Another national emergency! Terrorism...the banking crisis...now Swine Flu.

Why it is an emergency, we don't know. Our sister, living in Virginia tells us that several of her grandchildren have come down with the Swine Flu. It doesn't seem to bother them anymore than any other flu.

But every emergency is an opportunity. The feds don't want to waste it. Instead, they swing into operation with a rescue plan. It will end up costing billions...hundreds of billions...or maybe even trillions. We don't know what they've got in mind. But we know what will come of it. It will end up extending the power and influence of the government. So far, the feds are the only real winners from any of these crises. Federal outlays, as a percentage of GDP have shot up from less than 20% of GDP in 2000 to more than 26% in 2009.

Will it do any good? Public health is not central banking. And it's not economic planning. Force everyone to wear a surgical mask and maybe lives would be spared. Or, maybe not. Without the immunity of occasional bouts of flu, who knows? Maybe people would be more susceptible to the next disease. The American Indians were almost wiped out...because they had no immunity to European diseases.

Interesting...

Ain't nature amazing? Disease works like an economic correction. It winnows out the weak...and it toughens up survivors. Allowing people to get sick is a little like allowing them to go broke. It keeps the whole system from softening up...from becoming more vulnerable. It protects people from moral and biological hazard. In other words, it's the correction that really provides protection...the disease itself, not the cure. Or, to put it another way, it's the crash that is beneficial, not the rescue.

David Einhorn, one of the few people to make money in the crash of sub-prime debt:

"The financial reform on the table is analogous to our response to airline terrorism by frisking grandma and taking away everyone's shampoo. It gives the appearance of 'doing something' and adds to our bureaucracy without really making anything safer."

The Wall Street Journal reports that even bankruptcy can be a good thing. "Household Debt Can Hasten Recovery...when it goes unpaid," says a headline.

The whole idea of a correction is to wash out mistakes. If people can pay their debts down, the mistakes are corrected. The system is strengthened. If they can't, the process of correction can happen faster. Bad debts are written off quickly. Then, a real recovery can begin. Either way, the system comes back in better shape.

Too bad the feds are getting in the way!

A decent correction should carry off those who made the biggest mistakes - in the present case, the firms on Wall Street that wagered billions on a bigger and bigger bubble. But instead of letting them go broke, the feds rewarded them.

Wall Street profits are a 'gift' from the state, says George Soros.

But wait, what kind of gift is this? If you give $100 to your neighbor, that's a gift. But what if you tax your neighbor on the left $100 in order to give the money to your neighbor on the right? That's a gift too...but of a special kind. You're 'redistributing the wealth,' you might say.

And what if you do a quantitative easing? You know, you print up a $100 bill and give it to your neighbor? That's a gift too.

Yeah, thanks a lot.

Meanwhile, the recession is said to have come to an end in the US. GDP growth is positive, say the papers. But if this is a recovery, let's hope it comes to an end soon.

Existing house prices continued to fall in September.

Unemployment continued to worsen. "Signs of recovery don't extend to jobs," says the WSJ.

Bill Bonner
for The Daily Reckoning Australia

• Naturally the Feds Want to Raise as Much Money as They Can
• The Fed Cut Rates – But How Low Will They Go?
• Feds Buy Houses
• Feds Have Used the Correction to Increase Their Power and Add to Their Wealth
• AIG to Receive $85 Billion Loan from Fed

Two important things happened yesterday, both of which cast a crimson light on things.

First, the Dow dropped again; it has only gone up one of the last 7 days. It went down 203 points. Could be nothing. Could be something big...the beginning of the long awaited 'next leg down' for the bear market...the opening day of a bloody Red October.

Charts of oil, commodities, copper, the dollar, and Treasury bonds tell us the same story. The greed investments are topping out. The fear investments are headed up.

What's a 'greed investment?' It's anything that benefits from an improving outlook for the economy and inflation - oil, commodities, and stocks, mainly.

What's a 'fear investment?' It's something that goes up when people begin to suspect the boom is a phony - namely the dollar and US Treasury bonds.

The dollar is rising. So are Treasuries. Yesterday, 30-year US Treasury bond yields fell below 4% for the first time since April.

And what about gold?

Well, that's the other important thing that happened yesterday. Gold held above $1,000.

So what?

So what?? Well, dear reader, you are in a prickly mood this morning, aren't you?

This is important because gold could go either way. Gold is a refuge in times of fear - especially when people fear inflation or a falling dollar. Gold is also a target of greedy speculators sometimes, even when the going is good. According to a study done by the World Gold Council, you never know what gold will do. That study was a great comfort to us here at The Daily Reckoning; we thought we might have missed something. But no. We may not know what gold will do, but neither does anyone else.

Looking around, we see no sign of consumer price inflation. So gold's recent rise must have been driven by optimistic speculation - along with oil and stocks. Now, when oil and stocks go down... we have to wonder whether gold will go down too. The answer, given yesterday, was what we expected - yes, but not as much.

There's substantial risk in gold as well as stocks. The ultimate low for the Dow should be below 5,000. That is, let's say, about a 50% haircut from current levels. And let's assume that gold does what it did yesterday...let's suppose that it goes down only 40% as much as stocks. That would still be a drop of 50% of 40%, or 20% - to the $800- an-ounce level.

If you would be gravely upset by a drop of that magnitude...you probably shouldn't buy gold at this level. And, of course, you should have sold your stocks already. Stick to cash - and gold, if you're long-term oriented - until this next phase is over.

The economic news was mixed, as usual...with nothing to make us think that our basic outlook is wrong.

On the optimistic, bullish side...consumer spending rose in August. Pending homes sales went up too.

But on the pessimistic, bearish side... "September auto sales plunge," says a Reuters headline. Yes, auto sales drove off a cliff last month - just like we said they would. GM reported a 47% drop.

What happened? The clunkers program was an economic fraud. Like all attempts to boost consumption, it merely shifted sales from the future to the present (now the past). Which is a big reason why August consumer spending looked good too.

But wait a few weeks for the September consumer spending numbers. Especially if the stock market continues to fall... Then we'll find out how sustainable those retail sales numbers really are.

As you know, here at The Daily Reckoning headquarters...in the building with the gold balls on the south side of the Thames...we are often accused of 'pessimism.' We deny it. We're optimistic about the fate of mankind. But we are pessimistic about many of his current pretensions - such as health food, enlightened central banking, contemporary art, mass education, global climate control and progressive democratic government.

But maybe we are wrong to be optimists. Pessimists always have the last laugh - when the optimists die. "I told you so," they say, under their last breath.

Bill Bonner
for The Daily Reckoning Australia

• Is Gold Going Up Because People Fear Inflation?
• Biggest Factor Affecting Consumer Price Inflation is Growth in Bank Credit
• Abandoned Shopping Malls to Follow Abandoned Houses
• China Stepping Up Purchases of U.S. Treasury Debt
• September is the Best Month for Gold

We began having doubts about the 'feds inflate...gold soars' hypothesis last year. It was too easy...too obvious. And if it were that easy to inflate a nation's currency, how come the Japanese couldn't get the hang of it in the '90s?

So, we moved towards a contrarian position - inflation, yes...but not for a while. And gold? Well, we are in it for the long run. In the short run, anything could happen.

To clarify our view on gold, the Daily Reckoning is not bearish on the metal. It is not bullish on the metal either. It is buggish. We are gold bugs. In the long run, gold will retain its value. Since that's all we ask of it, we are always satisfied. Even if it is down in the short run - and it went through an 18-year downcycle from 1980 to 1998 - it will come back in the long run.

Gold is not a speculation for us; it is a means of saving money. As Richard Russell says, a man should count his wealth neither in dollars nor in euros; he should count it in ounces.

Our views on gold are still contrarian. But our views on the gold market have become commonplace. Now...everyone's a contrarian. As we read the opinions and the blogs, it has become common to forecast a dip in the gold price...followed by a new, big bull market after inflation has found its footing.

And so what does gold do? It goes up!

Yesterday, gold rose $11 - still comfortably above the $1,000 mark. Is gold going up because people fear inflation? Apparently not. If they were afraid of inflation we'd see it in the bond market. But instead of selling off - which is what Treasuries should do if there were any hint of inflation - bonds are going up.

Is gold going up because people are afraid of the dollar going down? Well, maybe. But that is like saying that the dollar is going down because people are afraid the price of gold is going up. Where's the chicken? Where's the egg? Which is the cause? Which is the effect?

The dollar is still going down...as gold rises. Yesterday, it closed just below $1.48 per euro. It is so low now that Americans' cost of living is among the lowest in the world. The average house sells for just $160,000. That's just over 100,000 euros. Even out in the country...you would have to do some serious searching for a nice house anywhere in Europe that you could buy for $100,000 euros.

And what about the economy? Our contrarian position has remained unchanged. As we put it last week, there are few problems that enlightened central banking can solve; a credit contraction is not one of them. All the bankers can do is to make it worse - by delaying it, disguising it or diverting it in another direction (such as converting deflation into hyperinflation).

Yesterday, the Dow rose again - up 51 points. As far as we can tell, the rally is still on. And now, the news media and the statisticians are in full support.

House prices rose 0.3% in July. Hooray! Of course, the government is giving huge tax credits to new house buyers. Since that program began in January, an estimated 350,000 houses have been bought thanks to the program.

Household net worth also is going up for the first time in two years - at least, that's what the papers say. Of course, what do you expect? The feds are pushing up asset prices - giving them the biggest push in the history of man. But remember, the market is also doing its usual post-crash bounce. When the bounce ends...so does the temporary wealth effect...

Is this still a contrarian view? Seems to us that it's becoming more contrarian every day. The longer the rally goes on the more people think it is the real McCoy.

Stay tuned...

Bill Bonner
for The Daily Reckoning Australia

• Themes from Day 1 at the Agora Financial Investment Symposium
• When People Fear Inflation or a Falling Dollar They Find Refuge in Gold
• When Gold Ruled the Earth, Part I
• China is a Key Driving Force in the Gold Market
• Gold Falls for Four Straight Days but is the Low Price a Bad Thing?

The Japanese persisted. They lent so freely that the yen became the 'funding currency' for a worldwide boom. Prices rose all over the planet - except in Japan itself. The land of the rising sun couldn't seem to get up in the morning. Property investors lost money. Stock market investors lost money. Japanese consumers sewed their pockets shut.

And now that the dollar is the world's 'hot money' the world's surviving gold bugs see their moment of rapture fast approaching. Gold is not an investment category. It is no investment at all. Instead, it is more like a religion or a political position. True believers stick with it through thick and thin. When gold goes up, they are insufferable. When it goes down, they are unrepentant.

The price of gold peaked out in real terms in 1979 at over $2,000 in today's money. Briefly, an ounce of gold was so loved - and stocks so despised - that you could buy all the stocks in the Dow index for just a single ounce of gold. But then, the gold martyrs suffered a terrible persecution - nearly two decades years of steadily falling prices. Not just in real, inflation adjusted terms, but in absolute terms. By the end of the period, it took 43 ounces of gold to buy the Dow stocks, and gold bugs were gathering in small groups praying for salvation and awaiting the end of time. It seemed as though the cult might be extinguished; few were still alive. Fewer were still solvent. Of those, even fewer were still sane. But then, like Christians huddled clandestinely in an unheated Soviet apartment, the wall fell. Gold began a comeback.

What inspires this little reflection, apart from a night of heavy drinking, is the price movement. At the beginning of the week, gold closed comfortably above the $1,000 an ounce mark. Then, on Wednesday morning...it shot up. The end of the world has been delayed, perhaps indefinitely. And yet, gold - an option on financial chaos - trades as if it were coming next week.

What gives? Here on the back page we keep an eye on the yellow metal. Not because we expect the end of the world. Still, you never know; maybe the gold bugs are onto something. No monetary system lasts forever. This one - an impromptu experiment, at best; premeditated larceny at worst - has already lasted longer than most marriages. The bust-up, when it comes, threatens to be nasty and expensive.

The easiest story to sell in the current marketplace is the inflation story. In an effort to revive the go-go economy of the bubble era, the feds are adding to the money supply. They will continue doing so until inflation rates go up. They make no effort to hide it. They have as much as warned the world: prepare to be robbed. According to the popular story line, the gold market now anticipates inflation. Investors should too. We have told this story ourselves; we still believe it. But today, we caution readers: there may be a plot twist.

The problem with inflation is that there is none. Consumer prices are falling in China, Europe and America. And if we look harder, we find out why. The feds are pumping the money supply as hard as they can. David Rosenberg reports that the monetary base rose at a 141% annual rate over the past four weeks. But the money fails to reach the real economy. The money supply figures that relate to actual cash in people's hands - M1, M2, and MZM - are shrinking, at -28%, -4.9% and - 6.2% respectively. Why? Because the banks don't lend and consumers don't borrow.

In short, the feds' money goes into cool bank vaults and hot speculative trades. When it tries to find its way to the consumer, it gets lost. As Rosenberg explains it, the transmission mechanism has broken down. We live in a bust economy, not a boom one. In a bust, consumers cannot borrow. They have nothing to borrow against. Both their wages and their assets are going down. Who would lend to them under those conditions? Not a bank that almost went broke itself 12 months ago.

And even if consumers had access to credit, they wouldn't take it. Consumers too, almost went broke a few months ago. Instead of saving money during the boom years, they spent it...or gambled with it. Then, when the bust came in '08, they realized that they were 10 years closer to retirement with little money saved. Now they have to make up for that lost decade, by cutting spending and saving as much money as they can.

Still, gold speculators think they've got God on their side. They march into the coliseum confident that the feds will inflate consumer prices and cause the price of gold to soar. Maybe gold will rise. If so, it will be thanks to speculators and Chinese central bankers, not consumer price inflation. The smart money is still on the lions.

Regards,

Bill Bonner
for The Daily Reckoning Australia

• The Interest Only Mortgage Option
• Gold is Suddenly Looking Good to Investors Again
• You Can Have a Deadly Depression and Dizzying Levels of Inflation Simultaneously
• Japanese Practically Gave Away Money to Anyone Who Would Borrow It
• Price of Gold Today is About Where it Was 26 Years Ago

For now, at least for this week, it sure does look like the appetite for risk is back. The U.S. dollar and Japanese Yen are weak, while commodity currencies like the Australian, New Zealand, and Canadian dollars are up. Bond prices are down, stocks are trending up, and even oil is creeping back over $50, looking to make a breakout. All of this confirms that we may have a "second wave rebound" from the March lows.

We have grave doubts about the durability of this rebound, given the state of the economy (unemployment, debt, and rising deficits). However we're not going to bother with any of that today. If you traded the rebound for profits, good on ya! We are using this moment of relative tranquillity to ponder what's just around the corner.

One object bearing down on the Aussie economy is a 'temporary' deficit that may last until 2016. Liberals, Labor, Republicans, Democrats...they all know how to spend money they don't have. All political parties appear to support big government these days. It's so trendy.

But you wonder if the Australian is starting to worry that the current government is writing checks the future will have to cash. Today's Australian Financial Review reports that next year's Federal budget deficit will be at least $70 billion. It says that Treasurer Wayne Swan has told his state counterparts that, "tax collections would fall by $200 billion over four years, worse than a $115 billion write-down in February."

"There is no doubt that the deficit will last longer, the temporary deficit will be longer, as a consequence of the revenue downgrades imposed on this country by the rest of the world," the Treasurer said. The AFR says the government plans to return the budget to surplus...by 2016.

Here's a stupid question: is something really temporary if it lasts for seven years?

However long it lasts and however big it gets, the deficit (and growing debt) mean Australia will be borrowing more to support its current lifestyle. This is an alarming trend. Temporary government spending and revenue programs almost always become permanent. And that's what would worry us about this deficit: it's the beginning of Australia's long road to debtor status.

But hey! Judging from the hate mail in the mail bag, people are tired of hearing about the long-term consequences of making promises you can't keep. It is not fun to think about the transfer of national income that occurs when you rack up debts to bond holders. And it's not fun to think about what happens when the government is unable to fulfil the promises it's made. So let's not think about that, shall we not?

Instead, let's go straight to the mail bag. Lots of good stuff. And finally, some contempt!

--Hi team,

Your comment "Copper rises on Chinese buy prospects" is interesting except that Chinese are buying copper ASSETS and will no doubt dictate the future price they pay from their owned Australian producers (refer Oz minerals buyout and others).

JHM

--Actually, we were quoting a headline from an article in The Australian, but your point is well taken. China is doing both. It's stockpiling raw commodities. And it's buying shares in publicly listed commodity producers. However, there's a big difference between a customer of an Aussie resource producer buying the producer, and another producer buying the producer. If the customer is buying the producer (iron ore), then it's conceivable the Aussie firm will be run not to maximise shareholder value but to give the consumer (who owns a sizeable chunk of equity) bargain basement prices. When a producer buys a producer, the interests of the two parties (getting the highest price of the commodity produced) seem more aligned.

--Dear DR,

I'm still curious as to how can we have hyperinflation and a property market crash at the same time. While I understand the logic, I still can't wrap my head around how the also heralded hyperinflation will come into this. Please end my suffering by addressing this in your next issue as this enigma just keeps me wondering.

Kind regards,

Susanna

--Ah. Two good questions. A real hyperinflation destroys wealth and puts a premium on real goods that are tradable (liquid). A house is not tradeable. So while the value of mortgage might quickly be inflated away in the early stages of a hyperinflationary scenario, we would not recommend it as a way to get rich. With prices so surreal, the value of large assets in hyperinflation becomes volatile. We'd suggest this makes for an illiquid market, and doesn't help you at all with respect to day-to-day economic activity (where you can barter liquid tangible goods for other goods or services). Try bargaining your rumpus room.

On the other hand, at least you have a roof over your head. It's a subject we need to more research into. But to be as clear as possible, we don't believe buying a house is a real hedge against hyperinflation. Not much is.

The other question you had is how it all begins, this hyperinflation. We would argue that the expansion of the global monetary base has been so large that it's going to be nearly impossible to reverse. So far, the huge expansion by the Fed and other central banks has not made its way into the real economy. Its being held as "excess reserves" at those central banks rather than loaned out into the economy where the multiplier effect would quickly lead to inflation.

The Fed thinks it can soak up these excess reserves before the banks loan them out. After all, the banks would only do so once they thought the economy was safe enough to lend into again, as my colleague Gary North points out. The Fed can try and prevent this increase in the money supply by raising reserve requirements (effectively forcing the banks to keep the cash parked). But if it does so, it risks derailing the so-called recovery. The whole point of the Fed's balance sheet expansion was to create a recovery anyway.

The Fed is hoping that it can reduce bank reserves before they hit the economy. It thinks that the demand for its short-term lending programs will go away as the economy recovers. It also says it can conduct "reverse repurchase agreements." This essentially means the Fed will be SHRINKING the money supply as the economy recovers.

Our guess? The Fed is going to have a devil of a time preventing excess bank reserves from departing the monetary base into the money supply and the real economy. New bank lending and higher interest rates will fuel even higher prices. And down the rabbit hole we go.

--Dan,

There has been a lot said about the problems easy credit has caused. But what is the solution to easy credit? How do you suggest credit is made harder to get? Is there any other ways than just lifting interest rates?

Glenn D

--Taking the power to dictate the price of money away from a cartel of bankers would be a good start. There is a market price for money, or a natural rate of interest required by lenders to make surplus capital available to borrowers. This natural interest rate is what Central Banking is designed to distort.

The government prefers a monopoly on money because two institutions stand to benefit the most from "just a little inflation;" the government and the banking sector. A free market for money would mean that the supply of credit would probably not exceed available savings. At the very least, the collateral required to secure a loan would be more substantial that it has been for the last twenty years.

Is there a cure, then, for credit excesses? The Austrian economists say no. The only cure is prevention. One the disease has been unleashed, you can only deal with the misallocated capital and try to liquidate the losses and begin again. Ludwig Von Mises argued that the government control of the interest rate is what sets off the boom/bust cycle to begin with. With a market rate of interest, these booms and busts would be moderated. But that would destroy the illusion that central banks can carefully manage an economy (price stability and full employment) by manipulating interest rates.

This was the subject line of an e-mail this week: "Stupid remarks from DR"

For example: "This represents a $50 billion deficit. Compare that to last year's $22 billion surplus. Not a good look for K-Rudd's CV."

What a truly mindless buffoon you appear to be.

Doubtless you also supported your erstwhile heroes who sat on an unprecedented minerals boom, passing the surplus out to their mates instead of investing the surplus in Australia's future.

Do you really believe that Rudd caused our current problems? Really? Maybe his solutions will prove inadequate or wrong but unlike you and your cronies he is doing something. And what suggestions have you got to get us out of the problems caused by your like thinking mates??

None, except the greed based "look after yourself and to hell with everyone else".

As I am sure even you have realised by now I am less than impressed by your vacuous political drivel.

Leave comments to those who are at least prepared to try and do something about the situation and stop the cowardly firing at their backs.

Contemptuously yours,

Alex Millar

--We don't support politicians in anything, ever. If more of us looked after ourselves and our neighbour and families instead of looking to government to "do something" the world would be a lot better off. Does this mean you'd like to unsubscribe?

--Dear Sir,

Your newsletter is really up with the best. My question is since most governments are going broke and most banks are broke where is all the money coming from? The Australian banks have $7-$14 trillion of toxic debt, the world supposed to have over $1000 trillion, ten times more than all the GDP of all the world. If this is the case, where is the money coming from? Who or what is holding up the economies of the world? If the money is just being printed which I believe it is there is no way out but a TOTAL collapse.

If you can answer me it would be really appreciated.

Thanks,

Rafael C.

--We're not sure about your toxic debt figures. But you ask a good question. Asset values-as we've found out in the last year-are largely bogus. They are deflating. As for what's holding up the economies of the world? Well, there are real industries and demand for real goods. But if you mean all this deficit spending and bail out money, that either is borrowed (mostly from Japan, China, institutions, and private investors) or its printed out of thin air by central banks.

--Hi,

Thanks for your constantly interesting pieces. My question is - why should we really believe gold has any value? For most of the last 5,000 years, animals were the key mode of long distance transport - they no longer are. Why will gold not go the way of the horse and cart?

I understand the reasons behind why you think the gold price will rise. However I think there is a flaw in your logic. You say that "But just remember, this whole experiment with fiat money is not even one hundred years old. Just because it's all we're used to doesn't negate that for 5,000 years of human history, people have been using gold as money". This always seems to be the argument for gold. The fact that it has always been used as a currency, therefore it is what will keep its value.

For gold to store value, don't people need to agree that gold is valuable? I have never understood why people put a value on gold. I agree it looks nice and is useful in jewellery and fillings, and I think it's also a reasonable conductor of electricity - but that's it.

If tomorrow, someone succeeds at alchemy, or the world just decides that gold isn't it anymore, it will be absolutely worthless - and it will go down the path of the Zimbabwean $. Wouldn't we be much better off storing some real, useful commodities (copper, tin, tarmac, soy, hogs, OJ - of course limited to the practical problem of actually storing these things). It seems to me that to believe gold will increase in price, requires other people to believe it will increase in price and has a real value/use - whereas actually it doesn't.

Thanks,

Samant

--Gold has four physical properties that have made it extremely useful as a medium of exchange over time. It is durable. It's divisible. It's convenient. And it's consistent. That doesn't mean other things haven't or can't be used as a medium of exchange. It just means these physical attributes of gold make it especially useful. That's not a matter of mystical belief. It's a practical benefit.

The fact that you can't "succeed" at alchemy is also what makes gold desirable as a medium of exchange: it's supply is relatively stable because it cannot be counterfeited by governments. The usefulness of any medium of exchange would decline if a person or a small group of people could easily increase the supply. It would make the unit less stable. Gold supply varies with mine production and above ground sales from central banks. But you can't just drop it from helicopters like brand new paper money. Well, you could, but it might hurt.

Does that mean it has intrinsic value? Well, if by intrinsic you mean that its unique physical properties make it useful as a medium of exchange, then yes. But value is only ever determined in an exchange. Gold is useful only as long as people believe it to be a useful medium of exchange. We think more people will realise that in the coming years.

--Dan

Are you an optimist, a pessimist or an economist?

Larry

--We're Catholic.

And one last note on property.

If we are already "smack in the middle of the biggest economic collapse in 80 years", this economic collapse is not that bad after all! In the worst case scenario; today's people living in the industrialized countries are unlikely to go begging for foods, unlikely to go through winter without enough clothing.

This financial collapse is largely on paper (or computer screen); the transfer of assert ownership from someone to someone else.

The world's factories are still standing, infrastructure are still there to facilitate economic activities. Demand is still there, the population in China is a few times that of the United States; with ever improving production technologies, they will not allow their living standard to be substandard for long.

Wherewithal is still there, if someone owe [sic] someone else three trillion dollars, that someone else must be rich, has plenty of money to spend and invest!

Even confidence is still there; for sure the share market will go down after ups, but the surge in the last two weeks indicated refreshingly, more investor [sic] than not don't share the dim view of the Daily Reckoning.

For those unfortunate home owners being foreclosed, many may not be eligible for a home loan in the first place.

I think you are wrong.

David Tam

--We'll drink what you're drinking. But fair enough. If we've learned one thing in the last year, it's that we can be just as wrong as the next guy. That's why we reckon it up every day. Keep thinking!

Dan Denning
for The Daily Reckoning Australia

• World Economy Faces Hyperinflation or Deflation?
• Brazil is a Good Place to Become Rich
• June Producer Price Index Indicates Slower Inflation in Australia
• Now is the Time to Find Out About Gold as Money
• An International Currency Not Just on Paper

That is not the way it works in modern central banking, though. Today, it's as if Hank Paulson is pointing his "big bazooka" bailout plan at Wall Street and demanding it opens up its wallet so he can fill it with other people's money. The Paulson Gang (or Goldman gang) is lining up for its share of the loot accordingly. But the real robbery is taking place in Washington.

Today's theft is a lot more subtle, mostly because it's taking place right underneath your nose. That is the trouble with the obvious. You become so used to it that you fail to find it unusual. Sadly, it is as business as usual in Washington D.C. this week.

First, the Wall Street Journal reports that the shclubbs in Washington have agreed on the "principles" of the bailout plan. The words "lawmaker" and "principle" probably don't belong in the same sentence. But our job is to investigate the facts, not pass judgment (yet) on the protagonists in our story. So what are the facts?

Surprisingly few! The principals involved all met at the White House and walked out of the room with no real agreement. They did, however, agree to four principles which any future agreement must address. Not exactly Wilson's 14 points. But give them time.

What are the four principles? First, a bailout plan must provide taxpayer protection. Second, it must provide oversight and transparency. Third, it has to preserve home ownership in America (though how it will or even CAN do this is anyone's guess). And fourth, the US$700 billion lump sum sought by the U.S. Treasury will be doled out incrementally, to make sure Hank Paulson doesn't spend it all in one place.

It doesn't sound like much was resolved, does it? Still, stocks appear to be trading exclusively on the idea that a bailout plan will be passed by the Congress and will rescue the banking system from the edge of the abyss. The Dow was up nearly 300 points early in the day. It faltered later, but still closed up almost two percent to 11,022.

While Wall Street tries to save its own neck at taxpayer expense, the sell-off in Australian stocks is making the assets of junior miners even cheaper to the parties that are happy to acquire them at any price.

In fact you could argue, as my colleague Al Robinson has in Diggers and Drillers, that one of the prime results of the market volatility is increased merger and acquisition activity in the juniors. Share prices are down. Yet many quality mining projects clearly have the potential to lead to growing earnings for the firms behind them.

There are two possible complications to Al's bullish scenario, though. One is commodity prices. If the equity market volatility turns into a full-fledged collapse, it's hard to see this being too terribly bullish for commodities. A major recession in the U.S. won't kick start commodity prices from their current doldrums.

But if the bailout plan in Washington is perceived as inflationary, but also just enough to prevent a U.S. recession, well then you may have the conditions necessary for a rebound in certain resource prices. High energy and labour costs have already pinched supply in some key markets. The spring is coiling.

The other complication is capital. With Aussie bank lending plummeting and the share market not an ideal place to raise money right now, how will small companies fund their big projects? Are there enough risk-taking investors to make it happen?

One group of investors that don't seem to care about the credit markets or valuations (perhaps because they find them so stunningly attractive) are the Chinese. Today's Australian reports that, "Chinese- controlled Australian Bulk Minerals has agreed to a reverse takeover of Grange Resources in a deal that secures future iron ore pellet production for China's biggest private steelmaker, Shagang, and will lead to the listing of Tasmania's Savage River mine and pellet plant."

If you keep looking for the action in the big blue chips like Rio and BHP, you will probably miss the flurry of action brewing beneath the surface. And it's definitely brewing. This brew, however, is not toxic like the mess in Washington. THAT brew could still poison us all. But we'll have to wait and see what the Paulson Gang cooks up before we know how much lower stock prices are going to go before we can buy. Until Monday...

Dan Denning
The Daily Reckoning Australia

• Bailout Deal Will Expand China’s Influence in U.S. Economy
• Geithner and His Toxic Asset Bailout Plan
• Parasites and Chiselers Who Benefit from the Bailout
• Congress Urged to Approve Bailout By George Bush and Warren Buffett
• Posco’s Production Cuts May Be Bad for Australian Iron Ore