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

Something more than meets the eye is going on here. The IMF sale was part of a plan to unload 403.3 tonnes of gold. It's halfway there, and will use the proceeds to fund itself and loans to the developing world (or perhaps Britain and America when they go broke). But what else is going on?

In the past, larges sales of gold - mostly by European central banks - swamped the gold price and kept it in check. The European CBs either felt like they had too much gold doing too little work on the balance sheet. Or, they were manipulating the price of gold down by increasing the supply to the market whenever the gold price began rendering its verdict on global fiscal and monetary policy.

India's central bank is now the proud owner of 557 tonnes of gold. That gives it the tenth largest gold holdings among central banks. But it probably isn't finished. Gold makes up just six percent of India's foreign exchange reserves. There's plenty of room for that to grow.

But don't forget China. China has $2.3 trillion in foreign exchange reserves. But 70% of those - or $1.6 trillion - are in U.S. dollars. It owns over just a 1,000 tonnes of gold. That makes up less than 2% of China's reserves and makes China the seventh largest holder of above ground gold. In fact the gold exchange traded fund (NYSE:GLD) owns more gold than China. France, Italy, the IMF, Germany, and the United States round out top five (from fifth to first).

What this tells you is that China could double (and then double again) its gold reserves and gold would still make up less than 10% of its total forex reserves. Compare that to 66% in Italy, 69% in Germany, 70% in France, and 77% in the U.S., according to official numbers. So what's the big deal?

There will always be a threat that European Central Banks release gold supply on to the market. In fact, European central banks just renewed a five-year agreement (including the IMF) to sell down a maximum of 400 tonnes of gold per year from their holdings. They've agreed to this to disgorge their gold in an orderly fashion.

But it would not surprise us to see the Europeans fail to sell the gold they're allowed to sell under the agreement. Our old desk mate in London, Adrian Ash (now with Bullion Vault) is at the London Bullion Market Association's annual meeting in Edinburgh. Word from UBS analyst John Reade, also at the meeting, is that European Central Bank official Paul Mercier reckons that official holders of gold will, "no longer be net sellers of gold."

As we predicted earlier this year, the European central banks would rather hoard their gold than sell it in a rising market. There may be a price at which they do sell it, in order to pay down sovereign debts. But psychologically, the fact that central banks want to own gold and not sell it is pretty important.

Also, it shows you how the balance of economic power in the world has shifted East. True, the European banks can still dump gold on to the market to drown the price. But between the ETFs, central bank buyers in India and China, and the average man on the street in Beijing, Mumbai, and elsewhere, there are more buyers of gold now than sellers.

And if we were right yesterday that the GFC is slowly morphing into a sovereign debt crisis, then the case for gold is that much stronger. This explains why gold futures were up by nearly 3% overnight and old yeller hit a new high at US$1,084.90.

The only worry? So many hedge fund managers and pundits are singing the same tune: long gold and short U.S. Treasuries. As we mentioned yesterday, the bond bubble could go on much longer than anyone expects. And when so many people agree on something, none of them are usually right. As a contrarian, you'd be worried about becoming a victim right about now.

But yes, in the long term, the end of the Super Cycle in fiat money results in the remonetisation of gold. That is what you're seeing now. And it's probably what you'll see for a few more years. It also ought to benefit other precious metals, and of course, precious metals shares.

Dan Denning
for The Daily Reckoning Australia

• IMF Deems Gold An Idle Asset
• Gold: The Ultimate Unlevered Hard Asset
• IMF Gold to be Used
• Unlike China, India is Not Willing to Learn from its Mistakes
• Buying Gold, Gossip & Russia’s Tu-160 Bombers

"Why so high...so fast?" That was the question in our Daily Reckoning analyst meeting this morning.

"In the last big boom in gold - in the late '70s - gold followed inflation...and the central bank. Investors saw inflation increasing. And they saw the central bank failing to react fast enough. They bought gold to protect themselves.

"But now...there is no inflation. And central banks are alert to the problem. They haven't raised rates...but they don't need to. There's no need to protect against a problem that doesn't exist. So what are investors trying to protect against?"

No one at the table had a good answer.

"They're just looking ahead to when all that money the feds put in the system finally shows up in inflation. If you believe there's a real recovery you might think it is coming soon..." said one analyst.

"They're worried about a crash of the dollar...they're just buying gold because it's the anti-dollar..." said another.

"Maybe the Chinese are switching their reserves to gold...just like they said they would. And maybe instead of buying at below $1,000 they're buying quietly below $1,100..." offered another.

"Gold is being re-monetized," says MoneyWeek editor Simone Wapler. "All the world's paper monies are losing value - and credibility. There's a race to the bottom as they try to devalue their currencies."

All countries are fighting for market share. In a price-sensitive world, they increase exports by cutting prices. And the fastest - sometimes, the only - way to do that is by devaluing the currency. But when one nation devalues - say, by printing extra money - other nations must devalue too in order to stay competitive.

What can they all devalue against?

"Gold is rediscovering its old role," says Simone. "Once again, it is the way we preserve wealth and keep track of what things are worth."

Your editor had his say too.

"Most people are buying gold only because gold is going up. Maybe they realize that the world's financial system is in a period of crisis. They see the central banks are being derelict in their duty. Instead of protecting the value of their paper money the bankers are intentionally undermining it. They figure that if the central banks aren't doing their jobs - that is, if they aren't maintaining a reserve of real money - they'll have to do it themselves. Each person now needs to be his own central bank, with his own reserve of real wealth - gold.

"Or maybe investors don't see that all. Maybe they just see the price going up and they want to hitch a ride. What else can they buy that has been going up for the last 10 years? Gold is up $150 - about 17% - in the last 6 months. It's up 27% in the last year. It's up 300% since 1999."

Gold is in a bull market. How far it will go and how long it takes it to get where it is going, no one knows. No one knows, either, how many scrapes and setbacks it will suffer before it finally reaches its destination.

But it is a bull market. And you don't ask questions in a bull market. You get on board and ride it to the end.

Then, you wished you had asked some questions.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• We are Confident the Bull Market in Gold is Not Over
• A Bull Market in Gold and Gold Alone
• China is a Key Driving Force in the Gold Market
• Gold Falls for Four Straight Days but is the Low Price a Bad Thing?
• Price of Gold Today is About Where it Was 26 Years Ago

Here at The Daily Reckoning, this is not the first time we've paid homage to these lesser deities. Nor is it the first time we've mentioned their perverse method: Those whom these gods wouldst destroy are first cursed with good luck. Today, we look at the bright side: later, they are blessed by misfortune.

According to a pair of researchers from the University of Michigan, a depression does more for longevity than diet or exercise. Life expectancy during the worst years of the Great Depression increased from 57.1 years in 1929 to 63.3 years in 1933, says the report by Jose A. Tapia Granados and Ana Diez Roux. It didn't matter whether you were a man or a woman, black or white. And it didn't matter if you were in the US during the Great Depression or in Spain, Japan or Sweden during their economic downturns. The results were the same.

By contrast, life expectancy declined during the boom years. For most age groups, "mortality tended to peak during years of strong economic expansion (such as 1923, 1926, 1929 and 1936-1937)," they wrote in the "Proceedings of the National Academy of Sciences."

Conventional wisdom holds that recessions are times of stress. People do not eat as well. They skip medical check-ups. They should drop dead earlier. Instead, they live longer. Perhaps it is because the economy slows down, allowing people to live at a more comfortable pace. Maybe the unemployed get more sleep. We don't know. But if you want to live an extra six years, nothing works like a slump. When it comes to economic health too, nothing beats a depression.

Last week, World Bank president, Robert B. Zoelick, explained to Washington how the dollar made Americans wealthy:

"The United States is incredibly fortunate that the dollar enjoys this special status [as the world's reserve currency.]" It made it possible for Americans could buy things abroad with dollars and then, rather than come back to the United States as a claim against US assets, the dollars stayed in foreign central bank vaults. It was as if the Untied States, and the United States alone, could issue IOUs and never have to pay up. An "exorbitant privilege," Valery Giscard d'Estaing called it.

Since the end of WWII, the world had no real alternative. It had to use the dollar in its international transactions, just as it once used gold. This had a marvelous effect on world trade and roughly the same effect on America as a winning lottery ticket. And like a lottery winner, she was ruined by it.

With no effective limit on the number of IOUs they could issue, Americans issued far too many. From a low of around 2% of disposable income in 1945, US debt service rose to nearly 15% in 2007. In terms of total debt/GDP, the ratio was only about 150% in 1945, but that was with public debt from the war years at 120% of GDP. By 1950, the war debt had been cut down to about 70% of GDP, with private debt still at about 35%. At the height of the bubble years - 2005 to 2007 - total debt in America hit 360% of GDP, only 60% of it owed by the federal government.

Of course, most economists saw nothing to worry about. Instead, they set to work proving that such a 'dynamic' and 'flexible' economy would never fail.

They even won Nobel Prizes for elegant formulae that showed investors how to beat the market, year in and year out.

Then, the bottom fell out of asset prices in '07-'09. In March of this year, Americans found that their stocks had fallen back to real values not seen since 1968. Their houses were sinking fast too. By May 2009, one out of every four US homeowners was 'underwater' - with a mortgage greater than the value of his house. Incomes and profits were falling, along with the net worth of the typical American household. Everything was falling - except debt. How the gods must have roared when they saw the looks on their faces! In the biggest, longest boom of all time - even with a monopoly on the world's reserve currency - Americans had lost ground.

But while Americans were once damned by good fortune, they are now blessed by bad luck. "Looking forward, there will increasingly be other options to the dollar," says Mr. Zoelick. Thank the rascal gods. Americans are saving again...rebuilding their balance sheets...and, eventually, their economies. They can even look forward to living longer. And with a little more bad luck, maybe their moron economists will wise up too.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Contradiction in the Balance of Economic Forces
• The Greatness of a Depression is Commensurate to the Government’s Efforts to Prevent It
• Good Luck with Money
• RIP Robert S. McNamara and California’s Holes in its Budget
• The Solution to a Depression is a Depression

And on to today...Shouldn't this be an interesting week? "Markets have gone up too much, too soon, too fast," says Nouriel Roubini. The ASX 200 fell nearly 100 points on Friday, or 2.11%. This echoed the previous day's trading in New York.

Friday wasn't so bad on the Dow. But the jobs report released by the U.S. Department of Labor showed 263,000 lost jobs in America and an official unemployment rate of 9.8%.

That rate is undoubtedly much higher, once you figure in people who've given up looking for work but are no longer included in the survey. In fact, the "U-6" figure kept by the Department measures labour "underutilisation" in the economy. And according to that figure, U.S. unemployment is at 17%, nearly twice the figure quoted on Friday.

There have been jobless recoveries from recession before. But you still have to wonder how there can be such a big difference between the stark news in the job market and the behaviour of the stock market. True, economists will tell you that jobs are the last thing to recover from a recession. Businesses don't hire until they are sure everything is in the clear.

And we are often told that stocks lead the economy. The market has priced in a recovery which the labor market will confirm...eventually. At least that's the conventional wisdom. It's reassuring.

But the unconventional wisdom is probably more correct. The unconventional wisdom is that low interest rates (near zero in the U.S.) have driven people out of cash and forced them into higher-yielding and often speculative assets. The biggest obvious beneficiaries of low rates and credit facilities has been financial sector stocks themselves (and presumably their options-laden directors).

The question this week is whether there is any momentum left in that trade. Can easy central bank policies keep stocks going higher? Or has the trade exhausted itself? And if it has, what happens next?

Well, one answer is that you may again see a mini-rally in the U.S. dollar and a fall in common stocks and commodities (oil and gold especially). We'd expect this to a cyclical dollar rally. In the bigger picture (a secular trend) the dollar is toast. But markets do not move in linear fashion. They give and they take. And the dollar may be due.

If we do get a greenback rally, this may pave the way for a higher Aussie gold price. The strength of the Aussie dollar has capped the gold price here in Australia. But we reckon you may get a nice move in the Aussie gold price if the greenback rallies. The question is whether U.S. dollar strength takes gold down too, neutralising the benefit of the weaker Aussie.

How do you sort out the relationship between two currencies, one commodity, and many stocks? It all sounds complicated. That's why we've added another mind to the trading desk here at Daily Reckoning Australia headquarters on Fitzroy Street. Murray Dawes is at the helm of the trading desk today. We'll keep you posted on what he has to say.

One question we'll have for him: what the heck should investors do with Woodside Petroleum (ASX:WPL)? Dow Jones newswires is reporting that over the weekend, Federal Resources and Energy Minister Martin Ferguson awarded permits to explore ten new off-shore oil and gas blocks in the Carnarvon Basin off the Northwest coast of Australia.

Woodside is one of the firms that won a permit. Ferguson said that, "The additional investment in Australia's offshore petroleum exploration sector not only offers exciting potential for petroleum discovery but will ultimately help to further develop our petroleum resource and underpin our security of energy supply,"

The security of Australia's energy supply is exactly the issue our special situations analyst Mike Graham took up in his research about Australia's oil industry. You can find that complete report here. The findings may surprise you.

With respect to Woodside, there are not too many better blue-chip energy stocks in Australia. Unlike the smaller explorers though, the blue chips are valued differently. Adding to their reserves is crucial, so that the company is not inexorably depleting its assets. But the energy blue chips like Woodside are well known by analysts and they are well-traded by institutions.

This, in our mind, makes Woodside a perfect candidate for a Slipstream trade. That is, if we were a full time trader, we'd be looking for a pattern in the stock chart to see where key levels of support and resistance were. But since we don't run the trading desk, we'll ask Murray and see what he says.

Today's thought of the day from John Robb at Global Guerrillas, "The American 'kleptocracy' has run out of steam due to too much debt and is already in the midst of a perpetual depression. Why? The US middle class -- faithful to the cult religion of free markets even while being taken for all they are worth via a 35 year process of substituting debt accumulation for income gains -- is financially broken. If this is even remotely true: is the US headed for Privatopia and the viral spread of Global Guerrillas?"

Substitute "Australia" for "America" and it makes just as much sense, doesn't it?

Dan Denning
for The Daily Reckoning Australia

• Looking at WPL and Oil Side by Side
• Apparently More Debt is Now Acceptable in Australia
• Commodities Tell Us the World Won’t Stop Turning in a Financial Crisis
• Oil Prices Under $70
• The Future of the Australian Resource Market, Two Ways the Boom Could End

"We may now be entering the Asian century, dominated by a rising China and its currency. This decline of the dollar might take more than a decade, but it could happen even sooner if we do not get our financial house in order. The United States must rein in spending and borrowing, and pursue growth that is not based on asset and credit bubbles. For the last two decades America has been spending more than its income, increasing its foreign liabilities and amassing debts that have become unsustainable."

Yes, it could take more than a decade. But investors could take a big loss any day. All it would take would be a sudden move by China...or a shocking inflation figure in the United States...or a Treasury bond auction that doesn't go as planned. Everyone is watching the United States...carefully. And foreigners hold trillions' worth of dollar- based assets outside the United States. These are dollars that people hold, not to pay their bills or buy gasoline, but as a speculation. They're speculating the greenback will hold its value as well or better than the other things they might do with their money.

Europeans hedge their bets against the euro - with dollars. Asians hedge their bets against falling stock prices. Russians hedge their bets against the ruble. Latin Americans hedge their bets against their own pesos, bolivars, and cordobas. Everybody likes dollars because they are the most trusted money in the world. For the last 50 years, nothing could compete with the dollar. (Even though the dollar lost value against a number of other currencies over long periods of time.)

These foreign holders are already nervous. They've seen the mess the United States has gotten itself into. They read the headlines. They watch the news. They know that the United States is running a budget deficit this year equal to four times the biggest budget deficit ever - a record set just last year. It is as if a runner broke the record in the 100-yard dash...and then ran the course four times faster a year later. This is not progress. This is spooky.

The Chinese already let the United States know they are worried.

"We trust you to protect the value of our assets," they in essence said to the US Treasury Secretary.

And in the middle of May 2009, from the Financial Times comes news that Brazil and China are working toward using their own currencies in trade transactions rather than the US dollar.

This comes on the heels of the news that China's central bank governor Zhou Xiaochuan proposed to create a reserve currency "that is disconnected from individual nations."

What Mr. Zhou would like is to replace the US dollar as the world's leading currency with a new international reserve currency, possibly in the form of special drawing rights (SDRs), a unit of account used by the International Monetary Fund.

Then in June, Russian President Dmitry Medvedev questioned the US dollar's future as a global reserve currency and said using a mix of regional currencies would make the world economy more stable. Russia may consider ruble-yuan swaps.

The dollar "is not in a spectacular position, let's be frank, and its prospects cause various questions as do the prospects for the global currency system, " Medvedev said in an interview published by the Moscow-based Kommersant newspaper. Regarding the global financial system, "therefore our task is to make it more mobile and at the same time more balanced."

But for now, as long as these countries trust the United States to keep its promises and protect its money, they continue to hold US dollar investments - notably, US Treasury bonds. But just wait until the United States loses their trust. In a matter of minutes, China could dump enough US dollars to set off alarms all over the world. All of a sudden, dollar holders would rush for the exits - each one trying to get out before the others. In minutes, the dollar market could collapse...taking down US Treasury bonds with it.

Regards,

Bill Bonner and Addison Wiggin
for The Daily Reckoning Australia

• The Greenback Dollar Decline
• US Dollar As Reserve Currency Not Working Very Well
• US Dollar a Sort of Monetary Brand
• 4 Ways to Protect Against a Falling Dollar
• Special Drawing Rights Used as the World’s Reserve Currency?

First, we hope you bought gold many years ago. That would make it simpler. Then, we could say: hold! Gold is an antidote to paper. There is so much paper...and so much more apparently on the way...that the gold play seems like a winner. It's a bet that the money system that has been around since August '71 is going to fall apart.

We still think that is a good bet. Our Trade of the Decade remains. Buy gold on dips; sell stocks on rallies. We've done well with this trade; we'll stick with it a bit longer.

But what if you don't own gold? The yellow stuff is now over $1,000. In fact, it looks like $1,000 could be a new support level for the metal - with most of the support coming from the Chinese. China has relatively little gold in its central bank. It must see what we see - the weakness of the dollar and of the dollar-reserve monetary system. It must worry about the value of the $2 trillion or so it has in dollars. It must also wonder how it is going to run its economy if the dollar falls apart. American buyers were its consumers of first and last resort. To whom will China sell if its most important customers' money becomes worthless?

Recent comments by a group of Chinese officials make it clear that they are thinking of these things...and that they have decided to add more gold to their reserves. In fact, all the central banks have become net buyers. No more selling off gold reserves. That is seen as a mug's game - which it is. Replacing gold with paper? C'mon, what were they thinking?

So China is a buyer. Trouble is, it has to be a discreet buyer. It has too much money. It could cause the price to skyrocket overnight. Then, it would be paying too much. So, perhaps it does what we do - China buys on dips! For example, the order may have gone out: buy gold whenever the price goes below $1,000.

We don't know what their buying strategy is...but the Chinese are probably going to be big buyers over the next few years.

Should you buy along with the Chinese? Should you compete with the Chinese for each ounce of gold that comes on the market?

Good question. Unfortunately, we don't have a good answer. So let's try a different question: Is gold going up or down?

The answer to that is simpler: gold is going up...then down...then up again. It is going up because the feds - including the feds in China - are encouraging speculation. Then, it is going down when the next phase of the bear market reasserts itself and the speculators run for cover. Then, it is going back up...much farther and faster...when the Fed becomes desperate and finally throw caution - and dollars - to the wind. We're confident this last stage will arrive. Our hesitation is that it will take much longer than we expect. Gold may rise in a deflation...but it soars in a period of inflation. That period could be a long way off.

The feds can't revive the consumer economy. Despite all you read...the consumer economy is probably going to limp along for many years. No boom in consumer spending = no inflation.

"US retail sales surge as economy strengthens," announces a Reuters' headline. Don't believe it. Between the seasonal adjustments and the feds' giveaways the retail sales numbers are meaningless. The real story is that there is little - or no - real organic improvement in the economy. The largest banks that get federal bailout money, for example, have actually reduced their lending for 6 months in a row.

But the feds can stimulate speculation. The dollar has become the 'carry trade' currency. The big players borrow in dollars...and use the money to speculate - against the dollar! They buy gold. They buy Brazilian bonds. They buy aluminum futures. They buy stocks.

The Dow rose 108 points yesterday. Oil rose over $72. Almost all commodities are up - except natural gas.

The post-crash party seems to be going well. It may continue. But the underlying problems of the real economy have not been corrected. They will rise up like zombies in a bad horror movie and bring the party to a close. Absent support from the Chinese, the price of gold will probably go down along with everything else. Which brings us back to the question we dodged.

"Dad, I made $2,000 just in the last couple of days...on that gold play I got in. But I'm nervous...should I sell it?"

Jules has graduated from college. He's investing his meager savings, trying to put together a big enough stake so he can take a year off from work and concentrate on his career as a composer and performer.

"Jules...I don't know," began the answer. "But you're a young guy. You can afford to speculate. If it goes your way, you make money. If it goes against you, you learn something...and you have plenty of time to recover.

"It looks to us as though this party is going to continue for a while. If I were you...I'd stick with it a while longer."

Our advice to a man of 21 is not the same as our advice to a man of 60. The older man would get older advice:

"Gamble not thy whole wealth on the gold market," we would say.

The older man needs gold. But he needs it as insurance...as a reserve against catastrophe...as a form of savings. The Fed has been negligent and derelict. It is not protecting America's money and Americans' wealth. The average fellow has to do it himself. He has to have reserves of his own...reserves of real money - gold.

He should buy. He should hold. He should buy the dips. But he should not speculate on higher prices...nor risk his wealth gambling in the gold market. Most likely, after this speculative boomlet, the price of gold will go down. How much? How far? For how long? Of course, we don't know the answer to those questions.

We're not buying now. But we already have our position in gold. We will add more - on the next big dip.

Bill Bonner
for The Daily Reckoning Australia

• China is a Key Driving Force in the Gold Market
• Bankers Take Money From the Government and Use it to Speculate
• Gold Doesn’t Always Need Inflation to Rise
• Chinese Yuan Marches Towards World Domination
• India Beats China to Walk Away With 200 Tonnes of IMF Gold

Probably most incredible is that the dollar has NOT collapsed. It has lost ground, and was trading at $1.43 per euro on Friday, but no one laughs at you when go to exchange dollars...or offer to pay in dollars rather than the local currency.

For the last 10 years, the money supply in the United States has expanded at roughly twice the rate of GDP growth. And the Fed doubled its balance sheet in just the last 18 months. This last bit of information is stunning. It took the central bank nearly 100 years to build a balance sheet of $1 trillion. Then, under the leadership of Ben Bernanke, it added another $1 trillion in just a few months.

What does that mean, exactly? It means they bought a lot of debt from US agencies and the financial sector. It means also that they "monetized" this debt...transforming it into cash by paying for it with money especially created for that purpose. It also means that the whole financial sector has a bigger financial base against which to lend. The Fed lends against its balance sheet to member banks. These banks then lend to other banks who lend to business and consumers. So the amount of potential credit - as well as the amount of actual cash - has gone up.

There is an iron law in economics. Quality and quantity vary inversely...which is another way of saying that when you add more of something...each unit is worth less than the unit that preceded it (assuming everything else remained unchanged.) Certainly, this is true of money. The more money in a financial system, the less each unit of it is worth. Add enough new money - as Zimbabwe proved recently - and each unit becomes worthless.

But so far, the dollar has not collapsed. It has fallen, but gently...

Meanwhile, the inflation rate has NOT gone up. Instead, it's gone down. Go figure. You add that much monetary inflation and you'd expect to get a boost in the CPI. Nope. Not yet.

On the other hand, we're already a year-and-a-half into a major recession/depression. You'd think you'd get deflation. That hasn't happened either. Prices are down. But not as much as you'd expect, given the scale of the downturn.

Related to both the dollar and inflation is the bond market. Even more surprising is that the bond market has NOT fallen apart. Let's see, a huge input of monetary inflation; that ought to kill the bond market. Then too, the biggest sales of Treasury bonds in history - needed to cover a $1.7 trillion deficit this year. That ought to kill the bond market too. And on top of it all is a projection from the White House telling us that the feds will add $9 trillion to US debt over the next 10 years. And that assumes a full recovery in the economy! Now, that ought to kill the bond market for sure.

Not at all! Bond yields have risen...but the 10-year T-note still only gives you 3.4%.

Of course, you say, it's a depression. Bond yields always go down in a depression.

But if it's a depression, how come commodities are up? And stocks are up? Above all, how come Chinese stocks are up? Everybody knows China earns its money selling products to Americans and other non-Chinese. If the rest of the world is in a depression, who is China going to sell to? How come China isn't in a depression already? But there you are - there's another thing that hasn't happened. Chinese stocks haven't collapsed.

And getting back to commodities, they're all up. Commodity prices don't go up in a depression; everybody knows that. They go down. But commodities are NOT in a bear market. Go figure.

And, of course, there's gold. The metal gave up a dollar on Friday, but it's still just $4 short of the $1,000 mark...and just a shadow below its all-time high. Gold is a commodity...but it's also money in its purest, more reliable form. Commodities go down in a depression. Money goes up. But since gold is an alternative to paper money, it tends to go up only when paper money goes down. As explained above, the dollar has NOT collapsed. So why is gold going up? It should be going down, reflecting the effect of a recession...

There are two possible answers.

First, maybe the iron laws of economics have been repealed.

Or, second...maybe the iron laws just haven't caught up to the market - yet.

Unemployment is at 9.7%. It will probably rise above 10% this month. The economy is supposed to be recovering. Now, The New York Times is talking about a "jobless recovery."

You'll remember the phrase. It came out in 2003. Then, the economy was allegedly recovering from a micro-recession. Economists were surprised that there were so few new jobs created.

What was really happening was that there was no genuine recovery. Consumers just decided to go deeper and deeper into debt - egged on by the feds. A regional governor of the Fed actually urged consumers to "go out and buy an SUV." So Americans bought more products from the Chinese...on credit...and the Chinese enjoyed a boom.

And now the boom is over. Americans are paying down their debt. And unemployment is getting worse. This time the feds are pumping trillions into the system. This time, it's not the consumer who is willing to go further into debt; it's the government. And once again, few new jobs are being created.

Without jobs, the recovery is an impostor...a phony...a fraud. Without jobs, people have no extra spending power. So they can't buy - except by going deeper into debt. They were willing to go further into debt in '03-'07. But not this time. They've reached their limit on debt. Besides, with house prices falling, who would lend to them?

No new jobs = no new income. No new income = no new sales. No new sales = no new profits = no new jobs.

But what about the government? The feds are still willing to borrow. How come federal borrowing can't create a new boom - even if it is a phony one - like the one in 2003-2007?

Federal borrowing, spending, bailouts and monetary inflation are not helping the real economy. But they are making a lot of money available for speculation. That's why so many things are NOT happening. Investors are speculating on commodities, gold and Chinese stocks - for example. And US bonds.

But this is not a durable, reliable trend. And it's not laying the foundation for a genuine recovery. Borrowing by the feds is different from borrowing by individuals. Private households can go broke. But they can't take the dollar down with them. When the feds borrow, they pledge the full faith and credit of the United States - and its currency - as security. So, as they borrow more...the value of the US currency comes into doubt...then, into play...and then into jeopardy.

Investors eventually sell off dollars and US bonds...then, what should happen finally does.

Caution: what has to happen does eventually happen. But it doesn't have to happen when you think it should. The big surprise might be how long it takes before these things happen. If we were Mr. Market, for example, we probably would not take gold much higher - not just yet. We'd let deflation take gold down for a while - long enough to separate the speculators from their money. Then, we'd let investors get used to falling prices - before bringing inflation back.

Bill Bonner
for The Daily Reckoning Australia

• Where, Exactly, is this Economy Headed?
• Geithner Reassures China that America Takes Financial Obligations Seriously
• Gold Doesn’t Always Need Inflation to Rise
• Fed Will “Monetize the Debt”
• We Expect No Recovery from the Economy

This week, Ben Bernanke got the nod for another stint as head of the world's most important central bank. Yes, he completely misunderstood the implications of the hugely negative US trade balance, believing that America did the world a favor by spending its "global saving glut." And, yes, he missed the approach of the biggest financial disaster in three generations. Then, when it arrived, he mistook it for a routine recession, until finally, panicked by the collapse of Lehman Bros., he insisted that Congress pass a $750 billion spending bill - or "we may not have an economy on Monday."

But except for things that really matter, he's been a pretty good Fed chief. Besides, he has the right credentials. He was a professor of economics at Princeton and holds a Ph.D. from MIT - just like the most recent Nobel Prize winner in economics, Paul Krugman.

The United States has just averted the Second Great Depression, say the papers. "What saved us?" asks Krugman in a recent New York Times editorial. "Big government," is his answer. Specifically, the big government of Ben Bernanke.

But the ghost of Milton Friedman haunts the central bank. Bernanke borrowed a phrase from Friedman, saying he'd even "drop money from helicopters,' if necessary, to prevent deflation. This led to one of the surest trades of the Bubble Era was the so-called on the 'Bernanke Put.' Investors thought they could count on him. Buy stocks. If they went down, Ben Bernanke would make sure you didn't lose. He'd add liquidity until the market bounced back. But the Bernanke Put trade went bad in '07. The market fell. Ben Bernanke added liquidity. But so far, stocks have yet to regain 50% of what they lost. Meanwhile, consumer prices are falling. And yet, he does not drop money from helicopters. Why not?

Few people would have more authority on the subject than the group gathered at the Beverly Hilton in Los Angeles earlier this year. Michael Milken, the Junk Bond King, gathered them thither and picked up the tab for Gary Becker, Myron Scholes, and Roger Myerson...each of their names is preceded by 'Nobel Prize winner.' With that kind of brainpower on hand, you'd think you could come up with a good explanation. But the best they could do was a simple analogy. Gary Becker (Nobel awarded '92) took the Friedman line; he argued that by putting out the little forest fires, the recessions of the '90s and the early '00s, the feds inadvertently created the conditions for an even greater conflagration. Instead of burning off the underbrush, the tinder built up until a huge blaze was inevitable. And in a speech honoring Friedman, Bernanke accepted Friedman's criticism of the Fed in the '30s. Yes, Bernanke admitted, the Fed made mistakes; but we won't do it again, he said. The burden of today's rumination is that he was wrong; he will do it again.

"Inflation is always and everywhere a monetary phenomenon," said Friedman. But deflation doesn't seem to be a monetary phenomenon at all. Despite huge inputs of new money from the Fed, prices are still going down. The Fed's balance sheet more than doubled in the last 18 months. It will probably double again - to $4 trillion - before Bernanke's next term is over.

Friedman won a Nobel Prize for his work. And he drew around him a community of scholars that won so many Nobel Prizes they ran out of room in the University of Chicago trophy cabinet. But it only makes you wonder about the Nobel committee. Friedman's acolytes won their prizes for elaborating a series of mathematical proofs for things that were either self-evident or self-evidently absurd. Most of them were later shown to be wrong, irrelevant or misleading. Modern Portfolio Theory, Black-Scholes Option Pricing Model, Dynamic Hedging - the farther afield the scholars went, the more they lost touch with home. The more scientific their work became, the more it resembled alchemy or phrenology.

Friedman's work itself was flawed in the same way. The general principle was correct - that the government that governs the markets least governs best. But when he got into the mechanics of 'monetarism,' he got lost. He believed that if the Fed kept its eye on the money supply; the free market would take care of everything else. But the free market didn't take of everything, at least not as people hoped. Economist Murray Rothbard explained why in 1971. You cannot expect the free market to function perfectly if you leave in the hands of the government the power to control money. Either markets are free or they aren't, was Rothbard's point. If they're not free, you can't blame freedom when they fail.

But free market economists are now blamed for everything. The free- market Chicago boys are out. The MIT crowd is in. And investors are buying the Bernanke Put again, confident that the Fed chief will keep pushing money into the system and stocks will continue rising. But Ben Bernanke, for all his bluster, is a victim of the trade. Everyone knows what he is up to. They can't help but look ahead and see where it leads.

As soon as Bernanke starts his helicopter engines, bond buyers get out their missiles; the Chinese - the biggest single customer for US debt - have warned that they will shoot him down. What can Bernanke do? He is damned if he doesn't. But even more damned if he does. He can't guarantee increases in either CPI or stocks. All he guarantees is that Big Government will play a larger role in the economy...and that Milton Friedman's history of the Great Depression will turn out to be prophecy:

"The Fed was largely responsible for converting what might have been a garden-variety recession... into a major catastrophe..."

Ultimately, Bernanke does what his predecessors at the Fed did in the '30s...and what the Japanese did in the '90s. He hesitates. He makes mistakes.

And he wonders why he took the damned job in the first place.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Ben Bernanke Pays Homage to Milton Friedman’s Theory
• Barack Obama and His Nobel Peace Prize
• Krugman Warns That the Run-up in Stocks Can’t Be Justified By the Fundamentals
• Keynesians Believe Governments Have to Manage Economy in Macro-Economic Way
• Ben Bernanke Averts a Second Great Depression

IT'S NOT OFTEN that Sweden gets to lead the world. Saab mimicked BMW. Ericsson improved on Motorola. Abba took The Carpenters and added a hi-hat.

In monetary matters, however, Sweden remains an occasional trail-blazer. The world's first central bank, beating even the Bank of England by 26 years, the Riksbank then copied the Old Lady by when it abandoned the Gold Standard in September 1931. But the Swedes chose to mimic Great Britain before anyone else, quitting the metal within two weeks of London's monetary bomb-blast.

That's why, according to academic consensus, Sweden recovered from the Great Depression before anyone else. (A more likely cause, we guess here at BullionVault, was the resulting 30% drop in the Krona, but economists hate publicly backing competitive devaluation today.) And Sweden really did break new ground in the Thirties by making an explicit rate of inflation its target - six decades before New Zealand, the UK, Eurozone and US caught up.

Inflation targeting wasn't the first or last time the Riksbank got ahead of its colleagues. But it did prove the least disastrous to date.

"A charge was drawn up against Goertz, who was accused of speculation, of having ruined public credit by imaginary money, of having formed a design to destroy the king..."

Thus relates a 19th century history of the first central banker ever to lose his head to an axe, rather than merely losing his head to some new tom-fool theory. Baron George Heinrich de Goertz, a successful minister in the early 18th century, was dumped into the Riksbank to fix more than 100 years of monetary madness.

Sadly for Goertz, his madness served to cap the whole show.

"He minted a representative currency in copper, validated with the king's head and a legal tender face value of a Daler," wrote Paul Tustain, director of BullionVault, on his popular Galmarley gold site back in 2004. "Goertz did not limit the issue, nor ensure the quality of the coins, which were beneath the technical capabilities of the day. Moreover, he attempted this exercise on behalf of an administration which had lost virtually all financial credit with its population, and compounded the error by allowing to develop a widely-held belief that at some unspecified time in the future, collectors would refuse the coins as legal tender payment of taxes.

"In other words he broke every rule in the central banker's book. The coins were detested, and sloshed around the Swedish economy depreciating rapidly"

Poor Goertz! His scheme collapsed with the death of his King and protector, Charles XII, in 1718. The new monarch - Charles' sister, Ulrica Elenora - abolished Goertz' paper money, and had his copper coins re-minted at something approaching their true commodity-price value. Forced to a show trial and denied counsel in court, he tried but failed to defend himself against execution, beheaded in front of a cheering crowd on 3rd March, 1719.

Just like today (as we'll see in a moment), such monetary madness was hardly unique at the time. Destroying public credit with imaginary money was also ruining both England and France, where John Blunt's South Sea Bubble and John Law's Mississippi Bubble would explode in due course in 1720. But just like 2009, the Riksbank was only just ahead of the game. Because the success of its thinking still clearly impresses today.

"The UK should follow the Swedish model," said ex-Bank of England policy-maker Charles Goodhart at a forum last week, "so that for commercial banks reserves held at the central bank of above, say 2%, they are charged 0.5% to hold their balances.

"This would then encourage the banks to buy short-dated gilts or commercial paper, increasing liquidity."

Simple, right? It's now six weeks since Sweden's central-bank governor, Lars Svensson - a great pal of Ben Bernanke's at Princeton - "broke the zero bound" on monetary policy. Yet the world still turns on its axis, despite the Riksbank knocking the interest paid to its commercial-bank users down below nothing, into a brave new world of negative rates.

Cash-hoarding in London is also more weighty at £161 billion ($264bn) than Sweden's own stock - now down 19% from SEK 48 million ($6.7m) just before the fateful decision. And like the US Fed's hoard of commercial bank cash, which rose 40 times over in 2008, the consensus view is that unused bank money is "socially useless" to quote another former Old Lady, Willem Buiter of the Financial Times.

But there's way more at stake, we fear, if the US and UK choose to buck history and now follow the Swedes. Starting with the outright monetization of their government debt.

"There have been suggestions that the Bank of England could introduce negative interest rates on deposits to encourage the commercial banks to lend as the Swedes have done," says one London analyst, RBC Capital's Russell Jones.

"This could also encourage banks to buy more short-term gilts."

As it was at the start of this month, the latest Bank of England policy-vote shocked the currency and bond markets by unleashing a fresh £50 billion of imaginary money for use in its Quantitative Easing. Analysts, investors and savers already fear it's simply funding state debt, passing the new cash straight to the government and walking us all straight to hyper-inflation. Yet today's release of the policy-team's minutes, however, showed the governor - one-time inflation hawk Mervyn King - actually voting for a still-greater injection of money from nowhere, hiking the Bank's total money creation to £200 billion.

That would been equal to half the entire government gilt market, and greater than this year's entire UK state deficit - currently forecast at £175bn, precisely where the Bank of England capped its money creation for now. Still deflation looms, Dr.King said this week, and still the Pound rises...back above $1.65 to the Dollar today.

If this central banker's scheme works, and he keeps his head until, say, the end of this year, how might the US Fed or ECB answer? On both sides of the Atlantic, and all across Europe we guess, expect more "imaginary money" - with or without negative bank rates - often and soon.

Adrian Ash
for The Daily Reckoning Australia

• Gold Coins for $870-$890 An Ounce
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• A Gold Standard, Without Gold
• Bank’s Inflation Projections Will Not Return to the 2 Per Cent Target Figure Until Early 2010
• Negative Equity Becoming the Norm in U.S.A.