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Manipulated Inflation Data Yields No COLA for Social Security Recipients

Analyst John Rubino: Explosive Demand Factors Setting up Possible "Perfect Storm" in Silver

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Welcome to this week's Market Wrap Podcast, I'm Mike Gleason.

Coming up we'll hear from John Rubino of DollarCollapse.com. John has a lot to say on how the dollar is making it tough for U.S. companies to compete in the global marketplace, what he sees ahead for silver, and some of the key drivers that may propel the white metal to new highs in the years ahead. Don't miss a very interesting discussion with John Rubino coming up after this week's market update.

Precious metals markets ran into a small headwind this week from a strengthening dollar. The U.S. Dollar Index surged over 2% through this morning. Falling GDP numbers out of China, talk of more desperate stimulus measures in Europe, and mixed earnings reports from U.S. blue chips have each helped give the buck a boost.

On Thursday, the European Central Bank kept its benchmark interest rate steady near zero. But ECB President Mario Draghi indicated that the central bank would consider new strategies at its upcoming December meeting aimed at boosting inflation. That could mean more asset purchases, more Quantitative Easing, and possibly more efforts to drive interest rates into negative territory.

If the ECB opts to pursue new stimulus programs, that could put pressure on the Federal Reserve to do likewise – or at least continue to refrain from tightening. But for the moment, currency traders are reading the ECB's guidance as negative for the euro and therefore bullish for the dollar's exchange rate.

Considering the dollar's sharp rally, gold and silver prices are holding up relatively well. They are each down less than the dollar was up. As of this Friday recording, gold prices come in at $1,163 an ounce, down 1.3% on the week. Silver, meanwhile, currently trades at $15.81, off 1.8% since last Friday's close.

Turning to the platinum group metals, palladium looks lower by 0.7% this week to trade at $694 per ounce. Platinum has shown some relative strength this month, but for this week it is down 1.6% and now comes in at $1,001.

What's been hit much harder by the dollar's rally this week has been the crude oil market. Oil prices slid more than 5% to under $45 a barrel. Softness in crude oil and gasoline prices over the past year has helped consumers cope with ever-rising bills for medical care, groceries, and other essentials. It's also helping the government save on entitlement outlays.

Last Thursday, the Obama administration announced that Social Security recipients would receive no annual cost of living increase next year. That's because the Consumer Price Index has been stuck near zero for most of the past year.

The CPI is as much of a political construct as it is an economic one. The CPI has been tinkered with many times over the years. Some of the most consequential changes were made during the Clinton administration. Since the 1990s, the government has employed tools such as "geometric weighting" and "hedonic adjustments" to give bureaucrats more subjective control over how the CPI is calculated.

The predictable result is that the CPI now consistently understates real-world inflation. Independent economists who have reconstructed the CPI using the old methodology find it tends to come in at about double the rate of what the Bureau of Labor Statistics is willing to admit. For one thing, the understated CPI allows the government to slowly but steadily reduce the real value of the Social Security benefits it pays out.

And the jerry-rigged unemployment rate published by the BLS allows the politicians in charge to always claim the economy is stronger than it really is. Millions of out of work Americans who aren't officially counted as "unemployed" can attest that the unemployment rate is a bogus statistic. Even Federal Reserve economists know it's not a true indicator of their "full employment" mandate.

But Fed chair Janet Yellen apparently has no sense of irony. On Tuesday, Yellen spoke at a ceremony honoring a former Bureau of Labor Statistics commissioner. Yellen talked about the importance of unbiased economic data. Then she described the BLS as "an authoritative, unimpeachable source of information and analysis about the economy."

Authoritative. Unimpeachable. So the Fed chair apparently believes that every statistic put out by the BLS is the absolute truth and never has any reason to question any of its calculations. Either that, or she knows better and is just lying for the sake of political expedience. Neither scenario inspires much confidence in the Fed's objectivity and independence.

And the Fed's failure to follow through on stated plans to raise interest rates risks undermining what credibility it does still enjoy. All eyes will be on the Fed when it meets next week. Policymakers are widely expected to again leave rates where they are. Fed officials will have one more opportunity to save face this year by hiking the Fed Funds Rate in December. If they don't, then they will basically be admitting that their economic models were wrong and that their forecasts are useless.

Well now, without further delay, let's get right to this week's exclusive interview.

Mike Gleason: It is my privilege now to be joined by John Rubino of DollarCollapse.com and Bearing Asset Management. John is a former Wall Street analyst, a writer for CFA magazine and a featured columnist with TheStreet.com. He's also authored several books, including

The Collapse of the Dollar and How to Profit from It. John, it's good to have you back. How are you?

John Rubino: Great to be back Mike, good to talk to you again.

Mike Gleason: Well, we'll get right into it here since time is limited. To start out, we've seen some disappointing earnings reports coming out lately. Way do you think U.S. companies are showing signs of weakness here?

John Rubino: That's really the big story right now. We've seen some brutally negative earnings reports on the part of some very big companies. Part of it is that the dollar is really strong. And that creates a headwind for a multinational company that's making stuff in the U.S., pricing it in dollars, and trying to sell it to the rest of the world because when the dollar goes up, that means whatever they're trying to sell is more expensive than it was when the dollar was weak.

That naturally impacts corporate sales and therefore earnings, but there's a lot of other stuff going on now too. The energy has just tanked in the last year, so anybody whose earnings are related to energy prices is affected by huge swings in the oil market for instance, but also coal companies are tanking. And the commodities bust is now global, so that affects anybody who is involved in mining or selling equipment to the miners. Caterpillar, which is the biggest earth-moving equipment company in the world has just gotten crushed lately. They've had multiple quarterly negative sales reports come out over the last couple of years, and it just goes on and on.

The big banks are not functioning well in this low interest rate environment. They like low interest rates, but they don't like incredibly low interest rates because it makes it hard for them to find people to lend to, and to lend at a wide enough spread that it is profitable for them. And then there's the volatility in the financial market. You've got stocks and bonds going up and down, and without really rhyme or reason, because a lot of it is just based on whatever the latest talking head from the Fed or the government said on CNBC. There's no fundamentals that work there.

And that's making hard for the big banks' trading departments to make any money because they can't manipulate these markets the way they can manipulate fairly stable markets, where they'll have one part of their trading desk place a bet and the other part of the trading desk push the market towards that bet. They can get away with stuff like that when there's no Fed talking head out there saying some controversial thing and sending the markets rolling in one direction or the other.

Anyhow, there's widespread weakness in corporate sales and earnings right now, and that's very scary from the point of view of the financial markets because stocks and bonds are priced for perfection. In other words, you need a really good environment in order to justify the level of the S&P 500 stock market index, for instance. By definition, a favorable environment for stocks is one in which corporate profits are going up, because that raises the value of these companies. Let their earnings start to go down and that calls into question current stock price valuations. That's happening out there right now, where you see companies blowing up right and left, and it's affecting the ability of even the best investors out there to make money in this kind of market.

I just published something this morning with the title "Genius is Failing. Hedge Fund Giants Burned by Changing Markets." It lists some stories about how Bill Ackman, a billionaire hedge fund manager has one company, a big pharmaceutical company of which he owns a huge stake, blowing up on him now. He's losing billions of dollars on that. David Einhorn, one of the great investors in the hedge fund world right now who's had a string of up years, only one down year in something like 15 years, is getting crushed this year. He's down like 17%, and that's because he placed a series of bad bets, he's getting crushed.

Warren Buffet owns a huge number of big brand-name multinationals like Coca-Cola and IBM and Wells Fargo, and a lot of them are getting beaten up now too, so he lost a few billion dollars in the past week. So even the giants in the world of investing right now are having trouble figuring out what to do, and that makes complete sense. It's exactly what you'd expect in a world that's undergoing a phase change. This is no longer business as usual, because so many big trends are getting ready to roll over or hitting a wall.

The debt binge has to end at some point, for instance. We can't continue to grow via increasing credit year after year after year. Fiat currencies are going to stop working, and they already are working less well than they used to. You're seeing so much currency turmoil out there that that makes it harder and harder to figure out what's going to happen in the year ahead and therefore how to invest accordingly.

So the financial world is going to be thrown into turmoil by the combination of these factors. It's going to be a fascinating few years, to watch this process play out and to see who adapts and who doesn't.

Mike Gleason: Given that a strong U.S. dollar is at least somewhat of a factor here with making it tough for them to be competitive in the global marketplace, how do you see that influencing upcoming Fed policy?

John Rubino: Well the Fed really wants to raise interest rates because that's their ammunition. High interest rates allow them to cut interest rates during the next down turn. They're facing the prospect now of heading into the next down turn because the economy has been growing for five or six or seven years, depending on how you calculate it, and that's a long recovery. Usually, you get a recession after that amount of time. They haven't been able to raise interest rates yet, so they really want to. They keep threatening to do it, but the global economy is failing. Quantitative Easing around the world has really not worked the way the textbooks say it should.

You cut interest rates to zero, you run massive government deficits, and you finance those deficits with newly created currency, you should create a rip-roaring boom that leaves lots of people being hired, lots of people getting raises, and then you have wage inflation, and then you have to raise interest rates to cool things off. Well that's not happening, and a lot of the internals in the U.S. economy have turned negative. Manufacturing, across the board is falling, and consumer spending is not growing the way you would expect with these top-line job numbers coming out.

If unemployment is five percent, people should be spending a ton of money, and they're really not. All that's really pumping up the economy right now is car sales, student loans, and to an extent, housing. Those are very cyclical, undependable trends. You can't expect people to keep borrowing money to buy new cars when they lock themselves in for seven years on a car mortgage. If enough people do that, there's no new car demand in the future, because everybody's already locked into a long-term car loan. Same thing with houses. We build a certain number and that's all we need for a while. Of course, student loans are bankrupting a whole generation of college graduates.

So we've got all these things that the Fed can look at just like you and I can, and they can see that they're really problematic. If they raise interest rates, they run the risk of blowing up these bombs that are just sitting there, waiting to blow up. Much more likely in your head is that the Fed's going to reverse course and say, "All right, I guess we can't raise interest rates after all. We're going to cut rates and we're going to institute a new Quantitative Easing program. Maybe we'll call it something different, but it'll involve bigger government deficits, more money creation, lower interest rates, yada, yada."

This morning, in a sign of what's coming, the head of the European Central Bank announced exactly that. He intimated that more QE was coming in Europe. The reason for that is that Europe's not growing. They did a lot of Quantitative Easing, they've got negative interest rates in a many European countries, and it didn't work. Same thing in Japan where, for decades now, they've been running massive deficits, financing it with borrowed money, running up huge amounts of debt, and they're still flat on their backs, economically. China, of course had this huge debt binge since 2008, 2009, where they quintupled their national debt, and that didn't work. They build a lot of stuff that turns out not to have been needed, and isn't generating the kind of cash flow necessary to finance the related loans, so China's seeing a pending credit crisis.

So you add all that up, and it's fairly certain that in 2016 and 2017, the dominant policy among the major governments of the world will be easing. Quantitative Easing, massive deficits, lower interest rates, and other various kinds of programs designed to get a weak economy moving. The problem is of course, that we've already borrowed so much money that it's not clear that new debt is going to have any kind of a positive effect, and might indeed have extremely negative effects. New money creation won't necessary help in any way because we've already created massive, massive amounts of dollars and euros and yen and yuan, thrown them out into the market, and they have not produced the boom that you would normally expect from the original numbers.

So in the next couple of years, there's a very good chance that the world figures out that the governments and central banks that have been managing their currencies and their economies are out of options and that they tried everything that they know how to do. They've thrown every weapon that they have against the debt liquidation that's been going on since the housing bubble burst in 2007, and it's not working. Then, we get a phase change in market psychology, in which people lose faith in the adult supervision that the markets have been thriving under for the past few years, and all head for the exits in at least one or two major asset categories.

Maybe they lose faith in bonds because they don't think the value of the major fiat currencies will be maintained in the future. Maybe they lose faith in stocks because they don't think corporations are going to be able to make good money and increase their profits going forward in this kind of an environment. You don't know which areas of the system will blow up first, but it's a fairly safe bet that we're going to see turmoil in stocks, bonds, commodities, and certainly in the political system out there, in some combination.

Of course, that feeds back into your business, which is selling precious metals. In this kind of turmoil, historically people have chosen to hide out in precious metals. Capital flows into the kinds of money that governments can't just create in infinite quantities by typing in a number and hitting "send." The things that are in limited quantity, like gold and silver, are going to look better and better in a world where interest rates are negative, so bank accounts don't pay you anything, and where stocks and bonds are incredibly volatile and untrustworthy.

Then, you'll have gold and silver just sitting there in terms of supply, growing by one or two percent a year, with their 3,000 year history of maintaining their value, and people are going to come to the conclusion that this is a pretty good deal in this kind of an environment, so you see a lot of capital flowing into precious metals I think. Of course, I thought that was going to happen two or three years previous to this too, and it hasn't really happened on any scale yet, but we're seeing signs that both small investors, the buyers of gold and silver coins, are starting to catch on and are buying vastly more such coins now than they were two or three years ago, and that some of the governments like China and India are aggressively buying gold and silver.

Let those two trends continue, and then the rest of the financial markets start to edge in and start moving one or two or three percent of available cash into precious metals and you'll see a rocking bull market, something reminiscent of 2010, 2011, in 2016, 2017. I think we have a good change of that occurring, and the main question is timing. Does it happen sooner or later? Do we have to wait to 2018, or will we start to make some serious money in precious metals next year? There's no way to know that, but I think the end result of the current set of policies is almost certainly great for precious metals.

Mike Gleason: I want to ask you about silver specifically because it's both a money metal but also an industrial metal, meaning it's both pushed and pulled from different directions. Since it has so many industrial uses, it often trades like an industrial commodity like copper for instance, but it can also get a boost based on monetary demand. How do you see silver performing in the face a worldwide economic slowdown? Because if we see a recession, you have to think the central bankers' response will be to print money and monetize debt as you just mentioned a moment ago. What are your thoughts on silver in the near to medium-term, given this push-pull situation with this unique metal?

John Rubino: Yeah, there are a lot of moving parts in the silver story. On the one hand, like you said, it's a monetary metal and it tends to move based on the same factors that affect gold. It gold goes up, silver will go up also, and probably by a bigger percentage because silver's a much smaller and thinner market. The fact that it's an industrial metal is actually good for the monetary story because the silver that's used in most industrial applications is not recycled, it just disappears once it's used. We're taking silver off the market at a time when we don't take gold off the market. Gold is money, and that's all it is.

All the gold, almost, that's been mined since the beginning of human history, is still around sitting in vaults or jewelry boxes or wherever, places where it's saved. There's a lot more gold out there than there is silver, relative to their prices. Silver, if it's caught in a monetary demand updraft, should spike. It should just take off, relative to gold. At the same time that you've got this monetary demand that is increasing now, people are buying a lot more silver coins than they used to, to the extent that the U.S. government has to ration the Silver Eagles that it produces because it can't produce enough to meet ongoing demands.

At that same time, you've got rising demand from interesting sectors that are fairly new, like solar power. Every new solar panel at the moment contains a little bit of silver. So as solar booms, which it is, solar is just taking over the energy market, which is a fascinating story in its own right, but it pulls silver along. Right now, the amount of silver that's being used in the solar market is dramatically greater than the amount of three years ago. And five years from now, assuming that silver remains part of the mix for the average solar panel, it'll be vastly bigger than the now. To the extent that you have this rising demand from industrial applications and rising demand for monetary interests, that's a really good mix for silver.

It looks like it could see the perfect storm in terms of higher prices out there in one of these years when both hit at the same time. When solar becomes really high-profile and people start figuring out that that's actually a new use for silver and it's growing like crazy, and everybody figures out that the central banks of the world have basically lost it, they no longer have the ability to manage the monetary system of the world and they're just going to inflate away the major fiat currencies because they have no other way of keeping us out of depression.

Let those things happen together and silver could really rock. I think you could easily see a return to $50 an ounce, and maybe quite a bit more because thin, highly-volatile markets tend to overshoot in both directions when the trend is right for a move up or down. I think the future move for silver is definitely up, and it's just a question, at that point, of how excited people get. If everybody decides that silver's the place to be and there's hardly any silver available out there, then you could get some real gaps up in terms of price.

The people who own it now and are just stacking, just putting it away, not really thinking about how much it's moving this week or this month or this year, they're going to have a really fun time watching their net worth soar. Again, timing though. I wouldn't say, "Mortgage the house and buy a bunch of silver this year because next year all of this is going to happen," that's a completely unpredictable thing, but I would say, continue to buy a little at a time and let your total build up and don't really stress out over what it's doing in the short run, because somewhere out there is a really good year in which, if you want to, you'll be able to sell part of your stack for a huge profit.

Then the question becomes, what do you convert it into? Do you want to hold these fiat currencies or do you want to buy real stuff? That's a nice problem to have, but it will be a problem eventually. You'll have to choose wisely when you start converting your silver into other things. Again, that's a 2017, 2018 issue for most people, and one where we can come back and talk more about it then.

Mike Gleason: As we begin to close here, since gold and silver prices have risen five to 10% in the last few weeks, we've actually seen a bit of the decline in retail demand from the very high levels over the summer. Why do you think that is? Are people just not buying into the rally because we haven't seen a lot of follow-through over the last few years when we did get an advance? What are your thoughts there?

John Rubino: Oh, I think day-to-day, week-to-week, month-to-month trading is completely unpredictable and unexplainable, except in retrospect. The markets just do what they do in the short-run. It's true, gold and silver seem to be firming up a bit, which feels good, but that doesn't mean they can't just fall off the table next week or next month and go back down and test their previous lows. We can't read very much into single digit percentage moves in the short run, but what we should be focusing on is the underlying fundamentals, which are very, very positive and which eventually will work out.

So I would say that if you're doing dollar cost averaging, if you're just stacking week after week or month after month, then lower prices are a actually a positive thing in the short run, because it lets you buy more. If they take off and go up from here, that's great. If they meander around from here, that's okay, and if they go down a little bit, that's okay too. As long as you have your eyes on the prize, which is $50 silver, $75 silver, then whether it goes from $15 to $22 this year or $15 to $13 this year shouldn't really matter all that much because you know, out there somewhere is that great year when everything goes your way. That's what we should be focusing on.

Mike Gleason: Metals market certainly are teaching a lot of investors patience, but I think you're right. Eventually, we are going to see that big move. It's just a matter of when, not if. Outstanding stuff, as always John. We appreciate your time and look forward to catching up with you as this all unfolds. It figures to be very interesting, both later this year and into next year. I know you're a busy guy. We really appreciate your time and your great insights as always.

John Rubino: Great. Thanks Mike.

Mike Gleason: Well, that will do it for this week. Thanks again to John Rubino of DollarCollapse.com. John and his staff put out some first-rate stuff, and you'll also find information there about a number of books that John has authored, so be sure to check that out. Again, it's DollarCollapse.com.

And don't forget to check back here next Friday for next Weekly Market Wrap Podcast. Until then, this has been Mike Gleason with Money Metals Exchange. Thanks for listening, and have a great weekend everybody.

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