Marius Kloppers had his numbers wrong. He said there were 74 resource projects in Australia at an advanced stage worth $80 billion. Yesterday, the Australian Bureau of Agricultural and Resource Economics (ABARE) said it was 74 projects for $112 billion. That's a 67% increase from this time last year. Is it inflation? Or just Gorgon?

These were projects already in the pipeline before the commodity price correction of 2008. The Gorgon gas project off the Northwest Shelf alone is a $43 billion project (nearly 40% of the total). Energy projects make up 38 of the 74 projects and 72% of total capital spending - which is why in both Australian Small Cap Investigator and Diggers and Drillers, Kris and Alex are recommending both conventional and unconventional energy shares.

But usually the companies doling out billions in new cap ex are larger companies with deeper pockets. That doesn't mean they aren't shares you want to own, or that their share prices aren't correlated with rising commodity prices. But we reckon you're going to find bigger cap ex related gains from the companies getting some of the contracts related to projects like Gorgon. These are the "pick and shovel" companies of the cap ex spending boom.

Or you can look at the other end of Resource City, to the explorers and developers. ABARE reports that last year set another record in resource exploration spending in Australia. Some of it was brownfield exploration (old sites or mines being redeveloped) and some was greenfield (brand new sites or mines). All up, there was $6 billion in exploration spending in Australia last year.

More than half of that was a frenzy of small companies drilling for new oil. $3.8 billion was spent on petroleum exploration. That tells you what the industry thinks about oil prices: they are going higher. Coal exploration spending was up 27%, with iron ore exploration up 30%.

The big shocker was that uranium exploration and gold exploration spending were both down by double digits in the last year. The uranium exploration spend was down 20% and gold down 26%. Yet the price forecasts for both commodities look, at least according to Alex's research, pretty damn bullish. So why aren't the explorers out kicking rocks and taking names?

It turns out they are, just not in Australia. The ABARE numbers measure exploration spending within Australia. But many Australian-listed firms are looking for gold and uranium in other places, especially in Africa. They're doing so because production costs are lower there, even if political risk is higher (although in some places, it's more than acceptable for the projects on offer).

They're also doing so because if you find a country with an acceptable level of political risk, you can also find greenfields mines to develop and build. Granted, that takes a lot of capital. But some of the developers never plan on running the mine anyway. What they're looking for is an economic deposit (high ore grades that can be produced easily) leveraged to higher commodity prices. They can then sell that off to a producer without ever turning a shovel in anger.

Just this morning, Aussie-listed Impact Resources said it believes it's found a large new uranium province Botswana. In a possible case of "nearology," Impact said the new province has similar characteristics to A-Cap Resources 98 million pound inferred resource in the same neighbourhood.

We have no idea what the facts are for either company. What we do know is that Alex told us two things (in his November letter) that you should look for with Aussie uranium companies: they need to have a resource big enough to produce a given amount of uranium each year and they need to be in production by 2012-2013. Impact's resource, according to Alex's research, was not big enough to qualify on the first measure.

As to the second measure, that's when Alex believes a shortage could hit the uranium market, thanks to interrupted mine supply at BHP's Olympic Dam and Cigar Lake in Canada. That, plus the removal of Russian-supplied recycled nuclear warheads. And that's just on the supply side. On the demand side, well, you've probably heard that story so we won't go into it.

Of course all this fuss about oil, gas, gold, and uranium presumes there will be a functioning world economy needing and/or wanting these things next year. Maybe not so, says a report from Societe Generale!

The French bank published a note to clients warning them to be ready for a possible "global economic collapse." In its report, "Worst case debt scenario," the bank said what we've been saying for the last month: the transfer of private sector debts to government balance sheets threatens a sovereign debt crisis (which is really a kind of debt-induced fatal heart attack for the fiscal welfare state).

The bank shows that overall debt-to-GDP ratio in the U.S. (when you include government, business, and households) is 350%. Bank analyst Daniel Fermon says in his report that even without more fiscal stimulus, government debt-to-GDP ratios will, within two years, be at 105% of GDP in the UK, 125% in the U.S. and Eurozone, and 270% in Japan.

This massive global debt burden is more than the underlying assets can bear. That is, the assets (collateral and the tax base) will not generate sufficient income to service the debt. It's global Ponzi Finance. What's in store, then, is another great forced deleveraging where debts are liquidated and asset values are forcibly written down.

That's not anyone's idea of a good time. "Under the French bank's 'Bear Case' scenario," writes Ambrose Evans-Pritchard in the Telegraph, "the dollar would slide further and global equities would retest March lows. Property prices would tumble again. Oil would fall back to $50 in 2010."

Hmm. Doomer porn? Or prudent preparation? You decide!

Rock-star bank analyst Meredith Whitney has already made up her mind. She told CNBC in an interview, "I haven't been this bearish in a year...There's nowhere to hide at this point...The Fed and the Treasury have to get the banks to pay back TARP. That means the banks are going to raise capital again."

She was asked if the banks are adequately capitalised? "No way," she answered evasively. "All this said...I don't know what's going on in the market right now 'cause it makes no sense to me. There's no root in fundamentals."

That's the trouble with a market trading on liquidity alone. Valuations don't make sense. But that's doesn't keep people from making them, or having an opinion anyway. Take gold (or pay $1,143.20/oz. for it).

Another report from Societe Generale - this one from analyst Dylan Grice - says that if the U.S. dollar were fully backed by gold, as it was in during the peak of the 1970s gold bull - it would trade for $6,300 per ounce. That makes gold, er, cheap at these prices.

Is this a case of gold entering its mania phase? Are analysts now starting to outdo each other with gold predictions? Maybe.

But Grice makes a sensible case. He writes that, "The U.S. owns nearly 263 million troy ounces of gold (the world's biggest holder) while the Fed's monetary base is $1.7 trillion. So the price of gold at which the U.S. dollar would be fully gold-backed is currently around $6,300. Gold is very cheap - at current prices, the USD is only 15 percent gold-backed."

If gold goes to $6,300, a lot of things will have gone wrong. Uber-bear Nouriel Roubini fears things are about to go from worse to much worse. He writes in an op-ed that the American unemployment picture is harbinger of bad times ahead.

"This is very bad news but we must face facts," Roubini writes. "Many of the lost jobs are gone forever, including construction jobs, finance jobs and manufacturing jobs. Recent studies suggest that a quarter of U.S. jobs are fully out-sourceable over time to other countries."

"As a result of these terribly weak labour markets, we can expect weak recovery of consumption and economic growth; larger budget deficits; greater delinquencies in residential and commercial real estate and greater fall in home and commercial real estate prices; greater losses for banks and financial institutions on residential and commercial real estate mortgages, and in credit cards, auto loans and student loans and thus a greater rate of failures of banks; and greater protectionist pressures."

It's pretty gloomy. But at least now, at the end of the week, the status quo seems to have clarified itself. We think we know what the opposing forces are in the market and just what's at stake.

In the red corner is the spectre of another massive forced deleveraging (debt deflation). Banks are undercapitalised. Assets are overvalued (shares, property, commodities, and most definitely most government bonds). This fighter will pummel stock markets and asset prices much lower as the world comes to grips with too much debt that produced too few productive assets and real income.

And in the blue corner is Helicopter Ben Bernanke. His mission, should he choose to accept it, is to devalue the U.S. dollar (and all those currencies currently pegged to it) and create more new money faster than deleveraging can wipe out debt. In theory, Bernanke is just the man for the job. Why?

He's an avowed deflation fighter. And, again in theory, there is no limit to how much money the Fed can create. Through monetary policy and other methods, the Fed can continue to shovel liquidity into the banking sector to keep it fictitiously capitalised and nominally solvent. In this fight, the Fed expands its balance sheet two to three times its current size (at least).

Of course if the Fed does begin growing its balance sheet at that rate one thing will happen and another thing might happen. First, gold will get closer to $6,300 as global dollar holders realise the Fed's intentions toward the dollar (not honourable). But there is another possibility.

The other possibility is that the U.S. Congress, not understanding anything, but seeing the fiscal deficit explode and the dollar plunge, begins to call for Bernanke's head on a pike. Or, to be more precise, bill's stripping the Fed of its independence and calling for a formal audit might began garnering support in the Congress.

There might even be some elected representatives of the American people who try and prevent a further currency calamity for Americans (who are rapidly realising that a weaker dollar means a lower standard of living and rising prices for imports). Don't hold your breath, though.

Congress get tough with the Fed? Granted, it's a stretch. My colleague Dan Amoss back in the States suggests Bernanke's political strategy could be to let a little deflation creep back into asset markets. A drop of 10-15% on the Dow would get Congress good and worried again, and mid-term elections are not far off are they? With another spell of deleveraging, Congress might just back off and let Chairman Bernanke continue his long-slow, back-door re-capitalisation of the zombie American banking sector.

You have to wonder, though, if the markets will be so compliant with the Fed's plans (assuming the Fed's plans are anything like we've described). You have to wonder if normal people are beginning to lose confidence that the so-called authorities have our best interests at heart, of even know what they're doing.

Above all, you have to keep really tight trailing stops to lock in your equity gains, increase your allocation to cash, and keep an eye on element number 79 in the periodic table. It's telling you exactly what to expect.

A final possibility is that the United States is ripe for a populist demagogue who either rails against the unfairness of China's currency policy and/or tells Americans it's time to close the borders, repudiate the debt, and get the fiscal house in order...with a big broom...and some pitchforks.

Dan Denning
for The Daily Reckoning Australia

• Uranium: A Carbon-friendly Substitute for Coal
• Energy Debate in Australia Needs to Get Serious
• Uranium Shares To Show Gains in Face of $120 Oil
• Red Bear Rising: Russia’s Resource Based Geopolitical Strategy
• BHP Billiton: The Oil Company That is Not an Oil Company

Of course there is. George Soros is picking up more shares of gold and potash producers. Mineweb reports that, "Billionaire investor George Soros' Soros Fund Management substantially raised its shares in PotashCorp as well as invested in gold ETFs during the third quarter. In Form 13F documents filed with the SEC, Soros Fund raised its PotashCorp from 1.98 million shares to 2.95 million shares with a fair market value of $266.4 million."

And while China and America bicker over currencies, Chinese firms are scrambling to buy real assets. And while Aussie banks source foreign borrowing to lend in local real estate, Aussie mining firms go begging for bits of capital that would bring world-class ore bodies (and key strategic resources) into production...by local producers and owners.

Take Moly Mines. It's aiming to operate a 10 million tonnes per annum copper and molybdenum mine at Spinifex Ridge in Western Australia. Prior to the credit crisis last year, things were going swimmingly. Molybdenum is a hardening agent used in steel-making. There aren't a lot of economic ore bodies in the world. Moly, according to the research we published in April of 2008 in Diggers and Drillers, had one of the most economic deposits.

But it all went off the rails with the credit crisis. The company couldn't secure the funding it needed to bring the project into production. And the share price fell. That made management amenable to any offer that would secure financing and rescue what was still, by all accounts, an immensely valuable and lucrative resource.

Yesterday, the Foreign Investment Review Board (FIRB) approved a $200 million investment in Moly by China's Sichuan Hanlong Group. It gives the Chinese group majority control in Moly and could see the development of the project at Spinifex Ridge begin in the middle of next year.

Good on the Chinese for finding a great project to invest in at a bargain price. The truth is, Australia has more good mineral and energy projects than the local capital markets can realistically fund (given the preference by the banks for investing in/spruikin property). BHP CEO Marius Kloppers made this point yesterday in a lecture to the Lowy Institute in Sydney.

Kloppers said there are 74 separate resource projects worth $80 billion the advanced stages of planning. Those projects need capital. "'Although clearly not simple," Kloppers said, "a part of the solution lies in continued foreign investment, meaning that both Australia and Australian companies need to be open to this kind of investment, despite its immediate and strategic implications."

What are those "immediate and strategic implications?" Well, up to now, existing Australian shareholders are being clobbered. Those who owned equity in these projects before the credit crunch have been diluted as the firms in question raised money with rights issues or institutional placements.

That's fair enough. Owning shares implies an assumption of risk. The stock market is not a savings account. But the other immediate implication is the transfer of majority ownership of these key projects to overseas owners (including the transfer of a big chunk of income from the assets).

This is what it is. And in most cases, it is not an issue of national security. The truth is, many of these projects won't get off the ground without foreign capital. They will create Australian jobs, export earnings, and share price gains for Australian investors. They will also secure key resources for foreign manufacturers.

There's no sense getting all lathered up about it. The status quo is a result of Australia's status as a net capital importer and the investment decisions made with the money Aussie banks have borrowed. The banks could have chosen to invest in Australian mines. But mining is a risky business.

Is it as risky as property? We don't think so. But the way the Australian property market is currently structured - with the government supporting prices directly through grants and indirectly through miserly land releases, and the banks channeling new lending into the market - it's a rigged game for the banks. Why wouldn't they invest in property? It's certainly in their interest.

Whether there is a national interest at stake in the mining industry is another question. You'd certainly think so, given how much government revenue is derived from royalties and exports. But most state governments and the Federal government seem happy with the current arrangement.

The large producers have an unassailable competitive position. And the smaller explorers and developers are left to their own devices to find capital for their projects. Hey...that's why they call it capitalism!

For investors with the patience to investigate the smaller fry, it's a great market. Our new editor of Diggers and Drillers, Alex Cowie, looks like an insomniac in a coffee shop when he comes to the office each morning. There are literally more good stories than he can possibly research.

The important point is that what might be a national problem - selling of mining projects to foreign investors - is an individual investor's opportunity. You always want to invest where you have an advantage. And as an Aussie resource investor looking at the mid and small caps, you DO have an advantage.

Sure, you may be investing alongside the Chinese, who may be getting a better deal. But there are dozens of smaller projects across the resource spectrum that - as long as the world does not plunge into a second great manufacturing depression - make compelling investment stories.

Murray got back to us with his U.S. dollar index chart. You may recall that the other day we published a chart of the dollar index showing that the short-term and long-term moving averages were in danger of crossing. Murray, a full time technical analyst, basically said our chart looked nice but didn't communicate any useful information to traders about when to enter or exit positions affected by the dollar's decline (or rise).

Murray sent over his chart with a note that begins, "The US dollar index is still in strong downtrend. My last update (to Slipstream readers) said that we needed to keep an eye on the 10 week/35 week Moving Average as the confirmation for any change of trend. Also we needed to see a close above around 81 to confirm a re-entry into the distribution between 78 and 89 formed over the last year."

"None of these indicators are close to being confirmed. So, from a long term perspective, you have to remain bearish the dollar although entry into any short positions is highly risky at this point. Have a look at the chart and you can see that the lowest dotted blue line comes in around a price level of 73 which is close to where we are now."

Click to enlarge

"The meaning of the lower dotted blue line is just that it is an area where a false break can occur. So even though the current price action doesn't look like it is related to the distribution between 78 and 89, it still could be so beware. You can see from the other ranges that I have shown in the chart that a break through the low of the range saw a move to around that lower blue dotted line and then saw a squeeze from there. The first one saw a move all the way back to the top of the range and the second one tried to re-enter its range but ultimately failed.

"The point being, if you had sold down at the lower dotted blue line on either occasion you would have ended up in a difficult position. The market usually looks terrible at those points, but all too often you will see a reversal there which will at least move back to the bottom of the range.

"In this case that would see a move back to 79ish. And from there a re-entry into the range could see a quick move to the point of control at 84 and on to the highs at 90. I think we will see the Dollar create a low somewhere between 67 and 74 and then we will see a big short squeeze to take out traders in what has become a very overcrowded trade.

"Don't get me wrong," he concludes. "I still think the US Dollar is toilet paper, but it doesn't mean it won't buck around like a wild bronco on its way to fiat currency heaven."

Yee haw!

Dan Denning
for The Daily Reckoning Australia

• Australian Recession in the Works? Ask the Sharemarket
• The Dark Underbelly of Australia’s Resource Boom: Chinese Resource Demand
• Australian Iron Ore Shares on China’s Menu
• The Aussie Dollar as a Measure of Global Risk Appetite
• Foreign Investment in Australia, How Much is Too Much?

In today's analog-inspired edition of the Daily Reckoning, we take a big step back and question some of our key arguments over the last three months. Is Australia's banking sector at risk from foreign borrowing? Will Japanese sovereign debt be the first to run into higher rates, triggering a rise in the cost of global capital? And are we wrong about China's fixed asset investment boom? Is it a bubble...or is it paving the way to decades of prosperity?

It's a lot of heavy lifting today. And we did have a quick glance at the markets at home before heading into the office. It doesn't look like anything important happened. So we're going to get tucked into some of these weightier issues and see how they taste.

First, for the last few weeks we've been making the point that Australia's banking sector is vulnerable because it's a large importer of capital. All the booms in the local market - in shares, housing, or commercial real estate - are, to some extent, financed by foreign lenders. Like most foreigners, overseas bankers like what they see from Australia.

Capital flows are good now. The sun is shining and the country is lucky. But if we're right and the strong Aussie dollar is mostly a function of the U.S. dollar carry trade, capital flows can reverse just as quickly. Currency traders probably love this because of the volatility. But the question is: how risky is it for Australia's economy to source so much of its borrowing needs overseas?

Well, until today we've neglected one aspect of that question. When you borrow, you can theoretically borrow in your own currency - a loan denominated in Aussie dollars - or in another currency, say, American dollars. There are risks and advantages to both. America has been able to issue debt in its own currency for years, always paying it back in the same currency. It's been a huge economic advantage (that's probably going away slowly).

The big risk to borrowing in a foreign currency is that you must pay the loan back in the foreign currency too. That's all well and good when exchange rates are stable. Let's say you're an Australian business and you borrow $100,000 in US dollars while the exchange rate is at .94 cents. If the rate stays there, you'll pay back US$100,000 plus interest, but neither nor more nor less in principal.

In fact, if the Aussie dollar appreciates even more against the U.S. dollar (say it goes to parity, or one Aussie dollar buys you one U.S. dollar) then the loan gets cheaper for you pay off. The nominal amount (US$100k) is the same. But because of the exchange rate move, you can buy more U.S. dollars with your stronger Aussie. A move to parity from here, for example, could make your $100k loan about six percent cheaper than you first planned.

But if you borrow in a foreign currency and your own currency weakens against the currency in which you have borrowed, look out! This is what happened in many Eastern European countries over the last five years. The local banks borrowed from larger bank lenders in Western Europe (Austria especially) in order to finance local housing booms (yes, this DOES sound familiar).

When the local currency depreciates against the one in which you've borrowed, paying back the borrowed money gets a lot more expensive. You must somehow raise money in the borrowed currency to pay it back. You can sell things, give up equity, or default altogether in which case the collateral posted for the loan is transferred to the lender. And there's always the possibility that you just throw your hands up in the air, shrug, and say, "Sorry. We're all out of money! Go screw yourself."

That's why having a large percentage of your borrowing denominated in foreign currencies is dangerous. But the larger your demands for capital are (and Australia's are large) and the less you can source new lending from existing deposits (for regulatory and other reasons), then the further abroad you must look to borrow, even if it IS in someone else's currency.

A recent study by the Australian Bureau of Statistics concluded that Australia's total foreign currency debts grew by 130% between 2005 and now. The ABS says the banks have $548 billion in foreign currency debts while "other financial institutions" have $117 billion.

If these borrowings weren't properly hedged, a fall in the Australian dollar would make repaying them more expensive. But, according to the ABS, 95% of the foreign currency borrowings ARE hedged. According to Geoff Winestock in today's Australian Financial Review, "The share of unhedged foreign currency debt is roughly the same as four years ago, even though the total volume of debt has increased."

Whew!

"In many cases," Winestock reports, "the debts are naturally hedged because they have been used to buy income producing assets of shore. Taking this into account, Australia had a large net-positive foreign currency exposure."

How about that? Not only is the rise in foreign currency debt not a problem, it's a good thing! Aussie borrowers have taken that money, the ABS reports, and bought foreign assets that produce income. It's a win-win! What could possibly go wrong?

Well, one interesting fact from the ABS report is that while the debts appear to be properly hedged, the assets are not. For example, Australia has $456.7 billion in foreign equity assets, half of which are denominated in U.S. dollars. The ABS concludes that, "Overall, the reported net exposure of $388.1b appears largely due to equity assets and net foreign currency receipts that are largely unhedged."

Hmm. The only thing we can think of that might go wrong is that assets can fall in value while debts generally do not. Take, for example, collateralised debt obligations and other securitised assets. They are bundles of debt whose value is based on the regular income and principal payments of borrowers. And they never fall in value at all, do they?

Oh wait. Yes. Sometimes assets DO fall in value. Like U.S. houses...and all the securities that derived their value from those houses.

So it comes down to the quality of the assets you get with your borrowed money and how regular the income is. And frankly, we haven't given the assets that much scrutiny yet. It could be that a U.S. dollar rally raises the value of Australia's dollar-denominated stocks, even as it makes paying debts more expensive. That would be the hedging.

But you can colour us a tad skeptical. We've heard plenty of people claim debt was not a problem. We've heard very few claim it was "net positive." And we're not hearing many people show that assets denominated in U.S. dollars and that are unhedged are risky assets.

But maybe we're just being old-fashioned. Is debt really that big a deal? Isn't a bit hysterical to claim, for example, that a sovereign debt crisis is unfolding in the Western Welfare states?

Well, maybe not. Yields on 10-year Japanese government bonds are up 12% since the start of the year. According to Brendon Lau in today's AFR, "The fall in prices and the subsequent rise in yields may reflect worries about the country's deteriorating fiscal position, as government spending is tipped to surpass tax revenue this financial year for the first time since World War II."

Japan's public sector debt-to-GDP ratio is approaching 200%. But the Japanese are no longer saving at the same rate they used to. Granted, the pool of national savings remains high. And the government is hoping the ageing Japanese population will transfer its pension assets to government bonds and continue financing large deficits.

But Lau reports that the Japanese saving rate has fallen from 15% in 1991 to just 2% today. That rainy day everyone was saving up for - or that retirement - is finally here. Japan's own people may not be able to finance the government's large Keynesian deficit. So the country will have to find the money from somewhere else.

Hmm. Britain and America are already shaking down the world's saving nations for more money. Japan may find lenders. But you can be sure that it will cost more money to borrow. Rates will keep rising. Already the five-year credit default swap spread on Japanese bonds has risen 0.75 percentage points.

In other words, the cost of insuring Japanese sovereign debt against default is rising. Japan's CDS spreads now put in the same neighbourhood as Chile and the Czech Republic. By all accounts, Chile and the Czech Republic are nice places to visit and live. Chile sounds like a great place to visit and the Czechs have great beer.

But Japan is the second-largest economy in the world. Its cost of capital is going up. This could be the first sign that the cost of capital is going up all over the world. Higher interest rates are on the way.

That would be a major change. As we showed earlier this week, the cost of capital (like the cost of energy) has been in a long-term downtrend. Cheap money and cheap energy have both fuelled a global boom - a boom in which 2 billion people have been lifted out of poverty and brought into the industrial economy. Nowhere has this been truer than China.

Which brings us to reconsider what we wrote about China yesterday. We wrote that its rates of fixed asset investment were largely driven by political and not economic considerations. China's central planners value stability, and full employment brings stability. Even if factories are cranking out goods Americans can no longer afford (or want) to buy, it keeps people working.

Idle hands do the revolutionary's work.

But Glenn Mumford tells us not to worry. He quotes from a report by Mingchun Sun, the China economist for Nomura International. Sun says that China's current investment boom will prove, "a major milestone in China's economic development." The main claim, though, is China is paving the way for decades of new growth, greater consumption, and more developed domestic economy with rising per capita incomes.

In fact, China might actually be UNDER-investing in fixed assets. "Sun warns that investment demand for capital goods, raw materials and energy could be so strong that some upstream sectors now facing overcapacity may soon experience shortages...[Sun] is forecasting fixed-asset investment in the first-half of 2010 to rise 40%, year-on-year. This would be great news for Australian exporters."

Anything is possible. It certainly IS possible that the China boom is sustainable and getting larger. But it's also possible that the Super Cycle in fiat money is reaching a thunderous climax. And after the boom?

Dan Denning
for The Daily Reckoning Australia

• Aussie Banks Addicted to Foreign Borrowing
• Rally in Stocks and Rise in Aussie Dollar is a Result of the Carry Trade
• Citizens Easily Coerced into Using Government Currency
• An International Currency Not Just on Paper
• IMF Report Concludes Aussie Banks are “Very Sound”…

And counter to our prediction of an imminent, counter-trend U.S. dollar rally, the dollar is most definitely not surging. Take a look at the chart below. We've been writing about the decline of the dollar for nigh on ten years. So we looked at a ten year chart to tally up the damage. It is considerable.

Click to enlarge

What's at stake with the interpretation of this chart? If the dollar rallies on short covering from the dollar carry trade (a BIG if), then other "risk" assets like gold, stocks, and emerging markets would probably sell off. And yes Australian stocks, that includes you. As well as the Aussie dollar.

The chart shows that the index's 50-week moving average is set to cross below its 200-week moving average. That is mixed news. The first time it happened on this chart was back in early 2003. That was the early days of a long decline in the index. The second time, though the move failed to confirm the "flight to safety" rally of 2008 had staying power in 2009.

Once the fear that gripped markets in 2008 went away, the investment world sold the dollar and started borrowing en masse to buy other, higher-yielding currencies and assets (like the Aussie dollar and resource stocks). That's where we are now.

But based on the chart, is the next move down in the dollar index a new low, which the crossing of the long-term MA by the short-term MA would suggest? Or is it a false move? Will the dollar quickly and violently rally for some reason (geopolitical perhaps) that currently remains unknown to the human beings of this world?

"It's an interesting chart," said our technical analyst Murray Dawes. "But it is not useful for timing your moves out of or into trades related to the dollar's movement."

"So you're saying our chart doesn't have any useful information from a trader's perspective?"

"Not really."

Murray promised to show us HIS dollar index chart tomorrow. We'll bring it to you, live and in colour. But in the meantime, we think the one piece of important information communicated by our chart is that the dollar's trend is down. But there IS a catch.

The catch is that when this many people are this uniformly bearish, everyone is probably wrong. Consider this a warning then, that a dollar rally is just the sort of thing that will lead to a correction in the gold price and the stock market. We won't speculate on the sort of things that could lead to a dollar rally. But surely they're out there and sooner or later they'll come.

The other possibility is that the dollar is in its death throes and that this is the big one, in currency terms. That is such a momentous and disastrous event that people consider it both kooky and unlikely, not to mention undesirable to a predictable and comfortable world. But it IS possible.

And do you get the feeling that this kind of manic melt up rally is the sort of irrational frenzy that comes just before everything goes haywire? Haywire is not a precise financial term. So what do we mean?

We meant that the world enjoyed a 20-year economic relationship based on a fundamentally unbalanced global economy. Manufacturing capacity migrated to Asia where wages were lower. For awhile, this was mostly good news in Western countries. Goods got cheaper but jobs didn't vanish.

Now the situation is not so pleasant. The world is awash in manufacturing over-capacity, especially in China. Wage deflation (in the Western world) looks like a long-term trend, leading to a lower standard of living. This wage deflation is occurring at exactly the same time that Western governments are encountering demographic crises of ageing populations.

We all knew the ageing of the Boomers would put pressure on public finances right around now. But no one reckoned on a global financial crisis further saddling the public balance sheet with debt. And no one reckoned that Western wages and incomes would be falling at just the time people needed them most. And no one reckoned that savers would lose the most from low interest rates on fixed income - even though those low rates are keeping the American housing sector on life support.

It's a bit of global impasse. America's needed structural adjustment has come. Households and businesses are reducing debt, trying to live within their means. But the net adjustment to the American balance sheet is not happening because public sector debt is growing so fast.

Meanwhile, the other obvious adjustment is that the Chinese currency ought to be allowed to strengthen. For political and social reasons though, China will not allow this. It means China is actually adding to its industrial over capacity. It is conjuring up the world's largest ever bubble in fixed asset investment, including commercial real estate.

It is easy to see why China is reluctant to allow a stronger Yuan. Exports account for 39% of Chinese GDP. The Chinese economy, and probably the Communist Party itself, cannot survive on unleashed Chinese domestic demand. They need American markets. But American consumers - in addition to reducing debt - are now realising that the focus on finance over manufacturing from American policy makers has worked out for Washington and Wall Street, but not terribly well for the average American worker.

Where do we go from here? How about the blame game. U.S. Treasury Secretary Tim Geithner once blamed the Chinese for being currency manipulators. He back-tracked later. And yesterday, Liu Mingkang, the chairman of the China Banking Regulatory Commission, had a go at America.

"The continuous depreciation in the dollar, and the US government's indication that, in order to resume growth and maintain public confidence, it basically won't raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation." He is blaming the U.S. for fuelling a destabilising global bubble.

Of course that bubble is felt most acutely because China pegs its currency to the dollar. China is right to blame the U.S. for manipulating its currency to try and improve its competitive position. And China is right to worry about the value of its dollar-denominated assets in a world of exploding U.S. debt supply.

But China has put itself in this position. And here we are at the end of 2009 with a world still fundamentally un-adjusted to a new, workable currency arrangement. The world remains burdened by trillions in assets purchased with debt. Those assets linger on bank balance sheets, on government life support but fundamentally lifeless at fictitious book value prices.

And meanwhile, the China-US currency arrangement has fuelled a global bubble. Australia is part of this bubble, too. The question is how it will end. In the U.S., the housing market looms as the Achilles heel of the economy. It could strike households, banks, and the government again in the next 12 months are more mortgages reset at higher rates (with lower home values).

If the event that pops this bubble comes from America, look for the supply of credit to the emerging world to dry up again. And though Australia is not a developing economy, we saw last time what happened when U.S. credit markets imploded. Australian banks had to get a government guarantee to borrow money in the wholesale market.

We'd suggest that lending for residential housing and commercial real estate would take a real dip in Australia on another U.S. housing crisis (even if Aussie banks aren't exposed to actual U.S. housing-backed RMBS and CDOs. You don't have to own toxic debt to be impacted by it.

If the bubble pricking comes from China, what then? Well, China does everything big. So a Chinese bust would be world-class. It's a subject that requires its own Daily Reckoning. More tomorrow.

Dan Denning
for The Daily Reckoning Australia

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