Consumers spent a little more than was expected of them. And manufacturing did a little better than expected too.

On the other hand, the federal government's tax receipts plunged in the month of February...and bank lending is still contracting. Last week it shrank $33 billion - the 7th week in a row it has contracted.

How does an economy expand when the banks are lending less money? Beats us.

We believe the "expansion" reported in the GDP figures is mostly counterfeit. It's government spending and hot money filtering into the economy. Still, it's amazing that the GDP figures are positive.

The Dow was flat yesterday. The euro rose a little - on expectations of a settlement of the Greek affair. Greece only had a month to sort out its problems. That was two weeks ago. The "clock is ticking," say news reports. Most likely, the Hellenes can't really sort their problems out on their own. Greece will need some sort of bailout - even if it is limited and tentative - from Germany. Stay tuned.

It will be interesting to see what happens when Britain runs into trouble financing its deficits. It won't have the Germans to help. Britain never took up the euro. It will be on its own.

But the big news from yesterday was the $19 boost in gold. Why did gold suddenly shoot up?

We don't know. But our guess is that gold will suddenly shoot up a lot more. We're in a deflationary period. That means everything is going down in price. But against what? Well, against money. Against real money that is - gold.

So gold should continue to go up until this deflationary period is over. That doesn't mean there won't be more hiccups and reverses in the gold bull market. But one of the surest trends of our time is the crack-up of the paper money system. And that is bound be good for gold.

Chris Wood of CSLA says he gives the dollar standard 5 more years. Maybe it will be a bit more...maybe a bit less. But one thing is sure. Governments cannot continue to run such huge deficits forever. There will come a day of reckoning...

The feds are hoping it comes at a time and place of their own choosing. They all want to ease their way out of their troubles...with the help of consumer price inflation. You heard central bankers talking last week about increasing the inflation target from 2% to 4%. If they can actually control inflation so precisely, it will be a miracle. But that is what they hope to do.

A few years of 4% inflation would do wonders. In ten years, they would have cut a third of the national debt - in real terms, of course (supposing that they don't add to it even faster). Not only that, the debts of the private sector would be eased too. At 6%...debts would be cut in half in a decade. With half the debt burden - the private sector might be ready to begin a new period of growth. That is the feds' real strategy...to de-leverage the private sector enough that it can grow...and increase tax receipts.

By the way, that was what happened in the Reagan administration. The inflation of the '70s forced up interest rates and caused the worst recession since the Great Depression. But it also lightened debt loads - so much that the economy was ready for another big growth spurt.

This growth really paid off in the '90s...and the very early years of the Bush junior administration. Thanks to growing tax revenues, both Clinton and Bush were able to pay down the huge debts of the Reagan years...and still increase spending. The economy was able to "grow its way" out of debt.

Then, with the war on terror and the micro-recession of 2001, the budget magic of the '90s was lost. Bush apparently never met a spending bill that he didn't like. Spending exploded...especially time bomb spending for health care, which increases automatically year after year.

Then came the depression...known popularly as the Great Recession of 2007-2009. Tax revenues fell. Spending increased even more. And now the deficits come hard and fast. And there seems to be no way to "grow our way out" of them. All of the conditions that made for a boom in the early '80s are making for a bust in the early 2010s. Interest rates are at record lows, not record highs. Stocks are high, not low. Bonds are high, not low. The government is the solution, not the problem.

Bill Bonner
for The Daily Reckoning Australia

• Have the Feds Given the Economy a Miracle Drug?
• Japan and its Economy Did Not Have Secret to Everlasting Success
• The Fallacy of the Fallacy of Composition
• Government Pretending Debt-fueled Spending is the Same as Growth
• China Reduces Holdings of Treasury Securities

The Dow rose 91 points yesterday. Gold fell $6.

Officially, the crisis is over. Everyone says so. Central bankers and Treasury officials have been congratulating themselves. It's been a year now since the end of the world didn't happen. These fellows take credit for it.

Bernanke said yesterday that he'll keep the monetary spigots wide open for a while longer...but that's just because the recovery is fragile. He also talks of an 'exit' from stimulus programs, now that the economy is getting back on its feet.

Claptrap! Balderdash! Flimflam!

The mainstream economics profession is guilty of dereliction of duty. They should be telling people that this 'recovery' is a scam. They should be warning investors that the markets could fall apart any day. They should be buying gold and selling US Treasuries...and explaining to the politicians that you can't buy your way out of a depression with phony dollars squandered on wasteful projects!

Instead, the dopes are patting each other on the back...praising themselves for saving the planet from destruction.

But what really has gone on? And what's going on now?

Glad you asked.

First, there is a real economic phenomenon going on - the depression. It's alive and well...and doing just fine. Households are de-leveraging. Businesses are building up cash. People are losing their jobs. Savings rates are edging up.

Almost everything is happening as it should.

Depressions are times of falling prices. Markets are always discovering what things are worth. In a depression, they find that assets - stocks and real estate primarily - are not worth nearly as much as people thought.

That's why we have our 'crash alert' flag still flying. Prices are vulnerable to sharp, unannounced drops until they finally get down to real depression levels. Since that hasn't quite happened yet...we figure it's still to come.

On the employment front, this depression has put more than 6 million people out of work. And every month, more people join the unemployment ranks. So far, so good. The US economy didn't need so many marble countertop installers and so many mortgage refinancers. (If only something could be done to get rid of lobbyists!)

But the worst thing about a depression is that it holds jobless people prisoner for so long. Many of them will become lifers...they'll never work again.

In that regard, this depression is similar to Japan's 20-year depression, 1990-2010. After the bubble burst, the Japanese...who were aging faster than any race ever had...figured they needed to get serious about saving money. So, they cut back on spending...and saved. Domestic spending collapsed. Fortunately, the rest of the world - especially Americans - were still spending their fool heads off. And Japan is an export-led economy. Even so, with its own consumers dragging their feet, the Japanese economy didn't go very far or very fast.

The Japanese put their vast savings, directly or indirectly, into Japanese government bonds...helping the government fund its massive stimulus programs. Of course, the stimulus programs were a waste of money. The economy never really recovered...and now the government is expected to have gross debt equal to 200% of GDP next year, according to the IMF.

For reference, the US is expected to reach 100% of GDP next year. Britain is hard on America's heels with debt at 94% of GDP.

And now Americans are entering retirement savings mode too. The biggest age cohort - the boomers - need to do some fast saving in order to finance their retirements. They're cutting back...not just temporarily...but permanently. They will never, ever again spend money like this did during the big bubble years 2003-2007. That's what makes for a durable depression...

Another thing that makes for a depression is a lack of lending. Bank credit is still falling. Households cut back because they need to get out of debt...and save money for retirement. Businesses cut back too. New projects typically don't do well in a depression. Small businesses struggle...and fail. Big businesses get bailouts and subsidies. Depressions are times to neither a borrower nor a lender be.

Debt is only increasing at the government level. But that's another story for another day...

Regards,

Bill Bonner
for The Daily Reckoning Australia

• Japanese Government Displays Generosity as Prices Fall in Japan
• Japan and its Economy Did Not Have Secret to Everlasting Success
• How Will the United States Finance the Biggest Deficit of All Time?
• The Solution to a Depression is a Depression
• Consumer Spending Rises

The S&P 500 fell by over three percent and the Dow Jones by 268 points and two percent (nearly closing below 10,000). Gold was off $45, or just over four percent. And oil was off by nearly $4, or over five percent. We'll get to what you should do about all that in a moment.

But first, take a look at that chart below if you believe the past is prologue. The chart shows how impressive and fast the rally was in the U.S. dollar from a level of 72 on the dollar index to a high just below 90 in late 2008 and early 2009.

During the dollar's rally, stocks and commodities fell. Yet once low interest rates and government stimuli found their way into stock markets, leveraged traders again bet on equities and higher-yielding risk assets around the global. The dollar fell and the stock market rally got pretty carried away with itself (mostly on the flimsy idea that the global economy had been rebalanced and was recovering, which was palpably not true).

The chart can't tell us what will happen next. This time around, we wouldn't expect the dollar rally to go as high or last as long. We don't think the monetary authorities would be inclined to let a deleveraging positive feedback loop set in again (which indirectly explained the dollar's ferocious rally last time). That is, the powers that be don't want to see falling asset values trigger forced liquidations by leveraged players, leading to more asset sales and further liquidations in property, commodities, and equities.

Now just because Ben Bernanke and the global cabal of counterfeiters don't want something to happen doesn't mean it won't happen anyway. The deflating of the reflated asset bubble is going to happen sooner or later. The world's massive inverse pyramid of debt is supported by a very small asset base. When the underlying assets (often commercial and residential real estate fall) the whole structure becomes unstable (this is what happened in 2008).

That means that this time around, you wouldn't expect the monetary authorities to let liquidity to dry up again. Granted, the fundamental issue is the soundness of bank collateral (and that has not improved much). But if central bankers and policy makers have been publicly worried about inflation in the last few months, you can forget about that now.

A ten percent fall in stock prices (though probably overdue) is just the thing to get policy makers in an accommodative mood again. The U.S. employment figures still suck. And markets are increasingly confused and worried about whether certain sovereign nation states (like Greece and Portugal) can finance their deficits and/or reduce public spending without increasing civil unrest.

Mind you, we don't think more money, credit, or liquidity is the answer. It is, in fact, the problem. The modern world economy is built on a foundation of unsound money. We may all be surprised at how just abnormal everyday economic life gets when the artificial life support of easy money is either withdrawn or simply ceases to be effective.

The young man above, who's keeping vigil outside the RBA in Sydney, would probably agree with us. His brother sent us the picture and this note, "My younger brother has been protesting outside the RBA every second Friday morning for the last three months. After discovering Austrian economics about three years ago Seb and I have been compelled to speak out against central planning through central banking. I have attached a couple of photos above of his mornings outside the RBA. As you can see it's a lonely battle and would appreciate all the help we can get."

Keep hope alive brother!

If you're not familiar with Austrian economics, don't worry. There's actually a small introduction to the subject we wrote last year that we're happy to send you if you're interested. Just send us a note to dr@dailyreckoning.com.au with "Austrian Economics" in the subject line.

The basic idea, when you strip away all the big words, is that the entire free market system is distorted/perverted/corrupted by the fact there's no free market for money. The interest rate is essentially the price of money (or the cost of capital). This rate is set by unelected bankers. The result, since central banking got its start with John Law and the Banque Royale in France, is a series of massive misallocations of capital and destroyed wealth.

When you change the cost of capital willy nilly, you change all sorts of incentives in the real economy. And you alter the economics of tens of thousands of investment decisions. Make money too cheap (always the preference of governments) and you create asset bubbles (in stocks, real estate, and commodities).

In fact there's a pretty persuasive argument that the commodity super cycle is itself a symptom of the de-facto dollar devaluation engineered by Richard Nixon in 1971. Once the world moved to free floating exchange rates and fiat currencies not backed by any metal, a tsunami of paper, credit, and debt has lifted (inflated) prices for everything (houses, stocks, commodities, and bonds).

Some people call this wealth.

But if the super cycle of paper money is ending (a big claim for sure), wouldn't it mean a dramatic contraction in global economic activity? Not just a severe recession like in 2008 but really, a long depression in which debts are worked off and paid down, or in which debtors simply default and their creditors must take capital-destroying losses?

Well, yes. All that would happen if the super cycle in paper money is ending.

We've argued that it IS ending and that one symptom is a series of escalating sovereign debt crises. The funding model for the welfare state is broken because it's base on unsound money. It's time to pay the reaper. Don't fear the piper.

The argument we hear most often against our position is that all of that would be terribly inconvenient and people would prefer to not believe it. People would prefer to believe that debt is wealth, that you can spend your way out of recession, that we all can live at each other's expense, and that the misallocation of real resources (capital, labour, land and commodities) doesn't have real long-term consequences.

But paper money has always been a con game based on belief. The emperors of Rome, the Kings of France and England, the chairmen of the Federal reserve cannot resist debasing the currency. It makes both warfare and welfare possible. Guns and butter are the health of the state and the death of sound money.

The counterfeiters always get first use of the bogus money before its purchasing power is diminished by the increased supply. And after all, the modern banking system IS debt-based money. The banker's product is debt...and the more you have, the better for them.

All of this is absurd and, as Murray Rothbard said about fractional reserve banking, deeply immoral. It's a pretty dodgy way to run a world economy. But the assumption - encouraged by the powers that be - is that the economy is a complex machine which can be controlled with the right tweaks to the right dials by the right people wearing the right suits in the right government offices with the right university degrees.

This is also absurd.

But enough of the theory. What now? If the correction becomes a rout, expect more quantitative easing or policy measures designed to mask the pain (more stimuli). That won't solve the basic problems either. But it might arrest the dollar rally and the commodities sell off. At some point, much more aggressive measures might be needed, at which point we'd expect to see a huge increase in inflation and interest rates (as deficits spiral out of control).

But in the short term, we'd say this is a chance to lower your average purchase price on gold and other precious metals. We hope you used the rally as a chance to liquidate some of your stocks and increase your allocation to cash. Our preference right now is for liquidity over capital gains or yield. Cash doesn't yield much. But you can keep it in your hot little hands.

Of course no one can see too far into the future. We're pretty sure that at some point down the road, the sovereign debt crisis will again become a U.S. dollar crisis. But it could be that the sovereign debt crisis is going to take out the smaller welfare states in Europe first and that this will actually lead to dollar strength as global investors concentrate their remaining capital in a few very liquid markets (like short-term U.S. Treasuries). Under this scenario, emerging markets (including Australia) would probably sell off more than developed markets.

One final note today. The South Australian Attorney-General, Michael Atkinson, has changed his tune on the new law requiring internet commenters to reveal their identity when commenting on the upcoming election. That seems like good news.

Atkinson wrote in a statement, "From the feedback we've received through AdelaideNow, the blogging generation believes that the law supported by all MPs and all political parties is unduly restrictive. I have listened. I will immediately after the election move to repeal the law retrospectively."

Hmm. "It may be humiliating for me, but that's politics in a democracy and I'll take my lumps...This way, no one need fear now that they are being censored on the net or in blogs, whether they blog under their own name or anonymously. I call upon all the other political parties who supported this review to also review their position."

Maybe Mr. Atkinson should review his analysis as well. From his comments, he seems to be unrepentant about the spirit of the law. But he says that because all the young whipper snapper bloggers don't like it, well that's democracy so we'll respect that, even if all the youngsters are a bunch of dunderheads.

The danger here is still clear. You have an elected official exercising his own discretion about what speech ought to be free, and then exercising even more discretion about whether to apply the law or not. How capricious. The law is the law. How can the Attorney-General not exercise it?

But really this shows why you need a constitutional protection for free speech in Australia. Take it out of the hands of legislators and put it above statutory law entirely. In some sense, this IS un-democratic in that you're telling the legislature there are some individual rights they can't tamper with just because it seems like a good idea at the time. In that case, we're happily un-democratic.

Protecting individual liberties is the fundamental reason (we think) for consenting to be governed in the first place. If the legislature becomes a tool for systematically stripping you of your economic and political liberties (as well as grabbing, without your consent, a larger and larger percentage of your productivity via the income tax), you'd have a serious think about withdrawing your consent.

Hmmn.

Dan Denning
for The Daily Reckoning Australia

• Commodities Tell Us the World Won’t Stop Turning in a Financial Crisis
• Teach Your Children Chinese Because China is the Next Great Country
• U.S. Dollar Rallies as Economic Foundation Crumbles
• Millions of Zimbabweans Face Starvation due to Nationalisation caused by Hyperinflation
• U.S. Dollar Bulls Rallying Behind Fed Statement

"Mr Aveling said Collection House, which sources most of its business by recovering customer debts for banks and service providers like phone and energy companies, opted to use its money to pay off debt, rather than borrow more to buy the debts of others and try to chase defaulters. He also said shareholders could expect an increase in interim dividend, contributing to Collection House shares rising beyond 90¢, before settling to a 12¢ gain at 84¢."

How about that? A debt collection company growing earnings, paying off its debt, and paying a dividend? What does that tell you about the world when the debt collection business is booming?

To be fair, earnings were up at a few companies like Flight Centre and Computershare. But the banks sold off and the market closed down about 1%. So which is it? Are Australian earnings going to be stronger than expected? Or are stocks already priced for earnings perfection?

We'll ponder that on the tram on the way into the CBD today. A group of investors touring Australia is in town and we're on our way to speak to them about our forecasts and strategies for 2010. Mostly this involves more cash, fewer shares targeted to industries where there is scarcity, and a handful of energy, precious metals, and small cap shares.

That may seem like a bit of contradiction: bearish on the stock market but bullish on the riskiest sectors of it. But we'd make that case that it's owning the banks and other so-called blue chips that's the bigger risk - given the rewards on offer. It's better to have at least some shares where when one good thing happens, the share can go up 3-1, 5-1, or 10-1.

But true to form, 2010 is going to be the year the solvency of the welfare state dominates the front pages. People are slowly beginning to understand that huge social welfare states have to be paid for by someone. And if your economy isn't growing, it's hard to "spread the wealth around." You have to "borrow it around." And that puts you in debt.

For example, Greece has a fiscal deficit that's nearly 12%, or four times what the suits at the European Union in Brussels say you're allowed to have and still be a member in good standing. What's worse for Greece, its total debt-to-GDP ratio is working way to 120% - which is pretty bad, even by American and British standards (although modest by Japanese standards).

It may be satisfying for the EU's finance chiefs to scold Greece. But they all live in the same very large monetary glass house. This is the proverbial Achilles heel of Europe's monetary union. Twelve economies, one interest rate, zero flexibility. It's hard to imagine a better recipe for a fiscal crisis.

Our old friend Marc Faber says to beware the PIIGS - Portugal, Ireland, Italy, Greece, and Spain. These are the Euro nations that borrowed up in the boom and now have to pay it back. If these nations ran their own monetary policy, they could set interest rates low or print money. That would inflate away some of the accumulated debts.

But Europe's central bankers are not as willing as their Fed counterparts to throw their currency to the dogs. Thus the PIIGS don't have the any monetary or fiscal stability left. They must live within their means, cut spending, or get some kind of bail out from their neighbours.

The whole situation makes you realise how much of modern "wealth" is just debt dressed up in fancy clothes with a flashy car. And that's just at the household level. We think some European nation's will realise this year that you can't infinitely redistribute wealth to achieve the goals of social justice and equality...if the economy itself isn't producing that wealth in the first place.

Faber reckons one of the PIIGs will default in the next few years. Whether this provokes a currency crisis in Europe is the open question. What the euro has going for it right now is that it is not the U.S. dollar nor is it the yen. That's not saying much.

Australia doesn't yet face the kind of fiscal reckoning that the PIIGs, the U.S., Britain, and Japan face. We meant to show today how that could change quickly in the future. It's a new scheme to put ultimate responsibility for bank solvency on the Aussie tax payer. But we have a tram to catch, so the story will have to wait until tomorrow. Until then!

Dan Denning
for The Daily Reckoning Australia

• USA Has Fives Times As Much Sovereign Debt As All the PIIGS Put Together
• Central Bankers Encourage Debt Booms That Become Debt Bombs
• It’s the Little Economies that Have Trouble
• Commonwealth Bank (ASX: CBA) Nearly Doubles Bad Debts Over Last Year
• Martin Armstrong Suggests the Sovereign Debt Crisis in Europe Will Lead to Rising Interest Rates

So what do you do? Is this the dip you should buy?

Well, as we keep saying...it depends. A few months ago, our view was simpler. We trusted gold because we didn't trust central bankers. We still trust gold. And we still don't trust central bankers. But now we see that the central bankers are even more unreliable than we imagined. They are diligently trying to do the wrong thing, as usual. But they're not very good at it.

They increase the monetary base at central banks. But they can't melt the huge overhang of cash and credit frozen in the system. A depression has iced over the economy. The feds turn on the pumps, but the liquidity freezes up. This cold snap could last a long time. In fact, with the feds blocking necessary adjustments, it could turn into an Ice Age. And there's not much they can do about it - except make the situation worse.

Bond yields are already rising. There is a report of rising prices at the producer level. It wouldn't take much to spook lenders and force the Fed to retreat...just as Greece did.

What's more, there are two major trends underway. Neither has fully expressed itself. The bear market that began in 2007, for example, never took stock prices down to the levels you'd expect at a major bottom. Far from it. That means a major bottom is still ahead. We have had Crisis I. We will probably have Crisis II in 2010. It will make it easier for the feds to finance their deficits. But it will make it harder for the rest of the world to pay its debts.

On the other hand, the other major trend that has not fully expressed itself is the bull market in gold. When we were in the US last week we saw an ad encouraging people to sell gold "while prices are high." People think the rise in gold is a fluke. But markets make opinions. At the top, they will believe that higher gold prices are permanent. Then, we will see ads encouraging consumers to buy gold before the price goes higher.

But don't expect the top in gold any time soon. The major top in gold may have to wait for the major bottom in stocks. And the whole process could take many years.

So, relax. Sit back. Keep your seatbelt buckled. And enjoy the depression.

Bill Bonner
for The Daily Reckoning Australia

• In Gono We Trust
• We Expect No Recovery from the Economy
• Historically, the Only Reserve a Central Bank Can Trust is Gold
• Everyone We Know Expects a Fairly Quick Up-move in Inflation
• Gold Market Was Looking for an Excuse for a Breather

Volcker was the last central banker in America to have any real integrity. He saw what needed to be done and he did it. He hiked up rates and brought consumer price inflation under control. Thus began the bull market in bonds that continues to this day...29 years later.

Volcker saved the dollar...and saved the US economy from a worse bout of stagflation.

Circumstances are very different today. Now, our central bankers are trying to weaken the dollar. They see it as a way to escape debt and get out of a depression. This is, by the way, the depression caused by their own loose-money credit policies. Under the influence of artificially low interest rates, people borrowed too much. Then, they had to cut back...creating today's depression.

Bernanke and company think they can hold off a correction forever - by increasing the amount of cash and credit available.

How does that work, again? People have too much debt...so you give them more, right? Investors and businessmen made too many mistakes...so you enable them to keep making them, right? The bankers lent too much money to too many people who couldn't pay it back, so you insist that they offer more credit, right?

Everyone is mad at bankers. Not us, of course. We pet underdogs. We champion lost causes. We stand by diehards.

As far as we're concerned, the bankers stole their money fair and square.

But the poor English bankers aren't getting away with it. The sourpuss government of Gordon Brown just hit them with a 50% super-tax on their bonuses. Boo hoo.

And here's Paul Volcker, as reported in the London Telegraph, telling them to wise up:

The former US Federal Reserve chairman told an audience that included some of the world's most senior financiers that their industry's "single most important" contribution in the last 25 years has been automatic telling machines, which he said had at least proved "useful". Echoing FSA chairman Lord Turner's comments that banks are "socially useless", Mr. Volcker told delegates who had been discussing how to rebuild the financial system to "wake up". He said credit default swaps and collateralized debt obligations had taken the economy "right to the brink of disaster" and added that the economy had grown at "greater rates of speed" during the 1960s without such products. When one stunned audience member suggested that Mr. Volcker did not really mean bond markets and securitizations had contributed "nothing at all", he replied: "You can innovate as much as you like, but do it within a structure that doesn't put the whole economy at risk." He said he agreed with George Soros, the billionaire investor, who said investment banks must stick to serving clients and "proprietary trading should be pushed out of investment banks and to hedge funds where they belong."

Bill Bonner
for The Daily Reckoning Australia

• We’re Not Threatened by Inflation but by Depression
• Bank’s Inflation Projections Will Not Return to the 2 Per Cent Target Figure Until Early 2010
• The Stinging Reproach of a Former Fed Chairman
• Everyone is Getting Tough on Bankers
• Fed Made More Money than Goldman Sachs

Now, we're back in good ol' Bawlamer, Maryland. No matter where you go in the world, you won't find anything like Baltimore. It's probably best that way.

This week, we've had our eye on gold...and the dollar. As the dollar rises, gold goes down. This is not the way we thought it would happen. We expected a crack in the stock market first.

But you never know. And we'll take what we can get. Gold is correcting; that's what we were waiting for.

Well, we don't really know what is happening. Stocks rose yesterday - with the Dow up 68 points. So far, no sign of the rout we're expecting. We'll leave our tattered Crash Alert Flag flying anyway...just in case.

Gold rose $5 yesterday. Was that all there was to it? Was that the dip you're supposed to buy?

We wish we could tell you. As far as we call tell, this is the part of the market that is "noise" and not much more. Gold is a very good bet for the long term. Because it is a bet against Bernanke & Co. Look at it this way, where would your rather put your money...on the brains and integrity of America's central bankers...or on a dumb metal? We'll take the metal!

Just look at what the Bernanke team does. Listen to what they say. They have no idea what they are doing...yet, they are doing a lot of it. They more than doubled the US monetary base in less than 18 months. They've bought hundreds of billions worth of the banks' dodgy loans. They've threatened to drop money from helicopters rather than permit the economy to correct its mistakes.

We'll take gold, thank you very much...and wait to see what happens next.

Markets are closer to living things than to inanimate objects. They have hearts, souls, and a sense of humor. They don't merely react to circumstances. They create circumstances. And then they react to them. And then they give a good laugh. That's why Modern Portfolio Theory and the Efficient Market Hypothesis are such folderol. They expect markets to act like rubber balls or iron filings. They expect them to behave like objects, rather than like human beings.

Anthropogenic Global Warming is probably a hollow conceit. Anthropogenic Market Warming, on the other hand, is a certainty. Put out enough hot money...mix with boundless delusions...and that is what you get.

Anthropogenic Global Warming, or AGW, is what climate scientists call the hypothesis that human behavior is causing the world to heat up. Anthropogenic means 'caused by humans.' Supposedly, humans release carbon dioxide that creates a greenhouse effect, raising temperatures. That's what the scientists claim.

The trouble is there aren't really any climate scientists and nobody really knows what is going on. Real science requires an ability to reproduce results and disprove an assertion. If there's no way to prove that a hypothesis isn't so, it's not really science. It's just guesswork. Nobody can prove much of anything related to the earth's climate. You can't do a controlled experiment. All you have is cogitation and conjecture.

Markets are the same way. Nobody knows for sure why anything happens. But we do know that humans play a central role in market behavior and that what they think matters. That's why you can't measure risk by looking back on past behavior. Investors didn't think the same things then.

In the '90s, investors began to believe that stocks always outperformed bonds and that the US stock market was the safest, surest bet on the planet. This gave them an almost unlimited faith in Wall Street, in equities and in the future. Stocks soared. Then, what happened? In the next decade, US stocks underperformed bonds and were the world's worst- performing major equity market.

Now that's a sense of humor!

And now what do investors believe? They think we are in a recovery. They don't expect it to be very robust. They may be mad at the authorities for giving so much money to the bankers, but they have confidence that the situation is under control. US bonds are still the world's best credits, in their eyes. And stocks are still almost as good as money in the bank. Sure, they may take a hit...but they always bounce back.

The bear has his work cut out for him. He must demolish these confident, inherently bullish, attitudes. He gave investors a fright in '08-'09. As near as we can tell, he succeeded in chasing consumers out of the park. With no source of finance or increased income, consumers have been forced to cut back. They have no choice. Fashion often follows necessity; conspicuous consumption is giving way to frugality.

But investors - particularly speculators - are still believers. The feds couldn't juice up consumer spending...but they wasted no time putting the asset markets into the blender. Speculators enjoy real short-term lending rates below zero...and the fruit of TARP. And now comes word that the feds are going to extend TARP until October 2010...and use unspent funds in other stimulating ways.

No wonder the markets are so frothy! Just watch. Mr. Bear is going to blow the froth off. That's his job.

Bill Bonner
for The Daily Reckoning Australia

• An Old Friend With a New Idea on Global Warming
• Global Warming Getting Bad Press
• More Quantitative Easing by Fed has Markets Spooked About Inflation
• Dubai Debt Story More Like Bear Stearns Less Like Lehman Brothers
• Global Warming Temperatures Falling for the Last 10 Years

But don't worry about it. Now, we're not threatened by inflation...but by depression!

It's fighting the depression that makes people worry. Smart investors and shrewd central bankers are afraid the depression-fighters will go too far...that they don't really know what they're doing.

Ben Bernanke is up for re-appointment. "Bernanke fights for 2nd term," says The Wall Street Journal. Does he know what he is doing? Well, no. He was wrong about the biggest single event in recent financial history. He thought the 2004-2007 super bubble was actually a period of "great moderation" brought about by his own superior monetary policies! He was still patting himself on the back when it blew up in his face.

And now, he still thinks the way to solve a problem caused by too much debt is to offer more debt. Of course, it didn't work for the Japanese. It won't work for us. But what we don't know is HOW it won't work.

That is big question. Will the feds simply retard a real recovery...with their bailouts and boondoggles...causing a long, slow motion depression, a la Japan? (In this case, gold may not be the one- way bet the smart money thinks.) Or will they tip the world into a hyperinflationary catastrophe, like the Weimar Republic in the '20s or Argentina in the '80s?

We don't know. No one knows. We wait to find out...

Bill Bonner
for The Daily Reckoning Australia

• Volcker, the Last Central Banker in America to Have Any Real Integrity
• Bank’s Inflation Projections Will Not Return to the 2 Per Cent Target Figure Until Early 2010
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• Does Gold Do Anything But Rise?
• Depression: A Time of Falling Prices

February gold traded above $1,218 yesterday and closed at $1213. Gold has closed higher 20 of the last 22 sessions. In that time, according to Dow Jones newswires, it's up 15% - nearly double the return of the S&P 500.

Does this mean investors are starting to give up houses and shares and speculate on gold instead? The U.S. government has been forced to suspend sales of American Gold Eagle coins, according to Javier Blas in the Financial Times last week. It's the second time the mint has had to suspend sales since Lehman went belly up in 2008.

There's a bit more to the story, though. The mint has sold 1.19 million ounces of gold this year. That's a 75% increase over last year. Hmm. But it's also sold 26 million ounces of silver coins - the highest level of sales in 23 years.

What does this tell you? Well, the rational answer is that bullion or gold and silver coins are assets without counterparty risk. True, the value of gold and silver coins fluctuates with metals prices and liquidity. But your payment does not depend on someone else's credit quality. Your payment is in your pocket.

That rational answer presumes that investors are now showing a preference for tangible assets that are...real. But is it more fear than reason? After all, a rational investor might prefer the leverage you get with gold stocks as the best way to profit from rising gold prices. That would be the easier investment strategy.

But that suggests to us the move to gold isn't so much an investment strategy as it is a financial survival strategy. Investors are less and less worried about capital gains and more and more worried about the preservation of their purchasing power and capital itself. Gold is the ultimate expression of that worry - a flip side of the lack of confidence in modern monetary policy (or just modern money).

Gee. It's soooo kooky to distrust central bankers, isn't it?

Morgan Stanley appears to distrust UK central bankers. Morgan released a report yesterday, according to Ambrose Evans-Pritchard in the UK Telegraph, which highlights the risk that capital will flee Britain and the country will be plunged into a debt crisis because of a mix of political and economic factors.

"Growing fears over a hung parliament would likely weigh on both the currency and gilt yields as it would represent something of a leap into the unknown, and would increase the probability that some of the rating agencies remove the UK's AAA status," report Morgan's Ronan Carr, Teun Draaisma, and Graham Secker.

"In an extreme situation a fiscal crisis could lead to some domestic capital flight, severe pound weakness and a sell-off in UK government bonds. The Bank of England may feel forced to hike rates to shore up confidence in monetary policy and stabilize the currency, threatening the fragile economic recovery," the analysts wrote.

Hmm. No wonder gold is making new highs. And not just in U.S. dollars either. If the GFC really has become a sovereign debt crisis, the UK may compete with Dubai to see which political entity is the first to put to the fiscal sword (made, probably, of gold).

Of course those are American and British problems. So what if Australia will have $120 billion government debt in five years? That's as small as a percentage of GDP. Why worry?

Well, frankly, there is a lot to worry about in a global financial system still weighed down by debt. You wouldn't know it judging by the performance of stock markets this year. But we can feel it (psychic like that). And we can see it in metals prices.

We're off to Sydney and then South Africa next week. We'll have more to report on the outlook for precious metals then.

Dan Denning
for The Daily Reckoning Australia

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• The Price of Gold is Low – But It Won’t Stay There Forever!

Your editors here at The Daily Reckoning have no answers - especially when money is at stake - but we do have guesses. In fact, we have a lot more guesses than money. And so we would guess that the gold bull market is far from over...very far. But having said that, we would also guess that the risk of a sudden, steep correction is far from zero...very far. In fact, an imminent correction seems like a plausible scenario.

"Yes, we extract less and less gold ore every year," our colleagues in the French office point out. "And yes, there have been very few large gold discoveries in recent years. Yes, demand for gold bullion is exploding; Yes, central banks became net buyers of gold for the first time since the '70s; Yes, Asian demand is booming; Yes, gold benefits from the massive indebtedness of states, and the resulting increases in the money supply that destroys the value of paper assets and paper currencies... Yes, yes, yes...But something else struck me...everyone wants to own gold right now...That worries us."

And it also worries us, dear reader. Gold is popular, finally, and we just can't stand it! "Edgy" is not edgy anymore. The lunatic fringe has shifted to the middle of the bell curve. The financial counter-culture has become a pillar of the Establishment. This is not the world we knew in 1999, when we fell in love with $300 gold...and no one cared.

Between 1980 and 2000, the Yellow Dog did little more than gather fleas. Gold's value fell by more than half. During that same 20-year period, the S&P 500 delivered a dazzling return of more than 2,500%! Clearly, therefore, gold was a dead-beat, a good-for-nothing - more suitable for a Steinbeck novel than an investment portfolio. And like most losers, gold attracted other losers.

One of those gold-loving losers was The Daily Reckoning's very own Bill Bonner. As the new millennium dawned, Bill declared his "Trade of the Decade" - buy gold, sell stocks. The decade isn't over yet, but so far, so good. During the last nine years and 11 months, the S&P 500 has delivered a total return of -11%. The gold price has quadrupled.

And so, today, we find ourselves in a very different investment environment. Very few people on the planet believe that gold is a "Sell." In fact, lots and lots of people believe that gold is a "Buy"... Or least they say they believe gold is a "Buy." No doubt about it, the ancient monetary metal is back in style, which worries Bill Bonner a little.

"Everyone seems to be jumping on the gold bandwagon," Bill laments. "Frankly, it's getting a little crowded...a little top-heavy. It's making us feel, well, a little uncomfortable.

"Here at The Daily Reckoning we never met a crowd we wanted to join...or a line we wanted to stand in. We don't even like being on the winning side of a football game - too much boisterous company.

"No, give us the lost cause, the diehard and the underdog," says Bill. "We are much more at ease as an outsider...an outcast...an outlier. Not only is there more elbow room, that's also where the bargains are - where others aren't looking. Trouble is, almost everyone is looking where we're looking now. At gold.

"Ten years ago," Bill explains, "only the gold bugs - those few who were still solvent and still sane - bought gold. Now, the smart fellows are buying it too. People like David Einhorn and John Paulson. Heck, even central banks are buying it. For the first time in a quarter century central banks are buying more gold than they're selling.

"Why? Because the story is so good. So easy to understand. So convincing.

"If the recovery is for real, demand will increase, diminishing inventories and turning the Fed's hot money into consumer price inflation. Investors will turn to gold to protect themselves. If the recovery falters, the feds will increase their stimulus efforts, setting the stage for even greater inflation later.

"If this analysis is correct, gold is a one-way bet. The argument is good," Bill concludes. "We believe it. But it bothers us that so many others do too."

Bill is not bothered to the point of wanting to actually SELL gold. After all, as he readily admits, 'the argument is good.' Nor is your California editor inclined to make a case for selling gold. Here's the problem: Once you've sold the stuff, what do you do next? Buy stocks? Buy bonds? Buy vintage Coca-cola bottles?

And while you're thinking about what you might buy, what do you hold in your bank account? A currency that's depreciating faster than net worth in a divorce court?

So long-term gold holders are probably well advised to remain faithful to their favorite dollar substitute, and just ride through the inevitable ups and downs.

That said; short-term traders do not lack for reasons to risk betting against gold. For starters, the gold trade has become a bit crowded, as Bill correctly observes. Secondly, the recent rally has triggered "overbought" signals on all major technical indicators. Lastly, the recent rally is bumping up against the performance targets that have capped all the major gold rallies of the last ten years.

In the September 17, 2009 edition of The Rude Awakening (may it rest in peace), we presented the following table and observed:

"The shares of gold mining companies are flashing a compelling short- term buy signal. Since late July, the gold mining stocks, as represented by the HUI 'Gold Bugs' Index have jumped more than 30%, while the gold price has advanced only about one third as much.

"As the nearby table illustrates, rapid 30% rallies in the HUI tend to bode very well for the gold price. The five prior instances in which the HUI rallied more than 30% in a very short timeframe, the gold price subsequently jumped an average of 27%. A similar advance this time around would land gold at $1,160 an ounce by Christmas - or about $140 higher than today's price. No such rally is certain, of course. But the monetary stars seem to be aligning for both a short-term and a long-term advance in the gold market."

As it turns out, the stars aligned exactly as predicted and the gold price landed at $1,195 an ounce by Thanksgiving - a 30% jump from the mid-July lows.

As a result, gold is making more headlines than the soon-to-be-filmed love scene between Angelina Jolie and Johnny Depp. In fact, gold just might be the sexier of these two news stories...and that's probably not a good thing.

The long-term outlook for gold remains as compelling as ever. This bull market is justified and "has legs." But the Yellow Dog has run very far, very fast over the last few months.

The pooch might need a rest.

Regards,

Eric J. Fry
for The Daily Reckoning Australia

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