Truer words have never been spoken, certainly not by this President. Wall Street listened up...and then despaired. The Dow closed down 300 points to 7,552. Its 52-week low is 7,392. You have to figure with GM asking for another US$16 billion from the American government, this could be the quarter of lower lows and lower highs.

Speaking of highs, are the governors of America's and Australia's central bank smoking from the same bong as Michael Phelps? It's a question that has to be asked after a series of perplexing statements over the last 24 hours.

First is St. Louis Fed President James Bullard. In a speech he gave in New York he said, "I think we face some risk - at this point only a risk - of sustained deflation... In some ways, our current environment parallels the Japanese experience after 1990. The Japanese banking system encountered difficulties with 'troubled assets' and the intermediation system broke down. That is an experience that neither we, nor the rest of the world's economies, want to repeat."

Inhale.

Let's be clear about what Mr. Bullard is calling deflation-falling asset prices, mostly stocks and houses. He's not suggesting that a contraction in the monetary base has led to a fall in the general price level. That's not true because the monetary base hasn't been contracting at all. It's been expanding.

So what is he playing at? Well, as near as we can tell, he is trying to prepare for the great inflationary swindle that the Fed plans to unleash later this year, if at all possible. The Fed wants you to think that the liquidation of bad investments built up in the credit boom is something else entirely-deflation! And that deflation-being by definition both Japanese, depressionary, and bad-is something that should be avoided at all costs.

And we do mean ALL costs. Because the cost of avoiding what the Fed is describing as deflation is, you guessed it, Inflation. But let's let Bullard do the selling/shilling, "To avoid the risk of deflation, it is important that the Fed provide a credible nominal anchor for the economy. One way to do so is to set quantitative targets for monetary policy, beginning with the growth rate of the monetary base."

"This has several advantages. First and foremost, the monetary base is relatively easy to understand, fostering better communication about the thrust of monetary policy. Second, we can be fairly certain that rapid expansion of the monetary base will be sufficient to head off any incipient deflationary threat. Rapid base growth has been associated with inflation in a wide variety of times and places in economic history."

Did you follow that? The Fed just told you and anyone who would listen what it's going to do. And do you know who was listening? Gold. That yellow metal...it has ears like a bat. Just check out the chart below.

Yes. The Aussie gold price went up over $82 in 24 hours. It nearly doubled the move (in percentage terms) of gold in U.S. dollars-although that too was up over three percent. If you were ranking currencies right now, the metal ones (gold and silver), would be first and second, followed by the U.S. dollar, and then a whole bunch of other paper currencies.

By the way, U.S dollar strength in the face of falling U.S. markets, a massive new spending program, and huge borrowing needs for 2009 is always a bit of a head scratcher. But we reckon its relative strength only. Not absolute. And for what it's worth, the six-month chart of the U.S. dollar index shows that the dollar is either near a short-term high against other currencies-or may actually on the verge of a bust-out move higher.

Why would the dollar make such a move higher? Pick a reason, any reason! But the best of them would be that serious doubts are surfacing about Europe's banking sector. With Japan's economy doing a convincing version of hari-kari, the Euro replaces the Yen as the most desired reserve currency that is not the dollar.

But with Europe's banking sector facing serious losses from investments in Eastern Europe, the Euro finds itself in a tough spot. A very tough spot. The dollar may look on and laugh. But it's the reaction of gold we're interested in. Will it trudge doggedly higher? Or will it take flight?

And what does all this mean for Australia? Well, Australia's banks are probably-and we say probably because we can't say certainly, definitely, absolutely, or even maybe-better off than banks in Europe and America, at least with respect to loan losses.

European banks went hog-wild lending to emerging Eastern Europe. Now, with currencies in Eastern Europe cratering, the chances of those debts being paid off-especially during world financial meltdown-are not good. American banks-well you know the subprime/CDO story there.

So yes, the good news for Aussie banks is that the aside from the odd investment here and there (for which the banks are provisioning themselves against losses) most of the local loan book is in commercial and residential real estate. If there's no property crash in Australia, the banks aren't going to face huge non-performance or default problems.

However it is not entirely good news. If there's a major break down in the European banking sector (even more major that what we already have) you have to wonder just how hard it is going to be for any Australian company in any industry to get a loan. Full stop.

Just consider it a thought experiment. Assume that your favourite share can't borrow a single dollar for the rest of the year in the local or international credit markets. How will it fare?

Despite that harrowing thought, the local central bank seems to think Australia will manage to grow this year while everyone else shrinks. RBA Governor Malcolm Edey gave a speech yesterday and said, "There are reasons to expect that the Australian economy can continue to perform better than its international counterparts in the difficult period that lies ahead."

Those reasons, apparently, are that the financial system is in better shape, the economy had lots of momentum prior to the failure of Lehman Brothers in September, and "substantial monetary and fiscal measures have been taken to support growth."

Right. That should do it. Any questions?

Inhale.

It's one thing to have bad judgement when you're under the influence of a narcotic. It's another to deceive yourself, or others, when you're perfectly sober and lucid.

We don't say this to be petty, mean-spirited, or simply carp about policy makers who are probably trying to do what they think is best. We're just showing you that the blokes running the show around the world are completely lost. They are trying to fix a system that is badly broken. And you had better be prepared when whatever plan they've concocted fails.

Speaking of plans, we got lots of reaction to our ten-point global recovery plan yesterday. Some of it is posted for your review below. Oh, and by the way, none of what we've said here is meant to disparage Michael Phelps. The man is a world class athlete. He had enough discipline and dedication to train his body and his mind so he could win eight gold medals. That alone shows you how stupid many drug laws are. Now, back to the plans...

"Your plan is totally absurd, insane, crazy and ludicrous, but heaps better."

"Step One: Immediately execute all politicians at the national and state levels across the world.
This alone would restore confidence in government and the economy would be free to correct itself.
This effect should last at least 20 years when we will need to do it all over again."

--Hi Dan,

You want a proper practical plan - give the right to create credit back to its rightful owners - the people - and eliminate the fractional reserve system that has allowed banks to create credit out of nothing and charge interest on it.

The original Commonwealth Bank of Australia was set up in 1911 to operate as the people's bank and served as a brake on the usurious operations of the private banks which were force to face some genuine competition.

The Treasury Credit system could restore some common sense into the stupid financial system we now have.

Without making some radical changes and just stuffing around trying to tinker with the existing system will do nothing to eliminate the ongoing boom and bust cycles.

I know that is exactly what all the casino gamblers - sorry - market traders - want to retain because it feeds their hunger for profits without the need to produce anything.

Regards

Graham P.

--Hello,

I agree with the majority of your points in today's DR Re: Your suggestions to save the world!!!

I like to add one (or two). In the DR dated 16th Feb you quoted Attali holding out one hope. He reckons a new global leader could emerge if one country or economy makes a great leap forward in new sources of energy.

Can someone please email Kevin Rudd and pass the above on!! That's what he should be spending his $42m stimulus on. There is enough diversity in resources in Australia to become leaders in Wind/coal seam gas/clean coal/clean diesel (using underground Coal Gasification (UCG) and Gas to Liquids (GTL)).etc etc. And whilst we are at it why doesn't he say to the big car companies, no cash unless it's towards R&D (and then manufacturing) of small green cars. The government should then tax heavy SVU/4wd etc etc vehicles (recreational not commercial) so to force people into driving smaller more sustainable cars and become a world leader in battery operated cars/alternate fuel cars. Then we would have some tangible sustainable industries not just good June qtr retail results with all his handouts!!! At present it's extremely short sighted and as usual is politically motivated (how's the current Polls!) not what is better for the long term for Australia.

Whilst I'm ranting how about regulating petrol prices. By my very rough estimations, oil is off 75% (from $150 a barrel), the dollar is off 30%. I'm reckoning petrol should be around the $1 p/l mark maybe slightly higher. The present current average in Sydney is $1.22c. Someone is creaming it and it ain't the average punter. By regulating the price if you saved the average punter 15c per lt x 40lts per tank at one tank per week ($6 p/w) for say 5 million cars (I'm guessing its more) you would pump $1.87 billion Aus annualised back into the economy in savings without tax breaks or hand outs (not accounting for lost taxes to the government by lower petrol prices.....conflict of interest???). I'll get off my high horse now and bid you good day Sir!

I'm just a dumb paddy (Irishman!) but it's not rocket science to figure this out!

Regards

Barry,

Sydney

Dan Denning
for The Daily Reckoning Australia

• Being a Homeowner is the Beginning of House-Induced-Bankruptcy
• Aussie Banks Addicted to Foreign Borrowing
• Life Goes On
• Is It Really the End of the Dollar Carry Trade?
• The End of the Range

Is there anyone in the known universe who thinks that the U.S. financial system is not fifty feet beyond the edge of the mesa of credibility?

Nothing will avail now. Not even if Sirhan Sirhan were paroled at noon today and transported directly to the West Wing with a.44 magnum in each hand (and a taxi driven by the Devil waiting outside to take him to the U.S. Treasury and the offices of the Federal Reserve).

It’s hard to imagine what kind of melodramas were unspooling on the Hamptons lawns this weekend, while everybody else in America was watching Nascar, or plying the aisles of BJs Discount Warehouse for next week’s supply of mesquite-and-guacamole flavored Doritos, or having flames and chains tattooed on their necks, or lost in a haze of valium and methedrine.

With the death of the IndyMac Bank last week, and the GSEs Fannie Mae and Freddie Mac laying side-by-side in the EMT van on IV drips, headed for the Federal Reserve’s ever more crowded intensive care unit, there was a sense of the American Dream having passed through the event horizon that denotes the opening of a black hole.

What would happen if the U.S. government acted to bail out these feckless enterprises (and what if they don’t)? Either way, it’s not a pretty picture. If Mr. Bernanke does start shoveling loans into the GSE black hole, he’ll further undermine the soundness of his own outfit and do nothing, really, to repair Fannie and Freddie’s structural problem of having securitized too many loans that will never be paid back. If instead Fannie and Freddie are flat-out taken over entirely by the U.S. government (and remember the Federal Reserve is not the government), then the national debt will roughly double overnight – which will pound the U.S. dollar down a rat-hole.

Meanwhile, the foreign holders of those decrepitating dollars might not rush to the redemption window, but they certainly would use them to buy up every oil futures contract on God’s not-so-green Earth as fast as possible – they’d be dumb not to – which would leave American Happy Motorists with gasoline prices north of $5 a gallon, and possibly north of $10. (In that case, say goodbye to the airlines. In fact, say goodbye to what passes for the rest of the US economy, including especially the vaunted retail sector that supposedly counts for 70 percent of the action.)

If Fannie and Freddie are left to die out on the desert floor, say goodbye to the housing market, the major investment banks, countless regional banks, the retirement accounts of virtually everyone in America, the viability of all fifty states’ governments, and the day-to-day operating ability of all their municipalities – and very likely the current incarnation of the world banking system.

This process is really out of control now. The bottom line is the comprehensive bankruptcy of the United States. The Republican Party under George Bush will be known as the party that wrecked America (release 2.0). Painful as it is, Americans had better get a new “Dream” and fast. It better be a dream based on the way the universe actually works, which is to say an operating procedure run on earnest effort and truthfulness rather than merely trying to get something for nothing and wishing on stars. We might begin symbolically by evacuating Las Vegas and calling in an air strike on the loathsome place – to register our new reality-based attitude adjustment.

After that, we’ve got to get to work re-tooling all the everyday activities of life, including the way we grow our food, the way we raise and deploy capital, the way we do trade and manufacturing, the way we go from point A to point B, the way we educate children, the way we stay healthy, and the way we occupy the landscape. I know, it sounds like a lot, maybe too much. But grok this: we don’t have any choice if we want a plausible future on this portion of the North American continent.

Of course, none of that is likely to happen. Instead, and under the worst imaginable economic conditions, we’ll probably embark on a campaign to prop up the un-prop-up-able and sustain the unsustainable – that is, defend every status quo habit and behavior that we’re used to, whether it can be salvaged or not. Of course, this would be a fatal squandering of our dwindling resources, but it tends, historically, to be the last act of the melodrama in any faltering empire.

The result, pretty soon into that process, will be social breakdown and political upheaval. Every tattoo freak out there who has been prepping for his own starring role in some kind of comic book Armageddon will finally get his chance to shine. Lots of people will get hurt and starve. Property will change hands in a disorderly way. And at the end of this process an American corn-pone Hitler may be waiting to set everything and everyone straight.

James Howard Kunstler
for The Daily Reckoning Australia

• What’s Going to Happen to the Mortgage Twins – Fannie and Freddie
• Freddie Mac’s Main Man is in the News
• Fannie and Freddie Say Goodbye to Veto
• Fannie Mae and Freddie Mac Seized By U.S. Government
• How Much it Really Cost to Bailout Fannie Mae and Freddie Mac