A survey showed that only 1 in 10 workers say his income is going up. This is the lowest reading since 1946.

Meanwhile, the news two days ago was that homebuilding took a dive in October. Work began on 11% fewer houses than the month before. On multi-family dwellings, the figures were worse - down 35%.

Why would homebuilding go down when the economy is supposedly gathering strength? Well, builders were wondering what would happen when they finished the houses. The new house tax credit was due to expire; they weren't sure the politicians would be witless enough to renew it.

They need not have worried. Give the politicos a chance to do something stupid and they will come through every time. Since the end of October, Congress passed and President Obama signed an extension of the housing credit. Until next April, at least, first time buyers will get an $8,000 credit.

You'd think that would have revived animal spirits a bit in the residential construction industry. But today's news tells us that mortgage applications are falling - even with lower interest rates.

How come interest rates are falling? Well, here again, we see the heavy hand of the feds. The "quantitative easing" has come to a halt...that is, the Fed is no longer buying US Treasury debt (it doesn't need to). But its buying of mortgage backed securities continues. That program will last until March of next year.

Still...housing is not cooperating.

This news hasn't had much impact on Wall Street. All that can be said is that investors have seemed to hesitate for the last couple of days.

Stocks fell softly yesterday, with the Dow down only 11 points. Oil stayed at $79. Gold rose to $1,141. And the euro remained at $1.49.

Investors must still believe in what The Washington Post calls a "lukewarm recovery." It is like finding a body on the street. You feel for a pulse and discover that it has not quite reached room temperature. It is tepid... Not quite alive. Not quite dead.

Too close to the quick to bury...too close to the grave to boogaloo.

Bill Bonner
for The Daily Reckoning Australia

• Housing and Unemployment Are Weaknesses in the U.S. Economy
• Most People Still Think – “You Can’t Go Wrong in Property”
• Economy Free to Recover?
• Aussie Housing Market Actually Leads the U.S. by Three Years
• Take Away Stimulus Spending and You’ve Got an Economy Entering Depression

You have to wonder who is willing to loan money to the United States government - given the state of its fiscal and monetary policies - for thirty years at below 5%. But the Treasury is anxious to auction as much long-term debt now as it can, locking in what it believes are low rates. This is another way of saying the Treasury thinks rates will rise (creditors will ask for higher rates when lending to Uncle Sam).

In the report from the Treasury's borrowing committee to the Secretary, the committee said it was getting a wee bit worried that the maturity schedule of the Treasury debt portfolio could be in trouble if rates go up. Specifically, it wrote that, "The potential for inflation, higher interest rates, and roll over risk should be of material concern."

Perhaps this is why the Treasury and the Fed are considering whether to "move out on the interest rate" curve and try and set rates for longer-term debt. If the market is going to push them up, the Fed will have to push them down (as it has been doing anyway with its purchase plans). Rules are made to broken!

Take the statutory U.S. debt ceiling for example. The Treasury's borrowing committee writes that, "Based on current projections, Treasury expects to reach the debt ceiling in mid- to late- December. However, the government's cash flows are volatile, and forecasting a precise date is difficult. Treasury is working closely with Congress to pass legislation to increase the debt ceiling. We will keep financial market participants apprised of developments as the debt outstanding approaches the statutory limit."

In other words, the jack asses in the U.S. Congress will have to pass a new law allowing the Treasury to borrow more. This would be comical if it weren't so disgraceful. U.S. monetary authorities continue to tell the world's savers that the U.S. standard of living is not negotiable, even if it means increasing public sector debt to over 100% of GDP.

But the world's creditors may not be in the mood to negotiate anyway. We think the rise in gold is one example of creditors deciding there are better things to do with their money. And in the meantime, take a look at the graph below from the Quarterly Refunding Statement of the Treasury's Office of Debt Management. It's a doozy!

Click to enlarge

Sorry about the size. We had to reduce the chart to get the whole thing in. In case you can't read the fine print, it says that in the next five years, there will 73 days on which more than $20 billion in Treasuries mature and 46 days on which more than $30 billion in Treasuries mature. That's 119 days of major league reckoning.

Normally, that debt is simply rolled over as a new (or often the same) buyer refinances it. But what do you think will happen in the next five years? The U.S. will be borrowing more and more and probably at higher rates. Our guess? It won't be good for the dollar.

Dan Denning
for The Daily Reckoning Australia

• Federal Reserve to Buy $300 Billion In U.S. Treasury Bonds
• Australia to Borrow as Much as $300 billion
• One Year Treasury Bills to be Reissued by Bush Administration
• Every Member of Congress Gets a Copy of I.O.U.S.A.
• U.S. Government Must Roll Over $3.4 Trillion in Debt Over Next Four Years

If you want to attend the presentations and discussions over the next four days, you can still do so. But you should contact conference organiser Marcus Matthews today. You can reach him via email at feketeaustralia@gmail.com. And if you're there on Sunday, be sure to say hello.

Yesterday we promised to show you how the funding model for the fiscal welfare state is blowing up. But this is going to have to wait at least another day. Don't worry though. It's not going anywhere.

Today, there is a banking story to cover. You recall that yesterday we were worried about the next banking crisis. But the lingering effects of the last one are still with us. National Australia Bank reported a 43% fall in net profit yesterday. Ouch.

Don't feel too bad for NAB. Net profit fell from $4.54 billion to $2.56 billion. But the bad and doubtful debts charge for the year grew by 53% from $2.49 billion to $3.82 billion. With $654 billion in assets and $616 billion in liabilities, the bank is sitting on $37.8 in equity. A few billion in bad debts and loan losses won't wipe out that amount of equity.

But it's worth noting that NAB's total assets are 17.3x times equity. This isn't as high as some leverage ratios in the U.S. just prior to the banking crisis in 2008. But it's not far off where NAB was at the time. And there are two further risks worth mentioning.

First, as the IMF paper on Aussie banks concluded earlier this year, Aussie banks are probably strong enough to withstand a normal shock to the balance sheet. That is, the IMF stress-tested Aussie banks for losses on their two largest loan portfolios - corporate loans and mortgages. The IMF concluded the banks were adequately capitalised to survive the shocks it tested for, but that, "The above shocks do not constitute a rigorous stress test and the results are only indicative of the health of the banking sector."

If we've learned one thing in the last two years, it's that bankers and analysts have consistently underestimated the frequency and magnitude of systemic shocks. That doesn't mean the IMF conclusions aren't to be trusted. But it means in the event of another more severe shock, the banks could face larger asset writedowns and losses than the IMF has modelled.

This brings us to the second risk worth mentioning. A bank facing bigger loan losses takes fewer risks. It reduces lending. This is how the credit crisis was transmitted from America's housing market to Australia's economy. The Aussie banks had to tighten up to prepare for losses on overseas assets.

Next time around, though, we reckon the losses - when they come - will be on domestic real estate assets. And with so much exposure to domestic real estate (mortgage loans), the assets could face a world of hurt. But even if bank asset quality doesn't crash (housing prices don't crash), an external shock affects Aussie bank liabilities.

The IMF report says that, "On the liabilities side, however, banks had sizable short-term external debt obligations, and access to offshore wholesale markets was disrupted by the Lehman Brothers collapse in September 2008." Of course the government's wholesale funding guarantee eased the pain of this shock, which is one reason why that guarantee may become permanent in all but name.

But the IMF wrote that, "A key remaining vulnerability is the roll-over risk associated with sizable short-term external debt. Banks' wholesale funding (domestic and offshore) accounts for about 50 percent of total funding, of which about 60 percent is offshore. Financial institutions short-term external debt (on a residual maturity basis) is estimated by staff at about $A 400 billion (35 percent of GDP) in March 2009."

Maybe the short-term external debt levels have improved in the last six months. We haven't checked yet. But in simple terms, it means a lot of domestic lending is funding from external funding, borrowing abroad to loan at home. If American banks again blow up on the destruction of their remaining collateral (mortgage loans and U.S. Treasury bonds) we'd predict another ice age in global credit markets.

Needless to say, as a capital importer, this would put Australia in an awfully uncomfortable spot. But hey! No one is worried about that at the moment. The Aussie dollar is being inflated by the U.S. dollar carry trade. It's a shame that the strong Aussie is going to devastate local industry and manufacturing with higher costs, but at least it obscures for now the risk that Aussie banks are reliant on foreign borrowing.

In the bigger picture, this means the investment needs of the economy can't be met by household savings alone. But that's an even bigger problem than we can address today. So we won't!

More cow bell!

And what about our theory that a U.S. dollar rally will trigger a correction in gold, oil, and stock markets and lead to a mini-rally in U.S. Treasury bonds? Bond fund king Bill Gross agrees. Writing on Pimco's website, Gross concedes, "Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets -- while still continuously supported by Fed and Treasury policy makers -- is likely at its pinnacle."

Dr. Doom himself, analyst Nouriel Roubini, called the present market "The mother of all carry trades." "This asset bubble is totally inconsistent with a weaker recovery of economic and financial fundamentals," Roubini said via satellite to a conference in Cape Town, South Africa. "The risk is that we are planting the seeds of the next financial crisis."

With the S&P up nearly 65% since touching 666 in March (seriously), we'd say the seeds are already bearing fruit. But maybe it's poisoned fruit. After all, the rally has been worldwide and extremely impressive by historical standards. But it's fully consistent with previous bear market rallies. If anything, it's happened faster.

What nobody yet knows is if it IS a bear market rally...or a garden variety stock market rally that precedes a recovery in the economy. You know what we think.

There IS one notable difference between 2008 and today, though. Yesterday we mentioned that U.S. banks have loaded up on a whole other kind of super-dodgy collateral; U.S. Treasury notes and bonds. Demand for those securities may go up with a U.S. dollar rally and a reversal of the dollar carry trade. But in the longer-term, we think the banks have invited another toxic house guest on to the balance sheet.

But where did the previous smelly houseguest go? You know, all those mortgage backed securities and subprime loans? Where does that risk now reside? And what happens if it comes home to roost?

According to this report by the San Francisco Federal Reserve, over 95% of all new residential mortgage lending in the U.S. is now being backed directly by the U.S. government. With the banks unable or unwilling to lend, Uncle Sam has become the sugar daddy of the U.S. mortgage market. See the chart below.

The Fed supports this market by purchasing the securitised mortgages issued by Fannie and Freddie. The Congress funds the agencies which make the loans available. But no matter how you slice it, the U.S. government is supporting the housing market. It will continue to do so as a political imperative.

But by taking on this massive liability - not that it doesn't already have its hands full - the Fed is further consigning the dollar to the scrapheap of history. Do you think foreign creditors will not realise that the U.S. is borrowing money to keep house prices elevated? Will they not notice that the U.S. is printing money to do this? And what will happen to the dollar then? And gold?

The truth is that creditors already do know this. Today's Australian Financial Review reports that overseas Chinese investment is "surging." Chinese policy makers are trying to trade dollars for tangible assets or equity in resource shares as quickly as possible. "China reported a 190% jump in overseas investment by its companies for the third quarter."

"Policymakers might be encouraging Chinese firms to invest abroad, in part to help counter pressure for the nation's currency," the article continued. "Investors are betting on the yuan to appreciate as China's growth accelerates from its weakest pace in a year."

Most currencies that are not the U.S. dollar could appreciate in the coming years. Australia's currency has already done so. Brazil is considering a tax on capital flows into the country in order to prevent investors from speculating on a further rise in its currency by buying Brazilian assets. And of course speculators have tried for years to find a way to position themselves for an appreciation in China's currency. China's capital markets are not friendly in this regard, although Hong Kong stocks remain a popular option.

The fact that countries like Australia, China, and Brazil are trying to limit currency appreciation versus the greenback shows you how unbalanced the world economy still is, how unprepared it is for the reality that America's deleveraging will take place for years. Households and businesses must save and repair balance sheets. Some other country is going to have to consume what the world produces.

In the interim, the U.S. government will increase deficit spending to make up the difference. It is the stupidity of Keynesianism to support aggregate demand when what everyone needs is a correction and a recovery. But all the Feds will succeed in doing is blowing up the balance sheet of the U.S. government in spectacular fashion. Go gold.

Mind you we still think the short-term move is a dollar rally and some profit-taking on the dollar carry trade. We asked Slipstream Trader Murray Dawes what he sees when looking at the U.S. dollar index. Murray spends most of his time finding trading opportunities in Aussie stocks. But he also knows that Aussie markets (and capital flows) are still massively affected by what's going on in America.

Murray wrote that, "If we look at this chart of the US Dollar index going back to 1985, you can see quite clearly that the 10 week moving average crossing over the 35 week moving average has been a very good indicator of the trend. There are only a few instances over that whole time period where this indicator gave a false signal."

Click to enlarge

"Therefore," Murray continues, "we should be keeping an eye on this indicator going forward to tell us whether the US Dollar index has turned back up and is ready for a counter trend rally. The short US Dollar trade is getting pretty full, as I have mentioned in the past. And there is a high correlation between the direction of the dollar and the direction of gold, oil and stocks.

"The US Dollar has taken over the Yens role of funding the carry trade and this will be the situation for as long as the Fed remains too scared to raise rates, which seems to be for the foreseeable future. So we can probably expect the dollar to weaken further over the long term, but a counter trend rally (short squeeze) may be closer than people think and this would lead to weakness in commodities and stocks.

"When should we trade this move? Well have a look at the chart again. Notice the false breaks that keep occurring when the all time lows get breached (denoted by the numbers 1,2,3). With the trend still strongly down we can expect to see either a false break of the lows around 71 reached last year or if that doesn't occur then a crossover of the 10 week/35 week moving average to confirm that the trend has changed. Trading the move before either of these are confirmed would be jumping the gun."

Murray is tracking which Aussie stocks will move if and when we see the dollar index break out. We'll keep you posted.

Dan Denning
for The Daily Reckoning Australia

• Rally in Stocks and Rise in Aussie Dollar is a Result of the Carry Trade
• IMF Report Concludes Aussie Banks are “Very Sound”…
• A National Mortgage Bubble
• Australian Banks Must Increase Fees or Expand Loans to Remain Profitable
• How Did Australia Get Caught Up Losing Money in Commercial U.S. Real Estate?

If you didn't catch yesterday's episode, you missed maybe the single most important piece of advice ever published in the Daily Reckoning: do nothing. Or, to paraphrase Nassim Taleb, "Negative advice is vastly more important than positive advice." Knowing what not to do in a dangerous environment promotes your survival. Improving your quality of life comes later, if you're still alive.

Some examples? Don't touch a hot stove. Don't eat stuff that's been on the floor for longer than three seconds. Never start a land war on Asia. Don't sweat the petty things. Don't pet the sweaty things.

Even some of the most important laws for the organisation of a free but ordered society are negative laws. "Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the government for a redress of grievances."

In a leveraged financial world with insider trading, corruption, incompetent regulation, and industry advice not aligned with your own best interests, don't count on the "experts" to tell you what to do. But let's talk specifically about what not to do before what we talk about a smaller portfolio of assets that ARE worth risking your capital on.

Don't buy the A-REITs. That's pretty simple. The group is talking itself up again, and the press is following suit. Granted with an average dividend yield of 8.1%, and after taking losses and write downs of nearly $40 billion last year, the sector is deceptively attractive. It doesn't mind saying so itself.

"Australia stands out like a beacon because the yields here are much greater than other parts of the world," says AMP Capital Brookfield chief investment officer Kim Redding. He tells Bloomberg that, "If you like the Aussie dollar and you like yield, Australian LPTs would be a pretty good place to be."

The logic of the trade is that the A-REITS have taken their losses (mostly on foreign commercial real estate assets) and recapitalised through debt and equity markets that are no longer so tight. But if you're long the A-REITS, you're also assuming there won't be any further losses on a portfolio of Australian real estate assets, and that there won't be any more funding problems for the sector.

Those are two pretty big assumptions. And you know what they say about assumptions. Besides, if you wanted to speculate in the A-REITS, the time to buy them was 73% ago in March, when the S&P 200 A-REIT index was trading at 546. Now it's trading at 950. Over in the research and analysis wing of our new mansion/headquarters, Kris Sayce and Shae Smith are preparing a short report on "5 time bomb property investments to dump now." We'll keep you posted on the results.

That's what not to do. But what about doing something? We'll get to that in second. Just one more quick point about what not to do.

We often cop it from frustrated readers for being a sceptic and critic of fiscal stimulus and deficit spending, but with no constructive solutions to "all the problems" of our own. We are all talk and no action. All doubting Thomas and no economic Saviour. But that criticism is lame, and vastly discounts the innate resilience of free markets and free people to recover from financial decisions that did not work out.

Left unmolested by know-it-all bureaucratic busy-bodies, free markets and entrepreneurs are remarkably resilient and self-adjusting. Businesses make investments and hire people and then reckon up a profit or a loss. Loss-making investments are ditched and products or services that actually serve customer's needs are modified and amplified.

But when the government steps in to prop up loss-making enterprises (investment banks, money-centre banks, non-bank property lenders who can't self fund) it promotes and perpetuates bad investments. This ties up capital in ventures that don't generate jobs and misallocates society's resources (human and real). It's also a way for politicians to line the pockets of their friends and campaign contributors.

When we say the government should "do nothing," we mean it should allow bad businesses to fail. It should not prop up investments at artificial values and directly support bad corporate managers and risk takers, even if they are good friends from the country club.

If it allowed mistakes to be realised, the market and the economy would adjust quickly and get back to the business of business, rather than the business of maintaining a lousy status quo. And taxpayer money robbed from the capital markets would go, in the form of available savings, to small businesses in the trenches of the real economy creating real jobs.

Now, on to doing something with your share portfolio. We'd like to draw your attention to the bidding war taking place for two separate Aussie resource firms, Polaris Metals (ASX: POL) and Rey Resources (ASX:REY). Mind you we haven't recommended them in Diggers and Drillers, nor are we recommending them here.

But our point about them today is that both are the types of investments you might make if you were building a portfolio of risk assets where the low-probability, high-magnitude event (the Black Swan) that the firm is aiming for is massively positive, and not cataclysmically destructive.

Polaris is mostly an iron ore play. Its chief project is the Yilgarn iron ore project in Western Australia. It reckons it has a 42 million tonne resource at an average ore grade of 58% iron. The bonus is that three of the five tenements have been drilled before and the entire project is close to both rail and port infrastructure, which significantly lowers the capital costs of getting it off the ground.

Polaris finds itself in the middle of a bidding war between Singapore-based Lion-Asia resources and former D&D pick, Perth-based Mineral Resources (ASX:MIN...It's a former pick, by the way, because we sold it at a profit.) Both bids take into account that Polaris is an exploration play. But both bids obviously place a premium on high-grade, low-cost iron ore deposits in WA that are close to infrastructure and not already owned by BHP, Rio Tinto, and Fortescue.

The long-term insight here is that even though contract iron ore prices are headed down this year and perhaps next, Asian steel-makers (especially the smaller ones) are still looking to lock up long-term access to Aussie ore...and they're willing to pay for it. If you find the right exploration asset as a small-cap resource investor, you can ride the share up as the bidding war does its work.

Rey Resources is sitting on another bulk commodity asset (thermal coal) that's facing a down-year in contract price terms but many years of higher prices, thanks to demand from India and China. Rey has been presented with duelling bids from Crosby Capital, which values Rey's coal tenements at around $35.5 million, and India-based Gujarat NRE Minerals.

Rey owns exploration licenses on areas highly prospective for thermal coal. Thermal coal is coal burned in power plants to make electricity. By the way, China and India are going to burn Australian coal no matter what kind of Emissions Trading Scheme the government conjures up. Rey reckons it has a 500-million tonne coal resource. And that alone-a mineral deposit of a highly-valued commodity headed up in price over the long-term-is attracting interest.

Details of both companies and all four bids aside, this is clearly the kind of high-risk worth investigating, and, from time to time, taking. Because these are exploration assets and because the value of the underlying commodities changes, valuing the mineral deposits and the companies is like shooting at a moving target. But the important investment point is that the target is moving up.

Speaking of Chinese and Indian demand for Australian coal and iron ore, third quarter Chinese GDP figures come out this week. Look out! Will it be 9% again? Odds are it will be. China's official statisticians also release figures on retail sales and industrial production this week.

Like all statistical releases from major economies, we are highly distrustful of official numbers. But the numbers do have an effect on market sentiment. And a bullish lead from China will contribute to the idea that the recovery (especially here in Australia) is taking hold and will sprint ahead in 2010. This could send the All Ords over 5,000 in short order.

But a word of caution: the insiders are selling. Barron's reports that's insiders at Leucadia National (NYSE:LUK) $47 million worth of shares in the last month. Leucadia is a bit of a poor man's Berkshire Hathaway. It's a holding company run by professional investors with an eye for value. Barron's reports that chairmen Ian Cumming, who owns 10% of the company, sold about 850,000 shares for nearly $22 million on October 13th.

There a variety of reasons insiders sell. Just because an insider is selling doesn't mean he's bearish on his own stock or that he thinks his shares are overvalued. But if they're optimistic and things are going well, how many business owners sell their equity?

Some reader mail. Send your comments, questions and disparaging remarks to dr@dailyreckoning.com.au

Dear DR,

Larry

--Hi DR,

Bob B.

We'll look into Bob.

--Hello DR,

Graham D.

Great question Graham. Investors have been trying to play the expected appreciation in the Yuan for ten years. But it hasn't happened yet. More on this subject this week. This is one of those major asset allocation decisions that, if you get right, can make you look like a genius.

Dan Denning
for The Daily Reckoning Australia

• The Australian Resource Boom Isn’t Dead Yet
• BHP Billiton (ASX: BHP) to Report Second Half Results Today
• Australian Iron Ore Shares on China’s Menu
• Australia & China: Already Partners in the Commodity Boom
• Australian Recession in the Works? Ask the Sharemarket

Then, word came that even Alan Greenspan thinks a recovery is underway.

"This is what a recovery looks like," said the maestro. That settled the matter as far as we are concerned. Alan Greenspan didn't see history's biggest financial bubble until it exploded in his face. In the following few words we undertake to show that Greenspan is as blind as ever.

"Great time for US consumers, America is on sale," says an item at YahooFinance. The "discounts are unbelievable," adds a blogger known as Frugal Rhode Island Momma. All across the nation, merchants are no longer selling the merits of their products; they're selling price. McDonald's advertises its "dollar meals." Hotels have cut room prices by 20% in the last year. House prices are down about 30% since 2006. Sellers are offering bargains and they want buyers to know it. "Sold for $365,000 in 2006. Now $195,000," says a typical house ad.

Foreigners have noticed too. Colleagues in London say they are thinking of moving to Florida where they will get far more for their money. The dollar falls; foreign purchases go up. Stocks, for example. In the first quarter, foreigners were unloading US shares. Now they're buying more than $100 billion worth per month.

It is a deflationary world, at least that part of the world between the Rio Grande and the 49th parallel. The CPI in the United States is negative and falling faster than at any time in 59 years. Households can only be induced to spend money by cutting prices. "Cash for Clunkers" cut prices on new cars by about 20%. As soon as it ended, so did auto sales. Most new house sales could be traced to a tax credit - which reduced the down payment by at least 20%. That program is scheduled to end in November.

And now, the White House frets about jobs. Unemployment is supposed to be a lagging indicator, but this time it seems to have dropped out of the race all together. Still, Congressional elections are coming up. Unemployed voters are surly and unreliable. So, the Obama administration is considering a $3,000 tax credit to bribe businesses to hire them. If the typical employee costs his firm about $40,000, this effectively reduces the cost of labor by 7.5%.

It's beginning to look more and more like the Roosevelt years. By the end of this year, all the jobs created during the bubble era - 2002- 2007 - will have been eliminated, making it the first decade with no job growth since the '30s. We're expecting a fireside chat any day.

Typically big businesses cut workers in a recession. Then, when the economy recovers, small businesses are quick to take them back. But this is unlike the typical post-war recession. This time, deprived of capital as well as customers, small businesses don't have a chance. Neither does a genuine recovery.

The authorities still do not understand what is going on. They are used to fooling most of the people most of the time. They think they can dupe them again - with bailouts and boondoggles. But real demand has vanished as households try to pay down their debt. That is not going to change anytime soon. Not while the federal government is sabotaging a genuine recovery. It's savings - capital - the US economy needs. A capitalist economy in which the capitalist have no capital won't work. Why is there no capital? Because the feds take it.

Supplying cash-for-this and cash-for-that is an expensive proposition, especially when tax receipts are falling. The money has to come from somewhere. As it turns out, the feds borrow it from the very people who are trying to rebuild their personal balance sheets. Of the $1.6 trillion the US government will borrow this year, the biggest single lender is the private sector, chipping in $700 billion. But instead of being put to use in a way that might stimulate a real recovery - providing credit for small business and consumers - it is taken up by the US government and then frittered away.

The banks are happy to play the government's game too. They can borrow overnight money from the Fed at only one quarter of 1%, annualized. But lending to small business is hard work. And it is risky. Why bother? The US Treasury will pay them 4 % for lending back to the government, long term. This is practically free money to the banks. Both the bankers and politicians end up ahead - with a bigger piece of the economy under their control.

Meanwhile, the real economy staggers. "Drought of credit hampers recovery," summarizes The Wall Street Journal. The United States needs to create a million and a half new jobs each year just to keep up with population growth. Currently there are 15 million people without jobs already...and a couple hundred thousand more unemployed every month. And if this recovery continues long enough there won't be a single person left in America who still has a job.

Even if the economy could be stabilized, it will leave millions without jobs - more or less permanently. Add the people working reduced hours, and those who have been looking for work so long they are no longer counted, and their families, and you have a quarter of the population without money to spend. That's why this slump is not going away any time soon. As in Japan in the '90s, we may have to live with this depression for the rest of our lives.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• Normally Small Businesses Lead the Economy Out of Recession
• The Business Bankruptcies and the Personal Bankruptcies
• Where, Exactly, is this Economy Headed?
• Feds Can’t Cause a Genuine Recovery Simply by Throwing Money into Economy
• There is No Real Economic Recovery Taking Place

We were thumbing through the transcript last night over some sashimi and a beer and highlighted this passage from Dr. Steve Keen: We are told that for example debt doesn't matter because if a company takes out a certain level of debt, say a very low level of say 10% debt to equity, that's irrelevant to the company's value because the person buying shares in that company can take out 90% debt to equity ratio."

"Therefore you're told the Modigliani-Miller proposition, after the two morons who got the Nobel prize for it, was that the level of debt that a company takes out does not affect its value. And those sorts of propositions are strewn through conventional economic theory, and of course people like Alan Greenspan and Ben Bernanke are experts in that very same theory."

See? Bernanke...Greenspan...morons, all of them! Debt does matter. And so do deficits. Just this morning we read that U.S. President Barack Obama will ask the Senate to lift America's statutory debt limit to $13 trillion. It's at $12.1 trillion at the moment.

The lower legislative body of the Congress, the U.S. House of Representatives, passed a measure lifting the debt ceiling earlier this year. But it used a parliamentary trick to do it in a manner which did not require a roll call vote. No jack asses had to go on the record.

The Senate is different. There are just 100 of the grumpy old men and women. And to increase the debt ceiling to accommodate annual deficits of over $1 trillion for the next ten years (it's $1.6 trillion this year) the Senator will have to go on record. Spending other people's money is generally easy (and probably kind of fun). But not when you have to publicly commit to it and "own" the debt. No one wants to own it, even though everyone wants to benefit politically from the spending (sound familiar?)

The investment fallout from the record U.S. debt and deficits is continued pressure on the dollar and $1,000 gold. Old yeller metal dragged itself up $2.50 in the futures markets to close over the $1k in New York trading last night. Gold has done this despite a 50% rally in stocks. We reckon once the punters catch a little gold fever - which they will if it can hold the line at $1,000 for a few days - higher highs will follow.

And let's not forget large owners of dollar-denominated assets like stocks and U.S. Treasury bonds. Do you reckon they're getting a touch nervous? Cheng Siwei, a Chinese official attending a conference at Lake Como in Italy, said he was worried about the Fed's indefinite policy of credit easing.

"If they keep printing money to buy bonds it will lead to inflation," Chen said. "And after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies... Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the markets."

In the meantime, why not try iron ore and uranium? Reuters reports that, "Chinese state-owned firms expanded their footprint in Australia's mining industry on Tuesday, agreeing to help fund two iron ore explorers in return for supply contracts and taking a controlling stake in a uranium prospector." The iron firms involved were FerrAus United Minerals both of which formed relationships with China Railways Materials Commercial Corporation. The uranium deal was between China Guangdong Nuclear Power Holding Co. Ltd and uranium prospector Energy Metals.

These deals are probably both operational and strategic. They're operational to the extent that in exchange for capital, Chinese firms get long-term supply contracts (price certainty) for key minerals and bulk commodities. They're strategic to the extent that State-owned firms can channel U.S. dollar reserves into tangible assets. This slightly reduces China's risk to the inevitable devaluation of U.S. debt securities through inflation.

Getting back to Cheng, he seems to understand exactly what happened over the last five years. Loose credit is the problem. "This is where Greenspan went wrong from 2000 to 2004," he said. "He thought everything was alright because inflation was low, but assets absorbed the liquidity." He's talking about real estate and stock markets.

He's also talking about the psychological and moral attitude in a country that's obsessively focuses on preserving its immediate lifestyle at the expense of future investment and growth. "The US spends tomorrow's money today...We Chinese spend today's money tomorrow. That's why we have this financial crisis."

Of course whether your Chinese, American, or Australian, it's everybody's crisis now. So what should you do?

Inflation has yet to really rip through the commodities sector. As Bill pointed out yesterday, the U.S. dollar has yet to really crash. It may do so only gradually. U.S. creditors are not exactly easy to cause a run on the dollar. They have a lot to lose. And we know the Fed and Tim Geithner and Barack Obama want a gradual devaluation, not a dollar crisis.

Will they get what they want? We don't know. But we reckon the Law of Perverse Outcomes applies here: people get not what they expect, but what they deserve.

For investors, we'd say again that markets are priced for earnings growth that we think won't materialise. It's wishful, almost nostalgic thinking. That means you should be on your guard for locking in paper gains since March with trailing stops. We're pleased that Gabriel Andre is just about ready to debut his new ASX 200 blue-chip timing service this week. The aim is to track the chart patterns and technical trends on the biggest Aussie stocks in order to avoid buying at the top.

But the big benefits - he hopes to prove - are the ability to take profits on long-term holdings and avoid the big declines we've seen over the last two years. Then, using the same analysis, Gabriel believes you can time your entry back into the same stocks. It's quite a proposition.

Of course, anything that looks or sounds like market timing probably makes a buy-and-hold investor really nervous. But it's time to question the conventional wisdom that buying and holding blue chip stocks is a guaranteed retirement strategy. It's not.

If we've learned one thing in the last two years, it's that the stock market is not a retirement machine. The name of the game is to generate gains. And we are at least open to the idea that it may be possible to make better gains as a medium-term trader of ASX 200 stocks than simply buying and holding for grim death.

On the other hand, there are some very exciting disruptive energy technologies that have a huge upside if you can stomach the risk. Woodside Petroleum Don Voelte took a swipe at those technologies in a recent article published locally. And for good reason. He's got a bit to worry about. More on disruptive energy technologies tomorrow...

Dan Denning
for The Daily Reckoning Australia

• American Family’s Share of Government Debt Now Over Half a Million Dollars
• The Very Large Bubble of Government Debt
• Uranium: A Carbon-friendly Substitute for Coal
• In a Bear Market Most Stocks Go Down, So What Do You Do?
• Choking on Debt in the Unfolding Anglo-Saxon Bond Crisis

Harassing us!

Recall that last week, we reported the latest news on the SEC. Investigators wondered why the agency had let Madoff run billions in suspicious trades without ever checking them out. The SEC responded by saying it lacked sufficient resources. Then, New York Senator Schumer said he would propose a measure to increase the agency's spending power by 75% - by allowing it to shake down the financial industry directly, rather than going to Congress for a budget allocation.

Which still leaves open the question of what the SEC was doing when it should have been making Madoff do the perp walk. We have the answer: the SEC was harassing us.

Yes, hard to believe that they would target your poor, innocent editor. And they didn't, not directly anyway. Instead, they targeted one of our colleagues. This was a couple of years ago...when Bernie Madoff was at the top of his game.

We haven't mentioned it in this space...on the advice of our lawyer. Judges don't like it when you "try a case in public." And the case still isn't settled.

But we won't discuss the merits of the case...only the circumstances around it.

This will help us understand what the SEC is really up to...and why the hope of regulating fraud out of existence is as vain and futile as trying to clear out a bar by using foul language.

Here's what happened. One of our researchers discovered what he thought was a great investment opportunity. He called the target company and spoke to a VP in charge of public relations. What he heard convinced him that he was on to something, so he published a recommendation, sending a copy of it immediately to the company.

He got no response from the company. But a few months later, the SEC knocked on our door. What was their beef? That we had misled investors. How so? In our report, we told readers what the VP had told us. We carefully called it "insider" information...putting the word in quotes to let readers know it wasn't the same as the forbidden 'inside information.' Anyone could have found out the same thing if he had just called the company, read the published reports, and put two and two together.

Our caution was lost on the SEC. They didn't see the difference between "insider" information and inside information. What's more, the fellow at the target company denied he had said what he had said. Curiously, he made no objection when the report was published; the objection came after the SEC started snooping around.

The SEC wanted blood. They thought they could get an easy win against a little guy in Baltimore. They wanted us to turn on our own associate...to stop defending him and cop a plea. Obviously, we couldn't do that. We stood behind our man.

Then came a quirky turn of events. Both the researcher and your editor's company were charged with what was effectively a new crime - a federal case, no less. The SEC, remember, is supposed to be protecting investors from stock fraud, manipulation, and 'insider trading.' But there was never any allegation of manipulating a stock or insider trading. Instead, the agency charged us with NOT having inside information. We never traded in the stock at all...or manipulated it in any way. So the feds alleged that we did not have any inside information to trade on...and that therefore our representation - of having "insider" information (in quotes!) - was a kind of fraud.

And the whole case turned on a telephone conversation between a stock market analyst and a public relations guy in a company. One said one thing; the other said another thing. Reporters make mistakes all the time; so do their sources. But this was the first time the government made a federal case out of it.

We believe our analyst. The SEC believed the other guy and spent millions trying to prove that our fellow lied. No one who bought the research report on the stock complained, let alone threatened a lawsuit. Prior to any SEC probe, refunds were issued to anyone who asked (most did not). Yet the SEC, protector of the public interest, spent years...and millions...on the case - while Bernie Madoff was stealing billions from his clients.

Case against your editor's company: judges ruled that we were innocent.

Case against our colleague: still undecided at the appeals court.

Case against SEC: guilty of negligence, dereliction and humbug.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Madoff Astonished SEC Didn’t Verify His Claims
• Rising in Defense of Goldman Sachs
• Social Security a Bigger Scam Than What Bernard Madoff Schemed
• Real Estate Brokers: The Latest Victims of the Housing Crunch
• Bernie Madoff and the SEC

So how does she quantify "relative peace and security"? Well, one good way is to look at the value of the dollar, which would be strong if the country was a good investment, which it was, and in fact, "It had not only retained one hundred percent of its value, it had gained eleven percent. That's right. The dollar we started with in 1776 bought us eleven percent more after almost seven generations."

Then, on the "quiet 23rd of December in 1913", J.P. Morgan and buddies got Congressional quislings to pass legislation authorizing the creation of the Federal Reserve, and to which I add that the jerk Woodrow Wilson then signed it, thus going down in history as the disastrous guy who set in motion the destruction of the dollar by the Federal Reserve creating excess money and credit.

She doesn't make a point of it, but back then, the dollar was still gold, and thanks to the loathsome Federal Reserve creating the money to finance the bubbles of The Roaring Twenties that resulted in the Great Depression, the despicable Supreme Court infamously ruled in 1933 (and upheld by every traitorous Supreme Court case since then) that, contrary to what the Constitution said, the dollar did not have to be made of silver or gold, and that a paper "fiat" currency could be created, without limit, for any reason, even at a mere whim, anytime, day or night, 24/7, including holidays, not realizing that they were the idiots that REALLY destroyed the dollar! Gaahhh!

With this kind of disastrous stupidity, I dryly and humorlessly ask that you don't talk to me about any "wisdom" emanating from the Supreme Court.

I was hoping that Ms. Lilley would spontaneously pick up on the theme of "heap scorn on the Federal Reserve for creating too much money and credit out of thin air and the despicable Supreme Court for letting them."

I was going to suggest that she could, you know, maybe even put in an endorsement for the Mogambo Mindless Mob (MMM) brand of products, like the popular Mogambo Pitchfork (very effective when brandished threateningly) and the classic Mogambo Flaming Torches that will be so hard to get when the proletariat bozos start forming mindless mobs bent on revenge after so much hurting from the horrifying inflation in consumer prices, the pervasive, lingering economic depression, ruination, bankruptcy and the embarrassment of realizing that it was caused by the people we elected to Congress, who picked the people to run the Federal Reserve, which is the biggest failure one can imagine and should be immediately abolished, how Ben Bernanke, its chairman, should be turned over to me for some sessions at my new Mogambo Re- Education Center, where our muscular, trained technicians will slap the hell out of his stupid face, and the stupid faces of Congresspersons (except Ron Paul), and the stupid faces of anyone who still believes in getting, or giving, a free lunch to, or from, anyone, especially the government, which is so corrupt that it once gave smallpox-infected blankets to the American Indians, which is only marginally worse than destroying the currency of the country and makes you reflexively scream in horror every time you see the money supply go up.

Well, it does me, anyway.

Instead, she goes on that the result was that since then, "the purchasing power of a dollar has plummeted over 95%", which means that "We now pay twenty times more than J.P. Morgan did for any item." Yikes!

Suddenly, my ears pricked up as she said, "Few have written on the mechanics of getting back to sound money", which I immediately noticed makes me a genius, meaning that people should worship my gigantic brain, my wife and kids should stop calling me "idiot" and saying how much they hate me and maybe I should get a Nobel Prize.

The reason I am suddenly so enamored of my intellect is that achieving a "sound money" is the easiest thing in the world! Just stop creating more of it! That's all you need! It's simple! It is my Profound Mogambo Genius (PMG) that has solved the puzzle!

Okay, I am embarrassed that I got carried away there, and I admit that I am not very smart, and that is why I stole the whole idea from the fact that this is all the gold standard did; it prevented increases in the money supply, and the only thing that Congress had to worry about was doing smart things so that gold came into the country (increasing our money supply) and not doing something so stupid that it went someplace else better (decreasing our money supply).

But those days are all over now, and the only people who are buying gold, along with silver and oil, are the people who know what happens to an unsound, fiat currency (like the dollar) in the hands of a government composed of a bunch of socialist, commie-think yahoos (like the US Congress) that willingly deficit-spends insane amounts of money thanks to a central bank (like the Federal Reserve) creating it and a population sitting around saying, "Duh! Okay with us!" Hahaha!

We're freaking doomed!

Until next time,

The Mogambo Guru
for The Daily Reckoning Australia

• Gold in the Art of Bread Consumption
• Federal Reserve Has Destroyed the Economy
• A Government of Spendaholics
• Oil Prices Has The Mogambo Guru Sticking His Thumb in His Eye
• Greenspan and His Demented Federal Reserve Chairmanship

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

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

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

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

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

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

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

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

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

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

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

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

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

Until next time,

Bill Bonner
for The Daily Reckoning Australia

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

According to the popular version, Ben Bernanke, our flawed hero, has averted a Second Great Depression. When the crisis came in '07-'08, he calmly took out the text he had written himself: "Dummies' Guide to Avoiding a Japan-style Deflation"...or something like that.

Then, he followed his own theory...coolly...confidently...cutting Fed rates down to nearly zero, pushing Congress to pass a huge 'stimulus' bill, and even forcing Bank of America to take over Merrill Lynch. In this last event, he is accused of deliberately hiding Merrill's enormous losses and then threatening the BofA board with dismissal if they refused.

Because of Bernanke's swift and assertive action, the nation's banking system held together during those critical weeks of late 2008. And because of his monetary (and fiscal) policies, all the worlds' economies are now in some stage of recovery. Stocks are rising. House sales are increasing. All the indicators point to a better world.

In recognition of the fact that he saved the world, Ben Bernanke was given the nation's highest honor; Obama picked him to continue as head of America's central bank, the Federal Reserve...even though his predecessor, a Republican, appointed him.

Everyone needs a story. It's the way we understand things. Data is just data. Numbers are just numbers. Facts are just facts. Without the framework of a good tale to hold them together, they are worthless.

That's why, here at The Daily Reckoning, we are suspicious of facts, data and numbers. As for the numbers, they are wrong before they get to us...often intentionally. Then, when they are later straightened out, they sometimes tell a completely different story. Even the 'facts' often turn out to be not facts at all...but distorted data, information has been twisted to fit into a storyline.

The more precise the data, meanwhile, the more they lie. Give us a CPI rate of 6.24% and we will give you back two numbers that are total fictions...and another one that turns out to be wrong later. As for the GDP growth rate...don't even bother to give us a number at all. Whatever the digits say, it's a lie.

This week came news that the GDP is falling at a 1% rate. This number surprised economists. They thought it was falling at a 1.5% rate. This better-than-expected number encouraged investors to buy stocks; the Dow rose 37 points yesterday. Oil and gold remained more or less where they were.

Economists are frequently surprised. In a study of GDP forecasts, a researcher found that economists did nothing more than extrapolate current trends into the future. If the GDP was growing at 2%...they projected that it would grow at 2.3% the following year. Or maybe 1.9%. These projections were mostly correct. Generally, one year is a lot like the year before. But whenever the direction changed dramatically, economists missed it completely. In other words, they're not really capable of telling us what the economy will do - unless it does nothing different.

We've discussed the emptiness of the GDP figures many times. Just because the GDP is growing doesn't mean people are really any better off. In fact, GDP growth during the Bubble Epoque was really a measure of how fast people were ruining themselves. Seventy percent of the GDP was consumer spending; as consumer spending went up so did debt. The result was a paradox and a shame - at the end of one of the longest periods of uninterrupted GDP growth in history, the typical householder was poorer than he was than when it began.

That's why we are skeptical of numbers...especially precise numbers. They lie through their decimals.

What matters is the story...and our story now centers on the role of one man: Ben Bernanke. But the story that most people hear...and believe...is false. It is like GDP growth in the Bubble Era...it may sound right on the surface, but the real story is opposite to what is commonly believed.

Bernanke 'wrote the book' on avoiding deflation, 'tis true. But he doesn't really have a clue what he is doing. He didn't really avoid a Second Great Depression. There isn't really a genuine recovery underway. And the world is not becoming a better place as a result of Ben Bernanke's exertions.

Au contraire...he's making a natural mess into an unnatural one. He's turning a depression into a Great Depression. He's making a bad situation worse.

At least, that is OUR plotline. But we'll let the story tell itself...day by day...and see where it leads us. If we are wrong about the plot...we'll find out...

Bill Bonner
for The Daily Reckoning Australia

• Ben Bernanke is a Victim of the Trade
• Does Bernanke Really Not Understand His Fate?
• Ben Bernanke is No Hero
• Ben Bernanke “Respectfully Disagreed” With Angela Merkel
• No Evidence of Recovery as Unemployment Getting Worse