Your editor was eating pizza at a café on St. Kilda Road last night with a friend who works in the mainstream financial media. The owner knew our friend, but not us. And once he picked up on our accent, he had a few questions like, "What is wrong with all those people in Greece?"

We'll get back to that story in a moment. But this week's markets make for compelling reading - and the week is barely half over! In today's Daily Reckoning, we confess the things we don't know, look at the routine rigging of the global financial system, and discuss whether the People's Liberation Army of China is about to drop the big one on the United States of America.

Let's quickly dispel a rumour. There was a rumour on the Internet of secret emergency meeting in Sydney of the world's central bankers. We've been assured by sources that it was just a regularly planned retreat by the Bank of International Settlements. Rather than some extraordinary rigging of the world's financial markets, it was just regularly scheduled, ordinary rigging.

In the not so mundane world of markets, today is looking pleasant, if not totally rigged. The futures were up overnight, so Aussie stocks will probably follow New York's lead and have a big day out. The big report today is the half-year earnings for the Commonwealth Bank of Australia. And the big question: have bad debts peaked?

"Yes!", says CBA chief Ralph Norris. Last year the bank reported nearly $2 billion in charges for "bad and doubtful debts." This year, it's just $1.39 billion. The bank also reported a 13% increase in first half profit to $2.91 billion. Yep, doing it tough is the old CBA.

There's no doubt that the reduction in bad debt charges is a good sign for the banks. The "operating environment" (the real economy) appears to be less threatening. We'll see how it goes, but the rest of the market could take the CBA numbers as a sign the debt problem has well and truly peaked. A re-rating of the bank shares might take place and you'd see a mini rally.

Mind you it's not a rally we'd care to go to. There was another interesting note in the CBA's media release about the last six months. It reported a 49% increase in home loans to $1.19 billion. The CBA said the home loan growth was, "mainly as a result of increased market share and significant growth in outstanding home loan balances."

In other words, CBA had less of a bad debt problem in the last six months. But just you wait. It rode the FHOG to higher loan values and volumes and market share. If those borrowers struggle with higher interest rates or - horror of horrors - Aussie house prices grow less fast (or even fall) - we'd expect to see the bad debt problem again affect earnings growth and, ultimately, the valuations on Australian bank stocks.

But there is a lot about the world we don't understand. As our old friend Thom Hickling used to say when he visited us in France, "Je sais rien...I know nothing Dan. That's my motto." It's more or less our motto as well. That's why we ask a lot of questions.

And it's also why you'll find apparently contradictory statements and advice in the Daily Reckoning. Your editor thinks you should use any rallies in the market to gradually liquidate your stock portfolios. In other words, retire now before the government seizes your super assets or the market crashes.

Yet we work with experienced traders and analysts who've spent years in the markets finding great investments. We publish and sell their research and that contains buy recommendations on all sorts of Australian stocks. We publish that because fundamentally, we have no idea what will happen. It's what we're all trying to figure out.

The best strategy in that case is to surround yourself with people who are thinking hard and working hard to figure things out. And ultimately, you get to choose the ideas and editors you agree with or whose thinking you're interested in and whose track record impresses you. And even if you never take a punt on any of those publications, we'll keep reckoning every day for free! How good is that?

While we're still on the subject of debt, three cheers for Senator Barnaby Joyce! The finance spokesman for the opposition is copping it from all sides for suggesting that Australia is in hock "to our eyeballs to people overseas." He also said, "You have got to ask the question, how far into debt do you want to go? We are getting to a point where we can't repay it."

Even members of his own coalition have turned on him for suggesting Australia may not be able to repay its sovereign debts. But we say if Barnaby Joyce is fiscally incompetent, we need more men like him in government. He couldn't do much worse than the debt-first mentality of the establishment.

You can also judge a man by his enemies. In an article titled "Credit experts line up to rebuff Joyce" published by the ABC, we learn that experts from Fitch, Standard and Poor's, and Citigroup assure us that Australia is in no danger of defaulting on its sovereign debt obligations. Yes, the same people that nearly brought the global financial system to its knees and didn't see it coming are telling us there is nothing to worry about.

Irony aside, it's true that Australia's fiscal position at the sovereign level is better than a lot of other countries. As Michelle Grattan points out in today's Age, "Australian net debt is expected to peak at 9.6 per cent of GDP, or $153 billion, in 2013-14. In contrast, debt in 2014 in the US is estimated to be nearly 85 per cent of GDP. It will be nearly 92 per cent in the United Kingdom, 143.5 per cent in Japan and 93 per cent for the major advanced economies collectively."

Based on these numbers, it's looking pretty grim for the Senator isn't it? He does look a bit alarmist for warning of an imminent crisis in servicing Australia's sovereign debt. What's interesting is how vigorous the attacks on him are. What's going on there?

Well, there are certain interests in government and finance who want the debt to go higher. It's the business they're in and it supports their livelihoods and lifestyles. Some of the people criticising the Senator benefit tremendously from larger and larger government borrowing in Australia - whether it's the politicians who spend it or the bankers who arrange it or the ratings agencies who get paid to slap a triple A on it.

And in case these folks haven't noticed, the funding model for the welfare state is breaking down all over the world. It will catch up to Australia eventually. Indeed the very premise of the welfare state - that society can enjoy less risk higher standards of living through progressive taxation on a tax base that's getting smaller and less productive by the day and faces global wage deflation - is being exposed as bogus and fraudulent. That's why you should expect more measures that punish you for withdrawing your money from super or the banks - or restrict it outright.

But on this issue of debt, if only the Senator had spoken about Australia's net foreign debt as a nation, he would have made a better point. The net foreign debt is the sum total of how much Australians have borrowed from the rest of the world, minus what Australians have lent or own in equity. According to the ABS, "Net foreign debt is equal to gross foreign debt less non-equity assets such as foreign reserves held by the Reserve Bank and lending by residents of Australia to non-residents."

A simpler way of thinking about it is "how much of the world do we own and how much do we owe to the rest of the world." The facts on this matter clearly support the Senator's position. According to research published last year by the Statistics and Mapping section of the Parliament of Australia's Parliament, Australia's foreign debt was just $3 billion in 1976. According to the ABS, it's now $637.5 billion - or about 63% of GDP. That's a lot higher than the sovereign debt-to-GDP level of 9%.

Even without knowing how this compares to other countries, it's safe to say that number is alarming. Australia has $1.1 trillion in foreign assets. Half are in equities and half in debt securities. As always, there's the risk that asset values, especially equities, can fall.

On the debt side, Australia has $1.8 trillion in foreign liabilities. Nearly $700 billion of that is foreign equity ownership of Aussie stocks. The other $1.2 trillion is debt owed to foreigners by Australians. The odds are that if there's a double dip global recession this figure will increase. Domestic consumption of imports will rise with more stimulus while exports would presumably fall in a global slowdown.

But so what? Who cares if Australians firms and households borrow abroad to finance their consumption and investment? Isn't that a private or market-driven decision? Well, yes. But we think it exposes the country to several big risks.

First, the lenders might not always be so forthcoming. With massive borrowing needs in places like Japan, the US, and the UK, it's probably not safe to assume a ready supply of foreign capital. Even with a great credit rating, in a credit depression capital is going to be scarcer and the cost of it will inevitably go up.

The big risk, of course, is that you build an economy based on debt which isn't sustainable when the creditors turn you down. You have long-term liabilities you racked up when the currency was strong. But if they're denominated in foreign currencies and the Aussie crashes again (as it might in a global W shaped depression) paying back your debts gets more expensive.

Ultimately, it comes down to what you've down with your borrowed money. Have you invested in wisely? An increase in debt - or even net foreign debt as a permanent feature of Australia's economic landscape - wouldn't be so bad if it translated into an increase in productive assets. You'd be a capital importer. But you'd use it to build your asset base.

Those assets - especially capital equipment in the resource sector - would lead to higher exports, lower current account deficits (also as a % of GDP) and generally more investment led growth instead of consumption led growth. It would be a responsible use of debt.

But if the debt - as we believe the numbers show - has been taken on to finance a housing boom, or worse, to finance speculation by Aussie banks and financial firms in asset markets abroad, then it's not going to be what we call productive debt. So we'll see, won't we?

Tomorrow, we'll show you why borrowing your way to prosperity is not only a sure fire bet to national servitude, but also a recipe for political instability. Our case in point will be the United States of America and its main creditor, the People's Republic of China.

Finally, our waiter last night asked us, "What's wrong with those Greeks? Is there some sort of crisis or something? Is it like that Lehman thing you guys caused?"

"What's wrong with Greece? They can't pay their bills. Nobody wants to admit it. But they're living beyond their means. All of Europe is."

"So what will happen?"

"Probably some fake bail out. The bigger countries in Northern Europe will guarantee emergency borrowing by the Greeks. No one wants to admit that standards of living have to fall and government spending has to fall too. They're going to fight it...but it's like fighting the orbits of the planets."

"Hmm. Imagine that. Even in antiquity the Greeks were bad with money. But the Romans figured it out didn't they? They were good at collecting taxes. Not the Greeks. They had all the good ideas though."

Dan Denning
for The Daily Reckoning Australia

• Corporate Debt is Just One Aspect of the National Debt Problem
• Australia to Borrow as Much as $300 billion
• Central Bankers Encourage Debt Booms That Become Debt Bombs
• Commonwealth Bank (ASX: CBA) Nearly Doubles Bad Debts Over Last Year
• RBA Buys $780 Million in Residential Mortgage-Backed Securities

Almost everyone everywhere is enjoying the show. Each headline brings more laughs. The financial markets give people neither what they expect nor what they want, but what they deserve. What a treat to see people getting it - good and hard.

Near to home, that galling "millionaire next door" - many will take pleasure in seeing his portfolio of stocks marked down. "Stocks for the long run," he used to say, smugly; the silly old coot will be dead before his stocks come back! He'll have to work until he drops dead, just like the rest of us.

On Wall Street, the masters of the universe - who had the pay slips to prove it! - are now getting blown up by their own debt bombs. The top five firms on Wall Street were thought to be "too big to fail." But Bear Stearns has been blown to smithereens. Lehman is exploding into small pieces. Merrill ducked and missed the blast. Then, the last big capitalist desperadoes - J.P. Morgan and Goldman - waved the white flag. They petitioned the government to allow them to become regulated, deposit taking banks!

And George Bush will leave behind the biggest nationalization program in history. Surely, that's worth a snide chuckle. The takeover of Fannie and Freddie alone leaves half the country living in what are effectively, government-subsidized housing projects. Meanwhile, the coordinated takeover of Wall Street, put together by his apparatchiks, left even the hardened lefties at France's Liberation in shock and awe: "This enormous statist intervention...is the work of the most ideological and extremist administration that the US has ever had."

How heartwarming to see that the meddlers and world-improvers get a second wind. It's like driving around in a '33 Lincoln...or throwing rocks at the gendarmes in '68. The old, gray Bolshies feel young again! Impetuous! Brainless!

And every capitalist is behind the bail out program too. All over the world, markets are out - state-sponsored meddling is in. Free market principles are fine - until prices start going down!

And there's the breathtaking chutzpah of it! After proposing a $700 billion program, in which the government buys up Wall Street's mistakes - otherwise known as "cash for trash" - Henry Paulson says he had no choice: "We did this to protect the taxpayer," said the former Goldman chief.

Even Russia got into the act. New to counterfeit capitalism, it's getting the hang of it fast, pledging $20 billion in the fight to keep stock prices from falling to what they are really worth.

Then, not be left behind in general hysterical absurdity, SEC honcho Christopher Cox announced a list of 799 financial stocks on which shorting is banned until Oct. 2nd. In Britain, the FSA's ban on shorting financial shares lasts until Jan 16. But Pakistan gets the King Canute Memorial Prize; by law in that benighted land, stocks can't go below their August 27th close.

And what a bunch of numbskulls - Greenspan, Paulson and Bernanke! Every word they've said so far has been financial poison. "Greenspan relaxed about house prices..." reported the Financial Times in 2005. "Most negatives in housing are probably behind us..." said the same sage in October 2006. "We believe the effect of the troubles in the subprime sector...will be likely limited..." said Bernanke in March 2007. It's "not a serious problem...I think it's going to be largely contained," added Paulson in April 2007.

But these are the same numbskulls who now say they are saving capitalism from itself. Ah, there's the rub...amid all this giddy merriment is a serious threat. The feds have bailed out the bankers, the insurers, the mortgage lenders, and half of Wall Street. But who will bail out the feds?

Since 1971, the world's money system rests on the dollar. And the dollar rests on nothing but faith, hope and the kindness of strangers. And while the full faith and credit of the United States of America is elastic, it can snap.

Last week, the price of gold popped up $120 in two days. Then, on Monday, it added another $43. Oil gushed up 44% in the space of barely a week. Investors felt the geyser of liquidity coming from Washington and beat a retreat from the dollar.

For the last 15 years, the U.S. money supply has grown about twice as fast as GDP. Federal government liabilities, meanwhile, have grown three times as fast. As a result, the USA now has more financial obligations than assets. It is, effectively, broke. Nevertheless, the debit side of its ledgers grow heavier and heavier. This year's US government deficit will add about half a trillion. The US trade deficit is about $700 billion. The U.S. bailout plan will probably cost at least $1 trillion more.

Where will the government get that kind of money? There are only two possibilities - one honest and depressing, the other corrupt and alarming. Whether it borrows the money, or prints it up, the world enjoys no net increase in financial resources. Borrowing takes resources from projects that might have been worthwhile and diverts them to the losers. Interest rates rise, as a consequence of the extra borrowing; higher rates generally worsen the economic picture. And while the U.S. borrows, long term, at almost 5%, it lends at barely 2%. It's like a bank that has gotten its business model badly mixed up. The more it borrows and lends, the faster it goes broke.

If, on the other hand, it merely prints the money - or if it creates it "out of thin air," to use Lord Keynes' handy phrase - the results are even worse. Inflating the money supply with new currency, a la Argentina or Zimbabwe, wipes out debts. But it destroys faith in the dollar and brings down the whole world's money system.

Sooner or later, this is just what will probably happen. Not because capitalism doesn't work - but because it does. Capitalism is doing just what it should do - it is separating fools from their money. But the fools vote. After a big bubble, there are more fools than sages...and, in the United States of America, more debtors than creditors. Sooner or later, Americans will realize that they are better off destroying their own money than preserving it...and that they would prefer to stiff their creditors rather than pay their bills. That is when deflation will gives way to inflation...and the world's post-'71 dollar-based money system comes to an end.

Bill Bonner
for The Daily Reckoning Australia

• Feds’ Attempt to Bail Out Consumers with Tax Rebates
• Fannie and Freddie in a Free Market Economy
• Obama’s New Stimulus Program
• Why Those Who Praise Capitalism Have So Little faith in It
• Where Do the Feds Get Any Money?