If everyone's running up the street bashing windows, you'll experience pressure to join in. On the other hand, if, say, everyone is buying stocks because no one appears to be concerned that they are expensive, you'll experience subtle pressure to do the same.

In evolutionary terms, doing what other people are doing is generally a good strategy. It saves you the time and energy of thinking about the decision yourself. And you have to assume that they probably wouldn't be doing it if it didn't promote their survival in some way.

The shrinks call this phenomenon "pluralistic ignorance." We were reading about it last night over cocktails at Barney Allen's, right next door to our new head quarters in the heart of St. Kilda. It made a lot of sense, at least if you're trying to explain why so many people do so little when they have so much to lose.

Speaking of losing and just what's at stake as September begins, why don't we start with where the entire global recovery - and Australia's resilience - are supposed to reside: Chinese strength. The Shanghai Composite fells 6.7% overnight and is now down over 25% from its highs. Uh oh.

But it's not Chinese stocks that worry us. It's true there is probably a huge bubble slowly deflating in Chinese shares. Chinese banks lent nearly $1.1 trillion in the first half of this year and a lot of that found its way into the stock and real estate markets. But the bigger issue for Aussie investors is whether Chinese industrial stockpiling of raw materials is over.

If it is, then one of the big drivers of the resource rebound is in real trouble. You got a whiff of that overnight when October crude oil prices fell $2.78 per barrel back under $70. Investors are reconsidering the idea that China can lead a global demand recovery and justify the high p/e ratios reflected on major indexes.

For example, yesterday's Age reports that the Morgan Stanley Capital Insights (MSCI) index of Asia Pacific stocks, "are trading at a price-to-book valuation of 1.1 times, above the 30-year average of 0.7 times and around the same level at the peak of the last bull market." These stocks are priced for an export-boom to America.

But what if that doesn't happen? It's almost certain that it can't, given the retreating balance sheets of U.S. consumers. That leaves a Chinese growth model that's not focused on exports. That leaves China buying its own toasters, cars, ovens, toaster-ovens, clothes, capital goods, and textiles.

Does China have the capacity, along with India, to consume the world out of deflation? Hmm. What do you reckon? We reckon all this is setting up for a traditional September/October correction. And yesterday, there was more evidence to show why that might be.

The first and second quarters looked good for corporations because of massive cost cutting. This cost-cutting helped stocks beat "analyst's expectations." That created a bunch of manufactured enthusiasm about "green shoots." But you have to ask if the earnings outlook for firms really improved the first half? We'd argue that it didn't.

For example, according to Goldman Sachs, 46% of Wall Street firms beat expectations by "a wide margin." But only 23% of firms actually reported better revenues than initially forecast. And for companies in the S&P 500, sales actually fell by 16% in the second quarter compared to the year before. And that was after a 14% year-over-year sales decline in the first quarter.

Now you can make more in earnings off declining sales. But we'd suggest that is not a very good sign of health. Companies achieved the higher earnings numbers through cost cutting and tentative restocking of inventories. You reduce your overheads and your cost of goods sold and fire people. That helps you beat "analyst's expectations." But it doesn't really mean your business is primed to throw off higher earnings and cash flows next year.

This may be why September sucks. As long as analysts are in collusion with reporting firms, you can fool investors for a quarter or two with cost cutting and some earnings engineering. But by the third quarter, the real state of the company is clear for anyone to see. All you have to do is look.

Amy Lubas from Ned Davis Research tells the Wall Street Journal that sorting through the market now is all about "differentiation." She says that, "In the initial stage of a recovery from a bear market, the stocks that have fallen the most tend to be the ones that rebound the strongest. After a bottom, the market shifts to more industry-specific and company-specific factors."

So if you're differentiating, what are you looking for? You're looking for the companies that have trimmed their operating overheads to become more efficient, that's for sure. But what you really want is a firm that increases its revenue growth without greatly increasing its capital spending (the secret of capital efficiency, as we have written about before).

There is good news and bad news for commodities here. The good news is that you can always find companies with ore bodies and assets that are exposed the higher prices that come with higher demand. The bad news is that you cannot generally assume demand for all commodities will rise, or that supply will stay constrained. You have to find out which commodities are correlated to the new kind of domestic-driven growth from the Chinese economy and which are not.

That's a full time job. It's what we're up to at Diggers and Drillers. And for now, the short answer is that we like LNG, lithium, rare earths, hot rocks, and precious metals. We do not, however, like commercial real estate one bit.

Dan Denning
for The Daily Reckoning Australia

• China Has Stopped Stockpiling Metals
• Bubbles… Busts… Bubbles… Busts…
• Chinese Economy Seems to be Growing
• Chinese Foreign Mining Acquisition Equal to All of 2007
• Buying and Holding a Bad Strategy if Bank Earnings Remain Unpredictable

A broad consensus has formed in the news media and among government mouthpieces and even some "bearish" investors on the street that "the worst is behind us" in this tortured economy. This view is completely crazy. It will only lead to massive disappointment a few weeks or months from now, and that disappointment might easily transmute to political trouble. One even might call the situation tragic, except a closer look at the sordid spectacle of what American culture has become - a non-stop circus of the seven deadly sins - suggests that we deserve to be punished by history.

The reason behind this mass delusion is not hard to find: it's based on wishing, especially the wish to retain all the comforts, conveniences, luxuries, and leisure that had become normal in American life. These are now ebbing away in big gobs for most of the population - while a tiny fraction of the well-connected pile on ever-larger heaps of swag, enjoying ever more privilege. Those in the broad bottom 95% were content as long as there was a chance that they, too, could become members of the top 5% - by dint of car-dealing, or house-building, or mortgage-selling, or some other venture enabled by easy credit and a smile. Those days and those ways are now gone. The bottom 95% are now left with de-laminating houses they can't make payments on, no prospects for gainful work, repo men hiding in the bushes to snatch the PT Cruiser, cut-off cable service, Kraft mac-and-cheese (if they're lucky), and Larry Summers telling them their troubles are over. (If I were Larry, I'd start thinking about a move to some place like the Canary Islands.)

Too many disastrous things are lined up in the months ahead to insure that we're entering a new phase of history: The Long Emergency.

• Government at every level is worse than broke.
• Our currency, the US dollar, is hemorrhaging legitimacy.
• Inability to service old debt at all levels or incur new debt.
• Bad (toxic) debt lurking off balance sheets everywhere.
• The housing bubble fiasco is far from over.
• Commercial real estate fiasco just getting started.
• Unemployment rising implacably.
• So-called "consumers" unable to consume consumables.
• Crucial energy import supply lines fragile.
• Food supply subject to energy problems and climate abnormalities.
• A world full of other societies who would enjoy watching us fail and suffer.

When The Long Emergency was published in 2005, I said then that the greatest danger this society faced would be its inclination to gear up a campaign to sustain the unsustainable at all costs - rather than face the need to make new arrangements for daily life. That appears to be exactly what has happened, and it didn't happen under the rule of some backward-facing, right-wing, Jesus-haunted crypto-fascist, but rather a "progressive" party led by a dynamically affable young man unburdened by deep cultural allegiance to Wall Street. Barack Obama has been sucked in and suckered. "Change you can believe in" has morphed into "a status quo you will bend heaven and earth to hold onto."

Whatever else you might think or feel about Mr. Obama's performance so far, this strategy on the broader question of where we go as a nation pulses with tragedy. What's remarkable to me, to go a step further, is the absence of comprehensive vision - not just in the president, but in all the supposedly able and intelligent people around him, and even those leaders not in government but in business and education and science and the professions.

History is clearly presenting us with a new set of mandates: get local, get finer, downscale, and get going on it right away. Prepare for it now or nature will whack you upside the head with it not too long from now. Attempting to maintain anything on the gigantic scale will turn out to be a losing proposition, whether it is military control of people in Central Asia, or colossal bureaucracies run in the USA, or huge factory farms, or national chain store retail, or hypertrophied state universities, or global energy supply networks.

These imperatives are so outside-the-box of ordinary experience right now, that to drag them into the arena of politics can only evoke blank stares or nervous giggling. But whether we like it or not, these are the things that will really matter in the years ahead - not whether General Motors can ever make a profit again, or what Target Store's sales figures are next quarter, or whether the latest high-rise condo - and - gambling complex in Las Vegas will be successfully marketed.

Here, in the dog days of summer, it seems to me that the situation in the USA is so fundamentally bad, so unpromising, so booby-trapped for failure, that I wonder if there has ever been a society so badly deluded as ours. We're prisoners of our wishes, living in a strange dream-time, oblivious to the forces gathering at the margins of our vision, lost in a wilderness of our own making.

Anything can happen now. I certainly wouldn't rule out international mischief as we arc around into fall. The air is so full of black swans that the white swan now seems like the exceptional thing. Whatever else happens, it sure will be interesting to see the public's reaction to Wall Street's announcement of Christmas bonuses. The folks at Rockefeller Center better be thinking about getting a fireproof tree.

Regards,

James Howard Kunstler
for The Daily Reckoning Australia

• Feds See Every Emergency as an Opportunity
• Inflation and Deflation Battle is a Long Way from Won
• Emergency Private Pension Plan
• All the World’s Stock Exchanges are Now Officially in Bear Markets
• Gold Standard: The Long-Run Value

Granted, private investment-the kind that drives job growth-was down 20.4%. But it was down 50% in the previous reporting period. Less bad is net better, no?

Here in Australia the Reserve Bank publishes notes on monetary policy later this week. The Aussie dollar is pricing in rising Aussie interest rates. And though those rising rates might peeve new home buyers a bit, the conventional wisdom says rising rates aren't so bad, provided they are caused by renewed strength in the economy.

All this statistical hocus pocus belies the fact that there are still hundreds of billions (or trillions) in bad bank collateral still languishing on the balance sheets of banks. And in securitised form, this bad collateral putrefies in the accounts of pension funds, super annuation funds, local councils, and other institutions who are quietly hoping it improves.

And maybe it will! But we aren't counting on it. In fact we still reckon a second wave of losses is due to hit the global financial system for a lower equilibrium can be reached. First more asset deflation, then monetary policy-induced inflation.

It's one of the notes that came up several times in our highly-stimulating debt symposium Friday night here in Melbourne. There is a still a lot of debt deflating. This was the position argued persuasively by Dr. Steve Keen. Dr. Keen reckons the amount of bad debts in the system will weigh down asset prices, including stocks and residential property in Australia.

Right now, of course, there's a bit of reflation trade going on. Oil is up. Stocks are up. Property is up. And even U.S. bonds moved up on Friday. However this reflation is not yet a monster hyper-inflation - the kind we fear comes when excess bank reserves move off the Fed balance sheet and into the real economy.

The inflationary position-the one where the global expansion in the monetary base leads to out of control consumer price inflation in Western economies-was taking up by Money Morning editor Kris Sayce. We tend to agree with Kris' position. But the interesting mechanical challenge is how the expanded monetary base will translate into expanded money supply-something that hasn't happened yet because banks haven't resumed pre-crisis lending levels, leading many people to believe the crisis is over an inflation is not a threat.

By the way, the panel discussion lasted about an hour and twenty minutes. Obviously, it was a bit more detailed than we can get into here. But we hope to have a transcript ready later this week and will keep you posted. We thought it was a good discussion, although some readers had hoped there would be a clearer consensus on what exactly was happening and what exactly to do about it.

One panellist who was not concerned about the direction of interest rates or whether inflation or deflation was likely was Gabriel Andre. Perhaps our resident Frenchman was content with the 45% gain he'd just advised readers to take trading a base metals stock that has rallied over the last month.

But his point, to be fair, was that this is not a market for a fundamentalist position. Trader's neutrality that observes only volume and price directions might be the most telling data. "The direction of currencies must always be looked at in pairs. Right now, the interest rate is the big driver for the Aussie dollar, not the growing deficits. But either way, it is a tradeable event. A weaker U.S. dollar is bullish for the commodities. However when the dollar rallies, the commodities complex weakens. Equity traders can take advantage of this, but with risks of course."

One item on which there was consensus? Aussie house prices. Australia will not be the only housing market in the world to escape a significant correction, the panel concluded. When the fall will take place and how big it will be depend on other factors (interest rates, bank lending, government support).

That said, a contrarian might view the bearish consensus on the direction of house prices as a bullish signal. We'll see. For now, the market is in definite bullish mood, until earnings or economic news contradict it. More on both tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Bank’s Inflation Projections Will Not Return to the 2 Per Cent Target Figure Until Early 2010
• The Only Thing Really Going Down Right Now is the U.S. Dollar
• The Aussie Dollar as a Measure of Global Risk Appetite
• You Can Have a Deadly Depression and Dizzying Levels of Inflation Simultaneously
• Gold, the Aussie Dollar, the Greenback and You

We'll let you know tomorrow what we find out.

As you know, the stock market is said to "look ahead." Sometimes it doesn't bother to look very far ahead. Instead, it goes along at full speed without noticing that the bridge has been washed away! And when it finally puts on the brakes, it's too late.

At least now, the stock market's eyes are open. But what godawful thing does it see?

On Friday, the Dow bounced a bit - up 494 points. But the collapse since Labor Day has been breathtaking. Even Warren Buffett's stock - Berkshire Hathaway - has been cut in half.

What does the stock market see that would make it want to treat the Sage of Omaha so roughly? What evil omen has the market noticed? What devil-on-the-loose does it fear? What plague, what war, what depression, what bankruptcy, what hyperinflation…

…did we say 'hyperinflation'?

Wait a minute. We're getting ahead of ourselves.

Whatever the world's stock markets see - it must be a damnable mess…as if the world didn't have a future.

So far…all we're sure of is that there is a "balance sheet recession" setting in. And maybe it will turn into a balance sheet depression. Asset prices are falling. People are cutting back. Companies, individuals and investors are all desperately trying to rebuild their balance sheets - by getting rid of debt. We're all Japanese now, in other words.

There will be Hell to pay…but it's not the end of the world. Stocks will come back…buyers will get out their wallets again…life will go on as before. Won't it?

Colleague Porter Stansberry thinks s

"Today…I bought a broad range of stocks with the intention of holding on to them for the very long term.

"The last two months have been grueling for me. It is very difficult to watch stock prices fall. I know many of my subscribers will lose interest in the stock market. I know the next few years are likely to be very tough on my business. I'm worried about the financial security of my family and my friends.

"I can't recall a more difficult time - financially - in my entire life.

"Ironically and paradoxically, these emotions that I'm feeling now - the anxiety, the sadness - are how I know it is time to make long term investments. Without these emotional difficulties and the huge amount of uncertainty in the markets, these stocks would not be available to me at any reasonable price.

"None of us know the future, but my bet is that the world doesn't come to an end."

*** Porter is right; the world isn't coming to an end.

But our guess is that some things ARE coming to an end. The myths of Wall Street - "stocks for the long run"…"buy and hold"…hedge funds that don't hedge…derivatives derived from nothing…millions in 'incentive' bonuses for executives. Or maybe the whole dollar-based world monetary system is going away? Keynesianism? Monetarism? The Efficient Market Hypothesis? Surely these silly theories have to go sometime too.

One thing we know that is not going to disappear is the idea that you can get something for nothing. If people ever come to believe that they can't get something for nothing, democratic government will disappear. Why bother going to the polls if you can't get anything out of it?

We'll take some further guesses about what is ahead as Mr. Market reveals his intentions.

But let's take a quick look at gold. Doesn't gold look ahead too? What does it see?

Judging from the evidence, gold sees a slump too - but a slump that won't be nearly as bad for the yellow metal as for other metals…and equities. Stocks are down nearly 50% worldwide. Gold is down only about half that much.

What else does gold see?

Our Oracle on gold is our old friend, Issy Bacher. Issy wrote a few months ago and warned that gold was going down. Friday morning Issy sent this note:

"I am sending you a graph of the Gold Price at yesterday's closing fix of $ 738.

"The bottom cycle graph clearly shows that the cycle has bottomed and is rising in the future zone.

"The top line graph shows that the gold price did find support just below $ 738

Conclusion is that for the immediate future the gold price is now in an upward trend.

"By the way, the Dow has very strong support round the 7500 level and the cycles are bottoming."

We don't know what kind of "cycles" Issy is looking at, but by the end of the day the Dow had gained nearly 500 points and gold was up 50 bucks, rubbing up against $800 an ounce.

As you know, dear reader, it's deflation now…inflation later. It's Japan now…Argentina in the future. Gold may be looking further ahead…to the pampas. Or else, inflation may be coming sooner than we think.

*** A news report on Friday afternoon: "Somali Pirates in Bid to Buy Citigroup."

"We need a bank to keep our ransom money," said the Pirates' leader.

*** "Matthias, are you by yourself?"

The boy was about 8 or 9 years old. He had come in the bar by himself and told the woman he wanted to have lunch.

"Why are you here alone? Where's your mother?"

"She's at home…but she's having some trouble with Dad."

The scene took place in a little town in rural France this weekend. We had gone out to work on our house - redoing the cement joints between the walls and the new windows. On our own for lunch, we went to the local bar, which offers a handy restaurant in the back room. A complete meal for only 10 euros, it advertises. In this time of financial crisis, it seemed like a good deal.

While we were finishing our entrée, Matthias came in…a good-looking kid with the well-defined head of a 12-year old and the body of a younger boy.

"Go take a seat," said the woman behind the bar.

After the boy had sat down, she turned to a man also working behind the bar. Both were in the mid-40s…the kind of people who run small businesses in France. Pleasant. Hard working.

"This is terrible. We can't let him eat lunch alone."

"What do you mean? His mother sent him here. It's none of our business."

"Well, it's not right. He shouldn't have to eat lunch by himself. The poor little fellow…"

"It's not our problem…"

"But it's our restaurant…and we don't want a lot of sad, lonely people eating here…especially, children."

Your editor tried to look cheerful.

"Go get Georges… He can eat with Matthias."

"He's already eaten."

"Well, he can eat again. He won't have any trouble."

A couple of minutes later, a big boy with a big grin came from upstairs. He appeared to be about the same age, but twice the size. He sat down opposite Matthias.

"Hey…how you doing?"

"Okay…"

"You eating by yourself?"

"Yeah…"

"Mom wanted me to join you. She said she'd pay for both of us."

"Oh…good…"

A minute later, the two boys were talking happily about TV shows…or video games.

Your editor finished his cheese…and left.

• They Say the Stock Market ‘Looks Ahead’
• Dumb Money Eyes Stock Market While Smart Money Watches Economy
• Looking at WPL and Oil Side by Side
• Reserve Bank’s Financial Stability Review Shows Bear Market in Credit
• Stock Market Collapse Can Be Explained By Panicked Forced Selling

Asciano has $4 billion debt on the books (much of it inherited from when the company was spun from Toll in 2007). But yesterday the company assured investors it wouldn’t be beefing up the equity on the balance sheet with another dilutive capital raising. And chairman Tim Poole told investors earnings were in line with forecasts.

The trouble is that with all that debt and, shall we say, challenging business conditions, investors aren’t convinced the equity in the company is worth anything anymore. This explains why the Citigroup analyst suddenly shifted from a discounted cash flow model of valuation (which focuses on the present value of future earnings) to an enterprise value model.

An enterprise value model adds up the market cap and debt a company has, and then subtracts cash and cash equivalents. It’s not quite the liquidation value of a firm. But it IS, generally, what it would cost you to take over the company and its liabilities, minus its cash.

So why switch valuation models in mid stream? Well, one reason is that you’re looking for any reason at all to get out of a stock, and one valuation model suggests a much lower share price than another, so you use it. But let’s assume the switch in valuation models is based on new and different business assumptions. What are those assumptions?

Well, if you’re taking your eye off earnings two and three years down the track, it means you think there are much larger immediate business concerns that affect the value of the firm. One of those might be access to capital. If a firm like Asicano has to rebuild its balance sheet by raising new capital on the equity markets, that dilutes existing shareholders.

But really, using an enterprise value model as the justification for selling a share means, as an analyst, you’re throwing in the towel on the business itself (not just the management or the balance sheet). It means you think being in the ports and rail business during a contraction in global trade is a lousy business, with zero earnings power going forward. The fact that Asciano has so much debt during a credit crunch certainly doesn’t help.

The challenge for resource investors now is to sort out which model to use for valuing over sold shares. For most resource companies (the non producers anyway) discounted cash flow models are pretty useless. The earnings are highly variable and cyclical for resource shares because commodity prices themselves shift.

Changing commodity prices affect the ebb and flow between supply and demand. If you asked us, we’d say low commodity prices are already leading to a tightening in supply. In addition to BHP, Rio, and Fortescue idling expansion and production plans in the Pilbara, Alcoa has shelved its expansion plans for its alumina refinery south of Perth. High-cost producers are already being forced out as well. What does all that mean?

It means the credit crisis and the deleveraging in the commodity markets in 2008 are going to lead to lower supply of key commodities in 2009. That lower supply, so far, looks like it will be enough to meet the lower demand that’s been brought about by the global recession/depression.

But it also leaves the surviving players in the resource patch in an enviable position. They tend to have cash. They tend to have lower debt/equity ratios. They tend to have better projects where ore grades are higher and costs of production are lower. And the really good ones have poly-metallic ore bodies, a sort of geological diversification that allows them to shift production to those metals with the highest current market prices, while leaving the other stuff in the ground for a rainy day.

The one-trick ponies (those without a poly metallic deposit) are in a tougher spot. But if you believe China’s stimulus package announcement marks the long-sought shift in the Chinese economy away from exports and towards domestic consumption, well then it’s not all bad news for the smaller Aussie resource juniors. More on that tomorrow.

Outside the Lucky Country, General Motors (GM) is telling anyone who will listen that if it doesn’t get a bailout before Christmas, it may not survive to see Barrack Obama inaugurated as the 44th President of the United States on January 20th. GM shares closed under $3 for the first time since 1946. At $2.92, it was a 65-year low for America’s big auto-maker.

Some of Australia’s new handout to automakers will probably make it back to GM and Ford’s Detroit coffers. But if the companies are going to survive in their current form, it will take a mighty Federal hand out to make it happen. And hey, everyone is getting one of those these days. So why not?

It is a remarkable thing that the icon of America’s industrial manufacturing might is on the verge of recognising its bankruptcy. In some ways, GM’s downfall reflects the conscious decision of American policy makers and CEOs to pursue financial services over manufacturing, to favour white collar work over blue collar work, selling stocks over making things.

It started with the passage of North American Free Trade Agreement by the Clinton Administration with the help of Republicans in Congress. Before we get into the details, though, let’s be clear about what happened. The U.S. pursued a “strong dollar” policy when Robert Rubin was Treasury Secretary from 1995 to 1999 under Bill Clinton. The U.S. opened its consumer market to the world and began shipping manufacturing jobs overseas. In exchange, the U.S. got two things.

First, American consumers got cheaper goods via dollar pegs from exporters who kept their own currencies relatively cheaper than the dollar and sold into wide open U.S. markets. You saw a great disinflation in manufactured and retail goods and, not coincidentally, epic growth in China’s industrial production. Earnings for American firms who outsourced labour also increased, and were passed onto shareholders via rising stock prices (and more generous P/E multiples based on the rosy new scenario of lower costs, cheaper capital, and higher sales).

This led to a huge explosion in the current account deficit, most notably the trade deficit. America was buying a lot more than it was selling. But while the current account deficit climbed higher as a percentage of GDP under Rubin, America began to rack up a huge surplus in the capital account. And perhaps that was Rubin’s idea all along.

Foreign dollar holders recycled their trade (and later petrol) profits back into U.S. stocks and bonds. This drove share prices up and long-term interest rates (to which mortgage rates are linked) down. Consumers levered up based on rising asset prices (can you smell a housing boom?). And for awhile, everyone appeared to be getting richer, with more stuff available at lower prices, and ever more credit available to borrow against rising houses and shares.

Further, Rubin’s preference for running a surplus in the capital account favoured the boys on Wall Street. IPOs flourished. Investment bankers thrived. Financial product innovation exploded like a thousand brilliant suns.

And in another fortunate side affect, Federal tax coffers swelled as capital gains taxes poured in from Wall Street. Corporate tax revenues poured in as well. When you threw in booming social security payments from the workforce along with the swelling tax take, the Clinton Administration was even able to give the impression that the Federal budget was briefly in surplus in the late 1990s.

But Rubin’s gambit has not paid off so well for the bulk of the American workforce, has it? It sent jobs overseas and by pushing real interest rates down, disincentivized saving. Savings rates accordingly plummeted while consumers took on more debt to make up the difference between their falling real incomes and their expensive (self-chosen) standard of living.

What hath Rubin really wrought?

By preferring to run a capital account surplus, Rubin essentially conceded that the current account deficit-a function of Americans consuming more than producing and spending more than saving-was an a priori fact of global economic life. He assumed the current account deficit as a fact, and engineered a strong dollar to boost the capital account surplus, which also just happened to be a huge boon to the financial services industry from which Rubin came from. He figured we’d become a nation of spenders and consumers, not savers and makers.

By the time a weaker dollar rolled around in the last year of the first Bush term, there weren’t nearly as many American manufacturers left operating that could take advantage of it. They’d all left for a siesta in Mexico or the world’s new workshop in China. America could compete on price, but there was nobody around to do the competing.

And now today we have GM, a car company that exists to pay off its accumulated healthcare and pension liabilities. It cannot make enough money by loaning money to honour the promises it’s made to its unionised work force. What would Rubin do?

Well, we know that generally in the Western world, government policy makers (many of whom come from the financial services industry or benefit from the contributions that industry makes to their campaigns) have favoured a pattern of trade that generates capital account surpluses and current account deficits. This is good for you if you’re in the financial services industry. Not so good if you make cars.

There is not much at this point that Kevin Rudd and Barrack Obama can do about it, assuming they would want to. And the bigger problem, at least for the U.S., is that foreign trading partners and central banks are no longer recycling trade profits back into American financial markets. Perhaps it’s because they believe the risk free rate of return from sovereign U.S. debt is no longer risk free.

And perhaps they’re right. The U.S. bailout plans take on debt via government borrowing in order to shore up the badly damaged and over-leveraged balance sheets of Americas financial companies. No real value is created. And what kind of investment is that? Besides, so far, the bailout has been a continuation of Washington to favour the financial services industry over real manufacturing.

In the next few days, and with Democrats in Congress pushing hard for it, the balance sheet bailout of the real economy will begin. And when it does, we think it will accelerate the movement out of U.S. Treasuries and into cash or even resources. More on how this happens tomorrow.

Dan Denning
for The Daily Reckoning Australia

• The Challenge of a Balance Sheet Recession
• You Can Never Be Sure How Fabricated Income and Earnings Are These Days
• The Growing Pile of Cash On Corporate Balance Sheets
• Dow Jones Has Worst June Since Great Depression, American Model in Decline
• The Australian Resource Boom Isn’t Dead Yet