"So what you're saying is that if the Fed leaves rates low, the market basically has permission to rally to new highs, even if they have no basis in projected earnings and stretch valuations even further?"

This was the question we put to our editorial roundtable yesterday. Kris Sayce, Murray Dawes, Alex Cowie, and Shae Smith were all there. The office was hot and sweaty. The air conditioners broke under Melbourne's mild heat wave. But everyone at the table seemed to be in agreement: the Fed has put a rocket under the market.

The conclusion is important to your investment strategy for the rest of this year and probably through half of 2010. The Fed is giving traders as much fuel as they'd like - via low rates - to borrow low and invest high (high yielding assets). The conclusion of the traders, the small cap guys, and the resource guys and gals in our office is that the whole market is going to float higher on a sea of liquidity.

That's just what happened yesterday in New York. The Dow rose over 2% to reach a new 2009 high. The S&P 500 was up 2.2%. And tangible assets like gold and oil surfed higher too. Only the sorry old excuse for a currency, the U.S. dollar, was lower.

Tactically, the editors here at the moon factory reckon that the way forward is up. But it's a dangerous journey. Valuations in a credit boom go out the door. If you participate in this kind of move, you have to be aware that it's liquidity driven (the Fed's liquidity) and not anything else. All the editors agreed to ride it with their open positions, but to initiate trailing stops in all the positions.

Why? The reversals - and they always come - can be brutal. A trailing stop locks in at least some of your gains. So here's a free piece of advice today: set some mental trailing stops on your open positions. No sense in not profiting from a good rally if you are in the market.

If you're not in the market, is now the time to jump in? Will you miss an even bigger upside by staying cautious? Probably. But we reckon that in the longer-term you're better off using moves like this to reduce your allocations to stocks. Sell into strength and get out while the getting is good.

Of course that's a pretty bearish view, not held (or spoken very loudly these days) by too many people. The conventional wisdom is that the stock market really is telling us that the economy is on the verge of a big breakout next year. And besides, stock rallies are always driven by liquidity.

The unconventional wisdom is that the Fed has learned nothing from the last bubble - or is so scared of deflation it's willing to gamble on another bubble in asset prices. The trouble , the eventual bust in asset prices has to be reckoned up. And the Fed, along with all central banks who key off the Fed's policy, are just kicking the can down the road, hoping asset values improve.

But stocks are not engaged in this debate. They are moving up nicely. One sign of a toppy market is an acquisition where the big fish try and eat each other (as opposed to dining on the little, more manageable fish). Yesterday AMP made a $12 billion bid for AXA. That's about all we have to say about that, almost.

Late yesterday afternoon, Kris Sayce sent out a note to Australian Wealth Gameplan readers advising to take a 37% gross profit and sell AXA (ASX:AXA) shares. He recommended the stock as an income play back in June - when we launched the super, income, and safety-focussed letter (as a companion and counterpart to the small cap letter).

Why sell a stock that's giving you capital gains as well as income?

"It's like getting nine months of income in one day," Kris reckoned. And that sounded about right. There will be other higher-yielding stocks on the market (and probably with less risk). Kris isn't changing the income strategy for AWG. But it is a good example of how you can use rallies like this to take profits on existing positions and gradually re-allocate your assets to a longer-term plan.

And speaking of super, the pressure seems to be mounting on the funds management industry to change its compensation model. That will tend to happen when you have two consecutive years of losses and charge people for the privilege. This exposes in plain sight the fact that most funds simply mimic the market (because most funds own the same big cap stocks). When the market drops, the funds go down.

Boom goes the dynamite!

"The reality of a rising market is that many managers generate large fees from general market growth rather than actually delivering out-performance for clients," wrote Frontier Investment Consulting's CEO Fiona Trafford-Walker, quoted in today's Australian Financial Review, under the category of "Gee, you don't say?"

But what's bad for the funds management industry - and end to management fees based on compulsory super contributions - is probably a good thing for investors. We say probably because most investors are lazy and don't want to actively manage their money. It involves thinking, and that competes with watching television, going to the beach, and pruning the hibiscus plants.

For those that do see this as the chance of a lifetime to take more control of super AND get better performance, it means fund managers will have work a bit harder, not just for their money. But for you. And obviously this is good news for the good funds managers. They'll get more business.

And what would a good funds manager recommend right now? Well, we're not running anyone's super. In fact, as an American we don't even have a super fund here in Australia. But we are doing exactly what we recommend to readers anyway: building a position in gold when prices look cheap and being very selective about how many and which stocks to own for this market.

By "this market," we mean one where it looks like another monster low-rate-rally....exactly the sort that preceded the all-time highs in 2007 - right before the reckoning. Once more into the breach...

By the way, we're trying out a new name for our newish offices, "the moon factory." It turns out the building we are now in is an example of Edwardian Freestyle architecture. What's more, historical records show the building has a name. It's called Thalassa.

Wikipedia tells us that Thalassa may be a primordial Greek goddess of the sea, and also a moon of the planet Neptune. The moon options just felt more appropriate than...writing as a primordial Greek goddess of the Sea. That might be interesting too, but what happens in St. Kilda should probably stay in St. Kilda.

Finally, you know you've had a good night when your dinner companion says "Waiter, could we have the cheque and another bottle of wine please?" Former Rude Awakening editor and current US DR editor Joel Bowman was in Melbourne last night with his lovely partner Anya. We joined them for dinner at Fed Square looking over the Yarra, although they had to catch a late flight back to Taiwan, hence the unusual request.

Joel is an Aussie living abroad, while your editor is an American living in Australia. We compare expatriate notes from time to time and talk about the market. We both agreed that the world is an exciting place with lots of opportunity, but probably with more risk than every day Australian and Americans are used to, or, in most cases, financially prepared for.

That's changing. For Australia, it seems to be a positive change. There are lots of income and capital gains opportunities in the Aussie stock market, although being coupled to the Chinese economy certainly has its own set of risks for the next few decades. And there is always the risk that Australia's current prosperity is largely a function of reflated asset bubbles, and thus just as vulnerable as last time (2007).

For Americans, the change is not so positive. The U.S. dollar is a secular decline, yet the American political establishment refuses to accept the fact that nation's finances are in massive disarray. They are either in denial, or just exceptionally stupid, even for politicians. Not surprisingly, their sense of entitlement knows no bounds.

They believe they will be able to keep borrowing from foreign creditors to enjoy a high standard of living. This is the same as saying that the social promises fulfilled with other people's money really are non-negotiable. This isn't high-minded. It's childish.

From our time abroad, we'd say that day of reckoning - where the world's up and coming populations subsidise American consumerism - is upon of us. Has been since 2000 really, when gold became the trade of the decade. The decade isn't quite over yet, and neither is gold's run. But we have a feeling the political, economic, and even military aftershocks from the dollar's decline are just beginning.

Dan Denning
for The Daily Reckoning Australia

• Your Average Australian Super Fund
• Your Actively Managed Superannuation Fund Cannot Beat the Market
• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?
• Superannuation Raiding Party Being Formed II
• Is Kevin Rudd Planning to Steal Your Superannuation and Bankrupt Your Retirement?

We're back in civilization... Wait...you call this civilization? Looks more like Bubble Land again!

Gold is headed towards $1,100...

Bonds are soft...so is the dollar...

Speaking of old friends, Marc Faber says he's long the dollar. Faber thinks the buck is over-sold. It could rise 10% in this last quarter.

But the Fed says it will keep interest rates low for an "extended period." So there is still no sign of the kind of policy turnaround that might send the greenback back up.

Instead, we'll have to wait until the bubble pops!

Oil is over $80...

Republicans are winning elections...

Hey, party like it was 2006...

The Dow is moving back up, too...and so are all the world's markets...led by Asian stocks. China is booming...with its stocks up 4 days in a row...

The rise in gold comes as India's central bank does the smart thing. Central banks need reserves. And historically, the only reserve a central bank can trust is gold. Putting US dollars in your vault - instead of gold - is a little like laying in a supply of lettuce to tide you over in a bad harvest year. Imagine what would have happened if pharaoh had stocked up on radicchio instead of grain? Those 7 lean years would have been a lot leaner than they were.

The Chinese have seen what happens when you rely on dollars for a reserve. You're stuck. Because your reserves can wilt fast.

The Indians have a better idea - they're buying gold.

The metal has outperformed stocks and bonds this year as it heads for the ninth straight annual gain. The Standard & Poor's 500 Index has risen 15 percent in 2009 through yesterday while returns on the benchmark 10-year US Treasury note are down 5.7 percent.

Gold may average $1,125 in 2010, "with strong investment demand anchored by a negative real-interest-rate environment and probable central bank purchases," analysts at Toronto-based Desjardins Securities Inc. said in a report.

And here's another interesting item we found when we got back to an Internet connection: "Companies that become too big, complicated and debt-ridden should be allowed to 'creatively destruct,'" says our friend Nassim Taleb, author of The Black Swan.

Taleb likens the process to natural selection. "Why is it that there are no land animals bigger than an elephant?" he asks. "Because nature doesn't permit it. Bigger animals die off. Likewise, the market system disposes of companies that are 'too big to fail.' It gets rid of them."

Unfortunately, says Taleb, the US government is impeding this natural process. The government is preventing the bankruptcies of large corporations that would clear the way for a new generation of healthier, more nimble, corporate organisms. Furthermore, these trillion-dollar bailouts are polluting the financial ecosystem with toxic piles of debt.

"We're not destroying debt," Taleb complains. "When you move it into the government, it stays in the government and that's a problem."

Bill Bonner
for The Daily Reckoning Australia

• Naturally the Feds Want to Raise as Much Money as They Can
• Life Goes On
• There is More to Wealth than Money
• Global Credit Shortage is Over According to European Central Bank
• Central Banks’ New Money is Piling Up

So we're moving. And we're moving people. We're moving.

But where are we moving to? It looks like another mini-bubble. The market seemed prime for a fall in conjunction with a U.S. dollar rally. That could still happen if the U.S. employment report tomorrow is a shocker.

A negative employment will remind everyone that this recovery (if it can properly be called) that is still largely a jobless one. The process of reducing household debt is going to take years and not months if households can't grow their incomes. Real wage growth (adjusted for inflation) is pretty hard to come by in most of the Western world (unless you run a bank).

All this adds up to lower household spending ahead. How much further ahead can stock prices get of corporate profits that may never materialise? We'll see. But valuations are already stretched. Investment advisor Jeremy Grantham reckons fair value on the S&P 500 is around 860 - or 24% lower than yesterday's close at 1,066.

But whether the market breaks up or down here (something Murray has been looking out with his technicals) is up to investors. There is a huge cash position on the sidelines that's still worried to jump back into markets. For the bear to really do his work, he's got to convince these people to get into the market. The Fed is helping by making cash a wasting asset (when you figure in inflation).

Thinking out loud, then, you could make a case for new highs on the market as this cash mountain moves into equities. We saw a chart on Sunday at the opening of the conference hosted by the Gold Standard Institute which showed that the amount of cash on the sidelines exceeded the total market cap of the Wilshire 5,000 (a broad measure of the market value of all U.S. equities).

In layman's terms, it means there is more money in cash right now than there is equity in U.S. companies. Now, there is a very good reason investors are reducing their allocation to stocks. As we've said before, we think the equity premium - what people are willing to pay for stocks - is regressing to the mean. It was so high for so long because corporate cash flows in the second half of the last century benefitted so much from low interest rates and globalisation.

But even if the equity premium is collapsing, it wouldn't take a small change in that cash position to power equities much, much higher. In fact, if the investors holding that cash realise that inflation is a bigger risk than over-valued stocks, they may decide to get out of cash anyway, despite the risk of being in the market.

In any case, we are not suddenly becoming bullish. But we are suddenly thinking that the next phase of this GFC (other than the sovereign debt crisis) is to lure investors back into an equity rally. Whether they are prodded by negative real interest rates on short-term deposits, or lured by equity markets lurching ahead with the backing of the dollar carry trade, well that doesn't really matter.

It could all be moving on up.

What's really worth watching is how the commodities behave in this market. They are moving on up too. This means gold is shedding its image as a risk-aversion asset and becoming something that people want to own. Its allocation in household and institutional portfolios is going up too. And of course, trading cash for things is probably a good trade these days, no matter whose cash you have in your wallet.

We'll have to cut it short today as other deadlines press. But beware. The bear is afoot and he is making mischief. He is doing is devilish best to convince investors that he's hibernating. After all, the November to April period is usually when stocks do their best.

This year has been unusual because, thanks to the Fed, stocks had a great six months during a time when they generally don't do much. It's unnatural you might say. But so are current fiscal and monetary policy, we might say.

We might also say that there is something tawdry about insisting that modern living standards are not negotiable and must be preserved with high public sector debt. In effect, today's policy makers are saying to the future, "Our current well-being and comfort is more important than any debt you may have to repay. We refuse to live within our means because it would inconvenience us to do so. We are too lazy and selfish to recognise our financial mistakes and pay for them. We're going to leave that to you. Suckers!"

It's not very nice. It's not very moral. But it is what it is. And right now, it gives you the chance to prepare your portfolio for the consequences of bad policy (fiscal, monetary, climate...take your pick!) More on all of it next week. Until then!

Dan Denning
for The Daily Reckoning Australia

• Australian Recession in the Works? Ask the Sharemarket
• Negative Equity Becoming the Norm in U.S.A.
• Largest Spike in U.S. Wholesale I/S Since 80s Recession
• Societe General Warns of Freddie Kruger Style Global Recession
• A Possible Holocaust in U.S. Bonds

Know what that means? It means the "Age of Thrift" is here...and that consumers really are cutting back - just like we said they would.

And it means that the consumer economy is not going to return to robust growth anytime soon. And it means, too, that people will find it hard to find jobs for a very long time.

Another thing it means is that housing prices are not likely to recover - not in our lifetimes. That was a once-a-century bubble and it has blown up.

Mortgage lenders say they expect the peak in foreclosures to come about a year from now. As for the bottom of price declines, you can expect that in 2013 or beyond. A housing bubble typically takes prices down for six years, says a study by professors Reinhart and Rogoff. But this was not a typical bubble; it was an extraordinary bubble. Seems logical that the correction will be extraordinarily deep and long too.

And it also means that this stock market rally is very vulnerable. The stock market and the economy seem to be reading different newspapers!

The Dow fell 14 points yesterday. It could begin a major drop any day. That's why our 'Crash Alert' flag is flying from our London headquarters.

Yesterday, we reported the curious fact that consumer spending as a percentage of the GDP had increased. But it only increased because the other parts of the GDP - notably business spending and investment - fell off even faster.

With output falling...sales falling...and investment (in new plant and equipment) falling even faster...who's going to hire new workers? Not many companies. And which companies are going to invest in young workers...who will have to be trained - sometimes over a period of many years - before they are really productive? Not many.

It's the "Lost Generation," says BusinessWeek. Unemployment nationwide is officially 9.8%. But for young people the rate is nearly twice that level - at 18%.

Their elders aren't doing so well either.

"Baby boomers working longer hours, for less," says a Financial Times headline. What do you expect? Their currency is going down in value. Their customers are disappearing. Their retirement savings disappeared with housing prices. They can't even borrow money anymore.

David Rosenberg:

"Now that lenders have started to respond to their record-high delinquency rates by rationing credit, a mad scramble for cash is occurring to replace the loans - food stamp usage is up 22% year-over- year, pawn shop business is up nearly 40%, and there is a tidal wave of applications for Social Security disability benefits that are not explained alone by workplace mishaps."

Boomers have no choice. They need money. So they work harder, and longer. And they get paid less. Why? Because prices are falling. Even the price of labor. It's a deflationary world.

Meanwhile, The New York Times reports, "China consolidates its lead in global trade."

This headline is a little like the announcement that consumer spending is a bigger part of the economy. It might lead you to think that global trade is growing - or, at least that the Chinese part of global trade is growing. Not at all! Global trade is still shrinking. Chinese exports too. It's just that China's part of the global marketplace is increasing...because America and Europe are losing market share. China is gaining market share because it competes on price. And price competition is what is driving this market.

No discount? No sale!

Power and wealth are shifting east. No doubt about it. The Chinese took over the Hummer this week. And they are even building a 'big plane' - the C919 - to compete against Boeing and Airbus.

Is there any business they can't compete in? We don't know...but we're counting on them to stay out of financial publishing at least until we retire!

Bill Bonner
for The Daily Reckoning Australia

• If Americans Do Not Return to Work, There Is No Recovery
• Bear Markets Do Not End With Stocks Still Trading at Nearly 20 Times Earnings
• Stock Prices Down Signals Bears to Hold onto Cash, Treasuries and Gold
• Economy Has to Grow at 1% to Stay Even With Population Growth
• We Expect No Recovery from the Economy

October is almost half over. Will we get through the month without a major sell-off?

Dear reader, if you think we know the answer to that you've got us mixed up with someone else. Someone who is crazy.

No one with his wits about him thinks he knows what the stock market is going to do.

Still, here at The Daily Reckoning, we have our hunches. We think it's time for a major pull back. Frankly, we'll be disappointed if we don't get one soon. Because, once again stocks are too expensive.

Too expensive for what? Too expensive for the circumstances.

The Dow rose another 20 points yesterday to a new bounce record. Oil rose to over $73. Gold didn't budge.

Of course, everyone now knows that the recession is over. NABE interviewed 44 economic forecasters. Four-fifths of them said the recession was over.

But we don't care what they said. These are the same seers who missed the biggest single event in financial history. There are many banking crises, recessions, panics and defaults in the record books. But none were as great as the one that hit September a year ago. Most economists didn't see it coming; why should we trust them to tell us when it is going?

Besides they've got the whole thing wrong. It isn't a recession; it's a depression. There is no recovery from a depression; instead, the economy has to re-invent itself in another form. Things aren't going 'back to normal,' in other words. Because the period leading up to the crisis was not 'normal;' it was a bubble. After a bubble explodes, you have a lot of debris to clean up. The bigger the bubble, the more damage it does when it blows up.

"The force of a correction is equal and opposite to the deception that preceded it."

You've heard our dictum before. In fact, you've heard our explanations for all these points before.

We just lived through the biggest bubble in history. Get ready for the biggest bust. Not just two years of falling stock prices and news- making bailouts. Not just 10% unemployment. Not just 100 bank failures and 30% off housing prices.

Noooo... We're talking about a worthy correction...a real correction...a noble and distinguished correction...a correction that can hold its head up in public.

This is a correction that will take many years...one that will knock housing prices down for at least five years...and stock prices down to the point where people no longer want to buy them. It's a correction that goes deep enough and continues long enough to do its work - wiping out the bad investments and mistakes of the Bubble Era, while allowing the survivors to pay down their debts and build up their savings.

Now, here's a confusing little item. Yesterday's news tells us that consumer spending as a percentage of the entire economy has edged up to 71%. Now wait just one cotton-pickin' minute. How could consumer spending be going up?

Hold on, cupcake. It's not going up. It's going down. It's just that the other components of the economy are going down even more.

In the second quarter consumers spent $195 billion less than they did the year before - a 1.9% drop. In the 20 years before that, consumer spending increased at an average rate of 3.3%. So, you do the math... that's an about-face of more than 5% of GDP - a loss to the economy of about $700 billion!

Consumer credit is going down (we reported the figures earlier in the week)...unemployment is going up...consumer spending is going down...

..those are not the circumstances in which stocks sell for 27 times earnings...and move higher. Those are the circumstances in which stocks crash.

David Rosenberg:

"By some measures, the S&P 500 is already trading at valuation levels that would ordinarily be consistent with an economic expansion that is five-years old as opposed to a recovery that, at best, is in its infancy stages.

"On an operating ('scrubbed') basis, the trailing P/E multiple on the S&P 500 has expanded a massive 10 points from the March lows, to stand at 27.6x. Historically, when the economy is taking the turn away from contraction towards expansion, which indeed was the case in Q3, the trailing P/E multiple is 15x or half what it is... While we will not belabor the point, when all the write-downs are included, the trailing P/E on 'reported' earnings just widened to its highest levels in recorded history of nearly 140x, which is three times the levels prevailing during the height of the tech bubble."

So, here goes...yes...today, we are officially running our "Crash Alert" flag up the pole here at the London headquarters of The Daily Reckoning. Cross Blackfriars Bridge and you might see if flapping in the wind, between the two huge gold balls on the roof.

Our Crash Alert flag is out because stocks have become too expensive...and because this bounce should be reaching its apogee by now. Already, central banks are talking about cutting back on their efforts to sustain the bounce with easy credit. Australia led the way last week with a rate hike.

It is also becoming clearer and clearer that the feds' efforts aren't really working. They can give money to their friends in the banking industry. They can give money to speculators who then make bets on the stock market, among other things. They can bailout major companies. But they can't really get much money into the real economy.

Au contraire; they take money OUT of the real economy. The feds will absorb $700 billion of private savings this year alone...to finance their deficit. They expect $1 trillion deficits at least for another 10 years. That won't leave much money for the private sector.

Naturally, Washington, DC, is doing well. While unemployment is near 10% in the rest of the nation, it's only about 6% in the Washington area.

But let's face it... What's good for Washington is bad for the rest of the nation. The feds have used this correction to increase their power...and add to their wealth. The average federal employee now earns twice as much as his counterpart in the private sector - if the fellow in the private sector has a job at all.

A news item tells us that TARP recipients spent $114 million lobbying for their bailout money - most of it going into Washington, of course.

And the feds now own major stakes in what used to be the private sector - insurance, automobiles, and banking industries.

This has been a great period for government. Money, power...it is all floating down the Potomac like raw sewage...and coming to rest in the capitol city.

Our advice to the feds: enjoy it while you can. When stocks fall again...and people figure out what a mess you've made of the economy...you'll be lucky if you aren't tarred, feathered and run out of town on a rail.

Bill Bonner
for The Daily Reckoning Australia

• Economists Agreed the Stimulus Was Working and the Recession Was Coming to an End
• Household Debt Represents Spending Taken From the Future
• Feds’ Plan is to Reflate the Economy
• Debt Built Up to Levels Even Obama Says Are “Unsustainable”
• A Battle Between a Natural Market correction and an Artificial Attempt to Avoid it

Starring Ben Bernanke, Tim Geithner and a cast of millions...

The new movie - Zombieland - about a group of survivors in a world of zombies, was the biggest grossing film in America and Canada over the weekend. It must reflect the zeitgeist of the North American public...a deep feeling that we are living in a decaying world.

Maybe it comes from the growing awareness that the old bubble economy of the 2002-2007 period is dead. Now, survivors must defend themselves from the zombies.

Survivors are being attacked in the streets, in their homes, and at their workplaces. Zombie banks - kept alive by artificial stimulants provided by the feds - take their money and their houses. Living-dead companies block new competitors. And the zombies at the Fed and the Treasury department try to gnaw on their savings, encouraging inflation to eat away the purchasing power of the dollar.

As to this last point, the feds have gotten nowhere. They wear down their teeth for nothing. Prices are going down, not up. Houses are 30% cheaper than they were in 2006. Hotel rooms are 20% cheaper than last year. You want a luxury room? Just ask for an upgrade. Chances are good that no one is renting the luxury suites. Just make them an offer. Discounts are available almost everywhere. The Sony Playstation, for example, is now available - 25% off.

Stocks are cheaper too. They've been going up for the last seven months, but they're still about a third less than they were in 2007.

Stocks fell again on Friday. Investors began to fret that maybe...just maybe...the authorities don't have this zombie problem under control.

"Jobs news gets worse," The New York Times tells us.

Since the stock market began going back up in March, the United States has lost 2.5 million jobs. It has lost jobs every month since December 2007. Now, unemployment - officially at one in ten workers - is the worst it has been in 26 years.

What kind of recovery is this? We don't know, but if it continues much longer we'll all be unemployed.

But not to worry, dear reader. Secretary of the Treasury Tim Geithner says the signs of recovery are "stronger" than expected.

We wonder what signs he's looking at. Of course, this is the same doctor who was on the scene at the New York Fed when strange things began happening. The financial industry started acting funny in the bubble years...spending money like there was no tomorrow. And then, wouldn't you know it, there wasn't any tomorrow. They dropped dead in the crash of '07-'08. But with huge injections from the Fed, they've turned into Zombies.

Of course, Tim Geithner missed the whole thing. So maybe he's not the best source of recovery sightings.

A survey by Business Roundtable tells us that the ranks of the unemployed are likely to swell. Only 13% of employers have plans to hire more workers. The rest are either sitting tight...or turning workers loose.

Naturally, of all those people cut off from paychecks, more than a few are looking a little peaked. Their eyes sink back in their heads. Their skin turns grey. Soon, they're starving for raw meat.

"Personal bankruptcies soar," says The Wall Street Journal.

And not surprisingly, when they become desperate, they tend to default on their mortgages. We know already that auto sales drove off a cliff when the summertime 'Cash for Clunkers' program came to an end. Now, summer's over. Housing sales should decline too - forcing more homeowners into default and foreclosure.

The zombies are having a depressing effect everywhere. The stock market went down again on Friday...the Dow fell 21 points. The oil market didn't do much better, with the price of the black good still below $70.

As for gold, the yellow metal continues to hold above $1,000. It fell below $1,0 00 for just a couple days. On Friday, it was back to $1,004.

The $1,000 level used to be a ceiling for the gold price. Now it seems like a floor. Are the Chinese buying below $1,000? Maybe. Do we have a Beijing put option available to us? That is, has the risk been taken out of the gold market by China's desire to stock its vault with something other than dollars? It is an intriguing thought. We don't know the answer.

We are holding onto our gold. It's insurance - protection against the feds. If they do something really stupid, the price of gold will soar. If they don't do anything really stupid, well, we'll be surprised. After all, they've already turned America into Zombieland.

Bill Bonner
for The Daily Reckoning Australia

• A Dispatch from the Zombie Wars
• Where, Exactly, is this Economy Headed?
• Funny Business at the Banks
• Economy Has to Grow at 1% to Stay Even With Population Growth
• Unemployment Rate at a Five Year High

When you get to the bubble phase, few people stop to ask questions. Instead, everyone assumes that the trends in place will remain...and even intensify. So even into 2008, in Phoenix as well as other growing areas - principally in the sand states - the building continued. And now it is 2009. Where are the shoppers? Where are the renters? Alas, they are thinner on the ground than anticipated...and the developers are having trouble paying their mortgages. Commercial mortgage backed securities are carrying 5 times the unpaid balances they had in June '08, says Bloomberg.

Imagine how disappointed lenders will be when these loans default. And then, imagine how American investors will feel when a new wave of mortgage defaults and foreclosures is hits the commercial property market.

A new wave of foreclosures and falling house prices may be approaching the housing market too. Alan Abelson, in this week's Barron's, reports on the outlook as described by Amherst Securities. The research group estimates an overhang of 'hidden inventory' of some 7 million units. These are properties owners would like to sell - if and when the market strengthens. Trouble is, the market may not strengthen soon enough. Then, many of these hidden properties could come right out in the open, as mortgages are reset, marriages break up, and people move on. Amherst says these people are in the "delinquency pipeline" which eventually flushes out the market. And it calculates that another 300,000 properties enter the pipe every month.

Falling prices have reduced 'owners' equity' - the part of the house the homeowner owns free and clear of a mortgage - to only about 43%. This number includes people who have no mortgage at all - more than 50 million of them. Abelson speculates that the actual equity in the hands of the 'owners' of mortgaged houses must be substantially less. Pushed by joblessness...not to many life's other, normal hazards...many of these people are surely going to default. Of those in the "delinquent pipeline," nearly 10% haven't made a payment in more than two years. Sooner or later, the banks and mortgage holders will be forced to take action...and more houses will come onto the distressed property market.

Eager to put this recession behind us? Hey, don't be in such a hurry. Recessions do good work. Depressions are even better (see essay below....)

More and more people get something from government. Fewer and fewer are net taxpayers. This is the basic formula that bankrupts democracies. The political system becomes skewed towards spending; then, there's no stopping it. Once the majority of voters and special interests has an interest in increasing spending - even by borrowing - rather than in limiting taxes and debt, the game is practically over.

USA Today reports on the number of children whose lunches are furnished partly at taxpayer expense. The figure rose from 24 million in 1990 to 31 million today. That is, the welfare program increased by a third during the biggest boom in history. Think what will happen during the bust.

Bill Bonner
for The Daily Reckoning Australia

• Another Big Wave of Foreclosures
• House Prices in California and Las Vegas Hit Hard by Wave of Foreclosed Properties
• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?
• Commercial Real Estate May Be the Next to Fall
• Commercial Mortgage Backed Securities Are Back

He writes that, "During the credit boom, from 1995 to 2007, the debt-to-GDP ratio rose quite a lot, to all-time record levels, eclipsing the 1920s by considerable margins. In our current system, money is created by debt: new debt creates more money. During that period the broad money supply in the US generally grew at about 8% per year, and in Australia about 10% (peaking at 23% year on year to January 2007). That extra money was spent in the real economy, thereby raising the GDP by about 1 - 2% per year. About 10 - 25 GDP points were artificially added by borrowing from the future (borrowing brings forward consumption from the future to the present)."

"Now here is the thing. With the ending of the credit bubble (and it will end eventually, despite any stimuli), the debt-to-GDP ratio will return to normal, pre-bubble levels. People won't carry abnormally large debts unless asset prices are rising quickly, so the debt-to-GDP level cannot stay permanently elevated. Reduced debt reduces the money sloshing around the economy: retiring debt destroys money, in our current system. So as the debt-to-GDP ratio returns to normal, that 10 - 25% of extra economic activity brought from the future by extra debt will now be removed from the GDP.

"The main economic issue of today is how fast the 10 - 25% reduction in GDP is going to take place. We could do it quickly in one year, with a sharp short depression. Force bad debts out into the open, those who are broke go bankrupt, and everyone starts over in a dynamic economy. Or we could drag it out indefinitely like Japan after its bubble popped in 1990, but pay the price of a moribund economy with hidden unresolved debts. Or we could go for something in-between, maybe giving back 1 - 2% of GDP per year for the next 12 years.

"So far policy makers have tried to postpone the GDP decline by simulating to keep the bubble going a bit longer. History suggests they can pretty much be relied upon to keep trying to put it off, and eventually reach for the printing press and inflation to lower the real value of debts (most voters are borrowers, not lenders) and disguise the reduction in real GDP (with enough inflation, no one will be sure).

"In the 1970s, after the smaller credit bubble of the 1960s, the formula was to run about 10% inflation from 1973 to 1979 before radically raising interest rates to bring an end to the inflation in 1980. Seven years of 10% inflation halves the real value of debts. Of course, all this will bring the nature of debt-and-fiat money into question, and the price of gold and silver relative to other items will probably increase dramatically (they went up 20-fold in the 1970s).

As Dr. Evans points out, if the gold price repeats its 1970s run, knowing which Aussie gold stocks have the lowest production costs will come in very useful. Goldnerds does a great job of helping you suss out who the low-cost producers are.

In the meantime, as one reader wrote in this week, don't forget the cash. The Aussie dollar is enjoying its moment in the sun as the most attractive currency in the G-20. The interest rate differential and rising commodity prices ad to its allure. But cash itself as part of your preparation for further economic turbulence is always a good idea. Don't forget it! Until next week...

Dan Denning
for The Daily Reckoning Australia

• Dr. Woody Bock’s Essay: The Future Evolution of the Debt-to-GDP Ratio
• Price-to-Earnings Ratio of the S&P 500 Index
• What’s the Best Way to Get Through a Debt Crisis?
• Now in Post-bubble Era as Financial Industry Bombs Out
• Rumours Swirl Over Chinese Equity Stake in BHP Billiton

'The Singularity' is an idea from Ray Kurzweil. The gist of it is that computers will soon be smarter than humans; by the middle of this century they'll be smart enough to figure out how to get smarter and smarter, faster and faster.

No doubt, many of them will go into finance. And no doubt, many will make a fast buck. But will more smartness really make the world a better place? According to the singularists, increased brainpower will be able to solve all sorts of problems - from global climate change to market crises.

But the brain is a big disappointment. No mechanical engineer has ever improved the old-fashioned kiss. Nor has any brain ever straightened out the business cycle. Dumb as a slide rule, the brain does what it is told to do; it doesn't ask questions. Tell it to build a bridge and it is on the case. Put it to work packaging tranches of toxic assets or selling aluminum siding...it is just as happy with one task as with the next. And the more a man's brain bends to a challenge, the more it elbows out of the way his finer senses...and the dumber the man becomes. He turns his back on his own intuition as well as the accumulated wisdom from previous bust-ups and bruises. Like a man who has gone crazy, as G.K. Chesterton put it, all he has left is his sense of reason. Then, with nothing more to work with, he comes down on his work like a blacksmith's hammer on a fine Swiss watch.

During the bubble period, the big banks were the biggest employers of top graduates from the world's top schools. Oxford, Cambridge, Harvard, Yale...the financial sector drew them in like flies to an open latrine. The financial industry made so much money it had a hard time explaining it. The smart dudes did not toil in the fields, neither did they spin. Then, what did they do? They earned millions, bought BMWs and got dates with actresses. They claimed they were doing a fine job of allocating the world's wealth and making everyone better off.

But when the bubble blew up, it was apparent that the financial world they created was fragile and perverse. Not a single one of the largest Wall Street banks survived without government handouts. And a news report from this week tells us that Americans were so damaged by the Bubble Epoque that their discretionary spending has now been cut to levels not seen in 50 years. The geniuses wiped out a half-century of economic progress in the richest, most successful economy the world has ever seen.

Smart people were also to blame for the biggest single error of the last century: central planning. The central planners thought they could fix the supposed evils of the natural economy with logic and reason. The idea was so alluring half the world fell for it. If the Nobel Committee had been on the ball they would have given Karl Marx a prize.

If the bug had come from stupid people...smart people might have avoided it. They might have come through the period without permanent scaring. But the wheezy intellectuals behind it were too clever for their own good. They soon infected the top universities...and the government. They convinced almost everyone that central planning was the wave of the future and that anyone who stood against it was a bumpkin, a parasite or a fool. Then, in the name of human progress, they took control in two of the world's largest countries and turned them into prison camps.

But by the last decades of the 20th century it was obvious even to central planners themselves that it wouldn't work; in both Russia and China, the planners simply gave up.

Central planning didn't work because people had plans of their own. They resisted. Then, the planners brought down their hammers. "If you're going to make an omelet, you have to break some eggs," said chef Vladimir Lenin. The "Black Book of Communism" puts the death toll as high as 100 million.

Then too, central planning didn't work for less obvious reasons. Planning requires information. The planners had plenty of it. But private individuals had far more - local, current, more accurate information from first-hand observation and experience. With better information, they could make better plans. Most important, individuals didn't limit themselves to only the fresh fruit of their rational brains. They put their hearts in it...and drew on instinct and tradition - the distilled spirits of previous generations - giving them a huge advantage over the apparatchiks.

But the brains kept at it. When the forensic experts sifted through the debris from the 2007-2008 financial blow-up they found fingerprints from a whole list of Nobel winners. It was they who had developed the formulae and the theories that deceived investors, and themselves. They believed they could tame risk...by calculation! They figured out the odds and worked out prices - to as many decimals as needed to put investors to sleep. And then along came a risk they had not foreseen - the risk that their own formulae were claptrap and that they were idiots.

Meanwhile, the brains were at work in the public sector too. There, they were still pushing central planning...albeit on a much less ambitious scale than in the last century. In Western countries, government economists fixed lending rates and credit policies in order to encourage over-consumption. In the East, they fixed exchange rates and recycled credit back to their customers in the West in order to encourage over-production. And what ho! Wouldn't you know it; now the world has too much debt and too much capacity.

And so the brains are back on the job. In China, the government boosts production. In America, the central planners are trying to boost consumption. In short, the fixers are still fixing. And soon, the world will be in an even worse fix than it is now.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Can Government Bureaucrats do a Better Job of Allocating Capital than Free Markets?
• The Bubble Deniers Deny that Their Own Stimulus Caused it
• Chinese Economy Seems to be Growing
• One of the Biggest Humbugs in Capitalism is Private Equity
• Fed’s Balance Sheet Increases As Much As $2 Trillion

But let's start with sovereign wealth fund of China, the China Investment Corporation (CIC). CIC was set up in 2007 with US$200 billion of China's nearly $2 trillion foreign exchange reserves. It's been shopping ever since, with mixed results. Last year, for example, CIC stood pat and only invested US$4.8 billion outside China. It preferred to ride the bubble in Chinese bank stocks, which worked out pretty well for it.

Yesterday, however, Reuters reports that CIC is now cashed up to the tune of $300 billion and ready to buy again. "It will not be too bad this year," says CIC chairman Lou Jinwei. And here's the good part. "Both China and America are addressing bubbles and we're just taking advantage of that. So we can't lose...We have to be in everything because you never know what's going to happen in this world."

Come again?

There's a charitable way of reading these comments and there's a straight forward way. The charitable way is that Lou and the rest of China's economic mangers know that their $2 trillion in forex reserves (which are mostly in U.S. dollars) are in perpetual danger of devaluation. If you had a pocket full of $300 billion in monopoly money, trading it for anything-anything at all-would be the sensible strategy.

You'd want to trade it for a real tangible assets or equity before asset sellers started treating your money with disdain. This is why CIC "can't lose." Better to trade it for something now then watch it turn into nothing later.

The straightforward interpretation is that the Chinese wealth fund managers have lost their marbles. Counting on more bubbles to increase your wealth is a portfolio destruction strategy. Chinese fund managers may end up being every bit as stupid as the hedge fund managers and bankers and CEOs at U.S. banks who ran their respective institutions into the ground making the worst leveraged bet of the century on U.S. housing.

The only real difference, as far as we can see, is that the U.S. bets were made with borrowed money (often borrowed from Chinese creditors, we reckon), whereas China is investing the fruits of its productive labour over the last twenty years. It is a massive gamble. The U.S. managers, who may have been criminal rather than stupid, did tremendous damage to their country's economy. Will China's managers replicate the feat?

This also makes you wonder how much the emergence of China itself is a function of a global bubble in fiat money since August of 1971, when Richard Nixon took the U.S. dollar off the gold standard. Sure, there are tens of millions of Chinese people working in real factories making real products out of real raw materials (many sourced in Australia). These people have real dreams, ambitions, and economic aspirations, not to mention real savings (in gold and paper money).

But is it possible that China's time at the centre of the global economic stage is limited because China's economic model itself always depended on cheap credit and fiat money? Yes, yes. It goes against the whole "next economic empire" way of thinking. But if China's official asset managers are counting on bubbles to make them wealthier, you wonder how sound the model is, and how long the wealth will last. We wonder anyway, which is our main job at the DR.

Empires. They sure don't make them like they used to. Rome lasted a good long while, with a big lead up as Republic. The 1,000 year Reich didn't last ten years. The economic and political clock seems to be speeding up these days.

That would be something. A twenty-year global boom from fiat money that simply accelerated the depletion of natural resources and the misallocation of capital to projects that are uneconomic at lower levels of household and business debt. Hmmn.

Speaking of resources, two notes that prove oil is still out there, but getting harder to find and more expensive to produce. PetroChina will spend $2 billion to buy a 60% stake in the MacKay River and Dover oil sands projects in Canada's Athabasca oil sands. Canadian sources reckon there are 5 billion barrels of bitumen on the properties. But turning bitumen into oil isn't easy or cheap. It takes lots of water and energy, neither of which are money.

The other note is that BP says it has found as much as three billion barrels of oil in the Gulf of Mexico. It found it by drilling 10,685 metres below the Gulf of Mexico, or 35,000 feet. So BP drilled the equivalent of a Mt. Everest underwater to find the oil. Actually, Mt. Everest plus another six thousand feet.

This is ample evidence of Peak Oil. It shows that oil is getting harder to find and more expensive to produce. Technology has improved, of course, allowing exploration companies to look further afield than ever before. Oil companies can increase reserves this way. They're finding oil. But it is not the cheap, easy, free-flowing stuff once found in the oil fields of East Texas or Saudi Arabia.

By the way, if you're wondering what could cause a second dip in the global recession, we have an answer: government stimulus. Yesterday was full of stories on how the stimulus spending by the Australian federal government made the recession less worse than it might have been and produced positive GDP growth. This has everything backwards, although it's being swallowed whole by the financial press.

A rebound based on monetary inflation and government spending isn't a real rebound at all. It gives the appearance of normalcy and economic health through rising asset values and more transactions in the economy (which GDP itself measures). But unless there's a big pick up in private investment, the economy is not on any sounder long-term footing.

In fact, it's worse. The illusion of prosperity created by stimulus spending induces people into maintaining debt loads they might otherwise reduce. Consumption patterns which ought to change in order to put the household and corporate balance sheets back in working order aren't changed at all. And when the government stimulus is withdrawn later---as it must be before higher fiscal deficits lead to rising interest rates-the economy reverts back to its pre-stimulus levels of growth-only without the underlying issues of over consumption and too much debt having been addressed.

Or the short version: there is no easy way out of this mess. The government can't create wealth by borrowing money or taxing people and spread the lucre around to favoured groups at the expense of others. That's theft and it's immoral. But the real issue is that the whole economy needs to reduce leverage. The housing bubble has to pop. And the nation has to quit living above its means (we remember writing this about America five years ago).

How about some reader mail?

Hi Dan,

Gene A.

Not this first time we've heard this and won't be the last. We write about outliers and Black Swans. Those topics are controversial, which is why the mainstream media is afraid to express a real idea about them. What's more, getting people's attention in this economy is tough. Sorry you don't like the ads. But don't expect them to change.

For one, we have to pay the bills. As much as we like writing the DR, there's an entire publishing operation to support that provides research to paying subscribers. Secondly, we wouldn't describe any of our publications as "loopy get-rich quick schemes." We know how much time and research goes into each monthly report. We stand behind all the ads and have a hand in a fair a few of them to make sure they're telling the stories we think you can profit from. If you really don't like them, you can always just ignore them.

--Hi Dan

Aidan

--DR

John

Dan Denning
for The Daily Reckoning Australia

• The Iron Ore Pricing War Between China & Australia
• China, the Miracle Economy
• Inflation: Enemy Number Two
• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?
• India Beats China to Walk Away With 200 Tonnes of IMF Gold