Throughout history, no empire has managed to rule forever. Instead, empires rise to power, they prosper and spread their influence. Thereafter, they over-extend themselves and then break down in some fashion. In fact, all the glorious empires of history had one thing in common - a spectacular collapse.

Now, there can be no doubt that America ruled the economic world for the better part of the previous century. However, this powerful nation has now entered a terminal decline. The recent credit crisis and the failure of some of the largest American financial corporations is compelling evidence that the world's largest economy is well past its prime.

Today, America finds itself heavily in debt and to make matters worse, its demographics are also worsening. Unfortunately, the American leaders are attempting to postpone the day of reckoning by taking on even more debt! It is noteworthy that over the past year alone, America's federal debt increased by approximately US$2.1 trillion and its projected budget deficit over the next decade is now slated to be almost US$9 trillion! If this does not shock you, then consider the chart below which shows the total obligations of the US government.

As you can see, over the past six years, American unfunded obligations increased by almost 50% from US$79 trillion to US$114.7 trillion! Alarmingly, over the same period, American government revenue rose by only 12%! Now, you do not have to be a genius to realize that no entity can continue to increase its liabilities by more than four times the rate of its revenue. If this spending frenzy continues, commonsense dictates that at some point in the future, the solvency of the American government will come into question. When that happens, foreign capital will flee America, interest-rates will skyrocket and we will witness an epic currency crisis.

Furthermore, it is worth noting that apart from the American government, the Federal Deposit Insurance Corporation (FDIC) is also in serious trouble. In an ironic twist of fate, the FDIC's Deposit Insurance Fund has spent so much money covering bank failures over the past three months that it has completely run out of money! This implies that there is no capital available now to insure bank deposits held at American banks.

Given the horrendous deficits and ugly debt obligations, the American government is now left with the following options:

a. Raise taxes (not sufficient to meet obligations)
b. Cut back on spending (highly unlikely)
c. Default (unimaginable)
d. Print money (only viable option)

Remember, America is the largest debtor nation the world has ever seen and the only way it can repay its obligations is through a process known as quantitative easing (euphemism for printing money). In fact, this stealth confiscation of savings is already well underway. A recent report published by the Federal Reserve revealed that the American central bank purchased half of the newly issued US Treasuries in the second quarter of this year. Needless to say, the Federal Reserve financed these purchases by creating dollars out of thin air - a short- term fix but a long-term disaster.

Let us put it bluntly; the days of American hegemony are drawing to a close and within the next two decades, China will become the world's most dominant economy.

If you are sceptical about our claim, you may want to note that twenty years ago, China's economy was worth only US$342 billion and as of last year, its GDP had grown to US$4.4 trillion; representing an annual growth rate of 13.6%. Now, if China succeeds in growing its economy by roughly 8% per annum over the next two decades, its GDP will grow to US$20.5 trillion by 2029. At that point, China may well replace America as the world's largest economy.

It is worth keeping in mind that whereas American households are up to their eyeballs in debt, their Chinese counterparts have a savings rate of almost 40%! Furthermore, at a time when America and other nations in the West are struggling to stay afloat, China's foreign exchange reserves have surged to US$2.3 trillion!

Now, we are aware that many commentators are criticising China for the sheer size of the stimulus unleashed by its leaders. In our view, this ridicule is baseless because instead of spending printed or borrowed money, at least the Chinese are spending their savings.

In any event, the stimulus applied by the Chinese policymakers seems to be working. Over the past seven months, money-supply growth in China has risen by 26% and loans have surged by 32%. In turn, this inflationary orgy is creating a residential construction boom. All this economic activity is in stark contrast to America, where despite all the policy-actions, private-sector credit is contracting.

Look. The Chinese economy is roaring along...and you can be pretty certain that the country's rapid growth will cause domestic consumption to explode. Already, roughly 900,000 cars are sold each month in China and by the end of this year, the Asian powerhouse will replace America as the world's largest market for automobiles. Interestingly, similar trends of rising consumption can be observed in various household items such as refrigerators, motorbikes, mobile phones and so forth.

So it seems to us that in this low-growth world, investors would do well to take a good hard look at high-growth opportunities like China.

Regards,

Puru Saxena
for The Daily Reckoning Australia

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And counter to our prediction of an imminent, counter-trend U.S. dollar rally, the dollar is most definitely not surging. Take a look at the chart below. We've been writing about the decline of the dollar for nigh on ten years. So we looked at a ten year chart to tally up the damage. It is considerable.

Click to enlarge

What's at stake with the interpretation of this chart? If the dollar rallies on short covering from the dollar carry trade (a BIG if), then other "risk" assets like gold, stocks, and emerging markets would probably sell off. And yes Australian stocks, that includes you. As well as the Aussie dollar.

The chart shows that the index's 50-week moving average is set to cross below its 200-week moving average. That is mixed news. The first time it happened on this chart was back in early 2003. That was the early days of a long decline in the index. The second time, though the move failed to confirm the "flight to safety" rally of 2008 had staying power in 2009.

Once the fear that gripped markets in 2008 went away, the investment world sold the dollar and started borrowing en masse to buy other, higher-yielding currencies and assets (like the Aussie dollar and resource stocks). That's where we are now.

But based on the chart, is the next move down in the dollar index a new low, which the crossing of the long-term MA by the short-term MA would suggest? Or is it a false move? Will the dollar quickly and violently rally for some reason (geopolitical perhaps) that currently remains unknown to the human beings of this world?

"It's an interesting chart," said our technical analyst Murray Dawes. "But it is not useful for timing your moves out of or into trades related to the dollar's movement."

"So you're saying our chart doesn't have any useful information from a trader's perspective?"

"Not really."

Murray promised to show us HIS dollar index chart tomorrow. We'll bring it to you, live and in colour. But in the meantime, we think the one piece of important information communicated by our chart is that the dollar's trend is down. But there IS a catch.

The catch is that when this many people are this uniformly bearish, everyone is probably wrong. Consider this a warning then, that a dollar rally is just the sort of thing that will lead to a correction in the gold price and the stock market. We won't speculate on the sort of things that could lead to a dollar rally. But surely they're out there and sooner or later they'll come.

The other possibility is that the dollar is in its death throes and that this is the big one, in currency terms. That is such a momentous and disastrous event that people consider it both kooky and unlikely, not to mention undesirable to a predictable and comfortable world. But it IS possible.

And do you get the feeling that this kind of manic melt up rally is the sort of irrational frenzy that comes just before everything goes haywire? Haywire is not a precise financial term. So what do we mean?

We meant that the world enjoyed a 20-year economic relationship based on a fundamentally unbalanced global economy. Manufacturing capacity migrated to Asia where wages were lower. For awhile, this was mostly good news in Western countries. Goods got cheaper but jobs didn't vanish.

Now the situation is not so pleasant. The world is awash in manufacturing over-capacity, especially in China. Wage deflation (in the Western world) looks like a long-term trend, leading to a lower standard of living. This wage deflation is occurring at exactly the same time that Western governments are encountering demographic crises of ageing populations.

We all knew the ageing of the Boomers would put pressure on public finances right around now. But no one reckoned on a global financial crisis further saddling the public balance sheet with debt. And no one reckoned that Western wages and incomes would be falling at just the time people needed them most. And no one reckoned that savers would lose the most from low interest rates on fixed income - even though those low rates are keeping the American housing sector on life support.

It's a bit of global impasse. America's needed structural adjustment has come. Households and businesses are reducing debt, trying to live within their means. But the net adjustment to the American balance sheet is not happening because public sector debt is growing so fast.

Meanwhile, the other obvious adjustment is that the Chinese currency ought to be allowed to strengthen. For political and social reasons though, China will not allow this. It means China is actually adding to its industrial over capacity. It is conjuring up the world's largest ever bubble in fixed asset investment, including commercial real estate.

It is easy to see why China is reluctant to allow a stronger Yuan. Exports account for 39% of Chinese GDP. The Chinese economy, and probably the Communist Party itself, cannot survive on unleashed Chinese domestic demand. They need American markets. But American consumers - in addition to reducing debt - are now realising that the focus on finance over manufacturing from American policy makers has worked out for Washington and Wall Street, but not terribly well for the average American worker.

Where do we go from here? How about the blame game. U.S. Treasury Secretary Tim Geithner once blamed the Chinese for being currency manipulators. He back-tracked later. And yesterday, Liu Mingkang, the chairman of the China Banking Regulatory Commission, had a go at America.

"The continuous depreciation in the dollar, and the US government's indication that, in order to resume growth and maintain public confidence, it basically won't raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation." He is blaming the U.S. for fuelling a destabilising global bubble.

Of course that bubble is felt most acutely because China pegs its currency to the dollar. China is right to blame the U.S. for manipulating its currency to try and improve its competitive position. And China is right to worry about the value of its dollar-denominated assets in a world of exploding U.S. debt supply.

But China has put itself in this position. And here we are at the end of 2009 with a world still fundamentally un-adjusted to a new, workable currency arrangement. The world remains burdened by trillions in assets purchased with debt. Those assets linger on bank balance sheets, on government life support but fundamentally lifeless at fictitious book value prices.

And meanwhile, the China-US currency arrangement has fuelled a global bubble. Australia is part of this bubble, too. The question is how it will end. In the U.S., the housing market looms as the Achilles heel of the economy. It could strike households, banks, and the government again in the next 12 months are more mortgages reset at higher rates (with lower home values).

If the event that pops this bubble comes from America, look for the supply of credit to the emerging world to dry up again. And though Australia is not a developing economy, we saw last time what happened when U.S. credit markets imploded. Australian banks had to get a government guarantee to borrow money in the wholesale market.

We'd suggest that lending for residential housing and commercial real estate would take a real dip in Australia on another U.S. housing crisis (even if Aussie banks aren't exposed to actual U.S. housing-backed RMBS and CDOs. You don't have to own toxic debt to be impacted by it.

If the bubble pricking comes from China, what then? Well, China does everything big. So a Chinese bust would be world-class. It's a subject that requires its own Daily Reckoning. More tomorrow.

Dan Denning
for The Daily Reckoning Australia

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Why this three part thought experiment? Well, just because our analysts are in agreement that the cautious way forward is to surf the liquidity in the markets higher, your editor is, at heart, a massive worry wart. Plus, all these disaster movies about the end of the world must be affecting our state of mind, or amplifying its natural tendencies.

We're always worried about the worst-case scenario, always thinking of the things that could go wrong. This just seems like a prudent way to prepare. It will be better if these things don't happen. But let's just assume they will and work backward from there. And then let's figure out what you can do - if anything - to avoid getting wiped out again, and maybe even making a buck or two on it.

First cab off the rank is the total implosion of the Chinese economy. This might be bearish for Aussie resource stocks. But how likely is it to happen?

Well, not very likely if all you were looking at is the raft of official data released this week. Retail sales in China were up 16.2%. Industrial output was up 16.1%. And exports, even though they were down 13.8% in October, decreased at the lowest rate in ten months. Fixed asset investment for the year is up 33.1% over last year's pace.

You could take all of these as signs that China is leading the world to recovery and managing itself quite well. It should achieve 8% GDP growth. That's the growth rate that China's economic planners reckon the country must achieve to maintain high unemployment. And high employment rates promote political stability - valued above all else by a regime that makes free market gestures but still is run by old school communists.

What's more, if you take up the question we asked a few weeks ago - when is it in China's interests to allow its currency to strengthen - the answer is starting to emerge: when a stronger currency keeps inflation in check. China's currency managers are making noise about letting the Yuan strengthen against the dollar.

But it's not to please Barack Obama, who visits Beijing this month. A stronger Yuan, among other things, gives Chinese consumers more purchasing power. That might slowly reduce the contribution exports make to Chinese GDP (and to forex reserves which are then recycled into U.S. Treasuries.

Or it could all fall apart more quickly than anyone expected. Why?

China has massive over capacity in steel and cement. Granted, these two materials are quite literally the building blocks of industrial society. But according to Bill Powell in Fortune Magazine, China has enough spare production capacity in the cement industry to meet annual cement demand from India, Japan, and the U.S....combined!

This fact would be consistent with a country that's massively over-investing in fixed assets to achieve high rates of employment. And then there's steel. China's own National Development and Reform Commission says the country will have 250 million tonnes of excess steel production capacity by the end of next year.

Chinese steel production is approaching 600 million tonnes per year. But its current demand is around 350 million tonnes. That means it's either planning to put the rest of the world's steel makers out of business by dumping cheap steel on to global markets...or there is massive overcapacity and inefficiency in the steel sector.

Either way, it's probably a good idea to consider the possibility that China's investment binge is more fragile than it looks. In short, the bear case on China is that, "the Chinese have dangerously overheated their economy, building malls, luxury stores and infrastructure for which there is almost no demand, and that the entire system is teetering toward collapse."

Naturally this would be bad for Australia, whose economy is lately coupled with China's prosperity. It would argue for reducing your allocation to common stocks, raising your cash position, and not taking the China growth story at face value.

Next cab off the rank is global rush to refinance debt while interest rates low. Moody's reports that there is $10 trillion of bank debt maturing between now and the end of 2015. What's more, the average maturity of bank debt fell from 7.2 years to 4.7 years over the last five years.

This means bank debt (like sovereign debt, especially in the U.S.) is getting more interest rate sensitive. Not only do banks have to roll over a lot of debt in the coming years, they may have to do so at higher rates (assuming they can find takers for it.) Moody's is not confident.

In a research note published to clients, and also on the FT's Alphaville blog, Moody's analysts wrote that, "credit costs should continue to put banks' earnings and profitability under considerable pressure, which might cause investors to seek additional risk premia, as governments gradually exit from the direct support they have so far provided. In other words, we see weaknesses on both sides of the balance sheet, and we are concerned that the risks associated with both assets and liabilities may fuel each other, cause losses and undermine investor confidence."

Even if you concede that Moody's might be overly-dire now to make up for its non-existent warnings about the risk of sub-prime related debt, you have to take the warning seriously. In fact, in a report released last weekend, the IMF said banks were not out of the woods yet at all and remained at risk.

Its analysts wrote that, "Banking systems remain undercapitalized, suffering from impaired legacy assets and, increasingly, non-performing loans. Deleveraging pressures will likely remain a constraint on bank credit for some time. Activity in securitization markets remains dependent on public sector support. Moreover, large public interventions have transferred risk to sovereign balance sheets, raising market concerns that have abated somewhat recently."

We'll get to the sovereign balance sheets in a second. But in your financial disaster preparations, spare a thought for the banks. Serious problems remain. And if you're looking for where risk resides in the financial system today - the next AIG, or Mrs. O'Leary's cow if you prefer - you might not have to look any further than the banks.

But as the IMF noted, a great deal of private sector risk has been transferred to the public sector via bailouts, loan guarantees, and other schemes. This exposes sovereign borrowers like the U.S. and the UK to interest rate shocks (increased borrowing and debt service costs). But more importantly, these countries already faced fiscal dilemmas with ageing populations.

There is not much detail to add to this point. We've covered it before. But it's the best reason to own gold and tangible assets (your house, vodka, cigarettes). All the world's paper currencies are drowning under a sea of public sector debt that's becoming increasingly unsustainable. And this has happened at just the point where the Western welfare states will begin spending more money on caring for ageing populations.

Where will the money come from? Between a China meltdown, a bank implosion, and the rising risk of sovereign debt default, there are at least three known unknowns that worry us right now. And don't even get us started on the unknown unknowns.

Dan Denning
for The Daily Reckoning Australia

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But let's not forget about oil. It too is priced in dollars. In fact, the big gold move started because Robert Fisk claimed the Gulf States and China et al. are tired of paying for oil in an unstable currency. You could say that gold moved closer to being money again because of how important oil already is to the real economy.

We'll get back to oil in a moment. But there was a story in today's Age that gave us the willies. "The Aussie dollar is poised to storm past parity with the US dollar, propelled by local interest rate rises and Australia's close ties to the booming Chinese economy, according to currency analysts," reports Chris Zappone.

It doesn't sound too creepy. But there IS a creeping hint of euphoria to the Aussie story at the moment. The dollar...the economy...the fact that summer is just over the horizon...you can feel the animal spirits getting friskier. It was like this in the summer of 2008 as well, right before the bottom fell out.

But enough of the weird sense of déjà vu. How does the big picture affect your investments? That is always the tricky part. It's one reason why we are stuffing our new offices with all kinds of traders and analysts and writers whose ideas would probably get them thrown out of a respectable job. These are just the people we want thinking about the investment future.

Dan Denning
for The Daily Reckoning Australia

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"It was that distributed information is more reliable than the centralized variety." In the non-communist world, if a man had money and no bread, he exchanged the former for the latter...and sat down to dinner. As if guided by an 'invisible hand,' millions of people did the same thing. Everyone tried to get a bit more grease on his plate, by making his own decisions based on the facts before him. The result: standards of living rose for practically everyone.

In the centrally planned economies, on the other hand, neither the householder nor the baker had a choice. Their tasks were set by apparatchiks who presumed to know exactly how much of society's resources should be devoted to making bread...and exactly how much each person should eat. But by the '80s, it was obvious that central planning had failed. And by 1990, both the Soviets and their neighbors, the Chinese, had abandoned the experiment. Mankind breathed a sigh of relief. It seemed to have made a genuine great leap forward. Finally, it was generally accepted that people should be able to offer up their money as they did their prayers - to whatever god they chose.

The planners had made millions of people miserable over the course of seven decades; remarkably, none were hung from lampposts. Instead, they retreated to the universities, central banks and finance ministries. From these defensive redoubts, they continued their meddling. Soon, they were in the drivers' seats...and headed for another wall. The crash of '08 cut world asset values by as much as $50 trillion. But did the planners learn anything?

"This is where I have the greatest problem with US economic policy makers," writes Marc Faber. "I don't think they have ever recognized that the excessive, credit-driven expansion of the US economy was unsustainable in the long run and that, sooner or later, the current crisis was inevitable."

The bubble deniers deny there was a bubble and deny that their own stimulus caused it. They see nothing wrong with what they were doing and no reason to stop doing it. Instead, they add more stimuli...and create new bubbles.

In the gallery of Hell bent deniers, China is a special case. "To get rich is glorious," announced Deng Xiaoping after coming to power in 1978. The state pulled back its long arm. People were free to run businesses, to pay wages, to keep bank accounts. Today, in many ways, the average Chinese entrepreneur is freer than, say, his counterpart in France or America. He faces fewer obstacles. Factories go up overnight...and he is in business.

So dynamic was the Chinese economy that it responded to America's centralized monetary policies in record time. Spooked by the recession of 2001-2002, the Americans cut rates and boosted public spending. This brought a bubble in the housing sector...which gave English speaking consumers an appetite. Soon they were gobbling up boatloads of goods made by people who spoke Chinese.

Now, it is indigestion to which the central planners respond. An IMF report gives us a measure of the response. Add up all the loan guarantees, toxic asset purchases and other forms of bicarbonate administered by the G20 nations and they come to about a third of their combined GDPs. Those are just the monetary stimulus programs. The fiscal programs add another 5.5% of GDP.

America's central bank adds reserves so fast it must be running out of storage space. As for its fiscal policy, this week it has passed the $1 trillion deficit milestone - with almost half the year still ahead.

For their part, the Chinese planners enjoy the liberty of the damned. With no creditor looking over their shoulder, they are free to fight the downturn even more recklessly. "China is back in bubble land," says the Financial Times. In the first six months of this year, Chinese banks lent more than $1 trillion - or about four times the rate of 2007. They have more money to lend because reserves of foreign currencies are still increasing...and recently passed the $2 trillion mark. The money is coming in from speculators, who have taken stock market trading volumes to three times last year's levels.

Chinese planners thought they were pretty smart. During the boom years, they fixed the yuan to the dollar and refused to let it rise. This spurred rapid growth in China's export sector. But like all central economic planning, it backfired. China's entrepreneurs were misled. They didn't know their biggest customers were going broke. Now, they have too many factories producing too much stuff for too many people who cannot afford it.

But that is the beauty of being a central planner; you never have to say you're sorry.

Instead, you double up. The Chinese economy is expanding at nearly 8% this year, according to official estimates. It is expected to generate 74% of the worldwide GDP growth in the 2007-2010 period. As for commodities, were it not for Chinese buying, prices would collapse. Of course, that could be said for a lot of things. Were it not for the Chinese stimulus, the whole world economy would probably be backing up. We'll find out for sure...when this next bubble blows up.

Regards,

Bill Bonner
for The Daily Reckoning Australia

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"Chinese economy bounces back," says one headline in the International Herald Tribune.

"JPMorgan profit soars despite downturn," says another.

The average reader or TV viewer will go no further. "Ah," he says to himself, "good news; the worst is over. China is a green shoot as big as the Amazon. And JPMorgan is a leader in the financial sector. If the financial sector is doing well, the whole world economy must be doing well."

But here at The Daily Reckoning, we can't help ourselves. If we see a silver lining, we look for the cloud. We see garbage...we look for the rat... We begin with the JPMorgan profit announcement, because it is the most intriguing. Let us set the stage:

In the last half century, credit has expanded faster even than dress sizes. Naturally, this has made the business of hawking credit extremely profitable. Profits in the financial sector soared to 40% of the U.S. total. And every momma wanted her baby to grow up to be an investment banker.

But then, in 2007 & 2008, the bubble in the financial sector popped. Many banks and financial institutions went broke...or had to be bailed out by the government. Instead of being the world's highest-flying industry...finance became the scene of its biggest crash.

And now, from all we've been able to detect, a fundamental shift has occurred. People are no longer eager to go deeper and deeper into debt. Instead, they are eager to pay off debt...that is, to rid themselves of finance...and to get as far away from the financial sector as possible. Savings rates, for example, have gone from zero to 7% in just the last 12 months.

But in the midst of this remarkable and historic change, we get news that at least a couple of the biggest firms in the financial sector - JPMorgan and Goldman Sachs - are making billions in profits:

"Even as it weathers the worst economic downturn in decades, JPMorgan Chase said Thursday that it had made a $2.7 billion second-quarter profit as a result of stellar trading and investment banking results."

This was essentially the same story we got from Goldman. Neither bank made its money the old fashioned way -- by lending to worthy projects; they made their dough by "trading" and "investment banking." In other words, they made billions from speculation.

Anyone who takes this as evidence of a recovering economy should work for the government. Only a government economist or a mental defective (excuse us for being redundant) could believe that genuine prosperity can be built on a foundation of speculating by large financial institutions. You can see why by asking a simple question: whom were they trading against?

Speculating is a zero-sum game. No matter who wins, the economy is not a bit better off; it has not a centime more in resources. Goldman and JPMorgan report earning, together, more than $6 billion. Who was on the other side of that trade?

There is also something fishy about the whole thing. Trading is not only a zero-sum game, it's a game of chance. Traders lose money about as often as they make it. Of course, normally, the traders at the big banks have an advantage; they are not idiots. They make money by taking it away from the amateur traders, who are idiots. But what amateur traders put up $6 billion?

Our guess: the fix is in. They are taking advantage of the feds' stimulus programs...and trading against the biggest patsy in the world, the U.S. taxpayer. How? We'll find out how, later...

Meanwhile, there is the news that China is back in business.

"Government spending pushes GDP growth to 7.9% for 2nd quarter," reports the IHT, "...fueled by a large economic stimulus package and aggressive bank lending...a surprisingly strong showing during the global economic downturn...

"...while most other major economies are contracting and suffering from the worst economic crisis in decades, China appears to have turned a corner...

"Growth in the second quarter was driven by strong auto and property sales, a rebound in manufacturing and huge infrastructure spending, which was propping up global commodity prices."

Further investigation reveals that bank lending and property speculation have gone wild. (More on this in today's essay, below...) And stocks in Shanghai are up 75% so far this year.

Now, let's try to get this straight. The world is in a slump. China sells stuff to the world. And yet, China is booming.

How could it be? Again, there's something fishy about it...as if the government were jiving the figures...as if the speculators had taken leave of their senses...and as if the whole thing were just the result of the same kind of misguided 'stimulus' that got us into trouble in the first place...

The Richebacher Letter's Rob Parenteau agrees that something isn't quite right. "Ask anyone who's done business there. Keeping a double set of books in China isn't just common, it's considered 'good strategy.' You've also got under-regulated Chinese banks hiding as much as $500 billion in bad debts - China's own version of 'subprime' loans to small businesses and Asian property speculators.

"On top of that, you've got a $40 billion tab left over from the Beijing Olympics... and a $140 billion tab for rebuilding Sichuan after their 2008 earthquake."

Boom...boom...ka-booooom!

Regards,

Bill Bonner
for The Daily Reckoning Australia

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Of course the market doesn't actually "think" anything. It's the expression of the aggregate actions of millions of buyers and sellers, each of whom has a brain, some personal experience, and a unique appetite for risk. And right now, the market shows that it's basically a range-bound standoff between buyers and sellers.

How about we focus on bigger trends, then? Here's one: China is now the world's biggest car market-at least for the first half of the year. As GM emerges from bankruptcy, the China Association of Automobile Manufacturers said that June car sales were up 36.5% from the same time last year. Car sales hit 1.14 million for the month.

Sales for the first half of the year were up 17.7% to 6.1 million cars. In the U.S. sales fell to 4.8 million cars in the first half. Not that we're putting these numbers up here to recycle the old argument that if you could just capture a small percentage of the Chinese market, any producer of anything would be rich.

In fact, in consumption terms, it's still going to take some time for the Chinese economy to catch up with the U.S. And in some sense, it may never reach the same consumer-driven heights. U.S. wages and asset prices over the last 50 years have been driven by America's privileged position in the post-war world as the last industrial giant standing.

What we're seeing now is a great global leveling of wages in Western industrialised countries with wages in the developing world. The whole McMasnion/SUV lifestyle will probably not go global. It would be a huge waste of resources.

However, what DOES interest us about China's growing car culture is that it may be electron based and not oil-based. That is, Chinese manufactures of electric motors and hybrid motors (both petrol and electric) are emerging as a global force. It's not something we were aware of until we researched the subject for a recent issue of Diggers and Drillers.

There are still some big challenges to the entire electric and hybrid car industries. But from a resource perspective, there are a few key elements you need to make the whole thing possible. One of them is lithium. And that's all we'll say on the matter for now, except that the engine of Aussie portfolio growth may not be Chinese consumption, but Chinese production.

It's going to be harder for banks to pay dividends in the coming years, we said earlier this week. And now more evidence that Aussie banks may have to provision their capital larders to make up for loan losses. "ANZ has already taken a $114 million provision to cover problem exposures in its private equity arm, but sources have told Business Daily that further substantial provisioning will be required before the end of September," reports yesterday's Age.

ANZ has at least $500 million of direct equity and loans at risk with more than 40 businesses it supported through the private equity arm, according the article. Ouch.

You didn't have to be a subprime lender to suffer from the credit bubble. ANZ got into margin lending, private equity, and of course, residential real estate. When money was cheap, setting up businesses to profit seemed like a good idea. Now, not so much.

Michael Lewis has written another ripper of a piece on how far a business can stray from its original plan. The story is on AIG's Financial Products unit-and how it became the engine room of the mortgage securitisation boom in America. If you have some time this weekend, you should definitely read it. You can find it here.

"THE end of the Government's first-home buyers grant boost and various state-funded benefits could force down lower-end house prices by up to 10 per cent," reports yesterday's Australian. "The warning from CB Richard Ellis coincided with Australian Bureau of Statistics figures issued yesterday that show the number of dwellings bought by owner-occupiers in May was 29 per cent higher than in October, when the federal boost was introduced."

The end of the first home buyer's grant is near (later this year). But then what? CBRE's manager of residential research Erin Rolandsen says, "The fact that first-home buyers have been driving this boom leaves the sub-$500,000 market particularly vulnerable once the boost is reduced from September, 2009...We expect falls could reach 10 per cent ."

And finally, on a comedic note, Federal Reserve Vice Chairman Donald Kohn has told the U.S. Congress-with a totally straight face-not to regulate the Fed or audit its balance sheet. He said it would reduce the Fed's independence and that, "Any substantial erosion of the Federal Reserve's monetary independence likely would lead to higher long-term interest rates as investors begin to fear future inflation."Or maybe an audit would show the Fed has made trillions in commitments via its loan facilities and that the only way for it to keep U.S short-term interest rates from rising is to print more money to buy more bonds-which itself doesn't exactly boost confidence in the Fed's policy or the U.S. dollar. Kohn might as well have said, "Don't audit us because if people find out what we're really up to gold will go to $5,000."

Dan Denning
for The Daily Reckoning Australia

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This from the Financial Times:

"Perhaps more than any major economy, China is showing signs of improvement, writes Geoff Dyer. Indicators suggest that the economy began to recover in March with industrial production rising 8.3 per cent from 2.8 per cent in January-February.

"But could it all be a bit of false hope? Could we, in fact, be misinterpreting a temporary stimulus-induced economic pick-me-up as an actual sustainable recovery?"

China says it is growing. But if it were really growing it would be using more fuel and more electricity. Instead, industrial demand for gasoil, used by factories and commercial plants, fell 12.6% in the first quarter.

Our old friend Sean Corrigan, chief investment strategist over at Diapason Commodities, also points out that electricity generation has been going down too. The last seven months' power output has been 8.5% below that of a year ago.

Another old friend, Jim Rogers, believes China - along with commodities - is still the best place for your money. He may be right. But we don't speak Chinese...and we fear the Chinese market may be subject to more risks than is popularly understood.

One of the risks we think is especially understated for China is the risk of central planning. Investors tend to favor China - over, say, India - because they think the Chinese government - even in the hands of communists - is capable of guiding the economy to prosperity. That is, in China's case, they believe central planning is a plus and pay a premium for it. But central planning is always a mistake as near as we can tell. It is only not a problem when it is carried out so clumsily that it is ineffective.

"China's head honchos tout a rosier future for the 'Red Dragon' economy than seems possible," says The Richebächer Letter's Rob Parenteau. "Over 15,000 factories in the Chinese provinces of Shenzhen, Guangzhou, or Dongguan have already shut down... with many more slated to close over the months ahead.

"It's an epidemic that's happening all across Asia, though you might not be hearing about the full scale of their meltdown on the evening news.

'Half of China's toy factories have shut down. In fact, at least 67,000 factories overall closed in the last six months of 2008. With another 60,000 factories in the Wen Zhou Province alone about to shut down.

"As many as 27 million Chinese are already out of work - with 20 million of them streaming out of the cities and back to the abandoned farms of the Chinese countryside."

Remember the 1980s? Then, too, investors were willing to pay a premium for central planning. Then, it was Japan that was doing the planning. Investors sold U.S. stocks - on the theory that the United States couldn't get its act together - and bought Japanese stocks, because MITI, the Japanese bureaucracy in charge of economic planning, was supposed to be doing such a fine job of guiding the country to eternal success. It didn't seem to bother them that this same agency had advised Japanese carmakers to stay at home and not try to penetrate the U.S. auto market.

Of course, in 1989, the Japanese market...and its economy...cracked. Then, the Japanese turned their central planning skills to the task of avoiding the kind of creative destruction that capitalism had in store for them. In this they were more successful - preventing the necessary restructuring for the next 20 years. Brain dead banks were kept alive. Zombie companies remained in business. And an amount of money equal to more than an entire year's total output of all the Japanese people was spent in futile 'stimulus' efforts. Today, Japanese stocks are still selling for 75% less than they were in 1989. Japanese property, too, is only worth about a quarter of what it was worth at the top of the boom.

Bill Bonner
for The Daily Reckoning Australia

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It is now thirty two years since we made that visit. The change in China has been beyond belief. In 1977, China was still a land of bicycles and physical labour. It was also a land of absolute authoritarian orthodoxy. One would get on an aircraft, leaving behind an obsequious official, spouting the party line. One would disembark a thousand miles away, and be greeted by another official minder, repeating the same party line, almost without a pause.

People still criticise the monolithic power of the Chinese Communist Party, but the relative change is what strikes anyone who knew the old China. China may not respect civil rights or allow certain kinds of free political discussion, but the new China is inexorably much more open and free than the old China.

That is just as well, as it is becoming apparent that the resilience of the Chinese economy is the world's best hope in the present depression. If one looks at the reaction to recession of the United States, Germany and China, one is impressed by the strength and confidence of the Chinese response. I would list the three powers in the order of China, the United States and Germany, for their contribution to the process of world recovery.

Joseph Schumpeter analysed the Great Depression in terms of "creative destruction". He thought that cyclical recessions and depressions wiped away obsolete economic systems and allowed them to be replaced by fresh structures. Recessions are necessary to speed up the capitalist forces of change.

For the last 33 years, the Chinese economy has been growing two to three times as fast as the United States, and that has continued even in a year of recession. The Asian economy has been taking over the lead from the Western economy, though the performance of the Japanese economy has been disappointing.

I expect that this Chinese outperformance will continue as the world moves into recovery. We can now see the pattern of the three centuries: 1815-1914 the British Empire; 1945-2008, the American era; about 2030 -2100 or beyond, the new Chinese era. China is overtaking the West and the process has been accelerated by the recession.

William Rees-Mogg
for The Daily Reckoning Australia

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My friends and I exited the train onto the long, cracked concrete platform. A drainage stream littered with rusty steel barrels trickled by. On the northern bank, a retaining wall backed by an even more daunting barbed wire fence served to support the numerous lookout posts dotting China's most traversed southwestern border. This wasn't the Rio Grande.

Lo Wu is called a "control point." I imagine the Chinese authorities used the Korean DMZ as a suitable inspiration.

Consequently, I saw no need to draw the army's attention. My friends, Western journalists from Hong Kong, certainly weren't the red-carpet type. So we hung back, letting the hundreds of Chinese scurry by.

The rush for customs ensued. The soldiers, dressed in their long pea-green military topcoats, suspiciously surveyed the masses. And the masses nudged to and fro, like cattle in a stockyard, hoping to find the most expedient line to re-enter the mainland.

My fire engine red North Face duffel bag drew some stares, but Western garb doesn't fascinate as much in Shenzhen as it would in the more remote, rural regions of northern China. After all, I should thank some among the Chinese hustling all around me for stitching it together. That's probably also true for just about every item of pure Americana attached to my privileged self. And if the Chinese didn't construct the authentic item, they could easily point me to an alley where I could haggle the repro.

Shenzhen, Deng Xiaoping's first attempt at capitalism, Chinese-style, received the elevated status of China's first Special Economic Zone (SEZ) in 1980. Seemingly overnight, factories popped up along the hot, humid delta like a nasty, uncontrollable case of Southern kudzu. Naturally, more factories required more transportation. Shenzhen became the world's fourth busiest port by 2005.

Within 20 years, market reforms turned a relatively remote city the size of Green Bay, Wis., into an industrial and financial powerhouse on par with Chicago.

Wal-Mart shelves and Christmas mornings in the West have been built on a 90-hour, six-day workweek in the East. The last 20 years of growth have produced more than 90,000 export-oriented processing firms on the mainland, with nearly 70,000 based in Shenzhen's Guangdong province alone.

It's no wonder Chinese officials fear what a slowdown in the export economy may bring. Domestic growth and stability have risen with Chinese workshops. And make no mistake, the first three long-term domestic priorities on Beijing's list are and will remain stability, stability and more stability.

The yuan-dollar peg has gone a long way in ensuring constancy. Chinese economic growth - we would argue, all economic growth - ensues under the auspice of a stable currency.

But ties to the greenback have recently come with a price. American policymakers have facilitated a weak dollar. The Fed, for its part, announced another $200 billion injection on March 11. Its most recent funding equals the $200 billion Bernanke set free on March 7. For its part, the dollar didn't know what to think ($400 billion in four days). Or else, it's in a rather cruel denial.

For the first time since Word War II, owning U.S. Treasuries is a riskier bet than owning German bonds.

On the basis of credit default swaps, which are used to speculate on a government's ability to repay debt, the 10-year note reached a record high of 16 basis points on March 12. German bonds traded at 15 basis points, also a record. A decline in these spreads shows improving confidence in the government's ability to pay... an increase shows the opposite.

"That's certainly eye-opening," writes our esteemed colleague Chris Mayer. "The market consensus is that you stand a greater chance of default investing in U.S. Treasuries than in German bonds."

Officials in Beijing must keep shaking their heads. China holds more than $387 billion in Treasury securities.

For China, a weak dollar makes critical imports (wheat, corn, iron and soy) more expensive. Expensive imports mean higher prices. Higher prices mean more inflation. More inflation means less stability.

Chinese Premier Wen Jiabao addressed the equal and opposite reaction on the other side of the planet.

"The primary task for macroeconomic regulation this year," he decreed, "is to prevent fast economic growth from becoming overheated growth and keep structural price increases from turning into significant inflation."

In his annual policy speech to China's legislators, Wen clearly labeled rising commodity prices and the subsequent food shortages as China's No. 1 policy issue for 2008.

So Beijing finds itself in a bind.

Going forward, yuan appreciation would certainly help alleviate rising prices (commodity imports would be cheaper). Export dependence, however, has thwarted this policy. On the other hand, protecting the export industry by enforcing a close yuan-dollar peg only intensifies further inflation as the dollar continues to slide.

In the meantime, Beijing has turned to price controls. But price controls are nothing more than a short-term stopgap. Price controls disincentivize ample production. Shortages ensue. Prices, therefore, rise even higher.

Beijing may have hope. China's appetite for consumption keeps growing. We see signs that China's GDP growth is no longer so export dependent.

According to The Economist, "The World Bank's latest China Quarterly Update suggests that net exports contributed only 0.4 percentage points to GDP growth in the year in the fourth quarter of 2007. Overall GDP growth slowed only modestly (to 11.2%) because of faster growth in domestic demand, which contributed an impressive 10.8 percentage points."

These recent numbers suggest that the Chinese economy appears to be transitioning into a sustainable form of adolescence. Achieving a more proper balance between domestic production and consumption should enable Beijing to gradually allow more currency appreciation as a means of fighting inflation.

What that will mean for the American consumer remains to be seen. Political threats of more American protectionism combined with a rising yuan won't do much to alleviate John. Q Public's pain. If anything, he'll have to spend more of something he already doesn't have.

On the other hand, companies with assets denominated in Chinese yuan should see a boost. Companies earning profits from people with money to burn (the Chinese) shouldn't do too badly, either.

And I've found a company that satisfies both conditions.

This company owns the franchise to manufacture, market and distribute the products of the Coca-Cola Co. And we're not just talking 7-Elevens on Hong Kong Island. This company also distributes Coca-Cola products in Taiwan, as well as in 11 states in the U.S. and seven provinces in mainland China. This represents a total franchise population of over 420 million people, or, if you prefer, 6.4% of the world's population.

And that's just the tip of the iceberg.

At Free Market Investor, we've warned investors to be very cautious on stocks reliant on American consumers. We stressed shifting focus from companies that produce luxury items (such as Apple, Starbucks or P.F. Chang's China Bistro) to companies that provide staples (such as Altria Group, Budweiser, Coca-Cola, Exxon or Johnson & Johnson).

Even if John Q. Public lost his house and credit card, he'd use that last $20 to buy what he needs. The list would read something like this: toilet paper, Diet Coke and a pack of smokes.

Every month brings us closer to this reality. In February, over 223,650 American homeowners filed for foreclosure. On top of that, unemployment insurance applications increased nearly 20-fold. Investingwise, that puts us back to the basics. Forget the MacBook Air and start thinking consumer staples.

For investors, companies that own or produce revenue streams from tangible assets (rental income), consumer staples (Coca-Cola) or natural resources (oil and natural gas) should prosper. Finding a single company - a conglomerate - capable of producing cash flow from all three seems even better.

That's the beauty of many conglomerates. Conglomerates often operate within a diversified group of income-producing industries. Meaning revenues aren't tied to any one particular division. Diversified income streams typically strengthen a company's margin of safety.

Christopher Hancock
for The Daily Reckoning Australia

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