about two years of work to get a house back in the 30's, in the 20's and today it takes about 5 years on average, full income for the average person to buy a home. And I don't think that's even, that number is going to start wasting away pretty quickly here just where things are. But anyway, I was about to talk about the argument that business is going to bail us out and with that kind of underlying infrastructure and you see the consumer slowing down, retail sales beginning to come well under consensus expectations, Wal Mart revising and if there's an indicator of how the average Joe is doing in the U.S. it's Wal Mart, and they're basically saying that they're going to be flat this year on sales over last year, in other words no growth. You know for what consumer is the U.S. business going to be investing into the United States economy? Why on Earth would a U.S. business start expanding at this point if it's watching the numbers as they see it right now? Now, on one level that's today, but especially when we consider what has happened business wise over the past few years, a lot of business, and this is one of those problems with inflation, inflation gives a lot of false signals to entrepreneurs out there, they think that the economy is doing a lot better, they see consumers running around doing all this buying, and the natural reaction for and entrepreneur who is not savvy when it comes to this economic side of things, and mind you, the majority of Wall Street is oblivious to what we're talking about on this level, it's called Austrian School of Economics, most people have dismissed that and they're on the Keynes bandwagon and the modified Keynes and the Chicago school, everybody's talking about Freedman, great guy in terms of what he talked about with liberty and freedom and so forth, but also still was a believer in manipulation of money supply. And Austrians will tell you, you monkey with money supply, you monkey with interest rates you start getting false signals out there in the economy. Great example, I was just chatting with someone before the show started who does consulting out in the Denver area, and they're telling me about a client of theirs who had been in the business of providing a pretty essential service to the homebuilding and real estate development community, and they had some new technology that they had been investing in and developing and developing that was literally revolutionizing how you would do certain types of surveys for environmental integrity. You know is the environment good or bad relative to that piece of property, that kind of thing. Just as they are finally, mind you, they are seeing the boom going on out there, and just when they are ready to come to the market with the final product, they've invested you know lots and lots of money in developing and they expected you know substantial demand based on all the testing they had done out there and everybody who was in the business of doing this kind of surveying was saying they want their product and they had orders all lined up, all of the sudden sometime at the beginning of the bursting, all of the sudden all interest in order started drying up, right about the same time all interest in housing started drying up, and suddenly they're left holding the bag with a product ready for market that nobody can, has any need for anymore. That's because the housing bubble started bursting. And that's the kind of thing that dislocates, that kind of dislocation we were seeing rearing its head in a lot of different areas, but I think that's really one of the things that nobody is talking about that's going to drag this economy down a lot further than people expect. All the wasted investment by entrepreneurs that are getting knocked, they're going to get knocked around.

Stephan: What you're seeing right now Johannes is the effect of that, it's the old term, stagflation, where you know, that loose money policy, a lot of newly created borrowed money, chasing a lot of things you know, the economy, everybody can get cheap credit, zero percent financing on cars, record low interest rates on home mortgages, pulling out home equity out of their homes, a ton of it to drive the economy. That liquidity is newly created money, out of thin air, if you understand our banking system. And you hear the Fed, the fed, there's comments from Fed Reserve governor Kevin Marsh basically saying, there remain I believe clear upside risks to that inflation outlook. Then you have Barney Frank, you know Massachusetts Democrat who is going to be you know, making statements today that you know, basically his statement is, the economy is slowing to an even greater extent than has been widely expected. This is particularly troubling giving the weight stagnation over the past 5 years, said Frank, who is [...] basically be the Chairman of the House Financial Services Committee. So in essence, you had the party was stimulated as you always say Johannes by loose credit, and hey you loan somebody a million bucks before they have to pay it off, you can spend a lot of money. That created a ton of inflation. That newly created money, those prices are still there okay? And you have those inflationary factors that will continue on for a while. At the same time you got job stagnation, okay? And you have a weight stagnation and you're starting to see consumer demand dry up. This is an important juncture, which is only going to go one way.

Yeah, it's messy. And you know again you have people who are dancing just on the surface, a lot of the apologists for the housing bubble, yeah, you know, this is just a housing bubble, they aren't looking at all these structural problems that are there, all the build up. And this is not something that just happened under a bush, this has been building for 30 plus years and it's one of those things that moves so glacially, that people just don't see it happening, and again I pointed out, if people were to look at a snapshot out of today's balance sheet and these various distensions, and you were to take the snapshot back you know 20, 30 years ago people, their jaws would drop. But if it happens slowly enough then the entire system goes on shrugging it's shoulders, hey this is the way it is, and it's nothing, nothing different at all. So, Wally I see you're there, do you have a question for us? Wally: Hi Johannes how are you doing?

I'm doing well Wally, thanks for joining us.

Wally: Yeah, I remember the stagflation period of the late 70's early 80's, so it's not a new concept to me by any stretch of [...] talk to the 20 and 30 somethings, they're not going to remember that.

Well it's amazing also how many people who should know about the stagflation then have dismissed it as an old fashioned phenomenon too. People who did experience it, people who do remember it. Think of that we've managed to offload all that potential risk just with all the fancy finance today. And it's almost like you know the modern form of alchemy where you can print dollars out of thin air and you can do M3 at a breakneck pace and MZM and M1 and M2 and you really don't have to worry about it anymore because we have this new financial system that can absorb anything. So stagflation, they all poo poo it and of course now we're you know starting to talk about it, worry about it more and you can't deny 60 dollar oil, I mean that's right in front of everybody. But, yeah, it wasn't pretty back then was it, Wally?

Wally: No, it definitely wasn't. Back when I was younger, what I remember quite well is the let the price [...] where gold went from 40 dollars, 50 dollars an ounce to over almost 600. It was there.

Yep, yep. Well, a lot of people will tell us right now that oil is at an inflated price, and at 70 dollars definitely was too high, unsustainable, when it was nearing 80 dollars, it was definitely unsustainable there and it was in a bubble stratosphere. But you know Stephan did a little bit of a study earlier this week where we were taking a look at oil's price back at it's peak, the last time it bubbled out when you finally had all that stagflation there in the 70's and then you know people started driving the prices up purely on speculation which is always a consequence of inflation. Speculation begins to supercede any entrepreneurial behavior. If you study any inflation all the way back to the [...] people forego actual business investment and saving and so forth and just get right into speculation. But you go back and you look at the oil prices back in, at their peak in the early 80's I think it was at around 39 dollars a barrel and when you adjust that just plain old at CPI and again CPI is grossly understated deliberately, you're looking at an oil price, Stephan what was it closer to about 95 dollars, 98 dollars, which was it?

Stephan: It was in the low 90's it's peaked out in 1980, I believe it was 37 dollars a barrel, if you plug that number into the Fed's inflation calculator in 1980, utilizing we feel their low ball rate or inflation the CPI figure, that high in today's dollars would be 91 dollars a barrel.

Yes I mean -

Stephan: -is not over priced.

Yeah, interesting environment though. I think people would be surprised, you know the one concern that we have is this inflation can go on for a while and we've talked before about just the massive federal obligations that are out there, all of these unfunded liabilities you have you know, Social Security. Medicare, Medicaid and you know, next month we can't wait for the big report to come from the U.S. treasury on what the official deficit was but, you know, the deficit everybody talks about, in 2005 it was 315 billion, that's the official deficit according to you know, when Bush talks about deficits or anybody in Congress, but when you start doing what they call general accepted accounting principles, what they call near gap in government because there is so many black holes they can't use business accounting standards because you can't really account for what the CIA is doing or the NSA or Homeland Security. But they come with near gap numbers and they find that in 2005, the 315 million goes up to about 680 billion, but then when you also consider net present value of future obligations and again any business out there has to account for proportionally their obligations for the future, things like if you have a million dollar loan due in 10 years, you just can't pretend it doesn't exist for 10 years and expect that you know just all the sudden have it appear suddenly at year number 10 and say okay, that's normal accounting, you can't do that. Except in government you can do that, with Social Security and Medicare/ Medicaid. You add those on to the balance sheet and the irony is that the Federal Government actually reports these in the U.S. treasury report that their fiscal annual report that comes out in December, the fiscal year ends at the end of September. The number goes from 315 billion up to 3.5 trillion. And you tell me, where are they going to get that money to pay off that obligation, especially when that number is just going to be bigger next year and the year after, because they're not doing any saving, they're still running deficits, the national debt just ran, crossed over 8.6 to 8.7 billion. So, I mean you're not getting any more fiscal responsibility there, you're certainly not going to get a whole lot from the Democrats verses the Republicans, it's going to be a shuffling of the deck, and who is going to be the recipient and they're going to have to print money to cover that. And the real question comes is when do people begin losing confidence in the U.S. dollar when they start recognizing that you know what, CPI is only supposed to be 4 points, you know 4 percent, but you know my oil prices, my gas prices at the pump doubled. Or, you know the, I used to get you know for two dollars a bag of 16 oz of Doritos and now I'm only getting 12 ounces. And you know people are picking up on that, it takes them a little while to realize it, but it ain't no 3.5 percent CPI, and the more they, it's not going to be able to be remotely sustainable at that level going forward when they have to start covering a 3.5 trillion dollar obligation for Medicare, Medicaid, you know where is that money going to come from? You can't tax enough, you can't cut the benefits because nobody will let you. And it's like you're getting closer and closer to that cliff and the entire financial community, almost all of Wall Street, most consensus economists will tell you that you know, nothing to worry about, and yet every day we take a closer step to the edge and we get more comfortable being by the edge the closer we get to it, it's crazy.

Wally: Very much like this putting the frog in the water and heating it up very slowly, the frog doesn't realize until it's already cooked.

Absolutely it's, anything that moved glacially people just don't see it happen and they, you know, grow accustomed to it.

Stephan: The important point [...] also Johannes is that you know, you said when will the face be lost in the U.S. currency. The price of gold in the last 5 years has basically doubled, okay? And you talk to the average American, you talk to the average quote, "financial advisor" and they say, "well, that's a commodity, that's risky, you shouldn't have those in your portfolios," and but when you really look at it, somebody is buying gold. And it is just not going up because the price of oil is going up. There's smart money going out there, there were reports that maybe the Chinese are already divesting themselves of dollar as they are diversifying into energy infrastructure, oil and gas [...] et cetera. So, something is going on.

Well, one of the Chinese top bankers in their central bank made a comment about 4 weeks ago or something, and had to do an awful lot of back peddling, it might have only been 3 weeks ago, where he was saying, hey you know it's time for us to start thinking about alternatives to the U.S. dollar, and he basically said we've begun doing that. And if you start looking at some of the graphs relative to acquisition of U.S. treasuries there's indicators that would tell us that foreign purchases are beginning to decline, okay. And that means your foreign purchases are coming from central banks. Basically how it works is we have this massive trade deficit, so people have to, you know we're spending all this money abroad. The Chinese are getting, you know 10's of billions of dollars a month in U.S. dollars, they can't used dollars in their economy so what are they going to do? They basically drop them off at the central bank, the central bank turns around and has these reserves of U.S. dollars and they want to turn them into something else or they've been turning them into U.S. debt. Now, that's had the benefit of keeping our interest rates very low, but we're so dependant on that now, I think over 50 percent of U.S. debt is now held by foreigners. And we've crossed a point where that value is crucial relative to the bond rates and their view of U.S. dollar value is crucial to our bond rates. And if China starts diversifying out of them and just starts cutting its purchasing pace down, you're going to look at interest rates starting to increase. And the strange part about it is that in the face of what appears to be some downturns here, and we're going to do some post on that in the next couple of weeks as we start digging into some of the causes behind that as I've been doing some research on it. But, you know in the face of what appears to be a backing off in terms of foreign central banks in terms of their, you know appreciation of the dollar's value, in other words they're divesting themselves in their new purchases. The price of the dollar still seems to be stable, and there's some people out there, some fairly prominent people who are big currency managers who are starting to suggest that maybe there's some kind of a management program on there to give the impression that the U.S. dollar is a lot more stable than it really is, given how narrow the volatility bandwidth has been with the U.S. dollar lately and others are suggesting that maybe, you know you've go a very creative and very progressive Federal Reserve and Henry Paulson, the new Treasury Secretary is suggesting that the U.S. needs to have its special hidden economic committee there engaging in maybe more international support of markets and so forth and you actually have people who have written papers suggesting that the Federal Reserve ought to be outright purchasing more assets than just U.S. bonds, which is something they've always done but actually manipulating in the markets in order to provide support level. Well, the Federal Reserve, let's not forget, does not have a dollar, does not have a dime that it did not print out of thin air. So, maybe they're using conduits, who knows. And I know that sounds awfully conspiratorial okay, these are little flashes, little glimpses, little flashes, you lose bits here and there and when you start piecing them together it makes you scratch your head. Their normal environment where the Chinese and other central banks start divesting of the dollar, you'd see a fluctuation the dollar price and a raise in [...] well, where the heck is it now? And that's really strange and I'm not the only person talking about it, Bill Gross at PIMCO, one of the U.S. largest bond management firms in the world, [...] Bill Gross manages one of the largest U.S. bond mutual fund. He's been questioning where the heck are the bond vigilantes and the bond vigilantes are the ones who basically hold markets true, and basically cry BS when they see things that are way out of whack. And he just can't believe he said, you know, you read Bill Gross he says, "things are way out of whack but where are the bond vigilantes?" And again a lot of people keep justifying, you know it's the new financial environment we've got all these ways of spreading risk with all these fancy derivatives, you know we cut up the risk and then we cut it up more and we divide it even more and it's so spread out we never have to worry about anything. And these derivatives don't forget are the same financial instruments that Warren Buffett had referred to in the past as, what do they call it, financial weapons of mass destruction. And he's talked a lot about how, you know a couple of blow ups here or there and suddenly you get cascading default and locking up of markets because of all the intermediaries and all the valuation problems you have etc, etc... Anyway, it's a crazy environment, it's unprecedented and I think that people really, really I wish you know I talk to people that are just kind of indifferent and they just say don't worry about it as much as you're worrying about it, they say. But these are just unprecedented factors, I mean look at this set of variables, look at the compelling things that are happening here, and yet people just shrug their shoulders and say, ah don't worry about it, buy, hold, you know for the long run and it all works out, I don't understand it.

Stephan: Well, Johannes, what's happened is it takes effort to move off center. You know once you got your sails up on your boat and you got the rudder in a certain spot and you're blowing a long, I mean you might be clipping along perfectly well, and if there's an iceberg up there it takes an effort to make that turn, okay? And people don't want to believe what they're seeing. You know, when you look at history, history is rife with examples from politics, like Neville Chamberlain with the appeasement of Hitler, you know people not wanting to believe that the communists were as bad as they were. The roaring 20's economically, most people don't realize there were double digit, there have been double digit basically booms and busts or crashes prior to our depression, okay? But it's the only depression in history of the world. And I think that the wrong approach for people to take and this it the doom and gloom approach, it's reality. It's seeing things as they are. And you can maneuver to protect yourself, you can maneuver to avoid these consequences, but that's only when people think as individuals, and when people think in mass or when you tell people sometimes something that takes them out of their comfort zone the majority of people, the majority, there are people out there that make purely objective decisions, and those tend to be more successful people, they tend to be your more successful investors. But people that don't want to deal with reality, it's a human nature thing and we're at a very intriguing time. As we have said, once the selection is over, and once oil prices you know, are no longer, we feel somewhat manipulated with what went on in certain commodity indexes with unleaded gas and the correlation there, unleaded gas is weighting in the Goldman Sachs index. But this election is over, all bets are off. And as we always talk about there's an intriguing correlation out there with the S&P 500 tracking the housing index with a 12 month lag, tracking it very closely. And the housing index is down about 45, 50 percent [...] into this January. So what does that bode for next January, we don't know. Objectively you can say that for the S&P not to go down dramatically, it's going to have to break a 10-year trend. So, we are at very interesting times now. The only advice we could ever give anybody, any listeners out there is, just keep your eyes open, don't avoid reality and be vigilant.

And that is the purpose of Vigilant Investor, why we started Vigilant Investor live every Wednesday night 9PM, again this is Johannes Ernharth, that was Stephan Ernharth you were listening to there. And we put Vigilant Investor on the map because we wanted to help people connect the dots and engage, get people to engage in this conversation. So much has happened over the past 18, 20 years where investors, where business people have been groomed to be more or less indifferent to what goes on in the economy, to really trust that the Federal Reserve and the people in charge can really manage an economy by pulling this lever and that lever. People have grown to be, you know overly trusting that things are always going to be the way they are because you know, and hey let's face it, things have not been really bad in a long time. The worst they got was in the 70's and you know most people came through that fairly unscathed, I think a lot of people who were blue collar felt that on the chin. But, you know today a lot of people who are out there running businesses even have a tendency to kind of laid back, and the average person you know who is doing reasonably well, you know it's you know why get worried over what, is the question. But, I think what people don't, or need to keep in mind is that you know, in the 20's they were roaring, everybody thought everything was all you know [...] and purely normal. A lot of similarities of what happened in the 20's is happening right now and yet nobody foresaw The Great Depression on the doorstep, and you know that was a painful time for a lot of people, not just the poor side of the coin, but the people who were pretty well off really got slapped around by that because you know, people were expecting things to kind of go along as they always did because you know it was good times. And believe me, that was after WWI where things were pretty bad for a lot of people relative to of course it was mostly in Europe, but we weren't entirely immune from what happened over there in terms of experiencing wars on our shores and yet the 20s pretty quickly everybody felt pretty good about it and now we're that much more complacent, we're clearly top dog in the world, and if anything gets you in trouble sometimes it's complacency or just kind of operating as is the current environment will stay on forever. But, any other comments out there? Wally do you have any other things to say? Wally has stepped away, that's fine, anybody else who -

Stephan: Johannes, I'd just like to make another point, and I think it's really important to hear, especially for first time listeners, it's a perspective that we always try to draw when we're sitting down with [...] and we have made the comment [...] you know if you adjust gold [...] 1980 at 850, in today's dollars that's over 2000 bucks. Gold at 620 is not overpriced relative to that. You made the comment about oil, you know peaking around the same time period at 37 dollars, today that would have to be 91 dollars, oil has not hit peak prices. But an important thing to remember is that if adjusted for inflation, the stock market at where it is today, using the Fed's figures is really a 10,500 Dow in "2000" dollars. The problem is 10,400 Dow is 13 hundred points lower than the 11, 700 Dow in January of 200. So, you know you're not making more money as inflation continues. The numbers are bigger, but you are losing purchasing power.

Well, we should probably get wrapping up here, we're pretty much an hour for the show. And, I want to thank everybody for tuning on in today, we get a lot of people we see that are streaming in all over. Most people do not join in the conversation, most people understandably just want to kick back and listen. But always remember, feel free to buzz on in. We want to thank people who have done that in the past, and current people today who are on our chat board, and as well as Wally who stepped in to actually be a person who joined our conversation, so very nice to have him on board. And Stephan, good to have you, hope you have a nice Thanksgiving out there.

Stephan: [...] to the rest of the family.

Yep, we'll do and Happy Thanksgiving everybody. And next week we'll be back on at our same usual Vigilant Investor time, our same usual Vigilant Investor night, and that is Wednesdays 9PM rain or shine, usually except for a holiday. So don't miss us, we'll miss you till then, so tune on in and don't forget to subscribe, we also have our Podcast, I mean this is a Podcast, so subscribe to it, you can do it via iTunes via our Talk Shoe link. And, take care until next week.

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