The
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February 23, 2008
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The
Next Wave: Price Revolutions in History
Other
Voices: Peter J. Sepp, V.P. for Communications, National Taxpayers
Union
Behind
the Numbers
Part
2
The
Case for Gold
Reinflation
Strategy
Part
3
Q-Calls
The
Next Wave: Price Revolutions in History
JOHN: I always wonder why that guy comes on before the segment of the show and tells me I'm online with the Financial Sense Newshour. I know that, Jim. Don't you know that? So why do we need --
JIM: Are we online now?
JOHN: Yes, we are. But why do we need this guy to tell us that we're online. Well, let's see.
You know, one of the best predictors of the future is the past because given the set of human beings in a situation, they tend to do the same thing and trends tend to mirror each other through history. And so if we go back and look at the great inflation waves that came through history, we discover some really interesting patterns today about what happened. Let's look at where we stand statistically right now: CPI in January up 0.4%, which is actually 4.3% year over year; the core CPI is up 0.3%, which is 2 ½% year over year; and import prices last month up 1.7%. But the PTBs out there, the Powers That Be, would like to tell us to ignore a lot of that data. [1:15]
JIM: What is very interesting about all of these inflation cycles, whether you're looking at what happened in the 70s with food and energy, just as we are experiencing today the same effects with oil at over $100 a barrel, natural gas at close to $9 and we've got the agricultural commodities, John. Corn prices are up over 16 ½% since the beginning of the year. Wheat prices are down slightly. You've got soybean prices up 16%. Sugar up nearly 20 and cotton up nearly 7.
And I've cited this book before, but what we're going to hope to do today is take history. You know that favorite line of mine from Mark Twain: History doesn't repeat itself but it sure rhymes. And we're seeing that rhyme play out in the commodity markets with the CRB Index hitting new record levels – commodity prices at all levels hitting new records. And if you listen to the talking heads, they look at this and they go: “This is unusual. You've got to ignore energy prices. You've got to ignore food prices.” In fact, we exclude them whenever we talk about inflation.
Well, David Hackett Fischer, the noted historian wrote a book, which I'd highly recommend if you want to get a perspective on what's going on today that you pick up a copy. It was called the Great Wave: Price Revolutions and the Rhythm of History.
Once again there’s the reference to Mark Twain. And he took a look at these inflation cycles over the last 1000 years and we had four inflationary waves: the 14th Century we had an inflationary wave during that period of time, the 16th century, the 18th century and then the 20th Century. About every 200 years over the last, probably, millennium, we've had these price revolutions as Fischer talks about. And what is amazing, John, is in these price revolutions or inflationary waves, they all have very common characteristics that you can identify in each one of those periods.
And some of the important qualities is they all tended to share the same sequence of development, the same pattern of price increases. You saw a similar movement in wages in rent and in interest rates. You had dangerous levels of volatility – just look at markets today, look at the VIX. And all of these price revolutions in modern history all began in periods of prosperity. There was a period of prosperity in the 14th Century with the Renaissance, the rebirth of the west. You saw a similar period in the 16th century, a similar period in the 18th century, as well as the 20th Century. And what is amazing is every one of these inflationary waves all ended in shattering world crises that were followed by a period of recovery and then eventually an equilibrium. [4:20]
JOHN: Is there a reason why it has started during a period of prosperity? Is it that this euphoria goes through the culture, people think the sky is the limit and then they begin to play other games ( people being either the common people or I guess in times past it would have been more monarchies than anything.) So why does that start there any way?
JIM: Well, you know, Fischer traces this; they begin with population increases. There was a huge population increase between the 12th and the 14th Century with population increases and what are the two things that you see? You see a demand for shelter. You see a demand for energy, you see a demand for food, the basic necessities of life.
And then what happens is government, in order to carry out the needs of society, what it does is it begins to inflate, so you also have an accompanying monetary inflation that takes place.
And what Fischer talks about here is a lot of this is man made; and he said that we need to pay attention to the economic decisions that we make because they have an effect on an outcome that leads to these tragedies. So he talks about, for example, what happens in the future is contingent on the choices in the present, which derive from our memory of the past.
So he said the result of this inquiry as he looks into it strongly suggests that when we make our economic choices, we would do well to improve our powers of recall and remember some of the very hard lessons of historical experience, and that's why we just spent four weeks talking about the next Great Depression.
When you over inflate, as all central banks are doing today and you have population increase, inflation at the same time putting enormous strains on the commodity complex and on governments, the inflationary policies that we are promulgating today in government. I mean just take a look at what Obama wants to do, what Clinton wants to do, and even some of the things McCain wants to do. And there are going to be consequences of that. And the consequences are going to be an inflationary cycle that we flippantly sort of dismiss as “well, you can't look at food and energy, that's just sort of an aberration, and that with the economy slowing down in the US, we're going to see lower commodity prices.” The facts aren't standing there, John.
You and I have been doing this show going on our seventh year, and every year we talk about higher energy prices, we talk about higher precious metal prices, we talk about higher food prices. And what happens? And we'll get into why I think we dismiss this, but what Fischer was talking about in The Great Wave, if you ignore this kind of stuff, there are going to be consequences. [7:25]
JOHN: Yeah. I would think that the real problem with ignoring it is the fact that a lot of times what you're talking about, Jim, involves what would be called fiscal discipline, but in a time when you have the public out there clamoring for stuff, it's very irresistible for a politician not to want to give it to them. And making an argument that, “look, down the road, there are going to be these horrible consequence,” either one they deny it; or two they take Keynes’s approach and say, yes, but in the end we're all dead anyway meaning somebody sometime later is going to have to deal with this. Right? And that's why we tend to repeat this pattern.
JIM: When you take a look at the Clinton tax hikes that were put into effect in 1993 they were so severe that even the IRS gave you two years to pay your taxes because it was such a steep increase. But to combat the drain on the economy from higher taxes, Greenspan began to inflate the money supply.
And there was a very famous conversation or meeting that took place in the White House. And this was documented in Bob Woodward's book The Agenda where Clinton had lost Congress in 94 and talked about how am I going to get reelected; and they said to inflate basically, bring down interest rates. And you can see this if you follow a graph of M3 from November of 1994 as the economy was weakening. As the market was weakening at that time, all of a sudden they crank the printing presses. And what we got was this false boom that we know as the TMT cycle (Technology, Media and Telecommunications) and that led to this artificial boom where you saw stock prices go up as inflation found an outlet in the stock market.
However, when that boom bust in 2000 and we got a recession in 2001, what people do is look to government and say, “you know what, we love the boom, we love the wealth creation, we don't want to suffer the consequences or the hangover of that, so do something about it,” which Greenspan did. He slashed interest rates, brought them down to artificially low levels. We got the real estate boom and the mortgage crisis.
So, you're right, John. It's like people don't want to experience any pain. All we want to do is feel the good times. And unfortunately, those good times and what brought them about was not real wealth creation through the production of goods or expanding the economy by expanding production, factories. What we did was we got an artificial boom and now we're suffering through the consequences. [10:09]
JOHN: Yeah. And of course people feel it first in what areas? In other words, when does the public come aroused to the fact that there is pain?
JIM: As a result of these inflationary consequences, what Fischer documents in his book, which we've seen in all inflationary wave cycles, and this will sort of put it into perspective. You've got one common characteristic to all of them is population increase, and I forget what the figures are, John, but I think we have about two billion people more on the planet than we did a couple of decades ago. So what happens is you have a population increase. This fuels demand for more food, fuel, houses and land. So demand for life's necessities expands more rapidly than the supply could increase.
So inexorably, prices go up and the most rapid rises appear, and this is going to sound very familiar to you today. The most rapid price increases occur in the price of energy, the price of food, the price of shelter and raw materials. The items most heavily in demand during a period of population growth and least elastic in their supply.
And we're seeing that with energy that when the price went from $20 a barrel to 30 to 40 to 50 to 60, to today at $100 a barrel, demand has not gone down. I mean it's curbed. It's leveled off in the West, but in the rest of the world where the population increase is occurring – China, India, Asia, Latin America – demand continues to go forward.
So the price of energy from both in the 14th century price revolution, the 16th, 18th and the 20th and then of course back then, we didn't have oil, but in the Renaissance area, it was the price of firewood and charcoal rose faster and farther than any other commodity.
And during the late 12th and 13th Century, Europe cut down its forest, consumed its timber and burned its brush wood for fuel. Timber and charcoal began to be increasingly dominating society. And close behind the soaring cost of energy came soaring prices of food. You know, the staples: grain, meat, dairy products – the staples of life.
We did see during those periods of time inflation in industrial prices, but they were moderate because the supply of manufactured goods could be expanded more easily to meet rising demand. So if we look at some of the consequences and the signs of this: rising energy prices first, followed secondly by food and shelter and then three, an increase in the money of circulation.
Back then they didn't have electronic printing presses, so what governments did is they debased their coins by coin clipping. You know, the king would call in all coins and say, “you know, we're going to commemorate a new coin to celebrate our victory in battle” and the new coins would be smaller. They would have less silver or gold content.
And so these are some common characteristics. And John, what are the headlines that we see today? [13:22]
JOHN: Yeah. It's pretty much the same. Actually, it’s what leads, I would think, to social upheaval. Remember what was supposed to be Marie Antoinette's famous line when she is told that the peasants have no bread, she says, “well, let them eat cake.” And that's where people begin to feel it, and that's where the revolutions kick in.
JIM: Yeah. And it's remarkable because what happens is that pain which is felt at the street level is you see during these periods of time a growing gap between the returns of labor and capital and also you see social unrest, an increase of crime and also various stages of instability and volatility.
And what are you seeing today? These very same things. And we've talked about this on the program is that if you take a look at periods of inflation, the reason the middle class are being squeezed, they are being squeezed from two things: taxes and inflation. And they are both related. Inflation is the invisible tax. And yet, the public will vote for politicians that will increase the level of inflation and taxation even more.
And the problem that you have in an inflationary period of time – gosh, we have cited example after example – if you are a wage earning American and you have the real rate of inflation going up at 8 to 10%, that is a tax on your income because it costs you more for the basic necessities of life, food and energy.
And John, you and I know today where jobs are – we have to compete in a global society, labor doesn't have the same bargaining chips. And so what happens, you can't walk into your boss and say, “look, my cost of living went up 10% last year based on the fact that my taxes are going up, the Social Security base is going up, I'm paying more taxes than ever, I need a 15% pay raise in order to have a 10% real increase in wages so I can purchase the same good and services. It doesn't work.
And so the only way that you survive in this period of time is cut your expenses. And those that can live in a lean way where they have excess, in other words they don't live beyond their means and they can have some surpluses, then you can invest and profit from inflation.
And that's one of the real tragedies is when the government inflates as it's doing today, it creates more inflation and those who receive the inflated dollars first, the government being a main beneficiary, the bankers and the financial system the second beneficiaries and then so on down the line. Unfortunately for the average guy in the street, he's the last person to benefit from the inflation, and he as a result is a victim of that inflation. [16:14]
JOHN: Well, obviously, Jim, there is a cycle to this. In other words, we go through stages. So what are the stages? That would be the first question. The second thing would be what is the end game? And the third one is, are there several different possible scenarios in an end game, maybe one violent, one peaceful?
JIM: You know, these periods of price revolutions end tragically. They end either in depression, famine, plague or war. And that's what brings this to an end. And in the 14th century, it was the plague. It was famine, and it was a depression. In the 16th century, it was plague, it was war. And in the 18th century, it was war. And in the 20th century, John, what do we see? War.
You know, the inflationary policies of the 20s led to the bust of the 30s, led to trade wars and eventually led to conflicts. We had World War I, World War II, we had the Korean War, we had the Vietnam War, we’ve had the Gulf War, we had the Cold War.
You can't inflate forever as Germany found out in the 20s. And unfortunately, sometimes, we forget these lessons of the past. And politicians – I mean look what the Latin American politicians are doing now. Look at what Chavez is doing where inflation in Venezuela is running over 20%. The infrastructure of the country is falling apart. Oil production is down about 40%. And as a result of his policies, right now you're seeing political unrest because you've got inflation.
So how is this going to end? That's the big question because you can't create prosperity through borrowing and consumption. You have to create wealth. You have to produce wealth. And printing money does not create or give you prosperity, and whether you look at the 14th century inflationary wave ended by famine and plague, the 16th century, John, you remember the religious wars that decimated the population. And also, wasn't it the 16th century, I'm trying to think of the plague that just ripped through much of Europe. Was it the Black – [18:35]
JOHN: It was the bubonic plague, but they had a number of different times when the bubonic plague would cut loose. At one point, I can't remember if it was in the 16th century, they lost close to half the population of Europe or something like that.
JIM: Yeah. So in the end, there is something that brings it to an end. During the 17th century, I mean it was the armies of Europe reached their largest size since the Roman empire. Their upkeep imposed heavy costs that the public revenues were reduced by the combined effect of famine.
You had pestilence, you had war, you had depression, you had regressive taxation and monetary inflation. War became highly destructive of life and wealth and it was during that period of time that we had this great period of time that followed it, which was the 17th Century and then towards the end of the 18th Century, you had the revolutions in France, in the United States, you had the Napoleonic wars; and then you had a period of stability that lasted almost 100 years with the gold standard and you had prosperity. But then once again, a social Marxism came into being in the late 19th Century, and you had governments coming in with social welfare and eventually you had another conflict. [19:47]
JOHN: Perhaps the reason that we forget is unless you're delving through history books, which means more than reading Wikipedia, you get about three generations down. Say there has been a horrible war that's fought or the Great Depression. The first generation that went through it, they remember, and they say: Never again! Now, their children may have been part of it, or at least their parents told them about it, you know, and so they sort of remember it. But by the time the children's children come along, now, that was something grandma and grandpa went through and you always hear this verbiage: This is a new day and we need change. And you always hear this promise like it's a new promise, something that’s newly thought up, but in reality, it's the same old stuff. Nothing has changed, it's just that the third generation, the fourth generation are too far down to remember what happened earlier on and what it was like. [20:41]
JIM: Yeah. So that's why those that failed to study history are doomed to repeat it.
JOHN: So if we look at where we even are today and compare this to the patterns of the past, look where we are at. We have a rising energy cost. We went from $20 a barrel to $100 a barrel. Rising food issues, and that may also come into a famine level now. If we have some serious crop failures in certain parts of the world, we're going to be hurting for certain things. Monetary expansion and inflationary response to that, that's what we're seeing today worldwide as a matter of fact, that causes a rise of volatility; and also a rise in criminal activity, especially nowadays in the high tech world: organized crime.
JIM: It was amazing. You just mentioned famine and we talked about famine and all four of these price revolutions in history. And the head of Potash Corporation, which makes fertilizer used to increase crop yields made a comment in terms of earnings, and he said this. He said grain farmers will need to harvest record crops every single year to meet increasing global food demand in order to avoid famine.
And he went on and he said people and livestock are consuming more grain than ever, draining the world's inventories and increasing the likelihood of shortages. Global grain stock piles fell to about 53 days of supply last year, and that's the lowest level since record keeping began by the US department of agriculture in 1960.
So what the president of Potash is saying here, he's saying, “look, we have 17 years of record harvests and yet our food supplies continue to dwindle.” And he said in order to avoid a famine, in every single year we are going to have to produce more grain, more agricultural output. He said otherwise we’re going to see famine, and that is what has happened in these price revolutions that Fischer documents in his book. So Houston, we've got a problem. If we have a drought, if you have some kind of locust or any kind of disease, John, we can't afford to make one mistake. In order to avoid famine, we have got to produce more this year than we have last year. And even though we produced more last year than we did the year before, our grain stocks continue to dwindle and that explains why this year corn prices are up, as I mentioned earlier, 16 ½%. It's why soybean prices are up 16%, why sugar is up 20%.
And here I was just reading – it's not just this guy. You can take a look at even all of the analysts, John, have had to throw their models out window. Goldman Sachs just had to revise their estimates for wheat prices, soybean and corn prices. I mean you're talking about everywhere you look at, we're having tight constraints in all of the commodities. And yet I saw today some experts on a cable show saying don't worry about inflation because as the economy weakens, these high price that's we're seeing today are going to go away. People still don't get it. [23:57]
JOHN: Dare I bring in ethanol here because we're diverting a lot of energy in that direction, farm energy, and also at the same time we are beginning to regulate. I just got an email from a listener to the show who was recounting all of the problems he was having dealing with governmental regulatory agencies. We're making it harder and harder to produce this material in the name of whatever we're doing, saving the planet or something else like that (and that's even questionable given some of the things these guys have to comply with). So it's interesting to see how we seem to set ourselves up for this. We're setting ourselves up for failure here.
JIM: I mean, sooner or later, we're going to have to make the decision do we want to eat or do we want to drive. And it's amazing, the trade deficit figures which are reported with a two month lag, the trade deficit figure for December was roughly, let's round it off to $59 billion. John, you know how much of that was made up of petroleum imports.
JOHN: No. I'm not going to guess on it.
JIM: 36 billion out of the 59 billion was made up of petroleum imports. I mean global oil output has been stagnant for four years failing to keep up with the demand in Asia and the Middle East.
I mean China's imports in energy last year rose 14%. Bio fuels from grain, oil seed and sugar are plugging the gap, but they are drawing away from food supplies which is one of the reasons why we're seeing agricultural prices.
I mean, talk about population. We're adding 70 million people a month in terms of population growth. If you're looking at strategic minerals, it was one of the things, there was an article in the US that somebody said if we had to fight World War II today, we couldn't because, you know, our Founding Fathers realized in our war for independence that this country was dependent on foreign nations for just about everything from iron to gun powder to blankets and clothing. And one of the things our Founding Fathers did is they implemented a national strategy promoting industrial and military self-sufficiency.
But, John, it is something that we have forgotten. Mineral production, America used to be the leader. We have allowed the nation's once formidable mining industry to erode. Many of the minerals including some that are strategically important for the military are no longer produced in the United States at all due to the lack of investment, radical environmental activism, low cost foreign competition. Many of America's former mining giants have turned off their drills, they have closed the refineries, they have sent the workers home and instead have chosen to develop new production outside of the United States.
In fact, the US army just issued a report to Congress that said that more than 50%, 23 of 40 critical materials essential to the United States’ national security, we don't even make here anymore.
And so more and more, everything from cobalt, which we quit producing in 1971, we used to be a large producer of that, and this report goes on: all of these strategic minerals that we were once self-sufficient, once produced here, we have shut down in this country and instead we’re importing from overseas.
I mean we are going into a self destructive mode here and nobody sees and all they can talk about is if we can get more consumption in this country, we'll have prosperity. Nobody ever built prosperity based on an increase in debt and consumption. You save, you invest, you build, you produce, and you make things. That's what creates wealth and that's why we're heading down a road, John...I'm not sure that we're going to be able to dig our way out of this. [27:55]
JOHN: That's what I'm saying. We're actually digging ourselves into our own hole. I was in Seattle a couple of weeks ago and looking around and Seattle of course votes according to –the state of Washington is sort of split east versus west – the west is very liberal, the east is very conservative. But in talking to the people and I love to do this in coffee shops and wherever we wound up, and I let the ladies in my family go into Pier One. That's really a mistake, don't ever do that. But while they were wandering around Pier One Imports I was talking to the manager and we began chit-chatting about prices and the economy and everything, and what really struck me while peaking around Seattle was this would be a population group that would vote to save the planet very easily. Okay? That would be their whole thrust of things.
Yet if you look at the lifestyle that's being lived there, the way they are living and the way they want to do things in terms of ratcheting down the economy, these are unsustainable. These are on a collision path with each other. They cannot exist side by side. Something has to give here.
JIM: The point that we've been trying to make here, and gosh, John, I've been writing going back to the year 2000, I said if you want to make money in this next decade and beyond, I listed four areas: I started out with precious metals because governments were inflating. Two, I talk about energy. I talked about, three, food and then water. And then another area that I added in this decade was something called infrastructure. We'll get into this in in our fourth segment on how to benefit from reinflation, but if you just take the country of China, it's going to spend over $700 billion by 2012 on infrastructure.
If you take the Middle East, and these guys have got the money, they are going to spend $800 billion in infrastructure, 600 billion will go into the energy complex, whether it's building refineries, petrochemical plants, but another 200 billion will go into infrastructure.
Saudi Arabia is building four cities, four new ports, highways, things of that nature so they can make more money on their own natural resources. And you see these analysts, they get on TV and say, “well, food and energy, but that is an aberration.” They've been talking about that this as an aberration but it's been going on for seven years now and people still don't get it. [30:15]
JOHN: And so in conclusion, I mean, let's frame this in a way...there is a big giant of facts we've thrown out and shown how history interacts. Let's add the “so what” test to this. So what? What does that mean to any of our listeners?
JIM: Well, if you take a look at this, we're in another one of these price revolutions that is heading for what I call a culminating event. In other words, we're going to see this unfold in the next two or three years and all of these price revolutions that we've seen in history the pattern of prices is very revealing, whether you're looking at the 14th, 16th, 18th or 20th or the current wave that's begun now, they all begin with rising energy prices followed by rising food, manufactured goods prices lag behind. That gives you a lower core rate. And these patterns move with population growth. These patterns are exacerbated by monetary inflation. I mean how many times have we talked about double-digit monetary growth in 18 out of the 20 top central banks.
And as we progress into these different stages, that's where we're going right now. And there is always some kind of culminating event, John, whether it's a depression, it's a plague, it's war, something happens that breaks the pattern and then the cycle starts all over again. I don't care if you take a look at all of these sequential events over the last 1000 years. I mean, John, you rattled off: rising energy of food prices, rising population growth, monetary expansion, inflationary response, rising volatility, rise in criminal activity. It all goes through a sequential pattern and we're seeing this pattern play out today.
So is it you're looking at a bigger picture, ignore what experts are telling you that you can ignore food and energy inflation. You can ignore the price of gold as being some kind of aberration. They've been telling you this has been an aberration for seven years. And so the best thing you can do from this is profit from it. [32:24]
JOHN: And you're listening to the Financial Sense Newshour at www.financialsense.com.
Other
Voices: Peter J. Sepp, V.P. for Communications, National Taxpayers
Union
JIM: Taxes are one of the bigger topics in this year’s presidential election: are the rich paying not enough; Should we repeal the Bush tax cuts and who would that impact? Joining us on the program is Pete Sepp from the National Taxpayers Union. And, gosh, there is a whole list of topics I wanted to cover with you, Pete, but the first thing I wanted to cover is Senator Obama’s global poverty tax bill that he’s got in the Senate; and as I’m reading through the details here, he wants to assess a tax amounting to 0.7% on our gross national product and this would come from a tax on energy in the form of a tax on energy producers, utility producers and it would start out at 65 billion a year, and then it would amount to roughly 845 billion in taxes over a 10 year period. The tax revenues would be transferred to the UN. And as I see here, the sponsors – Obama has sponsored it and the other senators include Maria Cantwell, Diane Feinstein, Richard Lugar, Richard Durbin, Chuck Hagel and Robert Menendez. Wow! Did they think they’re going to get away with this? Or why is nobody talking about this?
PETER:
I think a large part of it has to do with the text of the
legislation itself which is saying the administration and the United
States should commit to this goal and they’re probably saying,
“well, this is nothing more than legislation expressing our sense
that we should be giving more foreign aid and more aid to the United
Nations.” I think the legislation would do much more than
that; I think that making this kind of commitment up front would add
many, many billions of dollars on to what is already somewhat
considerable foreign aid contributions. We often talk about
how the United States only gives about, well, one billion dollars or
so to the United Nations regular budget. The US is in fact the
largest contributor. What that doesn’t count of course are
numerous other US contributions to the United Nations for emergency
operations, voluntary contributions from the government to other UN
agencies like UNICEF. Well, that’s all well and good that
it’s voluntary to our government; it’s involuntary to taxpayers
of course. [35:29]
JIM: And you know, that doesn’t include any time there’s a tragedy whether it’s earthquakes or a tsunami, the United States kicks in with food and aid and other things that we bring in. So Obama’s global tax is it because nobody has really read what’s behind the bill because I mean this is a massive tax increase?
PETER: Yeah, I think that’s part of it and it hasn’t gotten enough publicity, unlike for example Congressman Dingle’s plan – the Congress from Michigan – who was basically putting up a plan designed to scare people into thinking about how much it would cost to institute an emissions control regime on carbon dioxide in this country. He proposed a huge increase in the gas tax, well-over a dollar each, and proposed a new tax on CO2 production. It would have amounted to $50 per ton. When you consider though that the United States emits more than six billion tons of carbon dioxide, you do the math and suddenly you’ve got a $300 billion a year tax in place. [36:41]
JIM: Another topic besides Obama’s global tax, everybody is talking about repealing the Bush tax cuts, you know, “we’re going to get the rich folks.” And we’ll get to that in a minute but I’ve got in front of me, Pete, a 2000 tax rate schedule which included the brackets in which you would hit various levels under Clinton and then also the Bush tax cuts. Now if we look at where people are today, under Bush we got a 10% bracket versus a 15, so there was a lower bracket and the first $7800 of taxable income were subject to 10%. But here is the thing that I find amazing. For most middle class people, under Bush (taxes the way they are now) if you were a single individual you do not reach the 28% bracket until your income exceeds 77,100. If we repeal that and go back to the Clinton tax brackets, a middle class family would hit the 28% bracket on income of 26,250. So they start the 28% bracket at an income level that is 50,000 lower than where it is.
And gets even worse than that. If you look at the 31% bracket, $63,000 of income and you hit the 31% bracket under Clinton’s tax rates and then for a single individual 36% at 132,000. Wow. You don’t even hit that bracket until you hit 349,700. So all of this talk – and it gets even worse for married couples because the one thing the Bush tax cut got rid of a lot is that marriage penalty.
PETER: Yeah, absolutely. And the other thing that I think most people forget is there are other provisions beyond marginal rate reductions that would be affected here beyond the rate differentials for the marriage penalty. It’s the double child tax credit, for example. It was $500 under Bill Clinton, it’s $1000 under these Bush tax cuts and we all have to remember a credit is very valuable. It’s a dollar for dollar reduction in your tax. It’s not something you simply deduct from your taxable income. So, a family with two children, boom, it’s an immediate $1000 tax increase if the Clinton era law goes back into effect. [39:11]
JIM: It’s amazing because the one thing the Bush tax cuts tried to rectify was the marriage penalty of couples getting married and paying higher taxes, but if we go back to the Clinton tax rates I’m looking here at the tax schedule: a married couple would hit the 28% bracket on income of 43,850; and under Bush a married couple would not hit the 28% until their income exceeded 128,500. And you know, a lot of people may think, Pete, if you make 100,000 you’re rich but if you take Social Security tax which is 15.3% if you’re self-employed (half of that if you’re working for somebody else), you take Federal income taxes, you take state taxes – you’re not Rodeo Drive or Beverley Hills on $100,000 of income in California.
PETER: No, absolutely not. And here in the Washington, DC area including the suburbs the median family income is about $78,000. Well, that’s a snapshot of all families in the middle of this scale and it probably doesn’t account for folks who might have kids about to go into college who are the peak of their earning years. They could easily exceed $100,000 in income and they would be paying a whole lot more in taxes. [40:37]
JIM: So if we repeal the Bush tax cuts, it’s going to hit the middle class and the poor I would say probably even harder at a time that families are struggling to make ends meet.
I want to hit another issue that Obama and others have been making which is the rich aren’t paying their fair share of taxes because of Bush’s tax cuts. I’m looking at a schedule here of who pays the taxes in this country. And according to this schedule, and I’m talking about people that make $62,000 or more a year, the top 25% of income people in this country pay 86% of this nation’s income taxes. And they think that isn’t fair enough?
PETER: Yeah, it is a very small segment of our society actually or comparatively small one that is bearing the burden of federal income taxes. And of course, I hear the counter argument that well, that doesn’t include payroll taxes and excise taxes which hit lower income categories much harder than other upper-income categories. That’s certainly true, but it doesn’t change the overall results significantly. The Congressional Budget Office studied the impact of all taxes, not just income taxes, on various quintiles of income earners and the top quintile paid a whole lot higher rate than the bottom one – or even the middle one for that matter. [42:04]
JIM: The way they distort this and they make it sound unfair is let’s just take a simple illustration and let’s say, Pete, you pay $10,000 a year in income taxes and let’s say I pay a million dollars in income taxes because I make a whole bunch of money. And now let’s suppose the government comes in and they cut tax rates 10%. So on your $10,000 you pay in tax, your taxes are cut 10%, you save $1000 in taxes; I, who pay a million dollars in taxes, my tax rate gets cut 10% so I save $100,000 in taxes. And that’s why what they forget in the argument they say the rich got more in tax breaks but you know, the argument is they paid for 86% of the taxes. So if I save 10% on my taxes, I saved 100, if you saved 10% on your saved 1000 and what they do is they compare the 100,000 that I saved to let’s say the 1,000 that you saved and they go “this went disproportionately to the rich people.” But, disproportionately, they pay 86% of the taxes in this country.
PETER: Yeah, and the other argument I hear is, “well, they are making all of the money so of course they should pay the higher rate.” That’s not necessarily the case either. If you look at the richest one percent of Americans, they account for about 20% of all adjusted gross income but they account for almost 40% of all income taxes paid. In other words, they are shouldering twice as much in taxes as they accounted for in earnings. If you go to the bottom half of the scale and it’s incredible: the bottom half of income earners in this country take a 30% share of the AGI (adjusted gross income) pie but they barely pay 3% of the income taxes. So if this isn’t a progressive system, I don’t know what could possibly be designed that’s more so. [44:07]
JIM: Another issue here that comes into play and that is the increasingly – I forget what the numbers are, I heard a statistic and correct me if I’m wrong, Pete, it’s something like 50 million people in this country pay no federal income tax.
PETER: Yeah. It’s difficult to get a precise estimate but if you look at, for example, the number of individual income tax returns filed in the United States at about 135 million a year, some 95 million of those have reported taxable income and a tax liability of some kind. So that right off the bat signals there are 40 million filers who do not have any kind of tax liability even though they are filing a return. That doesn’t count the individuals who don’t have to file a return in the first place because their income levels are so low. So there is a very large share of America that are not paying any kind of income tax and in fact, they are often paying a negative income tax owing to that Earned Income Credit which can zero out their tax liability and even give them more money back. [45:18]
JIM: If we look at some of the various tax proposals, okay, let’s say Obama or Senator Clinton gets in and they repeal the Bush tax cuts so we go back to 39.6% income tax. Obama wants to lift the cap on Social Security so that would be an additional 15.3% for self-employed individuals which would take us to 55% or 47 or 48% if you were working for somebody else. Then they’re talking about, Rangel has got a surtax of 4% on married couples making 200,000, plus it would be 4% on single individuals making 100. Then I think when you get to – I forget what the figure is, maybe...
PETER: I believe 300 for couples – close to there.
JIM: And then you get to 300,000 and it goes up 4.6%. So you’re talking about Obama’s plan would take income tax rates to 60%. And this reminds, me, Pete, when the country had experienced a correction in the stock market, the economy started to weaken and I’m talking about 1929 and 1930 and Herbert Hoover took income tax rates from 25% to 63% and then Roosevelt took them from 63% all the way to 94%. They’re talking about doing the very same things here.
PETER: Yes, and unfortunately so. It’s this boom and bust period we have to worry about. The first real supply side tax occurred in the early 1920s under the Coolidge administration. Treasury Secretary Andrew Mellon crafted a number of proposals to turn back the rise in tax rates that began during the First World War; the top tax rate fell by almost 50% between 1921 and 1925, so did those for lower income brackets. The economy subsequently grew almost 70% prior to the 1929 crash and unfortunately, many things were made worse under Hoover because of his policies, as you say, and then Roosevelt’s. [47:38]
JIM: You know what is amazing is remember when Bush cut taxes in 2003, they said this is going to cut back on revenues and by the Treasury’s own admission, by Congress’s own admission tax revenues actually went up.
PETER: Yes.
JIM: Why don’t they understand this, Pete, every time they raise tax rates tax revenues go down?
PETER: Well, I think they’re able to argue that obviously giving money back to the American people that they earn somehow costs the Treasury money and therefore increases the deficit. But even if you just think about it intuitively that can’t possibly be true because if you want to get less of an activity you put a tax on it. Well, if you raise the tax on productivity innovation and profit-making, you’re going to get less of that and in turn, less revenue. I mean we can even look at the example of Bill Clinton. He was the first president since Ronald Reagan to cut capital gains taxes. He signed a rate cut into law in 1997 and that preceded one of the best stock market booms we’ve seen in three or four years since the year 2000. [48:48]
JIM: And when you think of the stock market, where it is today, we’ve got volatility, you’ve got concerns. But even more important, Pete, unlike maybe your parents or my parents that worked for a company 25 or 30 years, they got the Timex watch and a pension, a lot of the boomers who are now heading into retirement – the largest retirement population in the nation’s history – are going to be dependent on interest and dividends that they get from their investments because they don’t have the Timex watch and the defined-benefit, guaranteed pension from the company. All they’re going to get is what they get on their assets. Very few will have pensions in the way our parents did. And now you’re talking about getting rid of the 15% favorable tax rate, going back to double taxation; and then also getting rid of the 15.5 percent tax rate on capital gains and going to 28%. And they think that’s going to help the stock market.
PETER: And right now of course, the capital gains rate for some of the lower income brackets is zero. You don’t pay anything on them. And can you imagine what’s going to happen to people’s retirement investments if the old tax rates kick in. I mean it’s kind of ironic, the federal government keeps having these financial awareness months and weeks that they declare in legislation saying people need to take a long term outlook about their finances. How on earth can they do that with tax policies like this. I see that all time, whether you take a Roth IRA or a regular IRA depends on how high you think your tax bracket when you retire. Well, nobody can know that with policies like these. [50:33]
JIM: One thing that I’m going to ask a favor of, Pete, that I would think is very instructive on your website if you could put up the old rates and brackets under Clinton and then tax rates and brackets for single, married and head of households under Bush so that Americans can see first hand what’s going to happen. And we talked about this on the program and you know, I got all kinds of nasty grams from people saying, “oh, you’re just trying to protect rich people.” And I’m saying: No, taxes are going up on the poor and middle class under the old Clinton program, and what has prospered is these new favorable tax rates; and you don’t raise taxes when the economy is struggling.
PETER: Yes, and that’s a death sentence. I hear a lot from the candidates, and even the majority in Congress that we will find a way to preserve the middle class portion of the Bush tax cuts. Well, the budget resolution that was passed last year in Congress creates some fictitious reserve fund that they can use for this tax relief if everything works right. I still haven’t heard precisely how Clinton or Obama plans to institute this middle class tax relief or keep it alive. I keep seeing conflicting numbers and proposals. We have to assume that all this is going to disappear. [52:01]
JIM: I’m just looking once again at your statistics: People who make over $62,000 a year pay 86% of this country’s taxes. So are you going to take the top 1% of the country that pays 40% of our income taxes and tell them that they’re going to have to pay 75 and 80% of the taxes. You’re going to have a mass exodus of people out of this country.
PETER: Yeah, that’s become a lot easier in previous years than many people would think. There are lots of countries around the world shifting to flat rate income taxes, not only in the old Eastern European Soviet satellite countries but also in Asia and now perhaps even in Africa. So there are lots of places where people can put their wealth to escape punitive, extortionate tax rates like these. And some folks might say, well, good riddance, they’re not good Americans. Yeah, but we’ll still be out the money and we’ll still be out all of that experience and innovation and drive that creates jobs for the rest of us. [53:05]
JIM: You know, it was amazing they tried this in 91. Remember, Pete, they tried the 10% luxury tax on cars over 30,000, planes and boats because they were going to get wealthy people and what they did is they did is wiped out – almost wiped out –the boating and small aircraft industry in the United States. There were tens of thousands of jobs that were lost that were lost as a result of those taxes. It’s amazing to see history, you have countries like Russia and China that have gone to flat taxes and lower taxes and are experiencing some of the best economic growth rates in the world today, and we seem to want to go in the opposite direction. It’s amazing how we never learn.
PETER: Yeah, it’s almost protectionist tax policy making. They don’t want to look outside the American borders for lessons in taxes. [53:57]
JIM: Well, Pete, I want to thank you for joining us on Other Voices this week on the Financial Sense Newshour and on your website you have the proportion of Americans who pay the actual income tax. You also have a history of tax rates. And do me a favor, and if you can, put up the old tax rates under Clinton and where they are under Bush so people can see first hand just exactly what would happen to their taxes.
PETER: We’ll be happy to do so and that’s at www.ntu.org.
JIM: All right, Pete, thanks so much for joining us on the program. And boy, I tell you, I hope the message gets out because we’re talking about probably the largest tax increase in history that could take place next year if politics change in November.
Thanks so much.
PETER: Take care.
JOHN: Well, we have always said here on the program – we haven't always done it with a German accent, but we do it anyway -- the devil is in the details in any area. And of course as we talk today on the day we're recording this week's program, the markets are down. Everybody is talking about recession. There are issues in the credit markets, but in reality, if you look at some of the numbers and you know what you're looking at, there are still sectors that are doing quite well. So let's talk about that, and then let's talk about some of the hazards of people getting into that and beginning tugging and pulling on the levers.
JIM: The one thing the market’s focusing on is earnings and typically when you're in a bull market, the analysts tend to project earnings out in a linear fashion, so if you were up 10, 15% in one year, pretty much, you know the forecast for the following year is up another 10, 15%.
If you look at 2007 at the beginning of the year in terms of where analysts thought earnings were going to be, they thought that they were going to be in the high nineties or low nineties that is. From the forecast made originally in January of 2007, actual earnings for 2007 came in 20% below estimates. In terms of the actual earnings for the year versus let's say, 2006, earnings were down 12%. What was interesting is as analysts were looking at the following year (because they always take a look at forward earnings), last March they were projecting over $92 earnings for the S&P. By the end of the year as companies start missing estimates they downgraded their estimates to roughly $84. And then you take a look at what companies reported in the fourth quarter they were down to about $71.
So, you know, if you look at in a recession, earnings go down and they decline for about a two year period. As the economy contracts people spend less money. Companies contract. They lay off. Profits go down, so you have a situation where earnings are going down. So on the surface, if you look at where things go, you can see that the losses that you're hearing about in the financial system, a lot of companies have been writing off especially the banks, the monoline insurers, anything to do with the financial end, home builders, anything to do with the credit bubble. I mean we've seen some horrendous losses, about 148 billion written off here just in the US alone. And so that's where the market is focusing on. [57:35]
JOHN: But the S&P has 10 sectors inside of it. Now, is this problematical situation uniform throughout all of the sectors, or are some sectors actually doing well? They are functioning somewhat independently from each other?
JIM: You know, right now most of the losses within the S&P – the S&P divides the S&P 500 into 10 mystery sectors. You have telecommunications, consumer staples, technology, health care, utilities, financial, materials, industrials, consumer discretionary and energy. So we have 10 sectors. Where you've seen most of the losses have come obviously from the financial sector. And that has a lot of importance in terms of what's happening to earnings because within those ten sectors they carry different weights.
For example, financial services have a market capitalization weight of almost 23%, and so it's the weighting of the sector that has more importance to what happens to earnings. So if financial services are 23 or almost 25% of this sector and they are losing all of these horrendous write-offs, obviously, it’s going to impact earnings. Consumer discretionary stocks are also very important because they are losing money because consumers are pulling back. But if you look at some of the other sectors, what sectors are doing well? The industrial sector is doing well. You have GE report earnings were up 15% the fourth quarter. Thanks to international, you have health care doing well. You have technology: on Wednesday of this week, you had Hewlett Packard report earnings that beat estimates. Utilities are doing okay. Consumer staples are doing well. Materials are doing well. So most of the damage within the S&P is probably contained within two and three sectors of the economy. [59:37]
JOHN: Okay. Well, give me some examples and then tell me what that means.
JIM: We've been talking about commodities, so you’ve got oil prices at close to $100 a barrel. Last year Exxon Mobil earned more in 2007 than any public company. The health care sector, whether you're looking at Lilly, whether you're looking at Johnson & Johnson, you’re looking at the health care sector, they are doing well. I mean even industrial stocks. I mentioned General Electric. Technology: Hewlett Packard, Cisco – a lot of these companies are doing very well. And even companies like a company like Corning Glass that makes the glass for plasma TVs and LCDs, I mean they just had probably the best earnings that they've seen in nearly two decades in the company's history. Flat panel displays are expected to account for almost 40% of the company's sales. And John, I can tell you from talking to people at Best Buy, Circuit City, Costco, people are still buying flat panel TVs, they are still buying LCD TVs, high definition TVs. So certain sectors of this economy are doing very well.
If you look at materials, if you look at the commodity producers, they are producing record profits. So a lot of this damage, and I think this accounts for this bifurcated market that you'll hear people saying, well, maybe we won't go into a recession; or we'll have things go much better than anticipated. And then you're having earnings reports that come out of companies that are doing very, very well. And that's one of the things that you're seeing is that a lot of these industries –whether it's the industrials due to the international growth, health care due to an aging population, commodities due to higher prices, technology companies due to new technologies, consumer staples producing goods that we consume on a daily basis – they are still doing very well. [1:01:33]
JOHN: Let's do some number manipulation here, then. If we take just the sectors that are causing the problem which are largely in the financials, if you back those numbers out of the overall picture, how does it readjust everything.
JIM: You know, if you take a look at just fourth quarter earnings, we've had roughly about 420 companies that have reported so far. Actual earnings, as I mentioned, if you take out the financial sector, consumer staples, you take the financials out of the picture, earnings are actually up 18% in the fourth quarter, and they were driven by three areas, energy companies, pharmaceuticals and consumer electronics. And so the earnings growth and the prices of these stocks are very attractive because it's kind of like throwing the baby out with the bath water, John. “Oh, earnings are down so I'll sell.” So if you take a look at the energy sector, although it's corrected at the beginning of the year, energy stocks are down 7% for the year and yet they are paying attractive dividends. You can buy energy stocks from PE ratios anywhere from 7 to 10. If you're looking at consumer staples, they are doing well. That sector has corrected; it's down about 5% for the year. You've got many of these companies with high dividend paying stocks. You've got technology, which is doing well. That's down about 15% for the year. What's amazing is of the big sector that's losing the most money – financials – it is actually doing better than energy and technology because people are saying: “Ben is cutting interest rates, so therefore, we'll go into financial and home builder stocks because it's a bottom.” And I think that's a mistake at this point. [1:03:13]
JOHN: Yeah. But the over all view point right now, despite the fact that we know some of the financials are not doing well, energy, health care, the industrial sectors, there are other sectors that are really doing very well here and yet people seem to be applying the psychology across the board. It's almost an irrationality, just get me out of this right now.
JIM: Once again, it's like throwing the baby out with the bath water. It's like, sell first, ask questions later. And yes, if you were in financials, brokerage firms, home builders, anything associated with the bubble, which we saw in real estate or the credit markets, those are not doing well. But, you know, the other sectors of the economy are doing very well. They are increasing profits, they are more involved in the international economy. You take a look at companies like General Electric that have over 50% of their sales overseas, a lot of the consumer staple companies have 60 to 70% of their sales come from overseas. I mean they are doing very well.
And what's great is, I mean if you take a look at we've been talking about dividends and we had Kelley Wright on from Investment Quality Trends that tracks 350 blue chip stocks, he mentioned on the program and we're seeing it, John, for the first time in nearly a decade, he's got almost a one third of his universe of stocks that they follow that are in the undervalued category based on relative dividend yields. And so there are some very attractive opportunities here in the sectors that we've been talking about that. Energy, pharmaceuticals. Although we'll get into how to profit from reinflation given the topic we've just covered in the first hour.
But I think that you've got to look behind these numbers and I think there is a major mistake being repeated here by the bears. Unless we have a policy mistake, if we go down the wrong road and do some very stupid things here, which would then negate the Oreo theory that we've been proposing since the beginning of the year, but barring that, the Fed is cutting interest rates and it's indicating that it will still continue to do that, Congress added a stimulus program and we've probably got another one coming, we're going to probably work on some kind of bail out, whether it's somebody like Warren Buffett coming over and taking over the municipal bond business and some kind of bail out of the other sector, which I think you can see happen.
I mean last week you had the British government take over Northern Rock. Sooner or later, they are going to come up with some kind of rescue program, whether it's an RTC, it's some kind of bail out. We've seen it over and over through the years, whether it's the Hong Kong government buying 20% of the market in 1997 to prop it up, whether it's its US government backing foreign bonds with Brady bonds in 1994; sooner or later, you're going to see some kind of bail out and once that happens, then the fear and pessimism that you have today then goes away. That’s because remember, it can turn on the dime and remember we are programmed to look at things.
We are hardwired to think of things from the short term and we are hardwired to follow the herd. Those are the two chief characteristics that you see on Wall Street today. Everybody is looking at short term. What is it today? I mean just look at how things have changed in this country and the markets and politically in just two short months. They weren't talking about stimulus programs in December of last year. They weren't talking about recession or even a bear market in December of last year. And look how things have just reversed and gone almost 180 degrees in a period of about six weeks. This again reinforces the herd mentality and the focus on the short term. [1:07:07]
JOHN: Let me talk about that herd mentality a bit. I mean if we can trace back to where we were in the last segment and we were talking about when governments get into certain situations, the urge for them (especially for politicians more than government) is to want to get in there and begin tugging and pulling on the levers and also what they tend to do is to number one demonize; and number two, plunder successful areas of their economy, thus actually chewing out their own substance again.
But let me give you an example right now. Everybody has heard health care prices are somewhat disproportionately out of control. Listen to some of the election rhetoric. Now, what happens is historically is when governments get into this situation, they go into and begin plundering those parts of the economy that are left and functioning to try to say they are helping people, and again in result destroying what's left of anything functioning out there. [1:08:03]
JIM: Well, that's exactly what happened in the 30s where there was this great hostility to business. It created a climate of uncertainty. There is a big climate of uncertainty right now with political change, and I'm talking about radical socialism coming into this country where the government would regulate the profits of drug companies and energy companies at a time where you have our major oil companies only accounting for 15% of the world's oil production; and probably one of the most capital intensive businesses out of any business around today is the energy business. And as I mentioned, to go out and regulate, to penalize them. John, we are shooting ourselves in the foot. I mentioned in the last segment that we had a $59 billion trade deficit in the month of December and of that 59 billion, 36 billion went to foreign imported energy products, whether it was raw oil, natural gas or refined products such as gasoline, diesel or jet fuel. I mean it is just absolutely amazing to see.
And you're exactly right. What happens is the things that are doing well and functioning, we'll start a trade war, we'll start tariffs, they're talking about unwinding free trade. And the one strong element in the US economy right now is probably the emergence or rebirth of American manufacturing, the one strong element is our exports. In fact, the one bright spot in the trade deficit figures were the exports, John. Exports have been growing at almost 13 to 14%. And yet some of the policies that they are talking about were basically to protect certain industries, they would destroy the rest. And that's what politicians do, and that's why the difference between a recession and a depression is political. It's the politicians that make policy mistakes that turn a recession into a depression. [1:10:04]
JOHN: So how would you handle something like that? Have you given much thought about it? Because I think everybody agrees that health care premiums, say, for example, are way too high. The alternative is some kind of wage or price control or penalty. How do you deal with something like that as a politician?
JIM: Well, first of all, one of the reasons for the rise in the cost of medical are two major factors that nobody has ever addressed: frivolous lawsuits and regulations. You know, you talk to doctors and you almost have to have as many people dealing with government regulations in a doctor's office today than you do nurses treating patients. That adds to health care. That adds to cost. Then you take a look at the liability lawsuits. I mean you invent a drug, you're going to get sued.
And John, you and I know today, you look at your own mother that lived into her 90s. I look at my mother and her age today. People are living longer today due to medicine. And yet, you know, lawsuits and government regulation are a major factor in the cost of healthcare today. And you don't think all of those regulations, I mean, when a doctor's office has maybe two nurses and three people dealing with paperwork, what does that tell you? [1:11:17]
JOHN: Well, in addition to that, you're finding a lot of doctors, now, especially in the area of care for the elderly just refuse to take Medicare because not only is it a plethora of paperwork that they have to deal with, but there is a huge liability risk. There are heavy penalties say if someone fraudulently bills Medicare. Now, yeah, there are people who have billed Medicare fraudulently, but the flip side is you're dealing with a bulk of regulation that you're not even sure if you're complying with and you can wind up starting to deal with some kind of government entity.
I've known of cases where this has happened, so a lot of doctors now are saying: “We don't want to deal with this. We're not going to take Medicare or Medicaid in our practice.” And if you're an elderly person needing Medicare, you have to go somewhere else if you can't afford to just pay for it outright. So you're right. You've got one side that's frivolous lawsuits. The other side is this giant, what does it take to produce drugs, what does it take to do this, this micro-managing of prescriptions and everything right down to the bottom level. It's reached insane levels.
JIM: It's absolutely amazing. I have a group of neurologists – one of my clients was telling me about this client who had multiple sclerosis and they wanted to treat her with a special kind of drug and it could make a recovery or help in the recovery and ease some of the pain and the treatment was 700, I think. He told me you have to go in the hospital, you take the treatments and the drug itself is over $700 not counting the hospital stay but Medicare will only pay $400. So this patient will not get treatment for this illness because Medicare refuses to pay for it, so here is just a good example of the inefficiencies that are created through government in the system. And yet people are coming out there and say, well, if we have more government control over health care, it’ll get better. No. It will get worse. More people will die, the treatment will go down and you will have eventually where they are going government will make the decisions in terms of who gets treatment, who gets taken care of and who doesn't. [1:13:30]
JOHN: That will be made on some kind of life boat process if you look at the ethics today. In other words people over 50 or something like that, well, if you remember for Governor Lamm from Colorado, well, we just have a duty to die and move onward. We don't want to consume what we call resources. It will be resource allocation and apportionment. It will not be a decision that you and your doctor make. It will be government combined with insurance companies that will make these decisions ultimately. But let's get back to where we were. That's a rabbit trail that you look at the situation that's developing here in this country.
Let's go back to the numbers issue. What should we derive as a conclusion from that and especially from an investment standpoint.
JIM: Well, first of all, I think things are much better than the current pessimism would lead to. It's amazing. One of the guys that I have a lot of respect for, a guy by the name of Joe Rosenberg. He's the head investment strategist for the Tisch’s which runs Loews Corporation. There was an article in the Barron’s last issue and he's talking about that, you know, there are lot of stocks out there and the kind of things that he's buying. He's buying into the technology sector, especially in the software area. He's buying into the medical area. He's buying into a specialty retailer. So he's still finding bargains and he takes a look at the yield on government bonds, two year Treasuries at 2%, you've got 10 year Treasuries at 4%. And you've got the earnings yield in the market about 7%. So point being is that you've got to go where the earnings are and there is an opportunity here because in this panicked selling –and I think there has been a lot of panicked selling and there is too short term dominant thinking in the markets today. And as I mentioned earlier because psychologically we are hardwired to think short term and we are hardwired to follow the herd, so as you had some of these financial firms, whether it's an insurance company or banks or a hedge fund that had to liquidate because they got margin calls when stocks go down, you start selling anything that you need to get your hands on. If gold is up, you sell your gold stock. If energy is up, you sell your energy stock. If materials stocks are up, you sell those.
And that's what I think has happened here is this rush for liquidity being thrown out a lot of the good stuff which in my mind just creates a bargain because that's where the earnings are going to come from and that's where the earnings are going to continue into the future, so there is an opportunity to buy here. [1:16:02]
JOHN: Financial Sense Newshour continues at www.financialsense.com online all of the time.
JOHN: Well, we come back to that topic that everyone is really asking about, I guess, that barbaric metal, gold, and whether this is really going to do something or is this an anomaly situation right now. So we know there are two articles you want to talk about, Jim.
JIM: Well, you know, there was an article in Barron’s economic beat with Gene Epstein, and he said that Greenspan was right. The case for gold part one, (part two, will be in this weekend's edition) and he talked about Greenspan talking about gold from his earlier point of view, and then he sort of went astray, became a central banker.
But if you take the arguments that Greenspan made for gold, he said there are three things the gold standard protects people from: 1) the business cycle that have long been burdened by these boom and busts 2) the rapid price inflation that Greenspan sees as a future plague (in fact, in his book, The Age of Turbulence, Greenspan sees an end of the era of tame price increases, and we're going to get into that in a minute); and 3) the third is it prevents the government from raising funds through the unilateral expansion of money and credit that is used as a plague on our freedoms.
And so this was Gene Epstein's article. And then, you have got a lot of people that invest today as a result of charts. They are always following charts and whatever the short term chart says. And, you know, one of the most venerable technicians out there is Richard Russell, and he had a piece that he wrote about gold and what's going on. And he talked about, for example, the unfunded liabilities in Social Security and Medicare, the monstrous annual deficits and then, you know this “let's tax the rich,” and all of these things that we're seeing from our politicians today. And yet he talks about something here –and this is a picture that I think people aren't focusing on – that something very unusual and important is going on. What is happening is that gold has been rising against almost everything else; you name it, and gold is rising against it. And then he asks the question: Why is that? Well, it's a complex question, but gold is a universal time-honored standard of wealth. Gold is pure, it's tangible, it's safe. Gold is so safe it doesn't need to pay any interest to tempt people to hold it.
Then he asks himself this question. Why here in the year 2008 is almost everything declining in terms of gold. “And this is my answer: The world is now dealing with deflationary forces particularly due to low price global labor and a great outpouring of cheap manufactured goods” – in other words over-supply; and the governments or the politicians of the world will not accept deflation.
In fact, they are scared to death of it. Let deflation take over and the politicians would be kicked out of office. So when deflation, rotten business and unemployment enter the picture, the politicians blame the central banks, the central banks are fully aware of the unspoken political threats and they do what they do best: They counter the forces of deflation and contraction by printing paper. Currently, this inflating printing of paper is systematically reducing the value of almost anything else against the one immutable standard of value, which is gold.
So that's the great unspoken story today. Massive quantities of various currencies are washing across the face of the earth. The result is that all items and categories are losing value against a single immutable standard of wealth, which is gold. [4:15]
JOHN: You know what always fascinates me is since you and I have been doing this show together, which is 2001, is that every single year since we started doing that, the price of gold has been going up. But there still doesn't seem to be a recognition in the market that that is the case.
JIM: And I think there is an explanation. It doesn't matter, John, if you and I are talking about gold, if we're talking about that energy. You've got everybody saying gold prices have topped out. You've got people telling you that energy prices have topped out.
We hear this, John, every single year. And you and I, especially at the beginning of the year, then we get to December and you and I have our annual review for what went on for the whole year and what do we tell people? Well, energy prices just sent a new record. Gold prices just set a new record. Commodity prices just set a new record.
And I remember, oh, gosh, when was this, 2003, 2004, we interviewed Donald Coxe. He'd written a book about waterfall declines in the market. And I remember during the interview, he was very bullish on commodities – as we were. He had just gotten back from speaking at a conference of mining companies and he had told them that, you know, get out your checkbooks, start exploring, start building new mines because you're in for the commodity bull market of your life time.
After a speech, he was heading back to the airport, but I think this guy was probably the CEO of the third largest mining company in the world. And he went up to Don and he said, “you know what, we've had people like you come up and talk to us over the last couple of decades. You always tell us that the sun is going to come out and shine, the clouds are going to go away and things are going to get better, and maybe for a brief moment the sun shines, but then the clouds come back.”
He said, “I just hope it lasts a couple more years so I can retire and get my pension.” And what has happened is when you had this 25 year bear market in commodities –it didn't matter, energy, copper, oil, gold, silver, it didn't matter, any kind of commodity – when you have 25 years of that, most of the executives that headed these companies, I mean remember in the bull market in the 70s, what happened is towards the end of the market as prices were hitting heading record levels, commodity companies expanded output, they explored, they built mines, they added new plants for processing commodities – and then the bull market ended. And all of these huge billions of dollars of investments had to be written off over the next decade. So they lost a lot of money.
So now, as we got into this decade when the good times are here again with higher prices, a lot of these executives have a memory. John, I mean let's put it this way: If you spend most of your adult life in an industry that's in a bear market, you know, it's just like he went through a Great Depression. It impacts the way you think. So there is a lot of bearishness, nobody believes it. It's what I call the four phases of a bull market. You have the pessimism going to skepticism. It's the skepticism phase that we're in. Then you take that one step further.
Think of the analysts –if there are very many analysts left that cover the sector – analysts talk to company executives, so these analysts who have also been in this sector for 25 years of the bear market, they get their information, they talk to the companies, and they've got the same sentiment coming from the companies. They are seeing that they are not expanding output, they are reluctant to build new mines, they are reluctant to build new plants and they expand. So it becomes self-reinforcing.
And then if you've had these economic cycles that have occurred over a three decade period, where, you know, you go into an economic downturn and then there is less demand for commodities so the prices go down, and this sort of becomes self reinforcing. Every single analyst from Goldman Sachs to maybe all of them have had to redo and throw their models out because they keep telling us lower prices are coming around the corner – lower prices never show up.
Fortunately, now, we've got a new breed of executives that are taking over these companies that are expanding. You know, look what Ian Telfer did for Goldcorp. He took it from a company that produces 400,000 ounces a year to a company that's going to produce 3 million ounces.
So, John, any time the prices go up, people say to themselves conditionally –everybody follows charts: “This is a top. We're at gold prices which are close to the previous top.” And then there is a selloff. The gold companies have been reporting record profits. If you have unhedged gold production or unhedged silver production and you're talking today, silver prices are close to $18, gold prices are close to $950. You're making a lot of money.
But instead, they keep selling off the gold stocks. Three companies today reported record profits, what do they do? They sold off because nobody believes it. [9:35]
JOHN: Let's tie this back to something we discussed in the first hour of the Big Picture, as a matter of fact, that we were talking about the inflation cycle and the traditional pattern of inflationary waves and how they go through a series of stages ultimately winding up in disaster. But now we come back to governments of the world, whether monarchies or democracies or republics and sometimes sooner or later, they get pressed for funds. They have three ways to raise funds and to pursue their ends. That's to borrow money, to tax it, or to inflate. And quite often inflation is very attractive because the public doesn't see that happen at first. Nobody feels them reaching into their purses and siphoning off the value of what they have there.
JIM: And the other factor too is with inflation government can blame it on somebody else. I mean you've got the Fed which is printing money like crazy blaming inflation on food and energy prices as if the money printing doesn't cause the excess demand that goes into these sectors. So it's an easier outlet. And the one thing that I think people forget, and what rising gold prices are telling you is where we're going with inflation. And there are a lot of people that are thinking we're heading for deflation. And the definition of inflation and deflation gets distorted today where you actually have people that don't even understand what inflation is. They think it's more of the symptoms: If oil prices go up, rising prices are inflation, not rising expansion of money and credit in this system today. [11:12]
JOHN: